Avoiding The Elephant

You may be surprised to see that I've not mentioned the Government and the current banking fiasco/crisis. I've tried to avoid it as I think I would find it difficult to stop once I've begun*.

I've been following it, obviously - both on the BBC and in the Metro (the only newspaper I actually read now I'm a commuter) - but I've been in an unusual position for me. I just don't know what to say about it. I've read an analysis from an economist's point of view (Timmy), a stockbroker's point of view (British Dude), a Libertarian's point of view (LPUK) and from the ex-trader's more political point of view (Guido). And I'm still not entirely sure I understand what's gone on.

As far as I can tell - and anyone can point out where I've gone wrong here - the American banks were told by their Government that they had to lend money to people who they would not normally lend to (the so-called NINJA loans - No Income, No Job) in order to allow said people to buy houses. I'm guessing that the American economy isn't quite as built on house prices as the UK economy, but that by having a credit history, these people could be proper consumers.

So the banks lent the money, knowing that it was more likely these NINJAs would default. In order to avoid having the debt firmly sat on their books, the banks wrapped it up in smaller packages and sold it on. To other banks. But with a AAA rating so that it wouldn't look as toxic as it would turn out to be. Hence the amount of banks that started to get into trouble when the NINJAs started defaulting to such a major extent that the house prices in America started to fall dramatically.

As the banks couldn't trust each other (as the amount of trouble they were in was hidden or just plain unknown) they then wouldn't lend to each other. As they wouldn't lend to each other, the banks were less able to pay off any short term debts they had in trading balances. And they couldn't get any money in from anywhere apart from the Bank Of England, and going to them cap in hand made the banks look desperate & likely to collapse. Thus confidence in them eroded further.

The Government claim that they tried to save the banks, but after Robert Peston informed everyone that the Government had had a meeting with all the big four banks who were looking for cash, bank shares fell even further. Whether this was incompetence of the highest order, or a deliberate attempt by the Government to get the banks nationalised on the cheap, time will only tell. But when both the Prime Minister and the Governor of the Bank Of England come out within a day of each other saying the UK economy is going into recession (thus sparking a sell off of Sterling by any sensible trader around the world) the impression I get is that it's incompetence.

At the same time, Iceland's banking fell over quite spectacularly. UK public bodies had somewhere in the region of £1bn invested - hardly a surprise as the interest rate was unbelievably (for good reason) generous - and despite warnings being issued some months earlier. I've even seen reports here that there were warnings in July 2007 about the fragility of the Icelandic scheme. Entertainingly, the Audit Office (whose job is to ensure that £180bn of public sector spending provides "value for taxpayers" and should oversee any investment advice) had £10m tied up in the Icelandic banks, and the Audit Commission are now being investigated by the National Audit Office.

In order to "protect UK savers" the Prime Minister then used anti-terror legislation to freeze the accounts held in the Icelandic banks. Interesting that this legislation was used against a NATO ally, but such is the joy of function creep and badly worded (or not, depending if you're a conspiracy freak) legislation. More interestingly, the legislation only freezes the funds for 30 days, so in a couple of weeks we should have another announcement about Iceland.

The strange thing is, I've been through two recessions before, some bad financial times and three stock market crashes (yes, I am old). This latest one didn't wipe as much off the share prices as the last one (when the dotcom boom suddenly went bust in 2001 - mainly after everyone suddenly realised that none of the internet companies had a business model that actually made, you know, cash). This one hasn't seen interest rates go up to 15%, indeed they've just come down again. There hasn't even been a single power cut yet, let alone dead people not being buried.

I'm not saying that this isn't a financial crisis, but it seems to be based more in the financial markets than in real life. How many people (outside of bank staff) have been directly affected by this in the UK? 10,000? 50,000? 100,000? Out of a population of 62,000,000 that's not a huge amount.

Okay, so if you need to get a mortgage then it is now more difficult, but that's not necessarily a bad idea. The UK housing market was (and still is) over priced. If it falls, then more new buyers will be able to afford to get on the property ladder (having got deposits for more expensive properties). If you already have a mortgage that you can afford to repay, keep doing that and enjoy the fall in interest rates. Your house is worth less than you paid for it, probably, but you still have a roof over your head and you aren't starving to death. Chances are, if you don't move in the next 10 years it may eventually be worth more than it is now.

If you have a mortgage and can't afford to repay it, then (unless you've been made recently unemployed or had a change of circumstances) how were you planning on keeping the house anyway? Getting yourself in HUGE debt by hoping to sell your house for more money than you paid for it (so you eventually had no mortgage and a free house) is pretty much the same as the South Sea Bubble in 1720 - eventually, it will fail.

Why the Government were so insistent about nationalising the banks, rather than just letting them fail and guaranteeing savers their money back, I have no idea. Surely by propping the banks up, they're being told that no matter what stupid thing they do, the Government will always bail them out. Not going to make them take better decisions, is it?

Why the Tories didn't complain about the Government's plan and ask if there was a 'Plan B', I have no idea on that either. There was no mention in Labour's pledges to bail out banks. There was no discussion in Parliament about whether it was the right thing to do. Nothing. The Government just wade in with half a trillion pounds of taxpayer's money and do what, exactly? The FTSE is still hovering about 4000, the pound is still falling against a raft of currencies and the entire country is out of pocket.

How Gordon Brown has managed to come out of this looking like the saviour, when he was the Chancellor in charge of the country's finances for ten years prior, I similarly have no single clue. I'm still slightly surprised he hasn't called a state of emergency yet, and become a proper dictator.

Perhaps it's just a matter of time.

* - And having read the post, I think I was right. Apologies for the rather long rambling explanation of how I see the financial crisis.