So are Labour on their way out?

[Mr Q]

In my view, banks have always had the information to make a reasonable judgment about who will and who won't be able to pay back their debts. But because it's in the banks' interests in the short term to lend money (an immediate increase is reflected on their balance sheet), they lend anyway.

See, I fundamentally disagree with both of those points.

1/ I don't accept that banks have more information about the capacity of their clients to pay than their clients do. Certainly I know more about how much I'm earning, my job prospects, my spending & saving patterns than any banker does. Yes, banks might have more information about the state of the economy than some people. But that's not due to any deliberate imbalance in information - it's only because many people can't be bothered to find out what's going on in the world. I'm not inclined to impose more responsibilities on banks just because some people are ignorant though.

The point about the current financial crisis is that virtually no one saw it coming. So sure, the average punter on the street might well be wondering what the hell's happened now - but there are plenty of people sitting in banks all over the world who are still trying to figure it out.

2/ I don't accept it is ever in the interests of banks to lend money to people who they don't believe can afford to pay it back. Just the basic intuition doesn't make sense. If I lend you $100, surely I would like to get that $100 back? If you have no job, and only 2 cents to your name, what on earth would ever make me think that you could afford to pay me back. Where there has been a problem is that everyone - not just banks - has made what have turned out to be overly optimistic assumptions. But then when you've got a Chancellor (later PM) who turns around and says that his government has defeated the business cycle, is it any wonder why?

The culture of over-extending oneself with credit and debt has been driven by the banks offering facilities without checking that the affordability of such products is within their customer's means.

Only to the extent that the bank is exposed to the risk that I, as a customer, might not pay them back. So long as I pay them back, then they have no reason to be concerned. And that's the nature of the market - both those who demand and those who supply a good or service each enter into a transaction on the basis that they perceive it to be in their own interests.

You correctly point out that Britain has been worse hit - well I could suggest, although I know you would argue, that it was Brown's push towards self-regulation that allowed British institutions to dig themselves in so deep.

Yes, but the UK wasn't the only country that went down that path. Indeed, our structure of banking and pudential supervision here in Australia is much the same. And yet our economy hasn't even officially tipped into recession yet.

Stewart Lee put it very well:

"What kind of creature makes his home an investment opportunity? Only man. Home and investment are not the same thing. Home is a basic requirement of life. Like food. When squirrels hide acorns they are not trying to play the acorn market".

I think there's something in that. And governments have to take a lot of the blame for this. They have actively encouraged people (generally through favourable tax concessions or direct subsidies) to think of property as an investment opportunity, underpinned by the foolish assumption that property prices always go up.

The real catastrophe being observed now is that there was a housing bubble that was fuelled by central bankers (particularly in the US) holding interest rates too low for too long, and this has now burst. Central bankers not only stood by while bubbles were inflated - they were directly helping to inflate them!

[Gavin Scott]

Mr Q, you're certainly entitled to disagree that assessing affordability is the client's responsibility rather than the banks - its a valid opinion - however, its currently part of the FSA rules governing the selling of mortgage and other investment products. The same rules applied in the States through their regulatory framework.

A client must have their attitude to investment risk, as well as their knowledge and experience of investments and, crucially, affordability assessed by either the lender or an intermediary ahead of the transaction. This is there as a means of protection for both parties.

Once the healthy mortgage lending market was at saturation point, it was the desire of the US banks to push ahead into the untapped sub-prime marketplace, with self-certification being the only way around the troublesome issue of affordability. This offered the banks millions of new loan customers, and allowed expansion of their business at an almost exponential rate, with the addition of CDO securities based on this new cash cow.

The self-certification, sub-prime and CDO security market was exploited in the UK, too. It is patently untrue to suggest that no one saw this coming. It is well documented that certain ex-executives on the board of RBS warned about these potential toxic wrappers, and were swiftly silenced. Expand or be damned was the cry of the CEO.

I'm pretty sure more information of this nature will trickle out, once the dust settles on the current crisis.

I appreciate you are not a fan of what you consider to be unnecessary regulatory interference - but good god - can you really keep beating that drum in the face of what has happened here?

[Mr Q]

Once the healthy mortgage lending market was at saturation point, it was the desire of the US banks to push ahead into the untapped sub-prime marketplace, with self-certification being the only way around the troublesome issue of affordability. This offered the banks millions of new loan customers, and allowed expansion of their business at an almost exponential rate, with the addition of CDO securities based on this new cash cow.

Yes, but you're overlooking one issue which leads you to draw an erroneous conclusion. Why do you think the proportion of subprime loans in the US was so much higher than in other countries? The US Congress in the 1990s pushed for banks to start lending to people who they wouldn't otherwise have considered - the politicians wanted more people to be able to own their own homes. And they got what they wanted - right up until the point those people couldn't afford to pay the bills anymore, and so abandoned their homes and posted back the keys. Congress tried to co-opt the banking sector into the welfare system, and it has ended disastrously.

The self-certification, sub-prime and CDO security market was exploited in the UK, too. It is patently untrue to suggest that no one saw this coming. It is well documented that certain ex-executives on the board of RBS warned about these potential toxic wrappers, and were swiftly silenced. Expand or be damned was the cry of the CEO.

I don't disagree that people voiced concerns about some of the complex financial instruments on offer. But I think you'd be hard pressed to find too many financial executives who foresaw the events that have ultimately transpired. And, to be fair, that's because those derivatives were only one part of the problem - they're certainly not the whole story.

I appreciate you are not a fan of what you consider to be unnecessary regulatory interference - but good god - can you really keep beating that drum in the face of what has happened here?

I appreciate that there is a diverse range of views about the causes of the global financial crisis. The consistent theme I see when I assess the situation is that so many problems have stemmed not from the offices of greedy bankers, but from the offices of politicians and bureaucrats.

[Gavin Scott]

Forgive me, but I think its preposterous to suggest that the banks were somehow coerced into lending based on the Government's desire to see greater home ownership.

The suggestion that Governments can force banks to lend is pretty spurious - no Governments seem to be having much luck doing that right now.

I think its more likely that the bank executives were lobbying hard to allow this market to open, with the Government taking credit as "defender of the small man" after the fact.

Measuring the net potential benefit to both the Government and the banks, I am at a loss to see why you wouldn't reach the same conclusion as I have.

We may have differing ideas about where this all unravelled, but over-regulation would be VERY low on my list.

[Stuart*]

We’ve been told that the alternative is unthinkably bad, but nobody has actually explained to me what that is. Perhaps it’s quite ‘thinkably palatable’ compared to the prospect we face.

If the banks collapse, everyone loses their deposits.

Only beyond the actual capital value of the bank, surely. From a purely selfish point of view those who don’t keep a lot of money in banks wouldn’t lose very much or be particularly concerned about that prospect.

Those who took out mortgages they couldn't afford will probably be left with nothing.

Indeed, they don’t even walk away with the debt. Somebody is servicing those loans and it’s us, not them.

Err... their property is repossessed by the lender and is sold to recoup the debt.
Why would the buyer be left with a debt after that point, having lost their property, any deposit paid as well as the payments they've made up to the point of defaulting?

When properties are repossessed they are rarely sold for their true market value and quite often fail to cover the cost of the outstanding mortgage. The former owners are then pursued by the banks for the remaining debt, which normally leads to them declaring themselves bankrupt. The debt then falls to the Bank of England/taxpayer to foot the bill because of the commitment given by the Government.

I’m sure you are aware of the concept of negative equity, which is quite common in recessions, especially after the sort of property price boom the UK has experienced over the last decade.

[Sput]

Isn't the immediate problem of all the banks collapsing just that the cash machines switch off and no-one can buy any food? That'd definitely be my immediate concern.

[Gavin Scott]

We’ve been told that the alternative is unthinkably bad, but nobody has actually explained to me what that is. Perhaps it’s quite ‘thinkably palatable’ compared to the prospect we face.

If the banks collapse, everyone loses their deposits.

Only beyond the actual capital value of the bank, surely. From a purely selfish point of view those who don’t keep a lot of money in banks wouldn’t lose very much or be particularly concerned about that prospect.

Sorry that's utter tripe. Wouldn't you accept the logic that those with the least money saved are the worst hit, were they to lose everything?

I tend not to carry over residual funds at the end of the month, but if I were to lose even one month's salary it would put me in a very difficult position. Like most I have financial commitments which are non-negotiable.

Multiply that by a few million customers and you might be able to get your head around the scope of potential catastrophe.

[cdd]

1/ I don't accept that banks have more information about the capacity of their clients to pay than their clients do. Certainly I know more about how much I'm earning, my job prospects, my spending & saving patterns than any banker does. Yes, banks might have more information about the state of the economy than some people. But that's not due to any deliberate imbalance in information - it's only because many people can't be bothered to find out what's going on in the world. I'm not inclined to impose more responsibilities on banks just because some people are ignorant though.

It's not reasonable to expect everyone in the world to be an expert at economics. That's not the same as ignorance, it's just having the average skill set + whatever niche you choose. For many people, that's not economics. Consequently, people go to banks expecting to be told whether or not they can have a loan. The banks have access to information that it costs money for us to access - I've never had any interest in wasting a tenner to see my credit score, and I doubt anyone else does. And yet the credit market is governed almost entirely credit agencies, who are very secretive about the methods they use to calculate your repayment potential. I agree that it's the responsibility of the consumer to pay back what they borrow. But it's also in the interests of the banks to lend responsibly.

2/ I don't accept it is ever in the interests of banks to lend money to people who they don't believe can afford to pay it back. Just the basic intuition doesn't make sense. If I lend you $100, surely I would like to get that $100 back? If you have no job, and only 2 cents to your name, what on earth would ever make me think that you could afford to pay me back.

It's not in their interests in the long term, of course. But in the short term, it's an immediate profit on their balance sheet. For companies that sell things on hire purchase it's even more than the profit of interest, it's a sale. Salespeople are incentivised to get people to take out loans because in theory loans = profit. So salespeople do whatever they can to "make the figures work" - even if that leads to problems for the company in the long term.

In the long run, though, we are all dead. Nobody thinks about the future when they're trying to make a buck today. It's just not how the world works.

Suppose you are a lender, and you have employees who work for you. You want to get more loans than anyone else so you pay your employees bonuses based on how many loans they convince people to take out. Now, suppose I want $100 but I do not have a penny to my name. I go up to one of your employees. Consider these two scenarios.

In the first scenario, I deliberately try and create the impression that I have the means to pay you back. I falsify paperwork to suggest I have a steady income, and make all sorts of promises I can't keep. In this scenario, this would be my fault, not yours, when the time came to pay you back and I didn't.

In the second scenario, I'm perfectly honest. I admit I don't have a penny to my name. But the salesman wants to sell me a loan, because he doesn't care about you and he's look forward to his $10. So, he fiddles with the computer, stretching the truth, until finally it accepts the loan. In this case, how is the consumer to blame? The consumer didn't think he could even get a loan, but the salesman told him "it's possible". It's not stupidity, it's naivety. And it's the problem with the system of commissions and bonuses that has kept the lending market afloat all this time.

[Mr Q]

Forgive me, but I think its preposterous to suggest that the banks were somehow coerced into lending based on the Government's desire to see greater home ownership.

Why do you think quasi-government agencies like Fannie Mae and Freddie Mac have played such a critical role in this crisis? The government was using those agencies to backstop those subprime loans. And given the existence of those agencies - and with them, the implicit guarantee of a government bailout if market conditions soured. When Congress started pushing the banking sector to start lending more to the poor, the same implicit guarantee was extended to them. The message seemed clear enough to the banks: make those risky lending decisions, and we'll back you up. However they might have underestimated the political shitstorm that would eventuate.

It's not reasonable to expect everyone in the world to be an expert at economics. That's not the same as ignorance, it's just having the average skill set + whatever niche you choose. For many people, that's not economics. Consequently, people go to banks expecting to be told whether or not they can have a loan. The banks have access to information that it costs money for us to access - I've never had any interest in wasting a tenner to see my credit score, and I doubt anyone else does. And yet the credit market is governed almost entirely credit agencies, who are very secretive about the methods they use to calculate your repayment potential. I agree that it's the responsibility of the consumer to pay back what they borrow. But it's also in the interests of the banks to lend responsibly.

Of course, you're right that not everyone is and can be an expert in economics - I absolutely agree. But you don't need to be an expert to know that prices for assets can go down as well as up, nor do you need a PhD to realise that if you take out a variable-rate mortgage at a point in the cycle when interest rates are low, that you've got to be prepared for the prospect that interest rates will increase - and that they could increase by quite a few percentage points.

As for your credit rating: yes, obviously that means something to banks in their determinations about who to lend to. But I think most people would be at least vaguely aware of what sort of rating they probably attract, based on the pattern of repaying credit cards or other types of loans. I certainly don't know what my credit rating is, but I pay off my credit card and other bills early or on time, so I suspect I'd look pretty good.

In the end, a credit rating is just metric that is used. I come back to the point that we know more about ourselves than our banks do.

It's not in their interests in the long term, of course. But in the short term, it's an immediate profit on their balance sheet. For companies that sell things on hire purchase it's even more than the profit of interest, it's a sale. Salespeople are incentivised to get people to take out loans because in theory loans = profit. So salespeople do whatever they can to "make the figures work" - even if that leads to problems for the company in the long term.

In the long run, though, we are all dead. Nobody thinks about the future when they're trying to make a buck today. It's just not how the world works.

I don't accept that - if banks were all motivated by short term objectives, then none of them would survive more than a few years at a time. And, not to be too glib here, but many of them have in fact been around for decades.

Of course, there's always a probability that people won't pay back their loans. Banks can't (nor can any of us) ever be 100% certain about the future. So banks have to model these risks. And the models did not foresee the events that have transpired. That's certainly regrettable. But I can't expect banks to have known what virtually nobody else did.

In the first scenario, I deliberately try and create the impression that I have the means to pay you back. I falsify paperwork to suggest I have a steady income, and make all sorts of promises I can't keep. In this scenario, this would be my fault, not yours, when the time came to pay you back and I didn't.

In the second scenario, I'm perfectly honest. I admit I don't have a penny to my name. But the salesman wants to sell me a loan, because he doesn't care about you and he's look forward to his $10. So, he fiddles with the computer, stretching the truth, until finally it accepts the loan. In this case, how is the consumer to blame? The consumer didn't think he could even get a loan, but the salesman told him "it's possible". It's not stupidity, it's naivety. And it's the problem with the system of commissions and bonuses that has kept the lending market afloat all this time.

And if the salesman has lied, then he has (probably) broken the law, because he's misrepresented the client's position to his employer. I don't deny there were dodgy operators out there. But as you rightly point out, there were plenty of customers who lied too. These were all factors.

[Pineapplemint]

Trouble is and I think it's the same with the two main political parties
That they wont deal with the banks fairly for us because they dont want to upset the city bigwigs to much otherwise they wont get their jobs with them on the companies boards when they're no longer in power.

Gordon Brown must have know that the ballooning economy and debt that was partly fuelling, was stroking up trouble in the future, a good five years ago at least. Or he didn't know how best to manage national finances when he was chancellor but he couldn't be that incapable could he?

[Mr Q]

Trouble is and I think it's the same with the two main political parties
That they wont deal with the banks fairly for us because they dont want to upset the city bigwigs to much otherwise they wont get their jobs with them on the companies boards when they're no longer in power.

While I'm quite cynical about politics and politicians, I'm not sure I'd go quite that far. It's not really a question of upsetting the 'city bigwigs' - it's whether the government thinks it can do a better job than them. And while I don't suggest that those bankers, financiers and other corporate high-fliers are perfect, governments aren't perfect either. I would argue though that, on the whole, governments will invariably make worse decisions than the market will. And if you disagree with that --- if you believe governments will always do a better job through central planning than allowing the market to work --- then your ultimate conclusion must be for us to adopt socialism. However historical evidence would strongly suggest that if you measure the net effects of socialism against capitalism, socialism does not deliver greater economic or social returns.

Gordon Brown must have know that the ballooning economy and debt that was partly fuelling, was stroking up trouble in the future, a good five years ago at least.

Well, debt in and of itself is not necessarily a bad thing. Part of the reason so many developed countries ran the sorts of current account deficits they did was because credit was so cheap in foreign markets. Why was it cheap? Because countries like China as well as many oil-producing nations were running massive current account surpluses --- what has been termed a 'savings glut'. There was a lot of money floating around, and rather than just sit in a vault losing value over time (which money, left alone, will do - that's the nature of inflation), it needed to be invested somewhere. So it went to the US, it went to the UK, it went to Australia. We absorbed that money because it was so readily available.

Now, perhaps we might have been wise to ignore it - that's harder to judge. But the reason for that savings glut was not because we were doing anything wrong. It was because policymakers in many of those countries didn't want the market setting the exchange rate - they wanted to decide how much their currencies should be worth. What they did (and arguably still are doing) was keep their currencies artificially low in value. That boosts exports, but also has the effect of dampening demand within their domestic economy (imports will cost more, which is likely to raise production costs and also deter some consumption). That's why those countries became net savers - and the direct consequence of that was to create global imbalances, which was a key contributing factor in the global financial crisis.

I should say that people did see the effects of those global imbalances coming. They knew what could happen (and indeed, most of it now has, except their predictions about the US dollar have been so far defied - the Dollar, despite the American economy's general weakness, has held up extremely well as something of a 'safe haven'), but it's difficult to argue that those of us (countries) who were running current account deficits could have single-handedly stemmed the tide --- it takes two to tango, and we didn't have dance partners.

Or he didn't know how best to manage national finances when he was chancellor but he couldn't be that incapable could he?

Well, he is a politician................