Re: UK unemployment rises to 2.68m : Fri Jan 20, 2012 1:46 pm
Rock God X wrote:
I don't even know what your second sentence is supposed to mean. As regards your first one, I've yet to hear a single commentator say that the prime cause of the crisis was personal indebtedness. Most mention it as an aggravating factor only.
Yes it is down to sub-prime (ie very risky) debt but the implication that it's the fault of reckless individuals is designed to get the banking sector off the hook.
The reason the financial institutions went into meltdown was because they developed - and were permitted to by poor regulation - financial instruments to disguise the riskiness of debt and then sell it on.
From the perspective of a lender, if you lend to a 'high risk' individual, you can charge a higher interest rate so this is preferable. In the industry they have a term NINJAs which means No Income No Job or Assets, so if you lend to a NINJA the odds are you ain't getting the loan back. But you can charge them a high interest rate and so you have that contract worth repayments at a high interest rate.
If I lend £10000 to a NINJA over 10 years at an interest rate of 15% then I have a contract for repayments worth over £40000 so if I offer to sell that to you for £20000 then I am doubling my money instantly but that's also a good deal for you because you pay me £20000 now and have a contract that entitles you to repayments over £40000 over the years. However if you know the circumstances of the borrower you will not touch it with a bargepole as you know that contract won't be worth the paper it's written on when the NINJA defaults and you have no way of getting recompense as he doesn't own anything you can take.
However what if I make loads of loans to NINJAs and also loans to more reliable borrowers, then I offer to sell you a security that offers lots of small shares of the repayments of multiple loans, that sounds better, for one there are more borrowers involved so you are spreading your risk, also it is difficult to determine from that how risky what you are buying is. In fact I probably got it checked by a credit rating agency and they couldn't see anything wrong with it so rated it at AAA so you bought it. In this way I can make a lot of high interest loans to NINJAs then sell on the debt so that someone else is holding the timebomb when they all default, and I make money. This is what banks were doing and they had an easy way of getting debt off their books because someone else would hold it. So they aggressively targeted the NINJA market to make loans, then sold them on in disguised form. Except because they were all doing it and large banks have many different parts, sometimes the toxic packages they were selling on, would end up being bought back by a different part of the same bank, after being passed around the markets. So when the defaults started to roll in the banks had all infected each other.
From the point of view of the "free market", this is a classic market failure because it is one of 'imperfect information' - sellers had a means to withold information about the riskiness of debt from buyers, and so it created a huge moral hazard problem where banks had an incentive to directly make loans to people that would not repay them, so they could sell them on and make a quick buck whilst someone else held the risk. Now the banking sector is trying to turn round saying "its down to people living beyond their means".
Its the equivalent of if you got an inheritance of £10000 and I offered to keep it safe and pay you 10% interest on it a year, then I lend that out to a homeless person and charge him 15% interest, except he disappears and i can't trace him. When you ask me what has happened to your money, I can just say "a homeless person borrowed beyond his means....blame him, its not my fault".
