Tuesday, January 15, 2008

Buying lemons - banking in the US

I've watched the housing market for years (having been left behind by it, it has to be said) and laughed as people (seemingly everywhere in the world) have insisted that property couldn't go down in price. They justified this in so many ways - stable investment, shortage of houses, huge immigration. But what they never did is realise that like most "fad" markets, it was people investing in a market just because there is a "guaranteed" crazy profit. It may have taken longer for it to happen but just like time shares, calling card collectors (remember them?), and any other seemingly one way market - it burst.

If any idiot can make a profit by doing the same thing as everyone else then that profit will stop. Simple. Just like in any free market, if the barriers to entry in a market are low, anyone making large profits in a market will cease to as competition arrives to take their share of that profit. The housing market is hardly a place of restrictive entry (barring the ridiculous prices now), and certainly not with today's (or rather last year's) credit controls.

I've just read an article where an eminent economist said that the Federal Reserve should admit to its part in causing the credit bubble. A good point but there are a number of other perpetrators out there - unwise investors (one can side with a poor family trying to get a roof over their heads but not a person buying and selling their home every 2 years for the "guaranteed profit" - they should face the possible loss too), governments who do nothing to stop the bubble (why don't they base the property rates on the last sale value of your home - in England they certainly don't), and especially banks.

Banks should know better. Their business is lending. They should know who is a good person to sell a credit card, a loan or a mortgage to better than anyone else. That may not be exactly what a sane person might think (credit card companies seem to love people "on the edge") but it is fairly clear.

However, they have marketed mortgages with ridiculous entry requirements: bad credit history, no saving, little or no down payment and the most serious error of them all (and so far mostly unique to the States) not holding onto the loans themselves. This gave the lenders little reason to care about the quality of the loan. When a huge proportion of lending gets sold onto Fannie Mae or whoever, where's the incentive to make sure you're lending money to good risks?

If it was as simple as that, we'd just watch Fannie Mae implode and watch the US government sink further into the red (with the respective fallout for that), but banks went one better - they repackaged bad loans and sold them on with a top credit rating. Not only does this show that the credit rating agencies ought to be sued into destitution, it show how bad banks are - creating these things - then actually buying them themselves. Not only American banks but supposedly intelligent foreign ones like UBS, Barclays and HSBC.

Now, just to make a few more idiots in the world, the biggest losers of the lot (and if you count monetary performance as the way to measure a business - especially a bank - then the companies who make the worst losses are the worst of the lot) are repackaging themselves in a way. Selling themselves off to rich sovereign wealth sums at billions of dollars a pop.

Is it just me or is selling spectacularly badly run businesses for sums that previously hadn't been thrown around banks a great case of the Emperor's New Clothes again? "Please invest in us - we're spectacularly good at making losses small countries would be scared of, so we're a great bet for your investment dollars."

Maybe the sovereign wealth funds think it's a better option than leaving the money in a US bank...in US currency? Funny world.

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