Kaupthing Singer & Friedlander... About To Go Pop?

[Sebrof]

Mortgage vs average salary is a pretty worthless guide. Mortgage vs house buyer salary is far more useful, and house buyers have a higher average salary, first time buyers have an average salary of 35k vs the 25k national average, and movers have an average salary of 45k. The multiples never got as high as you're suggesting.

 

If it's such a worthless guide, how come it predicted a massive fall in house prices, which we are now in the middle of? And NR was offering 125% mortgages at 6 times borrower's salary, not average salary. B& B was offering self-certified mortgages. This is where they went wrong. They chased prices up, and some of the sillier lenders, like HBOS, followed. HBOS were also into commercial property. If you're going to have all your eggs in one basket, make sure you don't overfill it.

 

The Turner review pointed out that mortgage approvals over 90%, something that you bang on about constantly, were also not a significan't problem, their proportion of the lending total was under 15%, a figure that's been constant for many years. This is why Turner didn't include mortgage regulation in his action points, something you claimed was definitely on the way.

 

I think you will find that Turner is not infallible. 90% mortgages constitute a bigger and bigger problem as house prices continue to fall. But it's the ratio of loan to salary that is the biggest killer. Furthermore, there is nothing wrong with 90% mortgages at the start of the cycle. Prudent banks would raise the bar towards the end of the cycle (as most have now done).

 

In my opinion, the reason the likes of Sir Fred or the regulators didn't see the crash coming is because the products were too complex, like Chinahand says. The complex derivative structures were just too baffling for them to understand, they share some the blame for allowing this of course, but I don't think it was something they did intentionally.

 

As I have said before, there were two separate crashes that coincided, triggered by the collapse in the American house price bubble. This caused the collapse in sub-prime mortgages, which had a domino effect on the whole tottering edifice, including the UK house price bubble. And unlike you, Chinahand, and Pongo, I think it is the responsibility of bank directors to understand their business. You wouldn't expect to get on a plane and be told that the pilot didn't understand the controls.

 

As I have said repeatedly (and have been villified for it by the likes of Slim, hence our spat), the whole house price bubble was obvious from 2002, and despite the warnings, Brown did nothing. If house prices had been controlled, sterling would not have lost 25% against the euro.

 

Not at all, I've said many times on this forum that house prices should have been included in inflationary controls, and that speculation in property should be controlled better using mechanisms like decreasing CG tax like they do in France.

 

Not at all what? That the house price bubble wasn't obvious? That Brown did nothing? Or that if prices had been controlled sterling wouldn't have fallen? Presumably you agree that house prices should have been prevented from rising too far, or you wouldn't have mentioned controls like CGT, or including HPI in RPI (which I fully agree with). So, given that you think that house prices should have been controlled, and weren't, you must be agreeing that Brown did nothing, which leaves the obviousness or not of the bubble as the thing you disagree with. That being the case, I can only tell you, as I have done before, that many people DID see it.

 

At one time you were claiming that the root cause was an abundance of cheap money. That certainly helped things along, and aggressive markeing of credit cards didn't help either, but again, we come back to the responsibility of bank directors to set prudent lending policies. Just because money is cheap doen't mean they must stuff it down people's throats.

 

To sum up, there were a number of contributory factors, but the biggest problem was the failure of bank directors to do their job properly. Ignorance of models or whatever is no excuse.

 

S

[Sebrof]

Tweaking taxation is the only method which IOM govt has to control the local economy.

 

I don't think it is the only method. In the IOM gov's position, I would get the FSC to issue a set of principles governing mortgage lending, which would include things like properly checking salaries, a limit on loan to value, and a limit on loan to income. Any bank refusing to co-operate would have trouble renewing its licence.

 

S

[Sebrof]

What government is going to constrain growth while other governmnents let it go unchecked?

 

A good government?

 

I didn't see Germany encouraging a house price boom.

 

S

[Sebrof]

Although that might depend on what land was released and who already owns it or was likely to build on it.

 

Yep, but we can see the planners are constantly under pressure to release more land from the number of rejected applications from certain large developers.

 

Agree. The IOM gov' has to accept that a given size of population is going to require an appropriate supply of housing. If the plan to increase the population to 200,000 ever comes to fruition, I dread to think where everybody will be housed, and what it will mean for the roads.

 

S

[Sebrof]

Now Sebrof would point out that there were people shouting that it was all built on sand. And there were. So possibly what the system needs is some way of listening to the radicals. Since it seems to often turn out that they have a point. The people who stand up and say that everyone is wrong.

 

Quite so. And this is where Brown failed. He could see, and was told, that things were going wrong, and did nothing.

 

S

[Albert Tatlock]

Personally I think it's all quite simple - the bottom line was that living on credit became all too acceptable.

 

Here's my Jackanory version:

 

Between them: and them being the financial services industry; governments and their regulators; and Joe Public - they created a 'system' analagous to a three layer playing card pyramid:

 

The bottom layer of the pyramid consisted of Joe Public - and the housing market, and the credit card/debt market, which generated most of the money in the first place - built by a vast number of commission hungry estate agents, mortgage and credit brokers who made money from debt. Even the banks and building societies got into the act at this level - selling commission based debt to everyone. Everyone wanted a bit of the action - even if it meant selling debt to those that couldn't afford to pay it back in too many cases. And Joe Public bought into it, because he got what he wanted - an asset (a house) with a seemingly ever increasing value, plus he could go out and buy anything he wanted, never mind actually needed.

 

With all of this money from housing and general debt commission and interest having to go somewhere - on top of this bottom layer was built the second layer of the pyramid in which the money from the bottom layer was tied up into complex financial products to be sold all around the world to gain even more commission for the financial services sector and 'spread the risk' from some of the more dodgy playing cards at the bottom of the pyramid. There was so much money in the second layer - and risk - that looking to use it and invent even more ways of making commission and spread the risk, it was turned into ever so more complex financial product packages that employed lots more people to manage and constantly re-invent them. Some of this money was also dropped back down into the bottom layer to reinforce the debt being built and place new cards on the bottom layer - and of course used to fund other non-finance sector related businesses.

 

On the third and top layer of this pyramid sat the boards and shareholders who creamed off the profits from all this. Also sat alongside them at the top were governments, because the system generated much tax which they were happy to take, and of course encouraged people to spend money buying stuff from other sectors too - and so governments allowed (or didn't question) their own regulators who allowed the system to keep running. But the people in the top layer were too trusting and didn't actually realise that in the second layer, the people there sometimes didn't understand their own products, sometimes chose not to understand them, or understood them all too well and sold them on as quickly as they could.

 

But all in the pyramid thought as long as nobody questioned things too closely, the pyramid would maintain itself - Joe Public would be happy, commission and profit would be made, tax would be paid and the economy would grow.

 

But then a problem happened with some of the cards on the bottom layer of the pyramid. Someone discovered some of the cards on the bottom layer weren't actually there in the first place at all. They discovered these imaginary cards (later called 'sub-prime' cards) had been placed in the second layer, and there were far more of those cards than people had ever thought. Not only that, these 'sub-prime cards' were found to weigh far more than other cards and were often a different shape. And so suddenly being very middle heavy and mis-shapen, the pyramid started to teeter and wobble and people in all layers of the pyramid started to panic and fear. And because house prices and debt levels were so high, no one on the average salary could afford to be a new card at the bottom of the pyramid and help prop the pyramid up - and so it all fell over - injuring everyone who was still in or reliant on the pyramid.

 

And the danger is that this philosophy still hasn't gone out of the system, and is unlikely too - given the solutions being tried - with savers being penalised in an attempt to put more debt back into the system to kick start it again pretty much how it was a few years ago. And as well as Joe Public having lost out on the deal already, he is having to pay for it twice by refunding the banks with real money to the tune of the value of the imaginary cards in the pyramid...just so they can build it up again.

 

[Evil Goblin]

Albert - you might be interested in this explanation of the financial crisis.

 

"Heidi is the proprietor of a bar in Berlin . In order to increase sales, she decides to allow her loyal customers - most of whom are unemployed alcoholics - to drink now but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans).

Word gets around and as a result increasing numbers of customers flood into Heidi’s bar.

Taking advantage of her customers’ freedom from immediate payment constraints, Heidi increases her prices for wine and beer, the most-consumed beverages. Her sales volume increases massively.

A young and dynamic customer service consultant at the local bank recognizes these customer debts as valuable future assets and increases Heidi’s borrowing limit.

He sees no reason for undue concern since he has the debts of the alcoholics as collateral.

At the bank’s corporate headquarters, expert bankers transform these customer assets into DRINKBONDS, ALKBONDS and PUKEBONDS. These securities are then traded on markets worldwide. No one really understands what these abbreviations mean and how the securities are guaranteed. Nevertheless, as their prices continuously climb, the securities become top-selling items.

One day, although the prices are still climbing, a risk manager (subsequently of course fired due his negativity) of the bank decides that slowly the time has come to demand payment of the debts incurred by

the drinkers at Heidi’s bar.

However they cannot pay back the debts.

Heidi cannot fulfill her loan obligations and claims bankruptcy.

DRINKBOND and ALKBOND drop in price by 95 %. PUKEBOND performs better, stabilizing in price after dropping by 80 %.

The suppliers of Heidi’s bar, having granted her generous payment due dates and having invested in the securities are faced with a new situation. Her wine supplier claims bankruptcy, her beer supplier is taken over by a competitor.

The bank is saved by the Government following dramatic round-the-clock consultations by leaders from the governing political parties.

The funds required for this purpose are obtained by a tax levied on the non-drinkers.

Finally an explanation I understand…"

[Chinahand]

And unlike you, Chinahand, and Pongo, I think it is the responsibility of bank directors to understand their business. You wouldn't expect to get on a plane and be told that the pilot didn't understand the controls.

Sebrof, behave, claiming that I do not think bank directors should be responsible for understanding their businesses is a gross distortion of my views and you well know it.

 

Look the banks THOUGHT they understood their business - they employed lots of specialists to create risk models who reported to the directors etc. These people put in lots of assumptions - -3 sigma movements in house prices, 20% worse than in the 1990s or whatever, and the results came out that the banks capital ratios were sufficient. They were wrong - a pilot of a Comet in the 1960s didn't know about metal fatigue - they were also wrong when they thought their planes were safe.

 

You are stuck in a rut in that you are certain that it was obvious that the banks practices were unstable from 2002 onwards - really great hidnsight but the regulators THOUGHT (incorrectly) that the banks capital provisions were adequate, the banks THOUGHT (incorrectly) that their capital provisions were adequate, the politicians THOUGHT (incorrectly) that the banks capital provisions were adequate, the markets THOUGHT (incorrectly) that the banks capital provisions were adequate.

 

I do take the opinion that people have to be responsible for not only the things they know about, but also the things they don't know about - cos shit will happen.

 

I fully agree that the bank's directors etc are responsible for their businesses and should take the consequences. I have never said or implied that they should not take responsibility for the messes their banks are in - but that is only the first step - the next step is to work out what went wrong and how.

 

As Pongo says the derivatives etc were thought to be reducing risk making banks more stable - when the modellers went away and put a housing bust into the models they survived.

 

But they didn't account for money markets freezing up, a seven sigma or whatever drop in the value of their capital and an increase in bad debts.

 

One point I really want to make - I do not think the UK housing burst has started to have a significant impact on the operations of UK banks - they are coping with 125% mortgages and 6 times salary etc.

 

Most definitely that isn't what brought down NR - the banks were brought down by having business models that sold on their mortgage books and replaced them with collateralized debt. When that funding stream stopped they had nothing to replace it with and were high and dry. The money markets were frozen, they had to downgrade the paper on their books and had nothing to replace it with - hence the government had to step in.

 

It isn't the UK mortage market which sunk the banks, rather its buying Amro and significant amounts of US subprime paper and using over complex risk models.

 

I don't pretend that the UK housing burst couldn't really hurt the banks further - but that is what the stress testing etc that is being done at the moment is looking at - touch wood realistically!

 

But for all your and Slims arguing I don't think it is what has caused the banking bust in the UK.

 

That doesn't absolve the banks of anything - they still grew unrealistically quickly using dodgy finance and risk modelling on the backs of a housing boom inflated not only by risky behaviour by the banks, but also by unrealistically low interest rates and huge capital inflows from the likes of China.

 

Basically Sebrof, you are a stuck record saying its obvious things would go wrong. And I (and others) are a stuck record saying its complex, its not obvious where things went wrong or where to fix them.

 

The days of 120% mortgages are gone - good. Frightenningly at average earnings we are still as bad as the 1990s housing PEAK - maybe Slim's arguments that average earnings aren't representative are valid, but I think that is a nuance - there could well be an awful lot of pain still to come.

 

I've no idea how the mess will be sorted out - a large scale cultural change away from consumption I hope!

 

But one thing I want to make clear - I'm not absolving banks from using faulty risk models, and most especially using ratings agencies to price the instruments they were buying. But I do think it is necessary to understand why they did these things - and why the models were wrong. Sebrof, our approach doesn't seem to do that - it just goes it was obvious. I disagree.

[When Skies Are Grey]

God I hope he doesnt quote THAT!

[pongo]

I do not think the UK housing burst has started to have a significant impact on the operations of UK banks - they are coping with 125% mortgages and 6 times salary etc.

 

This short item in last Friday's FT is sort of related: Lenders target buy-to-let

 

The banks’ requests have come as lenders start exercising little-known clauses that allow them to demand additional funds if the owner’s equity shrinks in relation to the value of the property.

[Sebrof]

God I hope he doesnt quote THAT!

 

I considered it, but thought you good people deserved a break.

 

S

[Sebrof]

Chinehand, I've just reread your post and seen that whilst you said that the directors (as represented by Fred) didn't understand the models, you didn't absolve them from blame. So, apologies for that.

 

But equally, you have misquoted me in saying that "the banks practices were unstable from 2002 onwards." I said "the whole house price bubble was obvious from 2002", which is not the same thing at all.

 

I might tackle the rest later, but we are rather going round in circles, so perhaps not. None of us are entirely wrong, even Slim!

 

S

[P.K.]

But one thing I want to make clear - I'm not absolving banks from using faulty risk models, and most especially using ratings agencies to price the instruments they were buying. But I do think it is necessary to understand why they did these things - and why the models were wrong. Sebrof, our approach doesn't seem to do that - it just goes it was obvious. I disagree.

Every self-proclaimed "expert" I've ever met had Twenty-Twenty Hindsight.

 

The days of 120% mortgages are gone - good. Frightenningly at average earnings we are still as bad as the 1990s housing PEAK - maybe Slim's arguments that average earnings aren't representative are valid, but I think that is a nuance - there could well be an awful lot of pain still to come.

 

I've no idea how the mess will be sorted out - a large scale cultural change away from consumption I hope!

Currently the "average" UK house price is £150K. That's five times current "average" earnings. During the last recession house prices and average earnings reached a ratio of 2.2 to 1 before it turned around. However interest rates were a little "different" then than they are now. Uncharted waters at best I would say.

[Chinahand]

An interesting article from the WSJ by a Nobel prize winner and a colleague of his comparing and contrasting now to the tech bubble and the 1930s - it isn't a particularly positive read!

 

No idea how long it will be available without subscription, but its worth a read.

[Albert Tatlock]

God I hope he doesnt quote THAT!

I considered it, but thought you good people deserved a break.

Ooh - are you going on holiday?