Archive for the ‘sub-prime’ Tag
A good friend of mine from university went to work for Lehman Bros; I haven’t seen him for a while, but the last time I heard he was still working there. Very wealthy too he was; he lived in a lovely old manor house outside Beaconsfield; lucky chap.
Like most people working in financial services, he’d done very well since the 1980s deregulation. Although he’ll probably have to tighten his belt a bit now, he won’t be destitute. Losing a job is one thing; losing everything is another.
There will be many people picking over the bones of Lehman to try to work out why it collapsed, and more importantly, to try to prevent its collapse bringing down the rest of the industry. Is financial services really just a house of cards? It will be very bad for both the UK and the US economy if – as I somewhat suspect – the whole edifice is broken. So what has been happening with Lehman – and Fannie Mae and Freddie Mac? Superficially, the root of the problem is the sub-prime mortgage market. Lenders lent money to people who couldn’t afford the repayments; these deals were often pushed by brokers on commission. These dodgy loans were backed by mortgages on the properties bought with them, and in a rising property market they looked like a one-way bet. If the borrowers managed to keep up the repayments, all well and good; if they didn’t, just evict them, reclaim the property and sell for more than the outstanding debt. The key is, “in a rising property market”. The problem is that the property market was rising only because of the availability of these inappropriate loans.
To get money to continue lending, retail banks in the US, advised by the big boys on Wall St, “securitised” their mortgage books. Wholesale investors would buy the securities, and the retail banks would have more money to continue lending. But, as it became apparent that sub-prime borrowers were defaulting on their loans, the mortgage-backed securities became harder to sell. The banks who had underwritten the deals were left with lots of unsold securities on their books. With no new money to lend, the retail banks stopped issuing mortgages, and the US property market collapsed. As it did, the value of the properties backing the mortgage-backed securites did too.
This is the main story as to why Bear Stearns, Lehman Bros and Merrill Lynch have now collapsed. Fannie Mae and Freddie Mac are casualties of the collapse of the US property market; they were not directly involved in the market for sub-prime, mortgage-backed debt.
But there is another story, and it concerns wholesale money. Eight years ago, the Bush administration took over a thriving US economy, with a fiscal surplus measured in trillions. Even so, its trade balance was negative; a thriving US economy sucks in imports of oil from OPEC countries and manufactured goods from the Far East. This trade imbalance means that Arab oil exporters and Chinese manufacturers have lots of surplus dollars. They need to put those dollars somewhere safe, and Wall Street had just such a place: the mortgage-backed securities market. Not, by any means, the only place it offered, but a pretty good alternative to their preferred place: US Treasury bonds. With the fiscal account in surplus, the US Treasury had no need to issue quite so many bonds; but then came 9/11 and the Iraq war. Spending on the war rapidly tipped the fiscal account into deficit, so the Treasury needed to issue bonds, and these bonds absorbed a lot of the wholesale money which had been used to buy sub-prime debt. Ergo, the collapse of Lehman Brothers is the consequence of the war in Iraq. And of stupidly lending money to people who can’t afford to repay it.