Wednesday, 24 November 2010

Irish Banking Crisis

Three days of wall to wall coverage of Ireland’s debt crisis, and still the banks hold onto power.
On Monday morning I heard a contributor on the BBC’s 5Live, speaking of the events over the weekend, in which he reminded us that this whole global financial crisis started with American Sub-prime Mortgages. Where he claimed, “mortgages where sold to people who couldn’t really afford them”. Convenient as it is to blame the little man, this isn’t entirely true.

Maybe it’s a bit late in the day to be going on about this particular subject, but I’m not convinced that everyone gets it yet. The underlying flaw of the American Sub-prime Market was greed on the part of the bankers. Let’s look at the whole process.

A hard working, but not entirely scrupulous, mortgage sales man approaches a tobacco chewing, mash supping, welfare claiming resident of Tennessee who is sat outside his rented trailer playing his banjo. The sales man asks the hick how much he is paying in rent?

“50 bucks a week” replies the target. The sale man asks the guy if he has ever considered buying his home, and goes on to explain to him that a mortgage to buy the trailer at today’s low interest rates would work out at only $40 a week. “but I ain’t got a job” replies the banjo picker.

Not a problem! The sales man points out that the welfare cheque the guy receives each month from the government is as good a regular income as it gets. Besides rather than having to pay $50 a week, he will only have to pay $40 so he will have an extra ten bucks a week to blow on moonshine, and in twenty five years time, he will own his trailer and won’t have to pay any rent at all.

Shit! I’d be a fool not too” thinks the hillbilly, and the deal is done.

We won’t at this point look at how the bank issuing the mortgage, go about creating the money to buy the trailer, suffice to say the hick is now in debt, and the bank has monetized his asset.

So what went wrong? Answer: Nothing! The sales man got his commission for selling the mortgage. The US government is still borrowing money from the banks to pay the hick his welfare cheque. The hick is still in his trailer, and sending his $40 a week to the bank, and he and Mrs. Clampit go down the pool hall on a Wednesday night to meet up with the other good old boys, and drink the 10 bucks he has saved. So far so good.

(Those of you who are paying attention may have spotted that there is a massive problem in the working of the world order if the explanation in that last paragraph is correct – we will come back to that on another occasion.)

So where’s the crisis? Well the first part of our story is not what caused the problem. The problem comes a little later. The chairman of our friendly American bank is looking over the books and says “I can see we are doing lots of good business here but it’s not going to look good to the share holders if I can’t send them a bit of a dividend this year”. You see, the bank has paid the guy who used to own the trailer his $25,000. They have given the sales man his commission, another $2,400 but so far (six months on) all they have seen for their efforts is $1,200 from the hillbilly. It all looks good on paper, and sure if all goes well the bank will get $60,000 back over the life of the mortgage. But what happens if all does not go according to plan. The bank’s sales men have been very busy boys. There are a lot of new mortgages on old trailers, the bank may well be over exposed. The chairman is having sleepless nights.

Then one day, one of the bank’s bright young things working in a back room, comes up with a great idea. “Why don’t we sell some of our exposure to someone who has a load of money, and is in the business of looking for long term returns, over and above just leaving the money sitting in the bank”. A pension fund for example.
“Brilliant!” Exclaims the Chairman, “Get on it Jack! There will be a good bonus in it for you, if you can pull this one off”
So Jack bundles together a hundred million dollars worth of these mortgages, puts a bit of a sales brief around them, and comes up with a catchy name “Securities”. The trap is set!

Jack puts a call into a mate of his, who works for a pension fund, and tells him he’s got this great new product. They get together over a few bottles of bubbly one lunch time and talk it through. Jack explains that he has a package of a $100 million of “secured” loans (mortgages) which over the next twenty five years will show a return of $240 million and all he wants for them is $110 million cash! It doesn’t take much thinking about on the part of the young lad from the Pension Fund, it’s a no brainer. The Fund will make a profit in excess of a 100%, the loans are secured on properties, so in the event that any of the borrowers were to default, the fund would still own the asset. What could possibly go wrong? They shake on it and the deal is done.

Jack goes back to the bank and tells his chairman what he’s done, and the boss is thrilled. Not only has Jack made a clear profit for the bank of ten million dollars, but he has also converted a hundred million dollar accounting fraud into cash money. The boss gives Jack a 10% commission on the banks profit and the shareholders get their dividend. Everybody is happy.

All would have been well had only it stopped there! But a couple of months down the line the boss at the pension fund is having his usual quarterly meeting with his account managers and asks about this “Security” that young Johnson has invested in. It’s explained to the boss, who is not short of foresight and he can see the sense of young Johnson’s move, but he can also see that young Jack at the bank has made a quick buck for his organisation, and wonders what’s stopping the pension fund managers doing the same. And so starts the game of musical chairs that was the sub-prime market.
The $240 million asset goes back on the market. The asking price? A mere $120 million!

It sells quickly. People are queuing up to get a piece of the action. Each time the product changes hands the price goes up by $10 million. Each time the selling organisation makes a profit and the trader makes a good bonus. Until one day our friend Paddy at the Allied Irish Bank is on the phone trying to sell this sure winner to his mate at Barclays, and his mate says, “Hang on Paddy! You want me to give you 230 million for something that will be worth 240 million in 23 years time? No thanks mate, I’d be better off just putting the money in the bank!”       

And for Paddy the music stops, and there is no chair for him to sit on! But this didn’t happen just the once, there are computers in the City of London doing these deals a thousand times a second. And as every time one of these deals is made, another chunk of bonus money is sucked out of your pension fund. City traders and investment bankers do not create wealth, they only suck wealth out of the accounts of those who can least afford it! What has happened over the last few years is just the start. There are men sitting in pubs this lunch time who will never have to work again. They have more money in the bank than you or I will ever see, and it has come from commission on boiler plated deals that the stock market value will trigger one day and every penny in the pension funds of the working man and woman will vanish!
It’s time we all woke up and smelled the Châteaux Lafite 1961!

On the 7th of December Eric Cantona is asking us to take our money out of the banks, as a way of demonstrating our frustration with the way they operate. A run on the banks. It won’t happen and it wouldn’t work. The banks will just order in more cash, an additional cost to them and a reduction in dividend for the shareholders. If we really want to change thinks, then people need to start cashing in their pensions, and exposing them for the Ponzi schemes that they really are.

1 comment:

Apolitical Dave said...

Having just re-read that, I would just like to point out that I consider the Chateau Lafite 1959 to be the obvious candidate for this expresion of disdain, but my wife Charlie insisted on the 61, as being the year of her arrival!