One minute everything is rosy – house prices are increasing, living standards are rising, shops are booming and then we wake up one morning to find the bottom has fallen out. Sub prime mortgages in the US is somehow to blame but in reality it is something very much bigger. It seems that everyone has been living on debt – gambling on ever increasing asset values whether it be houses, stocks or company valuations. As these assets start to fall people want to blame someone and find a scapegoat for their sudden feelings of unease as we see house prices falling, job cuts and that sinking feeling of being in debt. The bankers are the popular fall guys – overpaid – massive bonuses and irresponsible risk takers – but is it really true ? Some of the biggest job cuts are happening in financial services and they can be brutal – sacked in the morning and escorted out. Were the banks fueling this or were they reacting to our demand?
I have just read an article by Robert Peston which gives a brilliantly simple explanation of how we all ( governments, banks, citizens ) found ourselves in this mess -see: http://www.bbc.co.uk/blogs/thereporters/robertpeston/newcapitalism.pdf – of how consumer led growth based on credit cards and massive borrowing in the west was funded by savings made in China, India, Asia and the Middle East. Their economies also benefited so long as demand for their products grew. The banks were really responding to our demand for fancy goods and real estate. While money was readily available for borrowing so the bubble could grow. However once the true value of the property, stocks and goods that the banks had leant to us started falling below the sometimes 100 % loan deals they made, so the originators of the capitol stopped funding the money markets and began calling back their loans. The banks and us their clients were thus left completely exposed, and required immediate public funds to cover their massive debt exposure or risk national financial meltdown.
In the past banks paid interest on savings deposited with them and leant this money to borrowers at a higher interest rate thereby making a profit. Traditional bank managers were conservative about who they leant money to because they prudently avoided companies and or individuals who might default on payments. It seems that the last time UK banks balanced the books between savers and lending was in 2001. Since then the flood of international money markets have been fueling lending for seeming financial “well being”. The banks themselves borrowed money on the money markets to lend to us as the debt bubble inflated in the West. When someone now calls time on all those loans – because for example the value of properties falls which secures them, then the banks are exposed in a short time to debts leant out over periods of 20 years or so. Credit dries up and so does the consumer/service driven economy on which we seem to depend.