Thursday, September 13, 2007

Banks pile up 'distressed debt'

The cynic is a man who knows the price of everything and the value of nothing, Oscar Wilde once wrote. Today, many cynical bankers don’t even know the price of things, let alone their value as the financial crisis takes its toll. While the financial markets were functioning, bankers offloaded debt packages and other so-called financial instruments on the market. In doing so, they established their price and usually made a profit. But since the current global financial turmoil got under way, bankers are increasingly reluctant to enter into market transactions for fear that the price will be much lower than they paid. Some estimate that the worldwide volume of what is known as “distressed debt” held by banks amounts to as much as $380 billion.

According to an analysis in today’s Financial Times – and this paper should know - this uncertainty has in turn created “a crisis in trust among banks about the credit-worthiness of their peers and therefore wary of lending to each other – which increases concerns about the possibility of bank failure”. Enter one Mervyn King, governor of the Bank of England, closely followed by Alasdair Darling, who is the Chancellor in the New Labour government. King’s message to the banks, expressed in a letter to MPs, was that they had got themselves into the mess in the first place and had to sort it out. The Bank of England would not ride to their rescue by lending them what is known as three-months money to ease liquidity problems. The European Central Bank has been doing this for weeks, but King warned that these actions could sow “the seeds of a future financial crisis” and encourage “excessive risk-taking”.

Darling’s message, given in an interview with the right-wing Daily Telegraph, was that what the City needs is a good old-fashioned lesson in the basics of successful lending. "My starting point is that Government can't stand on the shoes of borrowers or lenders. They [borrowers] need to ask themselves, 'Can I repay this?' and lenders need to ask themselves, 'If it goes wrong can I get it back?'. People do need to think long and hard about this. One of the by-products of the current situations is that, not just at a high level but right across the piece, people will be a bit more cautious." In reality, King and Darling are talking like men stuck in a time-warp. One banker told the FT that the Bank of England was still living in the 1950s and warned: “This liquidity problems could snowball. A lot of experienced bankers are saying: ‘We’ve not seen this type of illiquidity in the money markets for years. It could lead to a recession.”

But market bail-outs are impossible for several related reasons. The globalisation of financial markets has created mountains of credit and their twin-brother, debt. No one really knows the sums involved and now the banks are refusing to say what they have on their books just in case it is worthless. As part of the deregulation of finance, mortgages were handed out like confetti and New Labour, like the Tories before them, encouraged this. Home ownership should be everyone’s aspiration, the government has said time and time again. Easy credit helped to promote year-on-year growth in consumer spending, without which the capitalist economy grinds to a halt. Now consumers are forced to spend less because, through no fault of their own, the financial system is in crisis. Mortgages are becoming difficult to pay. The implications for the economy are obvious. No wonder New Labour is talking about holding an election sooner rather than later in a bid to beat the rising crescendo of bailiffs banging on doors to take possession of people’s homes.

Paul Feldman
AWTW communications editor

1 comment:

Anonymous said...

I agree with your points and just wonder what advice you might have for first time buyers? I've been cautiously saving until now when I have a good deposit. I've been looking on in despair and bewilderment as the government and banks have conspired irresponsibly to drive the housing market. Now I'm able to get on the ladder, but is it a good moment to take that first step?