News & Articles

Anyone for a Meltdown?

31st March 2009
Lee Werrell

The Turner Review is 124-pages of a superb summary of the current crisis. Labelled are the origins, ideas for resolving the crisis and explanations of how to prevent any future occurrence. A piece or art crafted by a maestro of his generation.

Many of the report's assumptions have a clarity and logic to them even though they can, and no doubt will, be disputed and the final conclusion hotly debated by all and sundry.

The report confirms that the sub- prime collapse gave birth to the global financial crisis. This seems to be the fundamental truth that confuses most people as they struggle to understand how a very small sector of the total US mortgage market, which most experts knew was unstable and expected to collapse, cause this horrendous universal meltdown.

It maybe contentious but one explanation for the crisis could be the appearance and maintenance of a structural fault line, including huge credit fines, which were managed by so-called shadow banks, such as hedge funds combined with the failure of the regulators to keep their eyes on the ball. Moreover, fundamentally caused by the repeal by the Clinton Administration of the Glass—Steagall Act which facilitated the removal and thereby removing the glass walls retail banks and investment institutions. This then caused a clamour for the growing demand, indeed hunger for credit, and leads the way for commercial and household credit lines to become blurred, with corporate decisions taken where common sense seemed to have already left the building.

Quite simply mortgages and other forms of credit were packaged and sold on to interested buyers at a premium with such deep rooted historical ratings blinding the purchasers and credit rating agencies, it appeared pointless to the buyer to analyse the credit-worthiness of the borrower since it was assumed the risk would be passed on to other investors. In fact the only measure of value is the credit rating given to the product for a fee by one of the big agencies.

There is obviously a moral question regarding the products sold, packaged and re-distributed that, combined with the accounting and increased complexity of the maths involved could well have hidden the actual risk from those who were required to make the decisions. The old adage of if it looks too good to be true, it probable is, was ignored en-mass. Such was the level of blindness that Securitised credit rose in the UK from almost nothing in 2000 to 18 per cent of the mortgage market in 2007, correlated to a massive growth of on-balance-sheet lending by many of the major banks.

As apparently clear now, Lord Turner states: "A crucial feature of the UK system in the run-up to the crisis, was therefore the rapid growth of a number of specific banks - Northern Rock, Bradford & Bingley, Alliance and Leicester and HBoS - which were increasingly reliant on the permanent availability of a large-scale interbank funding and/or on their continuous ability to securitise and sell down rapidly accumulating credit assets, particularly in the mortgage market."

In reality the US market was the first to package debt and sell it on, but they found an increasingly open, ready and hungry market in Europe, and especially Britain. However, other parts of the world did not join in the feast. The Asian economies seem to have avoided the crisis in ways that European banks have not.

Let us not just kick the banks although they were seemingly out-of-control in the way they grew their lending books, as they did so by what can only be viewed as sheer negligence of the regulator. The regulatory regime has failed over the years if you consider the collapse of banks and insurers since the mid 1970s, BCCI, Equitable Life, Independent to name but a few of the once proud financial institutions which should stand as reminders of the need of closer supervision.

So what is rotten in the state of Denmark? In Denmark alone: nothing. In the west we seem to have regulators staffed by individuals who when asking searching questions are swayed by pressure or waffle from the old boys who never quite let them into the running pack. There seems to be the culture of employing people on lackluster wages and expect them to do battle at senior levels with the people whom last year they may have called their boss.

The only way new recommended regulatory and supervisory framework for the stabilising of the banking system is going to work, not only calls for greater liquidity in the global banking system, but more and better closer supervision and regulation of individual banks, including the "shadow" banks and perform better risk assessment of the entire sector and not just the public face of banking.

Perhaps a good but possibly cumbersome and potentially dangerous if done too quickly reform is that of registration and supervision of credit rating agencies; reform of remuneration for senior banking executives; greater involvement for the Bank of England and the International Monetary Fund for the regulation of macro—prudential policy. Additionally the report suggests the separation of so-called narrow banking and investment banking, similar to the former US Glass—Steagall Act; and the creation of a College of Supervisors to coordinate global banking regulation for cross-border institutions.

There is also a suggestion that a new European macro-regulatory institution should replace the Lamfalussy Committees and the regulation of individual firms being done on a national level. The role of the IMF as a super—regulator and the BOE and how it could fit into the national equation.

Or perhaps we should just leave it all up to the bankers. After all, they know their business, don´t they?

Bibliography

Lee Werrell FInstSMM MSI is the Owner and Principal Consultant of CEI Compliance Limited, a Compliance Consultancy. CEI provide a broad range of expertise having worked with governance, risk and compliance functions for a number of years.