A week of scary numbers

We’ve heard all kinds of numbers bandied around this week, as Governments at home and abroad spray billions on the fire in the financial markets.
Spectacular as this bale-out has become, the most interesting figure of all was one flagged up last night by Richard Lambert, the boss of business organisation the CBI.
It gets right to the heart of why things have gone so catastrophically wrong in world financial markets - and in the economy that you and I live inside.
This is what Lambert said:
“In 2000, residential mortgage-backed securities hardly played a part in UK house finance.
“By 2006, they were financing no less than two-thirds of all new mortgages in this country.”
That is hugely significant.
Why? Because it illustrates just how much the bond of mutual obligation between borrowers like you and me and lenders like banks and building societies has become fractured.
In the old days, when you took out a mortgage from a building society it was just that – you borrowing a very large sum of money from the cash held by a big financial institution.
In order to satisfy itself that you could be trusted with other people’s money (because your mortgage was financed from savers’ deposits), your building society would carry out robust checks on your ability to pay and satisfy itself that the property you were buying was something sensible.
That all changed when the residential mortgage-backed securities which Lambert referred to were invented.
You may still have thought you owed money to a bank or building society (more likely a bank, because many of the building societies had sold mutual status for Stock Market cash) but the reality was that your loan had been packaged up with other loans and sold as a debt product (a security) to investors.
This severed the relationship that lay at the heart of homeloans. The bank or building society no longer had to worry so much about either your ability to pay or the property it had financed because if you hit trouble it was the investor who held your debt that suffered.
And because the bank was making money from the fee it charged you for setting up your mortgage and the fee it charged investors who bought your debt it had a vested interest in churning out homeloans.
That led to two further mistakes: bank staff being encouraged to arrange more loans because they were paid bonuses for doing so, and the banks starting to borrow more and more mortgage funding from wholesale money markets because they didn’t have enough in their deposits.
What kept this bizarre show on the road was the fact that most people knew nothing about it. All they could see was the loan they were being offered to buy something they otherwise couldn’t afford (and a wad of money is more persuasive than a lesson in personal finance)
The biggest smokescreen of all was rising property prices. The willingness to loan more money meant prices just kept spiralling out of sight. This made it seem like there was no danger for lenders or investors when people didn’t pay: lend £100,000, get £120,000 when you repossess and sell it.
That led to the final, fatal mistake: lending money to people who had a track record of failing to pay, even lending to people who were out of work.
When the losses from unpaid homeloans started stacking up, property prices started to fall. Suddenly, that £100,000 loan was supported by a property worth only £80,000.
Multiply that by a few million property transactions and you have the gargantuan losses hitting the headlines this week.
And they are losses sitting in the accounts of investment banks and high street banks because the investors finally stopped buying mortgage-backed securities.
Where did this get us all?
If you are/were a Northern Rock account holder, you will know already the fear that can strike when what you thought was a safe haven turns out to be holed below the waterline.
What stopped the panic then was a UK Government bale-out of a crippled bank. What may have stopped the rot this week is a US Government bale-out of an entire financial system.
Though the panic now appears to be subsiding there will be consequences. We have a downturn/recession to get through and the business failures and job losses these events bring still look unavoidable.
Gordon Brown may see this as a political opportunity: fix the banks, keep the show on the road and - who knows – may be that election won’t be such a car crash
The sanest suggestion I’ve heard so far, though, is that it isn’t banking legislation that he needs to pass.
It’s a rule that every kid in every school gets taught what happens when you borrow too much money.