The morality of financial disasters

 

           The rogue trader at UBS has allowed another round of banker bashing. Why aren’t more bankers in prison, the BBC and others ask. Wasn’t the granting and packaging up of low grade mortgages a crime? Shouldn’t they all be prosecuted?

           I agree that if a banker steals money or perpetrates a fraud they should go to prison. If someone steals your car from the street you expect the criminal to be punished. If a banker takes your money, saying he will invest it safely, and syphons it off to his own bank account he should have his liberty taken away.

             This much is not in dispute. What should be in dispute is who are the worse villains in the less clear cut cases?  

             Let’s take the case of the dodgy mortgages. These were granted to lenders by banks, then often packaged up and sold to other investors in the market. In due course the mortgage holders reneged on their debts, the investment packages fell in value, and large sums were lost all round the market. Who is to blame?

              Is it the banker who granted the mortgage to someone who failed to pay it back?

             Is it the borrower who should have known better and should not have borrowed more than they could afford?

             Is it clearly the borrower to blame if they lied about their income?

              Is it the regulator who supervised the mortgage bank making the transaction?

             Is it the politicians who urged the banks to lend more to people with low incomes, so they could own homes?

             Is it the banker who took piles of these mortgages and packaged them up, saying that as a portfolio they were a sound investment?

              Is it the Rating Agency who assessed the package of mortgages and  said it was a high class investment?

              Is it the professional investors who bought these packages, believing them to be good?

              Is it the Central banks, who created large amounts of credit allowing the banks and other investment firms to buy up all these investments in the good days?

             Is it the Central banks and banking regulators who then withdrew the easy money and exposed the dangers of these types of investment?

             Many of the people operating in these markets acted in good faith. The original borrower thought he could afford the mortage at outset. The bank thought he would repay. The Rating Agency thought a portfolio would perform just fine, as the loss rate would be under control. The Central banks may genuinely have believed that Chinese competition was ending inflation so more credit was justified.

              Doubtless there were some borrowers who knew they might not be able to afford the mortgage, and took a chance. Some falsified their return to get a mortgage they should not have had. Some bank staff may have had doubts about the suitability of some mortgage applicants, but were pushed by management and bonus targets to lend. Central Banks might have turned a blind eye to excessive credit because they wanted to please the politicians. Some politicians may have realised it would end in tears, but wanted to crank it up before their re-election.

            In these cases it is by no means clear who should go to prison, and why that would make the world a better place.

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83 Comments

  1. Public Servant
    Posted September 18, 2011 at 6:54 am | Permalink

    Mr Redwood, in my humble opinion you pose the wrong question. The question for me is simply this. When a company limited by shares fails who should bear the losses and in what order? I had always understood this to be shareholders, bond holders then creditors. At no point during my Company Law course at the University of London did we discuss the pain being passed on to the public at large. The public anger is at this idea of private gain and socialised loss. For this reason I am in favour of the Vickers recommendations.

    • Andrew Smith
      Posted September 18, 2011 at 9:38 am | Permalink

      The public at large get involved in two principal ways.

      1 They pay fore the deposit guarantee of £85k I think per deposit so the public and small businesses can have confidence in banks. That is regarded by politicians as a public good but they never seemed to work out how to control the resulting moral hazard. Several public bodies were foolish enough to invest in weak banks such as Icesave because they had developed a habit of not checking what they were doing.

      2 Supplying liquidity to the banking system as lender of last resort. That is a well known function of the central bank everywhere and it has not generally cost taxpayers much overall.

      What is new this time is that UK authorities have failed to use the central bank effectively and they have carelessly supported busted banks with our money. John Redwood has written in the past about what a wrong decision it was to bail out Northern Rock and I agree. But you cannot blame bankers for the foolishness of politicians.

      Similarly with the pressure by the government on a Labour supporting chairman of Lloyds Bank to buy a failed competitor; that has impoverished Lloyds and its shareholders. Barclays, HSBC and other banks have not needed tax payers’ capital but they seem to be the main targets of the coalition’s determination to drive banking from London to Zurich, NY and Singapore.

      What a crazy world!

      • outsider
        Posted September 18, 2011 at 11:35 am | Permalink

        Brilliant summary by Andrew Smith

      • Denis Cooper
        Posted September 18, 2011 at 12:50 pm | Permalink

        The Financial Services Compensation Scheme is paid for by the public, but as customers rather than as taxpayers – it’s funded by a levy on the participating retail deposit takers:

        http://www.fscs.org.uk/industry/funding/

        As I understand there’s no longer any unlimited state guarantee of retail deposits with banks – from June, about Southsea Mortgage and Investment going bust:

        http://www.cityam.com/news-and-analysis/bank-depositors-lose-cash

        “The bank’s savers, with a total of £7.5m retail deposits, are covered by the £85,000 limit insured under the financial services compensation scheme (FSCS). But 14 customers hold more than the £85,000 limit, and will be the first to lose some of their savings after George Osborne pledged to take a tougher stance on despositors in his Mansion House speech.”

        Arguably there would have been less panic with Northern Rock and the government wouldn’t have been forced to issue a blanket guarantee of customers’ savings if the FSCS had covered the present £85,000 rather than having a limit to compensation of just over £30,000, and if it has been clearer whether it was £30,000 per customer or per account and how joint accounts would be treated.

        Personally I can’t believe that the presence or absence of a scheme to protect a bank’s retail depositors would ever make the slightest difference to the behaviour of those who were prepared to take excessive risks in attempts to increase their bonuses – what might happen to the bank’s retail customers, totally unimportant little people in their eyes, would be just about the last thing on their minds.

        You could see that from the arrogant and unrepentant attitude of Adam Applegarth when he appeared before a Commons committee.

        • outsider
          Posted September 18, 2011 at 10:02 pm | Permalink

          Dear Denis Cooper: the point is that in the absence of guarantee savers would be much more choosy about depositing money with banks and would opt for what they thought might be the safest ones ( eg Nationwide, Coop Bank, National Savings) and when the money started flowing out banks would have to convince customers that their money was safe with them.

          • outsider
            Posted September 18, 2011 at 10:12 pm | Permalink

            PS: I have previously suggested that a voluntary prudent banking code could help: covering reliance on the interbank/wholesale deposits, new mortgage loan-to-value limits, high leverage loans (eg for buyouts or hedge funds) and non-exchange-tradable derivatives. If my bank did not sign up I would take my money elsewhere. Customers would not need to know the details.

      • Gary
        Posted September 18, 2011 at 2:03 pm | Permalink

        “. Barclays, HSBC and other banks have not needed tax payers’ capital”

        Barclays certainly did. In spades ! $3,3Trillion was borrowed by the banks from the FED during the crisis.

        “Barclays was the biggest cumulative borrower from TAF. The UK bank, which bought the US operations of Lehman Brothers out of bankruptcy in September 2008, borrowed a cumulative $232bn from the TAF through various subsidiaries.”

        http://www.ft.com/cms/s/0/4dd95e42-fd6d-11df-a049-00144feab49a.html#axzz1YJC8bJtx

        Reply: there is a big difference between borrowing on a commercial basis from Central banks, and needing share capital from taxpayers in the way RBS and Northern Rock did.

        • Thomas Ec
          Posted September 19, 2011 at 8:35 am | Permalink

          Mr Redwood, can you explain your comment to me? In what sense was this a loan on a commercial basis? The money was loaned at substantially lower than market rates. In fact, at the time, the markets were unwilling to loan money to Barclays because that was not a commercial proposition.

          The American authorities knew this to be the case, in fact they explicitly excepted loans from the TAF from the requirement to loan money at a commercial rate.

          reply: only because the Central banks had spooked the markets generally by their excessive lurch from loose to tight money.

          • Thomas Ec
            Posted September 19, 2011 at 9:15 am | Permalink

            Well, my argument is not that the US government was wrong to subsidise Barclays, but that it is wrong to call what they did anything other than a subsidy. And, if I recall, the US government also nationalised banks larger than the entire UK economy during the crises.

            I also find it hard to understand how such a relatively minor tightening as happened in 2008 caused such a big banking crises. After all, the last conservative government under Major carried out more tightening in a single day during the ERM business than the US Fed did during 2008.

            And yet, we didn’t have the entire banking sector grounding to a halt.

            It seems to me that governments making bad monetary decisions is common… whatever side of the atlantic you are on… and that therefore, banks should take that into account when setting their own capital and leverage requirements.

        • Gary
          Posted September 19, 2011 at 9:25 am | Permalink

          More than $3 trillion was borrowed by the banks from the taxpayers on a commercial basis. You joking?

          Why on earth is the taxpayer being used as a cash cow for commercial businesses? I am shocked that you are so sanguine about this!

    • lifelogic
      Posted September 18, 2011 at 10:12 am | Permalink

      I agree with your first point but there is no need for Vickers to achieve this and Vickers would be hugely damaging and risk pushing the banks away.

      Good regulation, accounting rules and risk analysis together with a plan for dealing with any bank stresses in a way that hits shareholder and bond holders only as you suggest.

      • Bazman
        Posted September 18, 2011 at 3:36 pm | Permalink

        Bob Diamond liked the Vickers report, so what does that tell you?

    • fAndrew
      Posted September 20, 2011 at 3:17 pm | Permalink

      spot on! Vickers is now necessary

  2. matthu
    Posted September 18, 2011 at 6:55 am | Permalink

    Doubtless in the circumstances you quote the ultimate sanction of prison would be to serve as a deterrant and not to make the world a safer place. The simple fact that the dterrant was there would make people less cavalier with the checks they run.

    In the same vein, it is not only the banker who placed the bet that is in the wrong. Every other check that had been put in place to prevent this happening is also circumspect and should be examined. The crime is so vast, the rewards for not being uncovered so disproportionate that it cannot always be a single individual held to task.

    And politicians who encourage (or even mandate) investors, pension schemes or the general populace to pay huge sums of money into vacuous green technology under false pretences should also have their day or reckoning. Witness the Solyndra scandal that is boiling up in the States.

    All of these crimes are manifestly worse than persuading someone to take your three points for a speeding offence and lying about it afterwards, and yet we have had ambulance drivers going to jail for that and doubtless there will be others.

    The deterrant needs to be inplace. What a pity they removed all reasonable deterrants from schoolteachers and parents for so long. Let’s not get it wrong again.

    • uanime5
      Posted September 18, 2011 at 5:12 pm | Permalink

      Was Solyndra any different that Enron, Eron, Tyco, Worldcom, or Bear Stearns?

  3. Mike Stallard
    Posted September 18, 2011 at 7:13 am | Permalink

    Morals are very much like giving to charity.
    Lots of people want to discuss which charity money should be given to.
    But when it comes to passing the hat round, they suddenly find that they have only very small change in their own pocket.

  4. norman
    Posted September 18, 2011 at 7:41 am | Permalink

    In my opinion the politicians are most to blame. They actively created the conditions for these dodgy loans to be approved. That the banks jumped on them as a way to make a quick buck shouldn’t surprise anyone.

    People have a tendency is to exploit systems for their own gain. That’s why we have regulators. In this case the regulators couldn’t exactly go against the politicians and say they were creating a disaster – most of them are political appointees and we’ve seen recently what the previous Chancellor thought of Mervyn King when he suggested Labour might be borrowing and spending too much.

    Should anyone go to jail? No, no actual fraud was committed as far as I can see, unless we want to make willful ignorance a jailable offence but then I fear we’d be left with a couple of dozen MPs and no Ministers.

    Wait a minute…..

  5. Sue
    Posted September 18, 2011 at 7:43 am | Permalink

    It’s not the bankers that should be in prison. It’s the politicians/governments who are still in collusion with them to rob the taxpayer blind. You are the ones who make up the rules, statutes and laws.

    Bankrupted banks should have been forced to declare bankruptcy and made to close just like any other failed business. It was the politicians that decided to steal money from taxpayers to save them.

    In the past few years, politicians have been guilty of breaking the law far more than other professions. THEY are the criminal classes and how many of them have gone to jail? How many corrupt politicians still have their jobs or have returned to politics?

    We have a ruling class that sends an 85 year old man to prison for 6 months for recording his own trial and yet (names one peer and alleges wrongdoing that has gone unpunished-ed)

    YOU ARE THE CORRUPT ONES!

    • Bazman
      Posted September 18, 2011 at 10:46 am | Permalink

      It’s a good point. In this life most people including bankers just take what they can get and the chance to own your own home and escape landlord no matter how small is a chance not to missed. Labour in this respect utterly failed to regulate the banking system backed by free market Tories and their fantasist cheerleaders.

    • Sue
      Posted September 19, 2011 at 9:20 am | Permalink

      Actually, you are wrong.

      54. We dismiss Lady Uddin’s appeal against the Sub-Committee’s finding that she wrongly claimed £125,349.10 in night subsistence and mileage allowance; instead, we endorse that finding. We further find that Lady Uddin did not make her claims for night subsistence away from the properties and for the mileage allowance in good faith.

      57. We endorse the finding that Lady Uddin has wrongly claimed, and has received, the sum of £125,349.10, to which she was not entitled. The recovery of this money is not a disciplinary matter, and so is not a matter for this Committee. We therefore recommend that it is for the Clerk of the Parliaments, as Accounting Officer, consulting the House Committee as necessary, to consider what arrangements with Lady Uddin may be necessary to secure repayment of this sum to the House.

      http://www.publications.parliament.uk/pa/ld201011/ldselect/ldprivi/39/3903.htm#a14

      (Goes on to make strong allegations which would need to be put to a court – this Lady is innocent until proven guilty in a court of law like anyone else-ed)
      I know you won’t print this because you are a coward like the rest of the Conservative MP’s (which is why we are still in the EU), but don’t think for one second that that we don’t know what is going on!

      • Sue
        Posted September 20, 2011 at 1:47 am | Permalink

        Why has this not gone to court? Others have stood trial(etc), why hasn’t she?

    • Electro-Kevin
      Posted September 19, 2011 at 11:52 am | Permalink

      To be fair, Sue, a lot of people would have lost savings, houses and jobs if they hadn’t rescued the banks.

      I wouldn’t like to be a politician now; not least because the money isn’t that great considering.

  6. Antisthenes
    Posted September 18, 2011 at 7:44 am | Permalink

    The left have put social programs ahead of economic reality and we can now see the result a financial disaster that will tip all those programs into cocked hat. If we had put economic reality before social programs as those truly on the right would do then gains in social programs would have been less but at least sustainable. So the left in their infinite stupidity are destroying everything that they set out to achieve, which of course is what they always do.

    • uanime5
      Posted September 18, 2011 at 5:17 pm | Permalink

      Given how bad the social programs are when the right is in power it’s no surprise that anyone who uses these programmes votes left.

      Thanks to high inflation, mass unemployment, and falling income more and more people rely on these programmes so it’s no longer politically viable to cut them.

      • alan jutson
        Posted September 18, 2011 at 5:56 pm | Permalink

        Uanime5

        There seems to be no limit to people who want something for nothing or something if someone else pays.

        Self interest seems more important to most, than being sensible over what we can actually afford and to sustain.
        Whilst a sizable number of people think like this, we will always be in a collective mess.

        Eventually those who do pay will wonder if its all really worth the bother, when they stop work and stop paying enough tax, is when the real crisis will start to strike home.

  7. matthu
    Posted September 18, 2011 at 7:47 am | Permalink

    Douglas carswell notes that “Last week, the government opted into another set of EU rules on home affairs and criminal justice. Yet another transfer of power in the wrong direction …. ”

    This flies right in the face of democratic opinion about transferring additional powers to the EU and is probably yet another example of an act of supreme arrogance and vandalism against the British public for which their should be a proper (and immediate) deterrant and not simply rejection at the next election.

  8. Ben Jardine
    Posted September 18, 2011 at 8:08 am | Permalink

    Great summary John, but you left out the obvious conclusion: there was a socialist culture of maximizing credit to those who couldn’t afford to pay it back. The banking system was simply the tool. As a very wise Polish friend said during his time with RBS: ” why are there so many f##in socialists working in British banks.”

  9. Ian B
    Posted September 18, 2011 at 8:27 am | Permalink

    Talking of financial naughtiness, I’m sitting here this morning scratching my head at how to square how a government who on the one hand made a great play of introducing anti-bribery legislation, on the other hand are boasting about how they’ve bunged Jaguar Land Rover £10 million to induce them to build a factory here. How does that work exactly?

  10. Javelin
    Posted September 18, 2011 at 8:35 am | Permalink

    As you keep saying John the safest route with others people’s taxes is not to over spend so you don’t have to over borrow. Same with mortgages don’t lend more than 3.5* salary.

    If you think you’ve mastered inflation and therefore mastered the economy you should be fired instantly. True of bank managers as it was of of Mr Brown or Mr Greenspan.

    Just think how much respect Tony Blair would have had if he sacked Gordon Brown that afternoon for saying “no more boom or bust”. Now that would have been that action of a real leader.

    • Javelin
      Posted September 18, 2011 at 8:51 am | Permalink

      You know this whole argument about morality comes down to sins of commission (fraud) and sins of omission (negligence). I’m not catholic but this distinction is very important in morals.

      Responsibility cuts both ways – when you are a bank manager, regulator or risk assessor your role is to be careful – not being so is negligence. If a mortgage borrower lies about their income then that is fraud. So I would find fault in all of the roles you mention, but reserve my greatest criticism for the borrower who has borrowed more than they can afford.

      • Gary
        Posted September 18, 2011 at 9:08 am | Permalink

        If the borrower lied, a prudent lender, doing due diligence, should uncover the lie. The lender holds all the power whether to make the loan or not. Under this system the lender had no reason to be prudent. If they had ,we would not have had the credit bubble. That is the problem.

      • StevenL
        Posted September 18, 2011 at 11:14 pm | Permalink

        Sorry Jav, read section 3 Fraud Act 2006 – fraud by omission. If you dishonestly don’t tell someone something you are under a legal obligation to, for your own gain or to expose another to loss or risk of loss, it is fraud.

        Technically that can include things like tax evasion or not telling the cops who was driving your motor when it got flashed.

  11. lifelogic
    Posted September 18, 2011 at 8:36 am | Permalink

    If you are taking about the US then you are perhaps rather being too kind on the banks. It seems quite clear to me that many of the banks knew only very well they were packaging up a very risky loans, taking their cut and then quickly trying to dump the asset on to some one else. Often they were non recourse loans and borrowers were quite entitled to stop paying and post the keys back.

    The way (and the timing) of how they were packaged and sold on or underwritten indicated that many knew full well what the scam was.

    In the UK you have to look at what happened to employees of (for example the Halifax) who pointed out to Directors what was going on (well before the crash) and were ignored and sidelined by management.

    Just as the banks, who profitably helped Greece fiddle its Euro entry requirements (using interesting structures clearly designed for this sole purpose) knew full well what they were up to also.

    • lifelogic
      Posted September 18, 2011 at 8:47 am | Permalink

      I see reported that a wind farm has been paid more than $1.5 million to stop producing electricity for 8-1/2 hours. The amount is 10 times greater than the wind farm’s owners would have received had they actually generated electricity.

      The sooner Huhne goes and this absurd expensive energy subsidy racket is stopped the better for all. Clearly he cannot do it, he would look even more absurd than he does already when for example defending the EU.

      He seemed, on any questions, to credit them with our large trade with Ireland – perhaps soon he shall credit them for kindly letting us trade with Scotland and perhaps Yorkshire!

      • APL
        Posted September 18, 2011 at 9:17 am | Permalink

        Lifelogic: “Clearly he cannot do it, he would look even more absurd than he does already when for example defending the EU.”

        He is implementing EU directives.

        • Martyn
          Posted September 18, 2011 at 11:32 am | Permalink

          He would have to strive very hard indeed to look more absurd than he already is – has he alreadt not demonstrated, time after time, the ultimate of absurdity?

        • Nick
          Posted September 18, 2011 at 1:01 pm | Permalink

          I was only obeying orders. Didn’t work at Nurenberg

          • APL
            Posted September 18, 2011 at 1:44 pm | Permalink

            Nick: “Didn’t work at Nuremberg.”

            I couldn’t agree with you more.

            But it still serves us to understand where and why we are being forced to pay higher energy costs in the UK.

            It is because of the ludicrous feed in tarrifs and associated green mania. We are meeting the EU imposed reduction of 20% in coal and oil consumption targets.

            Huhne can afford to be unpopular he will get a cushy little number with his paymasters once he can no longer be employed in this country.

            People paying more for their gas and electricity will be very unpopular, Huhne telling us that it is because we don’t switch our providers often enough will make him even more unpopular, but if John Redwood was serious about linking European Union policies with the popular vote in UK parliamentary elections this is the topic to choose!

        • Mark
          Posted September 18, 2011 at 4:10 pm | Permalink

          Who else will give him employment after he leaves government?

          • alan jutson
            Posted September 18, 2011 at 6:01 pm | Permalink

            Mark

            Who else ….

            Perhaps he will go back into Europe, as I understand it he already has a decent pension from past service

            Perhaps he may be offered a directorship etc with a green energy company.

            Sure he will survive, they always do. Thats the shame of it all, meanwhile we all still have to pay for his actions.

      • Tedgo
        Posted September 18, 2011 at 3:32 pm | Permalink

        re Wind Farm latest subsidy issue

        Seems to me that the National Grid has got its auction the wrong way round. If the electric load requirement, from wind power, is less than the available wind capacity then the auction should be to select the operators who are willing to supply at the lowest unit cost. This would be normal supply and demand.

        If its too windy to allow a wind turbine to operate then there should be no subsidy at all.

      • norman
        Posted September 18, 2011 at 7:59 pm | Permalink

        I live in one of the most overcast areas in the UK, pretty far north where sun is a rare sight in summer, in winter with daylight for 9 or so hours a day it’s even rarer. A lot of people I know are now ‘investing’ in solar panels, when I ask them why it’s always the same answer: They cost c. £10k to install and the government will pay them £1,200 a year for 25 years so in 8 years they’ll have made their money back then it’s pure profit for 17 years.

        I really don’t know how anyone, let anyone someone with a left wing view of the world, can accept the situation where people living in fuel poverty are paying higher and higher bills to line the pockets of affluent middle class home owners.

        Of course, further up the ladder we have everyone ‘feeding-in’ huge amounts of cash to subsidy farms built on the estates of landed gentry.

        It’s complete lunacy.

        Reply: Do you believe the promises on revenues that have to be delivered by future Parliaments and different governments?

        • norman
          Posted September 19, 2011 at 3:00 pm | Permalink

          I personally don’t believe that these promised payments will be kept, most probable scenario is that they will get parity i.e. 1kWH of generated electricity will generate 1kWH of payment, at some point in the near future, almost definitely before the 8 year break even point.

          A lot of people do believe that these payments will keep on flowing and a £30k return over 25 years on a £10k investment must seem tempting.

          Add the fact they are ‘saving the world’ into the mix and it’s understandably hard to resist if you have £10k burning a hole in your 0.75% interest savings account.

  12. Gary
    Posted September 18, 2011 at 9:02 am | Permalink

    Mis-selling, misrepresenting what you are selling ,is fraud. Refer to prof William K Black on this. He successfully prosecuted, and had jailed, over a thousand of bankers in the s&l crisis in the 1980’s. This is going to be repeated on a larger scale.

    But that is not even the biggest crime imo. The biggest crime is passing legal tender laws that suppress monetary competition and force taxpayers to underwrite the banks via the cental banks and deposit insurance, and thus removing the risk of lending from the banks themselves. That spawns unlimited greed. The banks, under these laws, have no reason to do much due diligence on any loan. Their only motive is to make as many loans as they can. Thus causing the credit bubble, that is now collapsing. The best regulation is that which makes both parties assume equal risk in a transaction. The banks lobbied to remove their risk, the politicians granted it to them.

    Politicians should be joining bankers on the stand.

    • Denis Cooper
      Posted September 18, 2011 at 11:55 am | Permalink

      How can you reasonably expect Mr and Mrs Smith of Anytown, who’re just looking for somewhere safe to deposit the money they’ve prudently saved rather than spent from their income over the years, somewhere they’ll get a modest rate of interest but hopefully enough to keep the real value of their savings a bit ahead of inflation, to “assume equal risk” with Megabank, which has many billions on its balance sheet, and armies of full time managers and analysts and traders, and which is constantly conducting all kinds of weird and large scale financial operations around the world, some so complex that even their professional experts sometimes struggle to fully understand them?

      It’s absurd, and Mr and Mrs Smith have every right to expect that their government will intercede on their side in what is such an unequal contest, just as they have the right to expect that their government will have laws passed and schemes instituted for consumer protection in other areas.

    • Nick
      Posted September 18, 2011 at 1:00 pm | Permalink

      The biggest crime is passing legal tender laws that suppress monetary competition and force taxpayers to underwrite the banks via the cental banks and deposit insurance, and thus removing the risk of lending from the banks themselves

      And that’s politicians.

      RBS, B&B etc should have been sent to the wall.

  13. Gary
    Posted September 18, 2011 at 9:15 am | Permalink

    Selling toxic derivatives to clients, and convincing the clients that it is good for them, and then shorting the clients behind their back, is probably the definition of fraud.

    • lifelogic
      Posted September 18, 2011 at 10:16 am | Permalink

      This seems pretty clear to me.

    • Fred Bloggs
      Posted September 18, 2011 at 11:50 am | Permalink

      Subprime CDOs are not derivatives. A derivative is a contract whose value is derived from the price of some other asset which is not physically owned by the investor.

      A subprime CDO is simply a pool of mortgages which pay the investors the interest rate cash flows from this in a specific order.

      Also, the investors who bought these “toxic” assets were not naive or uninformed investors. These were full-time professional investors who get paid hundreds of thousands of pounds a year who did not do their due diligence. They should have got off their arses and gone to Florida or California or Nevada where most of these mortgages were being originated and checked them out. That would have cost them $10k and a week of their time but they did not do this. Instead they relied upon the rating agencies who were fundamentally compromised – and the investors knew this too.

      The only case in which the toxic CDO was a derivative was the Goldman case since this referenced the ABX index swap rather than hold the underlying assets. It is true that Goldman did not inform the client that the reference portfolio had been selected with the input of someone who was seeking to take the other side of the deal. This was wrong. However the fact is that Paulson actually got off his arse and went to find out the truth about subprime and with a bit of digging he realised that these CDOs were full of crap fraudulent mortgages. If only the insurance company guys had done their job then they would not have made such a stupid investment.

    • Nick
      Posted September 18, 2011 at 12:59 pm | Permalink

      So lets give an example.

      You undertake a deal with a counterparty where you will pay them if the FTSE goes up.

      How do you hedge it?

      You sell the FTSE.

      That way you are neutral to changes in the FTSE. You won’t make, you won’t lose.

      However, you’ve ‘bet’ against the client’s view.

      Nothing wrong. The problem with this ‘betting against the client’ nonsense is that its clearly coming from someone who is financially naive.

      • Gary
        Posted September 18, 2011 at 1:49 pm | Permalink

        There is no mis-selling involved in your example. That is a natural market transaction. Mis-selling involves a breach of contract. You are saying that you are selling one thing, and it turn out to be another. I sell you a “brand new car”, you sign the papers to that effect, and the car turns out to be a used lemon, with a paint job.

        Charges were brought by the SEC against the banks for this type of fraud, and the charges were settled by the banks out of court. Why would they settle if they thought the transactions were appropriate ?

        Prof William K Black explains financial fraud in detail. Search for it.

        • Gary
          Posted September 18, 2011 at 1:53 pm | Permalink

          I will say, that in a free market, I would agree that the buyer has the onus to do due diligence, and the banker who mis-sells will quickly gain a reputation and be forced out of business. There may not even be a need for fraud laws. However, in this system, the banks cannot go out of business , because the taxpayer keeps them on life support indefinitely. In this asymmetric system there has to be legal recourse for the buyer.

      • Mark
        Posted September 18, 2011 at 4:25 pm | Permalink

        Something wrong with your risk analysis there: if you promise to pay out to a customer if the FTSE rises, you need to buy it to hedge. Selling would double up your risk, but might earn a reward on top of the margin charged to the client for entering the contract if it caused the market to fall.

    • Bazman
      Posted September 18, 2011 at 3:55 pm | Permalink

      Caveat Emptor. Let the buyer beware. The oldest advice is not to invest in anything you do not understand. Many of the people stung were sold a pig in a bag by middle aged, middle class smart Alec’s and were victims of their own greed and stupidity, not just victims. It’s always a different story when the rich get ripped off. Using their influence to get compensation. Should anyone less well of demand compensation for anything like the PPI scam or pension mis- selling, they are seen as scroungers who should have read the small print.

  14. Brian Tomkinson
    Posted September 18, 2011 at 9:42 am | Permalink

    On 8 September you quoted from Matthew Hancock’s and Nadhim Zahawi’s book about the banks: “toxic assets were camouflaged in off balance sheet ‘special purpose vehicles’ and outrageous risks were taken”
    I asked if this was allowed under accountancy rules. If so then those rules are useless and must be changed if this isn’t to happen again. If they were not allowed under the rules, what were the auditors doing and why haven’t criminal proceedings been taken against the directors of the offending banks?
    Do you have the answers to these questions please?

    Reply: That is their view, not mine. Special purpose vehicles were approved by auditors, purchasing investors and regulators. The idea was they had a spread of risks so they would be OK. The people involved did not expect the extreme monetary conditons created in 2007-8

    • Mark
      Posted September 18, 2011 at 2:41 pm | Permalink

      SPVs may of themselves have been sound entities – like Granite in Northern Rock , but in those cases they hollowed out the core, leaving the remaining business exposed. In other cases there were indeed used to bury toxic waste. Enron was the template: it contained SPVs of both kinds – Skilling’s “cookie jars” that he could dip into to improve reported results in a weak quarter, and the ones where the losses were buried, sometimes generating “profits” for the visible parts of the business.

  15. Bob
    Posted September 18, 2011 at 10:54 am | Permalink

    The underlying cause of the “credit crunch” was “The Community Reinvestment Act” which was a scheme devised by the Democrats in the U.S.A. to redistribute wealth.

    The U.S. banks were forced to lend to people from ethnic minorities who couldn’t afford to repay the loans, for properties in less desirable zip codes. The banks needed to conform to this directive or face dire consequences from the government regulators. The bank’s solution to this problem was to grant the loans in order tick the necessary boxes and then sell the risks onwards in the mortgage market by shuffling them in with a selection of sound mortgages, hoping that the buyer didn’t scrutinise the loan books too closely.

    The scene was set for a financial colloapse.

    Google “Community Reinvestment Act” or have a look at this article “The Real Scandal” in the New York Post.

    Social engineering at it’s best! The Liberal Democrats would be proud!

  16. Bazman
    Posted September 18, 2011 at 10:54 am | Permalink

    A clear case of the Soviet Union shooting the engine driver. In defence of the bankers they gave the chance for many to own their own homes They indirectly financed and provided to work for me via a massive increase in the world car industries production to pay the mortgage on mine. Cheers Guv! I was in a tight spot before you blew up the financial markets. Could you arrange it to happen again?

    • Gary
      Posted September 18, 2011 at 1:40 pm | Permalink

      I hope you have a good pension. You may find that the bankers have taken that. If not directly through now worthless toxic assets that were mis-sold to the funds, then through inflation.

      In fact, our future is extremely bleak. That is one hell of a price to pay for your house. Short term thinking was part of the problem.

      • Bazman
        Posted September 18, 2011 at 8:06 pm | Permalink

        Pensions? Good to see you can think that far Gaz! Many will just rely on the state. The future is never bleak. Well for some..

  17. Denis Cooper
    Posted September 18, 2011 at 11:32 am | Permalink

    As far as this country is concerned, the blame should ultimately rest with the main party oligarchs, the people who’ve been controlling the three main political parties.

    Why? Because they decide who will be presented to the electorate as their parties’ officially recommended candidates at parliamentary elections, which determines who will become MPs, and the House of Commons is the dominant chamber in Parliament, the supreme legal authority for the country, and moreover the chamber which insists on its right to supply almost all the government ministers and especially the senior ministers.

    Therefore, the character and ability of the main party oligarchs is always at the root of whether we are being well governed or badly governed, and as these oligarchies are largely self-perpetuating it’s difficult to feel optimistic about the prospects for better government in the future.

  18. outsider
    Posted September 18, 2011 at 11:58 am | Permalink

    Unfortunately, bankers are seen by most people to have got away with it. The climate would be much healthier if a few senior bankers (chairmen and chief executives) had been prosecuted to set an example. This was done by a previous Conservative government in the Guinness case, on flimsy legal grounds, to show the public that such shenanigins would not be tolerated ( and to placate a vengeful Scottish elite).

    I am not a lawyer but I guess several might have been accused of fraud by virtue of gross negligence or some other offence to let a court test the matter. As Andrew Smith implies,however, this was not possible because it was too embarrassing for the government. Two of the leaders of HBOS were closely connected to government, the Prime minister and his poodle at the FSA were heavily implicated in Lloyds’ “rescue” of HBOS and they had recently knighted Sir Fred for services to banking.

    The whole industry now pays for this political embarrassment.

  19. Bernard Otway
    Posted September 18, 2011 at 12:36 pm | Permalink

    Thank you for putting this in the public domain John,I have been talking like this to many friends and others,when I was still in South Africa before 2008 I was a friend of Tom Boardman the CEO of Nedbank who actually rescued it from the idiocy of it’s own previous board,we used to talk about the stupidity of self certified earnings being allowed,he as one of the most respected CEO’s in the country thought that our banking institutions had lost the plot.What you highlight clearly shows that it truly was lost via an interlocking WEB of
    partakers really a partnership of the DAMMED, because that is what they are now especially the Bankers where subprime is concerned BUT I blame the borrowers equally,even IF I was offered £1000000 on easy terms I would not take it UNLESS I could afford it.

  20. Nick
    Posted September 18, 2011 at 12:52 pm | Permalink

    I agree that if a banker steals money or perpetrates a fraud they should go to prison. If someone steals your car from the street you expect the criminal to be punished. If a banker takes your money, saying he will invest it safely, and syphons it off to his own bank account he should have his liberty taken away.

    I’ve made a booking at Wormwood Scrubs for you.

    You’ve taken money from me. You promised me a retirement income starting at 65, with a piss poor return if I look at the money you’ve forced me to give to you. You’ve then siphoned (no y in siphoned) the money off, and there is no fund.

    Why shouldn’t you and all the other politicians running a Ponzi pension scheme be jailed?

    Why should people be forced to give money to people who are running a Ponzi?

    Reply: The basic retirement scheme was always advertised as a pay as you go scheme – no-one ever said there were savings to back it.

  21. Nick
    Posted September 18, 2011 at 12:54 pm | Permalink

    I asked if this was allowed under accountancy rules. If so then those rules are useless and must be changed if this isn’t to happen again.

    Apply the same rules to the government, and the government is bust.

    For example, if you are a bank and a saver deposits money with you, that means you have to book it as a liability.

    For the government, oh no. They want to spend your money. So they commit accounting fraud. They say, look, if we define that money we owe you for your pension as spending, then its optional. If its optional, its not a liability. Now, what’s all this money coming in? If its not creating a liability, it must be income. If its income we can spend it! Wooopeee. Bonuses and gold plated pensions for all MPs.

    • Mark
      Posted September 18, 2011 at 8:49 pm | Permalink

      You’re right: the government is bust. It has gross acknowledged debt of over £3 trillion, and an expenditure that exceed its income by a substantial margin.

  22. Nick
    Posted September 18, 2011 at 12:57 pm | Permalink

    If so then those rules are useless and must be changed if this isn’t to happen again. If they were not allowed under the rules, what were the auditors doing and why haven’t criminal proceedings been taken against the directors of the offending banks?
    Do you have the answers to these questions please?

    Yes. SPVs are designed to do one main thing. Protect investors. So SPVs are set up off shore where the UK (or other governments) can’t lay their hands on them. For example, by changing the law and saying we will include the assets of the SPV into the general assets of RBS, in order to pay off RBS’s debts.

    So investors insist that for certain transactions RBS set up a SPV, and the assets are placed there.

    Next relates to risk. RBS doesn’t have a good credit rating. A SPV can be set up with more capital in relation to a transaction that RBS. That means it has a higher credit rating.

    There is no accounting fraud with regards to SPV’s that I’m aware of.

    • Mark
      Posted September 18, 2011 at 8:21 pm | Permalink

      Perhaps you should review the write-ups of Enron’s accounting that emerged from the trials of Ken Lay and Skilling et al. You might find widespread (problems-ed) via the use of SPVs. Do you think that there are no current businesses which would come out with a clean bill of health if their activities were subject to that kind of scrutiny?

  23. sm
    Posted September 18, 2011 at 1:38 pm | Permalink

    The bankers played the game (under the noses of the regulators and politicians and the taxpayers lost.

    Quis custodiet ipsos custodes?

    Meanwhile the EU,ECB,IMF, etc will be asking for more as well.

    Meanwhile its austerity for the prudent, honest and those unable to avoid or evade to bale out not just the innocent but a large number of vested private interests. I wonder what grates with most when they pay the inevitable tax bill.

    It maybe easier to dig deep if the cause is right and just.

  24. Mark
    Posted September 18, 2011 at 2:26 pm | Permalink

    I think you missed several people off your list of potential villains:

    The Estate Agent who lied about the price the next door house had sold for (I have personal experience of this: it was very revealing when I already knew the answer from Land Registry records on some occasions);

    The Chartered Surveyor who depends on the Estate Agent for referrals giving exaggerated valuations;

    The Mortgage Broker who provides false documentation whose commission depends on the size and number of mortgages he proposes and comes from the Bank, who designed his incentives;

    The Developer who falsified Land Registry records by neglecting to account for the cost of the free BMW X5 on the drive as a purchase incentive, thus justifying outrageous prices for subsequent purchasers on the development (who believe they are moving in with well heeled people on account of the expensive vehicle parked there) and for the Surveyor to “justify” himself;

    The FSA who were so busy generating 8 foot deep piles of rule books that they never bothered to peer outside to see what was happening in the real world, nor understood the regulation of many of the business areas they were responsible for after they became the monopoly regulator;

    The SFO who totally lacked the brains to take on some early high profile cases and pursue tough sentences “pour encourager les autres”;

    The accountancy profession who set the rules and then imitated (named firm-ed) in approving highly dubious schemes that took advantage of them, which they earned money inventing;

    Special mention should go to certain ex MPC members: Kate Barker’s barking Housing Review that suggested that people would end up paying 10 times earnings and more for houses (with interest on mortgages doubling that figure when rolled into total acquisition cost), and Stephen Nickell at the now thankfully defunct NHPAU quango, whose job seemed to be to justify Brown’s mortgage Ponzi scheme by voting for low interest rates in a boom inter alia;

    and finally, those of the media who promoted the idea of ever rising house prices as being a good thing.

    Like the Murder on the Orient Express, they all did it. The strange thing is that many of these villains were identified by the Money Programme back in 2003 – yet nothing was done about it:

    http://news.bbc.co.uk/1/hi/business/3222053.stm
    http://news.bbc.co.uk/1/hi/business/3478635.stm

    This was at the time that Labour and the BBC were at odds over Gilligan. It is interesting to note the names of the banks identified in those reports: Northern Rock and HBOS, who five years later became the basket cases of the credit crunch.

    Some of the morally guilty broke the law, but plenty adhered to it by ticking all the right boxes while others made it all possible by framing the rules and deflecting attention from the problems. The law and the penalties for breaking it, and the chances of prosecution were inadequate to ensure moral behaviour. Those who understand the Gramscian agenda might consider that this failure was orchestrated on purpose, with certain politicians who pushed key “reforms” being in the vanguard of that effort. We know who they were, don’t we?

  25. Stephen Almond
    Posted September 18, 2011 at 2:43 pm | Permalink

    So John, after an economic catastrophe of epic proportions no one is to blame?
    Rather like politics, isn’t it?

  26. Neil Craig
    Posted September 18, 2011 at 2:46 pm | Permalink

    It is easily arguable that broadcvasters who lied to us about our “successful” economy and about how much subsidy, money printing and regulation enrish us have thereby done far more damage than bankers. Certainly they have done only damage whereas bankers do both good and harm.

    I look forward to the BBC, with legally required balance, ask why there are no (eco)fascist BBC apparatchiks in jail.

  27. Mike Fowle
    Posted September 18, 2011 at 3:57 pm | Permalink

    I watched “Too Big to Fail” last week, the superb dramatised documentary from HBO about Lehman Brothers and the events that followed. Do catch it if you can. I must say it altered my thinking about the American response. Hank Paulson, the hero of the piece, clearly wanted to let the imprudent and dishonest bankers go under, but the consequences were just too frightful to contemplate. It was not only superbly watchable but it scared the life out of me.

  28. Electro-Kevin
    Posted September 18, 2011 at 4:55 pm | Permalink

    For all that, Mr Redwood, it would seem criminal to most that tens of thousands of uninteresting people can make millions for themselves using other people’s money and at no risk to themselves.

    This has to be wrong. Evidently so judging by the fact that the west appears to be about to go down the plug hole.

  29. ian wragg
    Posted September 18, 2011 at 5:52 pm | Permalink

    Why is ir always a rogue trader. He was doing what he was paid for. Gambling with other peoples money. If he’d have won we wouldn’t have heard about it. He lost and the bank needs a scapegoat.
    Who checks the checkers???????

  30. zorro
    Posted September 18, 2011 at 6:24 pm | Permalink

    Yes, I think that some bankers should be in prison, particularly if they’ve committed fraud by misrepresentation. If they’ve not committed crime then maybe debtors prisons might be more appropriate! The lack of moral hazard has allowed questionable people to mischievously appropriate other people’s wealth on false prospectuses. In any case, they should NEVER have been bailed out…..but who is to blame?

    Is it the banker who granted the mortgage to someone who failed to pay it back? – YES INCOMPETENT ON A LARGE SCALE

    Is it the borrower who should have known better and should not have borrowed more than they could afford? – ENTICED BY THE AUTHORITIES TO BORROW BUT CAVEAT EMPTOR

    Is it clearly the borrower to blame if they lied about their income? – YES THEY DESERVE WHAT THEY GOT

    Is it the regulator who supervised the mortgage bank making the transaction? – YES INCOMPETENT

    Is it the politicians who urged the banks to lend more to people with low incomes, so they could own homes? – YES GREEDY INTERFERING BUSYBODIES ON A MEGA SCALE

    Is it the banker who took piles of these mortgages and packaged them up, saying that as a portfolio they were a sound investment? – YES I WOULD BE INTERESTED IN SOME BANK RELATED FRAUD CHARGES HERE BUT DON’T BAIL THEM OUT

    Is it the Rating Agency who assessed the package of mortgages and said it was a high class investment? – YES INCOMPETENT ON A GRAND SCALE

    Is it the professional investors who bought these packages, believing them to be good? – YES INCOMPETENT AND CAVEAT EMPTOR

    Is it the Central banks, who created large amounts of credit allowing the banks and other investment firms to buy up all these investments in the good days? – YES INCOMPETENT ON A GLOBAL SCALE

    Is it the Central banks and banking regulators who then withdrew the easy money and exposed the dangers of these types of investment? – YES INCOMPETENT ON A GLOBAL SCALE

    A lot of people are to blame for this mess. They should fess up and not minimise their guilt!

    zorro

  31. StevenL
    Posted September 18, 2011 at 11:21 pm | Permalink

    It’s a public enquiry we need, not a load of fraud prosecutions.

    • StevenL
      Posted September 18, 2011 at 11:23 pm | Permalink

      And they should ammend the Financial Services and Markets Act 2000 to create some serious criminal offences for scammers. Most of it is civil/injunctive.

  32. APL
    Posted September 19, 2011 at 10:11 am | Permalink

    This post quotes an item submitted in evidence to the US governments investigation into the financial crisis.

    It is not hearsay, or gossip but evidence.

  33. Robert K
    Posted September 19, 2011 at 11:38 am | Permalink

    They all have a role to play, but the state-sponsored fiat money system is the main culprit. For me, the key is personal responsibility and liability. If a person takes out a loan they cannot pay back they must go bankrupt until they can pay it back. If a bank goes bust because it lends money unwisely then it should stay bust and not be bailed out by the taxpayer. If a monetary system collapses (Greece etc.) then the system must be allowed to collapse.
    Another way to look at it is winners and losers. The loser in all cases where intervention is carried out is the resonsible taxpayer and saver. The winner is invariably the political and especially bureaucratic elite.

  34. REPay
    Posted September 19, 2011 at 11:56 am | Permalink

    Whenever markets fail the people overseeing them, the regulators and central bankers are nowhere to be seen. No one at the FSA or Freddie Mac and Fannie Mae’s 400 strong regulator lost their job. They may know that it was the hounding of banks to lend to people by politicians in the US that created sub-prime. Bankers might be greedy, but politicians are greedy for votes and the idea of something for nothing – like the idea that the rich can pay our way out of the recession – abounds within our political class. How I wish JR could tutor them to be able to analyse the reality as opposed to the political context of our finances!

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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