There’s an old saying: The show’s not over ‘til the fat lady sings. But that said, this year is drawing to a close and I’m reminded that there are comparisons to be made between Sub-Prime and Covid, even at this incomplete stage. So, this two-part blog attempts to make some pertinent comparisons – both those that are similar and those that are different. The purpose is learning and through it, encouragement.
Long, long ago in Cloud Capitalist Land, a few guys got together and said: How could we create a product so curious that billions of US Dollars would be invested in it by the crème de la crème of financial institutions because it is fail-safe, linked to The US property market and bundled so simply that just with the stroke of a pen, you can buy as much as you want for returns you have dreamed of? Returns we have dreamed of? They cried. Yes! The few guys answered, And we’ll throw in something for just a weeny extra. We will get AIG to insure the credit so nothing – yes, that’s nada…nothing – can ever go wrong. And like the pedlar of Cowboys days selling Snake Oil, the few young guys packaged $33trn’s worth of “black boxes”. They were so appealing, top investors didn’t even need to look inside; they were “safe”. They were called, by the suspicious, NINJA loans. “Misinformed people” who doubted the system and the “few guys”, in the name of common sense. NINJA stands for No Income, No Jobs or Assets.
The “or Assets” was premised on the American dream – everyone should own a home. What a beautiful dream! So, drive the American property market into a frenzy with lose credit, and then sell their mortgages to the Investors because you cannot lose and wham bam, you have a winner! Whatever the credit behind the loan, because the property is going one way, you cannot lose. If they don’t pay, just sell the house, put the family on the street, get your money back and do it all over again. Fannie Mae and Fannie Mac, both most quizzical names for United Building Society of the American government, climbed in and the riotous feast was prepared. In fact, it still would have had trough-fulls of husks to go but for one or two glitches. Glitch One: Homeowners couldn’t pay [read: never in a million years, could have paid]. Glitch Two: The residential property market tanked.
Drat! What spoiling circumstances! Suddenly, everyone who wasn’t anyone got blamed….but, to this day, I have never heard of anyone going to jail because the scheme operated within the law even for all its stupidity. Banks began to fail, and President George Bush Jnr found himself between a rock and a hard place. Capitalism says that if you fail you go bust and burn. But when the entire banking system of America and later, many feared, of the world may fail, he and the world, needed to do something. I would imagine in cigar smoke-filled rooms, a deal was worked out that Lehmans would fail but AIG could not be allowed to burn. The reverse “at the trough” process began, and the government began to take over or stand good, for the debt in those obscure little black boxes. JP Morgan, Citibank and the likes were bankrolled by The Fed and were enabled to weather the storm financially. Of course, the bankers were then safe, and I’ll never forget the news that some lucky ones paid themselves enormous bonuses [probably this time of the year] just after the government money hit the bank’s account. About that time, Royal Bank of Scotland and the UK building societies were also bailed out by the British government. But by then, governments had begun to get clever and instead of giving loans, they compelled the banks to issue shares and then bought huge re-capitalisation stakes in the institutions. These stakes were later unwound at enormous profits by the governments.
But then of course, this begs the question, how does the financial system bail itself out of the chaos caused by “the few guys”? It’s actually easy, you sell the black boxes to Collections entrepreneurs who begin the seedy task of making people pay, or compelling them to pay rent, or, simply researching the books, sorting the probable collectable loans and selling these off to other Collections entrepreneurs at a profit. Effectively, the mess was sorted one black box at a time. But of course, you need money for that and, as easy as [mud] pie, you print money or sell Bonds of the government type into the market and you give this process that drives your currency closer to its real value – the paper it is printed on – a serious sounding name. That name is Quantitative Easing [QE]. QE borrows from your childrens’ children and pays the money over to the greedy “few” [but for the sakes of the “many”, you know!] so as to bail out the financial system. And just to make sure NO one borrows too soon and puts the banks at credit risk, you hike the interest rates. What a multi-whammy for the unsuspecting homeowner!
Thousands of smaller banks went belly-up, many affected by very long-term fixed interest rates. Thousands of homeowners suffer the ignominy of non-repayment of their homeloans. Economies begin shifting all the prudential Debt:GDP ratios, in fact as I recall it, 60% became the new normal threshold. Roll this trauma worldwide and you have recession of the highest order. 2008 into 2009 extended to 2010-2012 in most countries. But, as we have noted before, from 2012 to 2020, you have an unprecedented economic revival in most economies. The national debt ratio became absorbed into Growth and personal debt levels skyrocketed to accommodate a Consumer-led economic upturn.
Many lessons arose from Sub-prime:
- Legislation was passed to outlaw black boxes. As was always the case in South Africa whose bankers never participated in this practice, a see-through was compelled into the securitisation entity whereby every loan was clearly annotated and accounted for and only “eligible” assets ever found their way into assets to be securitised.
- The Ratings Agencies, hammered for their incompetence when approving black boxed loans, became extremely vigilant and relevant to future securitisation.
- When something is deemed “too big to fail” it became clear that it was certainly too big to fail. No matter how odious or expedient the rescue package needed to be.
- Raising the interest rate [Repo rate] is foolish. You kill the little man for the stupidity and greed of the corporate. Only one of our banks suffered a relatively small, recoverable financial loss and that for an investment made offshore, but all of them suffered the paucity of lending available from international lenders. This move paced severe strain on our very professionally managed banks.
- For the consumer, the age-old lesson that you never strain yourself buying fixed property. You could rub your eyes and find the bond unaffordable and the house difficult to sell in the prevailing market.
- National debt is hard to repay. From Sub-prime many countries were still struggling when the recent pandemic hit hard. You only need to listen to last week’s European Union’s recovery package to realise that many, especially Mediterranean, countries never recovered fully from 2008-2012. That why the other name for Sub-prime is GFC [the Global Financial Crisis]. Africa laboured under the same yoke.
The GFC set the stage for lending to be the preferred method of recovery from financial crises. On an astronomical scale it is being used right at this moment.
More in Part 2………
Yours in Property.