Some of the fault lies closer to home - By John Gapper
Published: October 8 2008 19:06 Last updated: October 8 2008 22:37
"Small island, big problem” was the headline in some editions of the Financial Times on Wednesday. It referred to Iceland, which has almost gone bust and had to seek a €4bn loan from Russia. But it could have been about the UK, which has pumped £50bn of equity into its biggest banks.
The previous moment of maximum danger for British banks in my lifetime came in 1973 when, during the secondary banking crisis, National Westminster Bank needed to assure investors that it was solvent. Words would not do this week: public money was required to prop up NatWest’s parent bank RBS.
When in trouble, humans tend to blame others and many British people have blamed Americans for the subprime mortgage mess, which started the global financial crisis. If only the Wall Street banks had not cooked up loans for people who could not afford to repay them, things would have been all right.
The British, Irish, Spanish and others could have carried on enjoying sharply rising property prices and cheap mortgages. European governments would not have spent the week gazumping each other with ever higher guarantees of assistance to their own country's banks.
Americans, meanwhile, are taking it out on Wall Street financiers. Dick Fuld, chairman of Lehman Brothers, and Martin Sullivan, former chief executive of American International Group, were hauled in front of a congressional committee to account for their blunders.
Both were excoriated by politicians for the millions they received in the good times. They looked, as Samuel Pepys wrote in October 1660 of a Puritan soldier who was hanged, drawn and quartered, “as cheerful as any man could do in that condition”.
There is no question that professionals of many nationalities – bankers, financiers, estate agents and regulators – behaved badly. They got paid a lot of money and wilfully loosened credit restrictions to keep house prices rising and bonuses flowing. Many of them, although far from all, were American.
But I would like to propose another culprit for the difficulty that many economies are in: you and I. We home buyers and mortgage borrowers share the blame, whether we are American, British or Icelandic.
Take nationality first. A year ago, when the US subprime mortgage debacle was evident but the British housing market was still doing well, I took a trip to London from my home in New York. On a visit to friends in west London, I was struck by the number of houses in their street with “To Let” boards outside.
At the time, there was a lot of talk about how the UK housing market differed from that of the US because it was a small island with a limited housing stock, there was no equivalent of subprime lending and so on. But those “To Let” boards said something different to me.
They showed that cheap debt and rising asset prices had led to housing speculation all over the world; it just took different forms. In wide, flat Florida it created sprawls of condominium apartments; in densely packed UK cities it generated a rush into buy-to-let properties. For subprime mortgages in the US, read “self-certified” UK loans.
The US housing market had unique flaws: the outsized role of Fannie Mae and Freddie Mac, the home loan agencies; low interest rates set by the Federal Reserve after September 11, 2001; high fees that gave estate agents and loan appraisers incentives to pump out mortgages.
But the housing bubble was global. It was financed by securities that were constructed and sold as much in London as New York and people from many nations borrowed to buy homes. Wednesday’s co-ordinated interest rate cuts, and part-nationalisation of UK banks, illustrate that.
Then there is our tendency to blame everything on bankers and other financial professionals. Here too, we are kidding ourselves. Bankers did many foolish – and, in some cases, unethical – things during the boom. But they did not force people to buy houses or take out mortgages; they mostly provided enough rope for borrowers to hang themselves.
In the past, people used to rely on bankers to guard themselves from their own worst financial instincts. They might have wanted to borrow 100 per cent (or 125 per cent) of the value of a home without the need to demonstrate thrift and reliability by making a down-payment. But they were shown the door.
Without bankers saying “no”, many people borrowed to the hilt, assuming that rising asset prices had eliminated all risk. Some confined themselves to buying bigger houses for themselves, while others bought second and third homes to rent them out while their capital appreciated.
We know why this occurred because we all lived through it, and financial bubbles are peculiarly intoxicating. When you are surrounded by people constantly talking about how much money they have made (on paper) by buying a house, you end up wanting to get a piece of the action and fearing being left behind.
It was the madness of crowds and, unlike some bouts, it crossed borders. Even countries with comparatively low rates of home ownership, such as Germany and Belgium, were caught up in the speculative rush.
Human nature is not going to change so public policy cannot focus – beyond the need for more financial education – on eliminating our urge to get rich quick. It is more practical to sharpen up regulation and reduce the incentives for bankers to finance our foolishness in future.
But, if for no other reason than to increase our chances of doing better next time, we must beware of blaming bankers and foreigners for everything. The fault lies closer to home.
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