大象传媒

Robert,

I can not help feeling that the banks are setting this up in order to buy cheap on the market. They have already stated that these underlying assets are difficult to value. The fact is the value is still there but the effect the write downs are having on the market in general is creating bargins from rumours.

Financial engineering has been proved to be too clever by half.

Real engineering has to take over.

Only goes to prove what we all knew deep down - that bankers deserve the rhyming slang...

Well well, the cupboards are starting to be opened and the smell comming out of them is far from pleasant...
As you say Robert, City is one of the big boys so the damage will be considerable but not catastrophic, what is more signifficant is how much of this debt is held by other banks?
Just when all the bulls were forecasting another nirvana, subprime has come back to haunt them big time. Surely lots of worried looks today in the City. But then again, it has happened before, and will happen again.

The concentration on Sub-prime perhaps hides a deeper reality. How much in short term loans covering long term debt is there out there? How much can now be re-financed let alone ever repaid? Some bank or banks lent Ford $15b just to keep going, just one small example.

Any takers on blaming Peston for Citi's troubles?

The comments to this blog is one of the best reads around! I wanted to get my contribution in early so there's a chance of getting my questions answered (there's a few).

As I try to understand the situation a few questions appear: Citibank loses are assets that no longer have the value that they once had, but are these marked to market which means that these loses themselves could be incorrect and have further to fall given the decline in US house prices?

As many CDOs are held off-balance sheet are they included in Citibanks losses? And why are banks allowed to hold investments off-balance sheet?

Final one: I've heard that once this hits the derivative market (the losses) the figures will be even bigger - can anyone explain this to me?

Thanks.

What did we all expect? for years the voiceless majority watched aghast as house prices and useless consumer goods went through the roof. We all knew that one time you couldn't borrow more than 2-3 times salary and the proof had to be there. And if you wanted possesions you saved and what you bought had to last more than the 12 months that seems to be the case now. Old fashioned? don't understand the way finance works? out of touch with modern expectations? NO aware that greed and stupidity go hand in hand and the ones at the top get away with it while thousands who had no part in this madness will feel the knock on effect.

Yes. there is an information supplier known as MarkIt that specialises in information on the credit derivatives area. To untutured eyes it could appear that they make their money by supplying the yarn for the king's new clothes.

I can't believe you're reporting this, Robert, don't you realise that it might cause a run on Citibank?

In the meantime, the Chancellor was less than convincing on the Today programme this morning. "Keep it in perspective"? Oh yes, I forgot that there's no subprime here.

Does anyone know of anyone in the UK that has borrowed a high multiple of their salary (4 x or more), self-certification, 100% LTV, interest only or a combination of all four?

Nope, no sub-prime here.

Pension funds and government funds are invested in various types of paper. Do you know how much of YOUR pension fund and YOUR government's funds are invested in these shaky derivatives? Find out.

The sub-prime crisis obviously still has a way to go. In the UK more than Northern Rock will have to face the music.

I understand that about 15% of mortgage borrowing in the 1st half of this year was for "buy-to-let". Given that a lot of apartment property was overpriced and that "the bright new things" working in Canary Wharf are about to leave town. I suspect a few mortgage suppliers are in you a poor final quarter, and beyond

I am now retired and I dont want to dwell in the past.
I obtained my first mortgage from the Leicester Building Society in early 1960's. To join the Building Society you had to be recommended, which the Company I worked for did.It was normal to be a member at least two years to become eligible for mortgage and to have a good level of savings in comparison to the mortgage.
I bought a good flat in Glasgow for 拢2800, mortgage 拢2500, salary 拢1200/year. I had 拢800 savings in the Building Society and it was just left there.
We do not want to go back to that but some sort of halfway house and this whole problem would not have happened.
There has been a suicidal drive for growth partly driven by governments and this has caused the problem.

regards
jimmy

Being an oldish chap, I'm struck that the sub-prime fiasco has something of the air of junk bonds and Drexel Burham Lambert about it. Low-grade debt is just what it says it is - no fancy financial engineering is going to change the poor creditworthiness of the borrowers at the base of the pyramid. Combine that with a bank's rapacious appetite and a willingness to ignore the law of gravity and it was only a matter of time before things came crashing down.

How long will it be until we discover who the modern equivalents of Milken and Boesky are, I wonder?

Matthew,

I can help with the second question,

It is dependant on exactly what is held off balance sheet. Essentially 'off-balance sheet' means the assets have been transferred to another company, an SIV. The Bank would receive a sum from the investors (Via SIV) for the assets transferred. However, when a CDO is structured a Bank will often retain some of the assets or tranches themselves. This is because sometimes people may be unwilling to purchase the most risky tranches or because the investors want the bank to maintain an interest in the CDO. This will often be the most junior tranche and first hit when times are bad, and because the asset is still owned by the bank, it will be a declared loss.

OK so there is US$ 1 trillion (or more or less ?) of sub-prime loans advanced by bankers (gamblers) and it turns out the 'security' is not worth a cent. But is it to anyone's advantage to 'know' this. Isn't it better to be ignorant of the 'facts' and gamble on a solution, be it a slump or inflation one or the other will fix the problem some day. Which of the two does less harm? Who knows. But hold on to your hats its going to be a bumpy ride! May you live in 'interesting times', as the Confusian curse says.

Mr Darling's 'emergency' appearance on the 大象传媒 Today programme today will not calm the market rather it serves only to emphasize the problem as did the interventions over Northern Rock..

The Citigroup reported above wouldn't be in any way related to the Citigroup that are financial advisors to one Northern Rock plc would they?

Old fuddy-duddy here. We bought our first house in 1976 and resisted the mortgage seller's insistence that we take out what was then the 'buzz word' deal of an endowment plan. Our repayment loan was paid off in 1986 and we now own our sebsequent home outright after a further 19 years.

So what? The point is that we have always stuck to buying what could be afforded, and yes that includes cars and electrical goods etc.

Too many of our friends, and they're not all youngsters, have swallowed the unpleasand 'pills' of banks and advertising agencies persuading them to take what they don't really need and cannot possibly afford.

It's wake up time folks, the chickens are all coming home.

Oh and the other advisors to Northern Rock would be that fine financial institution Merrill Lynch who have also seen fit to fire their boss in the last week!

Robert.

I worked for Citi during the recession of the late 80s and that mortgage debacle. John Reed, Chairman and CEO, and Pei Chia, Chairman of Global Retail had to have a meeting with the U.S. Treasury, as they ran the 'Bank too big to fail'. They were asked to explain
how their mortgage lending process worked. And they could not. What has changed in 15 years? Not a lot.

Paddles,

you are seriously confusing what a sub prime mortgage is and what lending normally is. Sub prime is for customers who have experienced arrears or the like in the past and would not be able to obtain a 100%, self cert of 4x income mortgage. You need to be careful when talkig about things you clearly do not understand.

And just for the record, some people need 100% loans as salaries have not moved anywhere close to house price growth.

thanks

The global banking industry needs to return to the basic principals of banking and lending, moving away from target and bonus driven management.

Matthew W. asks why the losses might be even bigger once this (crisis) hits the derivatives markets.
The answer rest on the fact that derivative insruments,as these CDO financial instrumentsare, are funded on a highly leveredged basis.

I've seen the picture of tatty houses and understand Cleveland council will spend money bulldozing them.
If the house has gone and the houseowner becomes a penniless pensioner then the securitized asset becomes a Total Loss.
Bearing in mind how expensive any house is and that 2m will become homeless in 2008 in the USA, Sub-Prime is the new dot-com bubble. Now that took 4 years to get over. We may still be talking about this for a bracing long time.

If it's the spiralling interest rates that results in most of the defaults surely it would be better for the banks to charge the standard "prime" interest rate than to reposes homes many of which get vandalised and presumably are then worth next to nothing.

So Mr Peston, are you starting another run on another bank? What jolly media japes.

Its well known that greed is a pandemic disease always has been always will be! But just as an aside I was carefully sorting my household waste stream this weekend and was staggered by how much "junk mail" we receive each fortnight, almost the equivalent of 14 Torygraphs. This unwanted and unsolicited trash was full of "Investment Opportunity" "Property Portfolio" "Cheap Loans with up to 18 months interest free holiday periods" and invitations for credit cards too numerous to count - again with 3 to 12 month repayment holidays. The financial marketing industry seems to be suffering something of a "lag phase" not to mention an "environmental impact free" conscience. Deregulation of industry I suppose!?

Having just spent two years of my life working on a project to make something valuable (boiler fuel) out of waste (sawmill and forestry waste) and having just got the private investment and bank lending for the startup phase in place it's all been kicked into touch by the knock on effect of this 'financial engineering'.

Now the investors are worried about their their own backing assets and the banks just won't lend (not that they understand real wealth creation anymore anyway).

Five or six peoples futures have been ruined, some sixty or seventy direct jobs and a couple of hundred indirect jobs won't happen, hundreds of thousands of tons of carbon dioxide per year will not be nullified and a bit more 'secure energy' won't be created . . .

Is it not time that regulators separated the functions of banking and sorcery? With monotonous regularity this greed cycle of lunacy and retreat occurs with its attendant damage to the real economy of real assets, real jobs, making real things and selling, storing and transporting them.

Then these jokers tell us they can make more money by taking our savings and putting them into the latest smoke and mirrors machine rather than into the underfunded and deeply unfashionable 'real world' that we have to inhabit.

Well, they should be made to prove it before sale and also declare all the possible side effects much as is the case with drugs and medicines and they should be forced to insure the risk to the purchaser. All prudent sensible things in my humble opinion. Only then will we get these parasites off our backs.

Post 13 has it right, These securities were engineered so they could be purchased by pension funds and insurance companies around the world. The problem is the banks were convinced that the financial alchemy of over collateralisation and derivative based insurance would eliminate the chance of default or at least minimise the impact. The models used where, I am sure, adequately stress testedand to all intents and purposes provided the necessary comfort to investors who were hungry for yield. Unfortunately the data used in the testing process is limited to recent history and fails to take into account scenarios that have never been recorded. After the Russian default and the LTCM crisis the use of VAR was widely discredited , VAR or value at risk is te estimate of how much an institution can lose in a single day based on available historical data. VAR didn't fail, just the interpretation of it. VAR numbers were generated by the risk managers to placate the directors of a company that they were 95% sure that the maximum they could lose was xxx million. Unfortunately it is the other 5% you have to worry about. Most people would be surprised at how little data is available on the markets. Ok there is a lot of historical data on stock prices, but just ask a quant to tell you how many yen to the pound there was in 1961, from his bloomberg terminal.
Citibank has plenty of other issues to worry about, asset backed securities encompass more than just sub-prime, what about the $1trillion plus of credit card debt that has been secured in the US alone, what about the auto-loans that have been securitised by Ford Motor Credit and GMAC, these companies provided the bulk of profits for their manufacturing parents for many years. Also what happens if the dollar weakens enough that people no longer want to purchase US treasuries? The Fed could start issuing debt in other currencies but the only way to repay it would be to print more dollars and then I think that deflation in the gousing market would be the least of the US governments worries. I doubt it will come to that, you may hear many analysts saying that emerging markets can make up for any decline in US consumption, but just think about that. China and India are getting richer because they are selling goods and services to the US but domestic savings rates are still at high levels, why s that? Because the US and to a far lesser extent the UK is still the consumer of last resort. If the US and UK stops buying Chinese prducts what will happen to their economies? Remeber last year all the reports about the giant Emma Maersk container ship dubbed the "christmas ship" by the tabloids because it was full of Chinese made products coming to the UK. The biggest ship in the world, and it isn't transporting precious crude oil, it was full of the things that we buy from China to have a merry christmas, who knows what it carried back, because a ship with no cargo is a black hole to the owners, probably junk from the uk to be recycled in China. That might explain the UK's fiscal imbalances.

The focus is primarily about failing sub-prime mortgages but bank lending and securitising of Private Equity loans may prove a far worse problem. This will be the equivalent of the Drexel period 'junk bonds' debacle.

The loans too have been sold on by the banks straight and re-structured and whereas a bank would be there to advise and support a corporate borrower once the deal has been accomplished in these deals it most likely isn't. Just as in house mortgages, many of these were safe on wafer thin margins on optimistic projections which when the economy slows become exposed. I see the leveraged purchaser of Sainsburys has withdrawn and since many of these deals were based on an assessment of property assets and the commercial property market is looking weaker this will be another problem leading to job losses and business closures.
It may well usher in the fire sale of the century.

It strikes me that the ratings agencies in partnership with the banks deliberately overvalued these assets for far too long. As many of these institutions had a vested interest in doing this should there not be an SFO investigation and those responsible taken to court?

I've worked at Citigroup for 4 years now, about the same time that Prince was CEO. It's apparent to me that all of the problems that he's been blamed for (and has largely dealt with) he inhereted from Sandy Weill. There's been an extraordinary amount of work done on compliance and controls and I think we're the most geographically diverse super-bank by a far margin.

SubPrime mortgages have been available for over 10 years now and in that time Citi and over investors have made a fortune. Everyone knew this crunch was coming, the trick was to not be standing when the music stopped. Unfortunately Citi have been caught out, which again, given it's size was inevitable but because of our diversity it's not as critical as it is for some of the pure Fixed Income houses.

I think it's a shame Prince never got a chance to show what he could do, he's been fire-fighting since he took over.

Oh, Mr Peston, You do disappoint me !

Surely this was your 'golden opportunity' to use the banner headline..

"Citigroup Prince gets Chucked.."

I wonder if Eric Daniels is glad he got out when he did, or is angling to quit Lloyds TSB so that he can 'help sort out their problems' having been a reasonably good 'troubleshooter' after the wasted years of Peter Ellwood.

Time will tell..

Well, the collective description of a group of bankers is a Wunch. The older term was Usurers. Banking has never been an honourable profession.

You really need to learn how banking works. Where our money really comes from. You have to understand the nature of money and banking to even begin to understand the other problems we have.

I recommend Murray Rothbard's "What has Government done to our money?". It's from an American and libertarian perspective, but it applies just as much to the UK. Google will tell you where it is.

Then, there's the "Debt as Money" animated video on Google video, an easy to understand introduction to banking and the monetary system we currently use; "Fractional Reserve Banking", or you could look it up on Wikipedia.

If you are of a rather paranoid or conspiratorial mind you could watch the 3 hour "The Money Masters" video on Google video.

'Bubbles' Greenspan is on record, while still chairman of the Fed, as saying that deflation is not an option. The Fed will simply print money till the cows come home to inflate away everybodys paper debt. And so will Gordon Brown and his 'mini-me' puppet chancellor.

In the UK this will have the effect that GDP will continue to rise (suuure the paper is worthless but the number will increase) thus meaning Brown will still be able to boast of increasing GDP's no more boom and bust longest continous period of growth .

Meanwhile millions of low-wage jobs will disappear as the great british consumer stops buying new cars, white goods, foreign holidays, takeaway Pizzas and all the other ways they've indulged themselves in the last decade of easy money and rampant house-price inflation.

The jobs that won't be disappearing however are the million or so massively overpaid Labour voters recruited with borrowed money since 1997. Dame Shirley Porterwas hounded around the globe for using tax-payers money to buy votes and yet when it's government policy it's somehow okay. And the rest of us will still have to find the money to pay for them even while they stifle our economy and slaughter us with MRSA.

Our house is currently under offer but I have no confidence at all in us getting to completion. The buyer will surely see the writing on the economic wall and decide now is not a good time to be taking on debt. But even if we do complete and we plan to move into rented accomodation I am most concerned that Gordon Brown will simply 'do a Mugabe' and print enough paper to render a lifetimes savings as worthless.

Damned if we do and damned if we don't.

3 years ago Citi changed in management direction, Sandy Weil was forced out, his groomed successor, Victor Menezes, also had to go by the unwritten rules. Shouldn't there be some examination and accounting to evaluate whether the Menezes team would have followed a different guidance path compared to the present team who landed it into this huge rose colored gamble and lost?
I doubt Memezes whose strength lay in international banking would have lead down this path.

Robert

As I read the blog I am increasingly reassured that you bring thoughtful objectivity to the issue.

Equally, I am horrified by the prejudice and old fart smugness of some of your correspondents (and I'll not see 60 again myself).

The error lies with banks not making proper risk assessments and allowing themselves to be caught up in the market. You can't imagine the sage of Omaha being suckered this way - perhaps he ought to be an NED on all bank boards.

But then, both in the UK and the US, the climate of easy credit has been both tolerated and encouraged by government. Despite being a good Thatcherite by inclination, I still recognise that there are many innocents out there and letting the free market have full rein has been unwise at all levels - for business, the country and individuals.

Difficult for our government to criticise dodgy financial dealings when its racking up tens of billions of PFI debt which are mysteriously allowed to appear off-balance sheet.

To Mark at 31:

I agree completely with you about all the troubles we face - however, if an established bank like Barclays (for example) goes into insolvency, there won't be enough money in the Treasury to prop it up. That means that anyone who gets paid their wages through Barclays will not get paid. No one with any savings with Barclays will be able to withdraw their money.

How much hard cash do you have on you to buy food?

The insolvency of a major bank (or banks) in this country would be a catastrophy. We, as a society, have allowed ourselves to become so ultra-dependent on banking as part of our everyday lives that literally nothing can be bought or sold without the banks being involved.

I recently withdrew several thousand pounds in cash from my bank. I HAD to tell them what I was going to spend it on before they would allow me to have it! Plus I had to fill in a lengthy form. I was so taken aback at the banks demand to know what I wanted the money for, I said it was to buy copious amounts of alcohol, heroin and prostitutes, to which the girl behind the counter said' No, really, what's it for?"!! I had to tell them it was for a car purchase before they let me have it!

It's currently under the mattress awaiting the financial armageddon.

Mark,

It would be naive to consider Sub-Prime a US problem.

As you have seen it has (and has had) far wider implications for the Global market.

Firstly, how banks thought it a good idea to indirectly lend to persons that ordinarily would never have got a loan through a direct approach is beyond me. A basic banking error, when you lend, first question is how will I get my money back?

Secondly, I think that the whole thing needs to be put a bit more in perspective. In part, these "write-downs" are simply changes in the current value of loans that have to be valued at market and whilst there are many, many poor loans, many others are still "performing" so not all of the current market "losses" will bear fruit over time.

The reduction in profits that these write-downs have an impact upon is a paper number for the taxman, not necessarily a real cash drain. It could be some of these tarnished loans are valued upwards again - certainly not in the near term but as a longer term "hold to maturity".

Look at the "pension crisis" in terms of funding hole from corporations. How bad did this look say four or five years ago even to today? How will it look in say ten years?

Keep things in perspective, is this really a long term doom and gloom story or will it all be forgotton in five years or so, until the next financial crisis?

The car crash that is Northern Rock has quite a long way to go and I wouldn't be surprised if one A Darling is stearting to sweat a bit.

If no one is bidding for NR now, who is going to bid when the debt to the treasury (at 6.75%) has built up to 拢50 or 拢60 billion or more?

The Northern Rock mortgage book may overall be 100% backed by the value of the security, but if one half of the mortgages are 125% of the value of the properties, and the other half are at 75% of the value, then there is still a 12.5% deficit on the book. And if property values drop, then that loss increases.

Martin,

You are doing great work. No skittish bank will be able to stop you. We are all in for a tough time. You have the determination and foresight to get through with flying colors. Hang tough.

Jim

A run on Citigroup? Maybe not.

It's a downturn, triggered by a different set of events than the last, but a downturn nonetheless.

IBanks are taking the hit now while performance generally remains good so that they will still demonstrate earnings when times are bad.

Executives who would have in any event gone are jumping while their packages remain valuable.

The wonderful thing about cyclical events is that they happen again and again....

Who Is Next to Fall.....

Robert

To steal a quote from TV (who Micheal Palin stole from a friend); "you can't polish a Turd".
But if you can you want to make sure you don't get covered in it. Hence the unwillingness to lend.

Why not just reduce interest rates, or "re-engineering" payments so people don't lose their homes....it would probably work out then but of course the banks wouldn't make a much profit.

It feels like the banks have been playing poker...and someone has to lose...the problem is everyone gets to pick up the pieces while they recieved record bonuses last year...feels like 1989 all over

#32 Martin.... Well it will interest you to know that I recently completed some work looking into UK investment in clean technologies ... Not the financing of a windfarm type deals but the investment in the wind technology..

The UK is just about bottom of the pile in Europe and zillions behind the USA.

But it's OK because the City financial engineers have made huge amounts in commission from carbon trading and other such worthless activities.

Parasites my friend is too kind a word.

The next few months are going to be very uncomfortable as this sorry story unravels. As many have already pointed out the write offs announced so far are small fry compared to the overall amounts that will surface once the derivatives situation is understood better.
I'm not sure what the overall impact will be but am certain that my pension funds (sadly includes Equitable Life) will take another hit due to some highly paid people being incompetent and not understanding (or maybe not caring) about the risks they were taking. The lack of faith, and Gordon Brown's raid in 1997 which continues today, in pension funds partly enticed people into buying 'buy to let' properties. A nice mess.

I can't help to think that not soo long ago "off balance sheet" deals were raising eye brows with Enron and there was a smelly odour of dishonesty lingering. I believe the scent is getting stronger.

Message 37,
Matt, you beat me to it!
Oh how I long for the days of responsible lending.

Obviously subprime lending works (in financial, if not ethical terms) as a long as the housing market is strong. After all, it is a secured debt.

If house prices rise by 10% per year and someone stops paying after 6 months then the security is worth 5% more than was paid for it, and the purchaser has been paying a higher rate of interest and other fees.

The real problem occurs when there is a dip in the housing market.

For years the media have alarmed non-homeowners about the record increases in house prices - panicing people into over-stretching themselves to get on to the housing ladder at any cost, scared that if they leave it any longer they will never get on the ladder.

For the moment, the media has a fairly luke-warm stance on the state of the housing market, reports of slow downs here and strengths there.

But if the media were to turn in support of the idea that there is going to be a crash, coupled with lenders tightning up their lending procedures, then a crash there will certainly be - as some people wait for prices to drop, whilst others who still want to buy are prevented from doing so by stricter lending policies.

If that happens then the lenders will end up with a portfolio of repossesions they either can't sell or have to sell for less than they lent.

In a country which increasingly doesn't make or own anything that has become increasingly dependant on financial services and housing wealth to pay for an ever growing stream of imports, it could be very worrying indeed.

To Matt> Number 47:

One of the main problems is that the house prices are grossly inflated and just not worth what valuers say they are. People stretch themselves to get a nicer property, and lie about their income in order to buy a decent home in a decent area, then expect outragous house prices when they sell them. We need to build more decent, affordable housing, and banks and bulding companies need to stop being greedy and hiding behind "in the interests of our shareholders'

Capitalism is creaking. Barclays is wobbling, The stench from the Northern Rock is getting worse. Go for gold and batten down the hatches.

When greed is rampant and the herd instinct is driving this greed,any common sense is driven out of the window.No one looks at the big picture because it shows that ultimately the sums just did not and do not add up!
It takes a while for it to show at grass roots.
Well its showing up now with neon lights attached.
"Profit is finite"

Mr Peston I have become an avid reader of your writings over the past few weeks and have found them both illuminating and entertaining. Thank you.

I would find it fascinating if you were to devote one of your pieces to an analysis of a financial institution that has adopted a sensible, prudent approach that has meant it has steered clear of significant exposure to all this dodgy stuff. Obviously lots of banks have yet to declare their hand - but is there anyone out there who is looking justifiably smug?

At the moment we are focussing on the losses from sub-prime in public institutions in America because they have auditors and report quaterly. However British and Continental banks hold similar loan packages and there is no doubt they will have to report similar write downs in due course. That leaves the hedge funds many of whom are based in tax havens with minimal reporting requirements. They probably own the majority of the CDOs and CIVs etc and are hoping that the problem will go away by Xmas. The wealthy and sophisticated investors who clamoured to buy into these funds will have to wait a long time to get their money back.

Mark Bostock, please post up a website address if possible, the idea you have is a lot more interesting from a pensions standpoint than the investments in "traditional" financial firms which appear to be bent on money creation rather than wealth creation...

Question for all.

Do the banks have gold reserves and theoretically could the massive gold rise in the price of gold save the banks from insolvency (providing the losses are as big as some of the posters claim)

CHARLES PRINCE IS NO VICTIM. HE HAS GAINED FROM THE BIG FAT BONUSES AND OTHER REMUNERATION ARISING OUT OF THE ACCOUNTING ENGINEERING THE BANK HAS CREATED IN THE PAST. HE SHOULD ASK TO REPAY THESE NOW

Its hard to tell the difference between busted consumers using multiple credit cards to revolve their debts and global financial institutions rotating CDO and CLO tranches between their prop desks and hedge funds.

Only difference is that the man on the street doesnt get a multi million dollar payoff when he is caught naked

to #12 - I know a couple of people who've borrowed significantly high multiples of their salary - as high as 8.5x in one instance, at 99% LTV. These aren't people with poor credit histories or low pay, but well paid young professionals struggling to get on the housing market within 2 hours of their work.

Boards have no incentive to be cautious in lending. Everything in the financial markets is about growth regardless of how it is done or the long term consequences. Only when boards are punished heavily for bad management rather than given large payoffs by way of compensation, will there be any change in their behaviour.

Matt Birchall; Sub Pime has nothing to do with the % being borrowed or the deposit being laid down it's simply the borrowers credit history which detirmines if they are Sub,Mid or prime borrowes. I am sub prime borrower myself, I earn good money and work in the financial sector actually managing CDO's. I previously had poor credit history from the days when I ran my own company which wasn't doing so well so I accept my sub prime status. I put down a 20% deposit which I saved and borrowed x4 of my wage, I easily afford my repayments so what is wrong with that?

If people like me could not borrow x4 of there wages the rich people would buy the houses and the rent back to us meaning the rich get richer and the poor will have no assets until inherited and then the tax man will take his large share!!!!!

I must admit that recent fiscal events have turned my blood to ice.

Imagine then the joy I felt on hearing our great Chancellor stating with much sang-froid that "We have a strong economy, its momentum will carry us through."

I gathered the whole family together so we could all listen to a repeat of the Today programme this morning.

Our French au pair was the most impressed and has coined a catchy phrase for our children to repeat at school - merde tr猫s profonde!!!

Happy days are here again!

Keep up the good work Robert.

Banks have acted like insurers with their massive sub-prime debt portfolios. They have repackaged these and then spread their risks globally.

In the insurance market, this activity is called re-insurance. Lloyds of London is the daddy. When natural or man made disasters arise (Katrina, Tsunami, Piper Alpha (for those old enough to remember) and others) the insurance market dips into its Solvency Reserves to pay for this. Yes, the insurance market works in three year cycles, but the point is that insurers' business models "plan for failure" and can stump up when needed.

Bankers however, should "price for risk". They have done so, but they appear to have failed to "understand the risk they are pricing"! Banks also carry the minimum amount of solvency reserves (according to Basel II rules), unlike insurers of course. Therefore, the scales of losses being now disclosed by the major banking groups is not a surprise.

Regulators are toothless here, as they themselves are struggling to cope with understanding the complexities of these new collateralised securities being traded. If they don't understand, it's no wonder Joe Public is flummoxed. Yet, Joe Public and his family will ultimately pay for failure, either as a stockholder or depositor (despite all Government assurances - the Government cannot underwrite an open cheque book for us all).

The more worrying aspect of the credit crunch this year, is that it is 2008 when it bares its teeth to everyone in full glory. Who knows how this will be dealt with. We just have to wait and see. The BRIC's (with large currency reserves) are speeding up their steady bail out of US Dollar T-Bonds and currency and into stronger currencies and solid, cash earning stocks. Hmm, trouble's comin for he US, and then onto Eurozone!

My Anderson shelter is being prepared!

I live in Ireland (belfast) and property has become so overvalued recently that something had to happen, there are houses for sale beside me which have been on the market for months. Whats happening in the US is very scary and i suppose the real tragedy about this is that a lot of decent hardworking people got sucked into/had no option but get one of these mortgages, and a lot of families are going to end up on the street because of this in the US the UK Ireland wherever, never mind about investor(most of them are banks and financial instutions anyway)losing out.

Funny how every post to this blog returns to Northern Rock. I will repeat my call to Mr.Preston to write an entry explaining NR's funding SIV , Granite Master Trust. Just check out the teams of highly paid lawyers who claim credit for this "innovative" funding structure. I am led to believe that NR stumped up over $1billion to a US investment bank aspart of Granite and their innovative techniques - no wonder Lloyds walked.
The problem with credit derivatives is that they promise that risk can be dispersed by spreading it thinly enough, a good concept but obviously the risk is still lumpy if the likes of Citi and Merrill can lose between $8-11billion and don't forget that the sub-prime in the US has not yet reached the bottom, the majority of the most recent, (and presumably most speculative), mortgages reset next year. Barclays is being nailed because Barclays Capital has quietly set itself up as one of the biggest hedge funds in the world and has sed the clout of its domestic retail presence to increase leverage for other less fortunate institutions. Like citibank it is a car crash waiting to happen. I would also like to ask Mr.Preston to explain the role of credit derivatives, you see banks don't just blindly lend to companies, even in the days of easy credit, the CDS market allowed them to buy protection in the event of a default or credit event. the problem with this market, which has spiraled to $50trillion, is you have to rely on the writer of the CDS to make good the payment, so really you have just replaced credit risk from one party to that of another.

#57 has just about got it.

however, let's not forget to mention that there are increasing inflationary pressures such as oil/fuel, food and other commodities on the UK and US economies which are decreasing the room the FED and BoE have to make intrest rate cuts. Their interventions in early September also have inflatonary consequences. These institutions will not be able to be the white knights, slashing intrest rates and so prop up housing markets.

Mr Peston.
Is the tsunami analogy taken from the FT article 'What's the damage?' by Tett and Davis yesterday?
For other readers the quote was 'such a tsunami of red ink would undoutably be shocking at any time.' In isolation not the most assertive point!

Ben:

"And just for the record, some people need 100% loans as salaries have not moved anywhere close to house price growth."

Just for the record, Ben, you actually have it backwards: people being given 100% loans has been a major contributory factor to house price growth running far ahead of wages. If you expand the quantity of cheap credit available, all that will happen is that asset prices will increase. People often think that the "demand" side of the supply/demand equation relates to how much people want something. Crucially, it also involves how much money people have available to pay for it. Forget divorce rates and immigrant numbers: cheap credit has been the single most important factor inflating this house price bubble. When the credit disappears, so will the ludicrous prices, and Britain's true "wealth" will be plain for all to see. Count on it.

Are the rating agencies helping the cause?

CDO's are structured in such way that if an asset is downgraded it has to be marked to market for the puposes of overcollaterlisation tests, if you fail these tests interest will be diverted away from all noteholders and is paid to the super senior investor to reduce that liability/notional value.

Diverting the interest away from junior holders has knock on effect to other investors CDO's as they will then begin to fail tests.This is a vicous circle and is all down to the huge amount of downgrades on ABS debt which is out of control.

As long as the underlying homeowner is paying there mortgage then the concept should still work, perhaps we should look into refinancing the failing mortgages before crippling a market with multiple downgrades.

Matt,

I work for a bank and please dont tell me what a sub prime mortgage is in the context of this conversation. Call it specialist or sub prime or whatever you want 100% plus lending does not fall into any of the brackets. Go ask any high street bank and they will agree with me.

Thanks

Ceri,

that means my generation will pay for the short comings of those before. That was my point, I can not earn enough to buy a house, regardless of how we came to this situation, it will not help me get on to the property ladder.

Robert, I've said it before and I'll say it again. Alistair Darling and Gordon Brown have come out and said we need more transparency and openness so that people understand the risks. How to achieve this? The government issues banks with a bank licence in order to carry on business as a bank, and supervises licenced banks for compliance with the requirements, responding to breaches of the requirements through obtaining undertakings, giving directions, imposing penalties or revoking the bank's licence. Following up these requirements is well nigh overdue.

Interesting piece about ratings and how the agencies got it wrong:

"Joseph Mason (Drexel University Finance Professor and co-author of a paper in Feb 2007 outlining how lack of transparency in Collateralised Debt Obligations, combined with deteriorating mortgage lending standards, could lead to a broad market collapse) was asked in the September edition of Credit:

What percentage of the market do you think should be downgraded?

A great deal. Much of this market did not warrant triple-A rating to begin with.
How many sovereign states deserve a triple-A rating on their debt? 27.
How many US corporate firms receive a triple-A rating on any of their debt? 67
How many municipalities in the US can receive a triple-A rating on their debt? 160.
How many residential mortgage-backed securities receive a triple-A rating on their debt? Over 8,000!

So how much of the ABS CDO market do you think should be downgraded?

I would not be surprised at all to see that number go above 50%"

Ouch

As someone in his late 60's (and still working, in manufacturing) I often read Robert Preston's articles about the happenings in the finacial markets and generally speaking I find them both interesting and informative. Many of his comments clearly shows that he has a good grasp of finanacial matters and in particular, what is happening in the financial markets/"city".

However some of the jargon he uses to describe what is happening in these areas appears to be the same jargon used by the "city slickers" describe (or conseal) some of the more questionable practices that go on in the financial markets. As far as some one such as myself can tell these practices have not been designed to make the businesses more financially secure, instead they are being used to over state the financial institutions performance figures, simply in order to over inflate the traders bonus earnings, and didn't many of them do well.

To my way of thinking that is just plain dishonesty and should be regarded as such.

Subprime losses could be atlast $100 bn. So far banks have disclosed 25% of potential losses.I guess bulk of their losses are hidden by their dodgy accounting practices.

What does it matter what name you give a loan. There are loans on which the payments are being made and there are those on which the payments are not being made. Bundle the latter in SIVs how you like and only fools or the ignorant purchase them, or should have purchased them. Blame the credit ratings agencies if you like, or those so greedy that they believed that the normal rules of common sense have been suspended.

The way ahead is the sanguine, unemotional appreciation of the possible and probable outcomes and we should look to support only the institutions that display an honest appreciation of the pickle they have created. We and they have many historic examples to learn from after all!

The 'duty' of the politician, and indeed the financial journalist, is to bring comfort to the injured in a time of battle to do otherwise is irresponsible. An honest rendering of the 'facts' can do us all harm (see Northern Rock). If you cannot say something nice, say nothing. I advise a period of introspection and reflection, whilst the bankers sort out the mess they have created and we quietly construct a more robust system of checks and balances (and probably a remuneration system that does not overvalue risk taking.)

The problem with these complex credit products is two-fold.

Firstly the traditional lending model had built-in checks and balances. If you lend money to someone, and they can't pay you back, you lose the money. The new lending model does away with those checks and balances because having lent to someone you simply sell the loan to someone else, pocketing a slice of the proceeds.

Secondly these complex credit products work on the basis of correlation, namely the idea that the conditions causing one borrower to default may make it more likely that another will default. Trying to objectively calculate the correlation across a range of subprime borrowers is nigh on impossible, so a best guess is made. A low number gives the senior tranches of a CDO a nice high credit rating, but when reality bites the realisation that correlation is actually very high dawns, and everything goes south.

The third problem, of course, is the way the financial sector likes to say things like "Past performance is no guide to future performance", while pricing structured products based on historical correlations.

My prediction remains the same as for the last couple of years, things are going to get much uglier than they are now.

Interesting that the majority of the blogs blame the banks and/or the system...

what about the idiots who assumed debt way out of proportion to their ability to pay (assuming the rising real estate market would cover them)...

they were talked into it by greedy, unscrupulous salesmen (are there any other kind? dont we all know this by now?). If you went looking for a cheap used car but walked out with a new Jag and huge monthly payments--who would you blame--the salesman?!?

M

Who cares what happens to the economy ?
The mega rich don't care..they will survive either way.
The poor aren't even aware,they're too busy watching X Factor and Celebrity Dancing on 大象传媒1 (dumb down TV).
They have nothing to lose.
The middle/working class,PAYE taxpayers saver ...you're going to get screwed again..big time ... and end up poor.
When you're house is worth less than 50% of what you think it's worth,see how well off you feel.
My advise..do what many businesses do using the Laws of Limited Liability.
Borrow as much as possible.
'Lose it'.
Go Bankrupt.
Then spend your stash abroad.

So couldnt 大象传媒 economist throw som light over the CDOs.

Isnt that a fairly new "invention" or "product" whatever these monglers call them ?

Hasnt there also been some sane people questioning the nature and virtue of these (the CDOs that is) ?

When did they become leagal? By what means, how did it happen ?

I have always found banks very strange when it comes to lending because they don't evaluate the lending risk. The emphasis is always placed on the risks associated with repaying the load, such as job security, family stability and income multipliers.

When the proverbial hits the fan the most important aspect to the lender is the value of the underlying security.

A 50% mortgage to someone on the dole is not a risk - the lender liquidates at a fire sale valuation adds on some super inflated costs and actually makes a good profit...

So the emphasis on sub-prime borrowers is misplaced... The emphasis has to be placed on high mortgage percentages, say of 70%, 80%, 90% and even 100%.

And these high percentage mortgages have been given to prime and sub-prime borrowers alike...

So don't just worry about sub-prime mortgages... its the whole lending industry that is balanced on the edge.

The other interesting aspect of the current situation is that in the US the Federal Reserve has finally had to admit that high interest rates cause human suffering and damage the economy. The powers that be can no longer go blundering around blinding tinkering with interest rates... At long last Central Banks will now have to be responsible when they manage interest rates...

And if we look at the US it seems we are moving back to using Exchange Rates and Printing Money as the main levers which can be used to manage the economy...

So reckon we will have to look to inflation and devaluation to get us out of this one... And again the Americans are showing us the way...

So it won't be too many years before we get back to four dollars to the pound and we can then all buy a Florida retirement home...

About 15 yrs ago Barclays Bank 'wrote off' about 拢700mill that it had lent to foriegn governments that for one reason or another had met their end - many of these were dictators supported by the US.

The customers and shareholders of the bank had no say and eventually we all started talking in billions and those fgures seemed small - here we are again!

Major bankers are talking about uping the ante on the good customers- namely we who pay our bills to pay for their mistakes!

Isn't it about time that governments - including Bushe's administration and Brown admit that their financial controls are inadequate and it is their fault that unbridled lending by bankers leads always to this type of financial collapse.

Perhaps those in charge should take the strain this time and help those poor families forced to leave their homes because of their mishandling of the economice of running the country.

You have to house people one way or another so why not bite the bullet and keep those people in their homes, their communities together and the homes intact until it can be sorted out - one way or the other society will pay anyway - surely this would be best?

In reply to post 37

Eric Daniels is welcome to go back to Citi from Lloyds TSB.

The Lloyds share price has been stagnant for all of his time their.

He has sold of some assets at cheap prices and then done nothing with the profits.

He has added no value but negativity.

Comment 42 : John Simmonds : 12.24PM

"... The error lies with banks not making proper risk assessments and allowing themselves to be caught up in the market..."

Did serious, prudent bankers really have freedom of action over whether or not they chose to participate in the greatest money-making wheeze the financial markets have ever seen? No, of course they didn't. No bank board was going to be allowed by its shareholders to walk away from the chance to make easy mega-profits in the short-term; no matter how much the board recognised these profits to be completely illusory and bad business for the bank over the longer term.

I actually think it all goes deeper than CDOs.... In my most paranoid moments I can see a direct link between the actions of the banks and other lenders and the increase in house price inflation.

Lending people four, five or six times their salary was to enable them to sustain house price inflation in order for the lenders to make larger and larger margins. In short there was collusion between the property developers and lenders. Indeed one Scottish Bank actually bought into or bought over a developer last year which I thought smacked of market manipulation..

The Govt/Boe also colluded in this scam.. By not allowing the BoE to include house price inflation in its calculations interest rates have been far lower than they should have been.

But then the margin on a mortgage when interest rates are low is actually higher than it is when interest rates are high. So it was in the lenders interests to ensure Gordon Brown kept house price inflation out of the equation..

I'll go and take another anti paranoia tablet but I remain convinced there is more "merde profonde" surrounding this saga than meets the eye..

*rattles, in a most presbyterian fashion in grave*

Conceptually the repackaging of asset backed debt is not the issue; the premise of such exercises remains entirely sound - there is still an appetite in the international market for such assets, but I suspect now forever more only where the underlying asset pool is strong and performs without credit enhancements.

Flawed macro-economic policy and angolphone societies in which few live anywhere near their means (in no small part due to the aspirational values espoused by the mass media) are the issue. Societal pressure to borrow and consume without resort to rationality is what has driven this crisis. With so much staked all it takes is a little bit of "invisible hand" wobbling the markets and it's "Alice in Wonderland" time.

I blame Milton Friedman. He never understood me.

Post #90, referring to high LTV levels, makes a good point although misses the obvious aspect that sub-prime borrowers are unlikely to have significant funds with which to make a down-payment. If they had these funds they would be unlikely to be classed as "sub-prime".

Yes asked, earlier:

'"So couldnt 大象传媒 economist throw som light over the CDOs. Isnt that a fairly new "invention" or "product" whatever these monglers call them ?'

There was a very good article in the Financial Times last year ("The Dream Machine," 26 March, 2006) dealing with the brief history of credit derivative products. Worth a read.

Poster #90 is almost exactly right for almost exactly the wrong reasons. Of course banks should concentrate on repayment ("performance") risk - believe it or not, a few levels below Charlie Prince, Stan O'Neal and co are a lot of lending bankers who work hard at building relationships with their clients and would prefer to see their loans repaid through profits and cashflow than by enforced realization of collateral, profitable or not. Those that don't get pilloried by Peston and his mates for "irresponsible lending" (exactly the scenario you suggest by giving someone on the dole a 50% mortgage).

Lending ratios ARE important, even critical, but not for the reasons you suggest. It's important for the borrower to have a stake because that provides the motivation for the borrower to keep up the mortgage payments/make a success of the business/whatever the loan is for...without that, the borrower can walk away without losing a penny and oh look! Here we are back at "moral hazard"...

But moral hazard cuts both ways. Loans where the borrower has no personal stake tend to go bad. Loans where the LENDER has no stake are equally perilous and poster #86 and other hit that particular nail on the head very eloquently. CDOs in the highly-leveraged market, by creating an instrument that often neither lender nor borrower has any major personal stake in, are just plain toxic.

Citigroup could very well be able to turn the page to a happy story now that Robert Rubin is at the company鈥檚 helm. Today鈥檚 NewsVisual article maps out his experience in a very lucid way.

Yet again a comments regarding northern rock are made on a blog that doesn't concern the bank! People are obsessed.

FYI Post Number 47, Northern Rock's mortgage book has an average LTV of 57% so your calculations are totally incorrect.

Also NR have not borrowed the 23 billion that is misquoted, the new chairman has confirmed it to be somewhat lower than 拢20 billion, so where is the rest????? My money is on barclays! But they wouldn't want that publicised would thay....perhaps Peston has his accounts there!!!!

CHIU KIN YUEN #65 - 99% of the population agree with you.

What percentage does the princely package represent of the Citi write off - about half a per cent !

To anyone who says that's not much

- what percentage is that of Citi's annual dividend ?
- what percentage will it be of Citi's coming cut in its annual dividend.....?

Chuck - hand in your bonuses and the rest of your package now, or at least stop bending the meaning of the word 'honourable'.
Alternatively, follow the old model and keep going 'til there's a riot.

Interesting, this. Everyone seems to think that someone else is to blame.

As a thirty year old single teacher, I'm not sure whether I want to buy a house at the moment (even though I have key worker status) because, rightly or wrongly, I feel the housing market is overpriced.

I remember first looking at houses 10 years ago when the prices were perhaps 75% lower than they are now (I don't know what the real increase after inflation would be).

Since then the market has flourished as it has become an investment market (made possible by the invention of the protected shorthold tenancy). Historically, land is a good investment. But property detached from land (e.g. a flat) is not something that has existed for very long at all, and leasehold cannot be regarded as a good generational investment (999 year leases aside, perhaps).

Here's the thing that bothers me: is living in a tiny flat by myself worth the premium I have to pay versus sharing with family in a small house? If it is not, the bottom of the housing market is overvalued. Many people buy houses or flats at the moment because they are sure the property will go up in value. Surely that is the very definition of a bubble. This bubble is based on the easy availability of credit for buying houses. Is the bubble about to burst?

In other words, if I buy a property 鈥� or a share of a property 鈥� am I going to find myself landed with a monetary debt (to the bank) which cannot be covered by the cost of the property (i.e. the horrible negative equity) because the property price has been unduly inflated by a surplus of cheap credit (from the banks)? Do others worry about these things? Should I just buy shares in the banks (who would seem to win in the long term anyway)?

On the other hand, if this is just a blip and property prices continue to rise I may never ever be able to afford to buy a property.

I have little sympathy for the banks or their shareholders here. The banks make huge profits as the cost of housing rises, so their priority is to ensure that prices keep rising in the hope that someone else will clear up the mess when things go wrong (and it's a fool's game to try not to be holding bad debt when it starts to stink). Simultaneously the financial sector's meddling with the housing market (or any other sector) in order to sell profitable financial 'products' muddies the water to such an extent that an ordinary bod like myself cannot possibly work out whether it is financially worthwhile to enter that market.

Consequently, we have to seek advice from the financial institutions (banks).

So should I try to buy a flat? (I can't even think about a house!)

I'm sorry, but all you blame the borrowers need to realise that 97% of all our money is credit.

It just isn't possible any more for our economy to function without huge and increasing levels of borrowing, public, business and personal.

The monetary system would have to be reformed so that money could be created without debt.

Greed kills, and every so often, the banking types are reminded of the truth of that axiom. Remember the S&L debacle of the 80's? How come the guys with the MBA's keep forgetting basic stuff, like valuation, and what a bubble is?

Hopefully, Washington(especially Congress) will allow Citi and Merrill to take their medicine. The profitable bits will be sold at a profit, and the unprofitable parts will be sent to a fire sale.

And, maybe, just maybe, we'll all learn once again the virtues of banking locally, with the people whose kids go to school with our kids, who sit on the same church pews with us, and whose fortunes are tied to how well we all do here at home.

Uhhh #90 it is because of low interest rates and wrong inflation calculation(i.e lower than what it is) that this credit crisis has arisen. What the Fed needs to do is to maintain relatively high interest rates over the next few years. Otherwise it will only encourage Wall Street to do more of the same. Clearly this is not going to happen what with the precedent Greenspan set during the last recession.

Robert, any concern for an average wage earner like me who deposited almost all his life savings in Citibank? Many thanks and god bless.

hi, this is all very frightening stuff! what does this mean for current employees of citibank/financial? any ideas?

Ben, in posting 102 my advice is simple don't buy now wait 12 months.

There are thousands of unsold flats in big cities that have been vastly over priced and now can't be sold. Just look in your local papers for all of the ads offering incentives to buy them. Two years ago many developments were being sold out off plan.

Many of those who paid over the odds to buy to let will soon be hit with a knockout blow as they get hit with a double whammy.

1) Rental incomes are falling on flats in particular as the swing to excess supply continues. Simple economics will confirm this.

2) As fixed rate interest deals on interest only loans come to an end the speculators won't be able to refinance on anywhere near as good terms and the whole economics of buy to let on new flats will fall apart. There will be a rush to sell to cut losses.

If I was you I would find a good regular savers account (some are paying up to 10 or 12% for investments up to one year) and sit it all out for 12 months.

what i simply can't understand is what this Bank's highly paid (presumably) credit risk staff were/are doing and how they failed to spot this.

We keep hearing that these assets are difficult to value. The truth is that they can be fairly valued - just the amount is too uncomfortable for the banks to handle. They should come clean now and then we can all try to move on. They will face this soon anyway when the auditors come in.

For those who think this is a 1-200bill problem, think again. The greedy Inv Banks have really filled their boots on this lot. This is only the tip of a rather large iceberg and dont beleive these so called write offs are what they are called. I suspect all they are are lowered earnings forcasts against forward booked fees etc derived from churning over this toxic pile. The real damage cant be known until the current mark to make believe situation changes meaningfully. In the meantime, we can all expect commercial lending costs to skyrocket (if its available).Unable to cheaply hedge against default, I dont see banks offerring up dosh like the good ole days.

**

According to the Bank of International Settlements, the OTC market for Credit default swaps (CDS) jumped from $4.7 TN at the end of 2004 to $22.6 TN to end 2006. From the International Swaps and Derivatives Association we know that the total notional volume of credit derivatives jumped about 30% the past year to $45.5 TN. And from the Comptroller of the Currency, total U.S. commercial bank Credit derivative positions ballooned from $492bn to begin 2003 to $11.8 TN as of this past June. It today goes without saying that this explosion of Credit insurance occurred concurrently with the expansion of the riskiest mortgage (and other) lending imaginable. It鈥檚 got 鈥渃ounter-party fiasco鈥� written all over it. The inability to hedge rising default risk has become and will remain a major systemic issue.

These follies will continue until we apply some old fashioned "retributive justice" to the world of finance.

If we want this nonsense curbed, it鈥檚 time to stop larking around. The magnitude of the punishment must be seen to equate to the severity of the damage caused. "Stepping down", "resigning", and "considering my position" is all very nice, but it鈥檚 not much of a deterrent when there are millions to be made.

So let鈥檚 go after these guys with a big stick and make an example with them. I鈥檝e got plenty of ideas for suitable chastisements 鈥� just let me know if you need any ideas!

well perhaps i'm the only one but does this seem very similar to the savings and loans debacle that happened at the end of the 80's along with the Junk bonds and all that hassle. do we never learn. perhaps the central bankers should govern these markets more effectivley.....my heart is not bleeding for these large banks, although it's always the least able to bear the fallout. 2 million extra homeless in the usa is a scandal.

I can't help thinking that talk of a "credit crisis" is overstating things. Sure, some people have lost money, and a few have lost a lot of money, but is there really much of a knock-on effect on the wider economy?

The reason why I think this is this: just look at the FTSE. Sure, it's lost a little bit of its value over the last couple of weeks, but really not very much. Nothing approaching a crash. Doesn't that suggest that the majority of traders think that things are still ticking along nicely? Or am I missing something?

Ian, (post108), You are fairly accurate with your numbers, it is generally assumed that the CDS market is $50-55 trillion, which represents bets made on a notional outstanding $7-9 trillion in real bonds. The question is why did the market grow so quickly, the answer is of course greed. The spike in CDS trading happened shortly after the introduction of TRACE. For people not in the business, TRACE is a system that was implemented to record every bond trade. What this means is in the past an investor, be it a pension fund or high net worth individual would phone up an investment bank for a quote on a bond it wished to buy or sell. The bank would quote a price and if it read the customer correctly it would make a wide spread, (difference between buy and sell prices) This resulted in fat profits for the bank and large bonuses for the trader. TRACE enables everyone to see the interbank spread so foolish pension fund managers can no longer be ripped off by the investment bank. The result - investment banks slashed their fixed income trading, sales and research desks and started trading credit default swaps, which have no real reporting system and relate only casually to credit default indexes.

The whole issue of CDO's has the awful stench of the LMX spiral about it.

For those too young to remember or not involved in specialist insurance markets the LMX spiral was a means by which insurers looked to pass on risks they weren't prepared to take on to other companies. Poor risk controls meant the true extent of who held the risk was lost until a disaster struck. Many insurers and reinsurers found out that they had ended up being left with some of the very risks they had looked to reinsure away in the first place.

In the case of the LMX spiral it was the Piper Alpha oil rig explosion that provided the tipping point.

Of course every time the risk went round and up the spiral the brokers and middle men took a commission so in the end there was very little left to pay the claims.

Sound familiar to anyone?

There are people that have made millions in bonuses and companies that have made billions of profits over the past few years in this Emperors new clothes charade called the CDO market.

Like any Ponzi scheme it works fine until people want their money back.

Here I am in San Diego California where the average house price is (or was a couple of months ago) $550,000 USD and the average income here is $45,000/year USD. Well, d'uh that is asking for trouble, banks need to value housing based on income in the area not "what the market will bear". I fear that we are losing our middle-class and will soon be a 3rd world country.

I'm afraid those of us in the English speaking world (I'm in the US) are in for a rough ride. What is it about us and debt? Is there a something about our language that makes us think we are more credit worthy?

Absolutely right. Yes, you can sell merde, loads of it. And Citibank has experience. Remember the Argentinean Crisis? They all sold the Argentinean convertibility merde. In Argentina, it was the retail depositor who paid the price. In the US, employees of the Enron's & World Com's merde factory. Brilliantly done with a Master Degree, a fabulous lifestyle and political connections.

The Banks are largely to blame and the biig cats that took huge bonuese out for all the business they did should now pay it back because business that cost you moneyis not good buisness and should not be rewarded.

Secondly, as an Englishman who has a home in the uS why don'y Ammericans look inward. You are fighting a war at a ridiculous expense per day and it hasto be paid for and money is not printed to order, at laest it hsould not be. Gas prices are up but a lot of that is the fact that tese commodities are paid for largely in US$ andthe dollar is worth a lot less now than two or three years ago. So prices increse to maintain the asset value ofthe producers Oil.

I think post#106 raised an important point.I think the banking systems is unfair towards savers. When Banks make profits savers dont get anything. However, when banks use savers deposit to buy CDOs and other fancy products and when things go wrong, its the savers who pay the ultimate price. I dont care shareholders loosing money.

As a young 22yr old student I find it unbelievable that many my age know so little about basic economics. We are almost born into debt, our university is paid for by a student loan, of which, all goes to a landlord who has borrowed 9 times their earnings for a crappy buy to let. It鈥檚 hard to advance from nothing these days when your fellow rich students have three extra days a week to study while you are working. Looking at this it is easy to see why the young find the idea of a mortgage so appealing especially after the huge profits that have been made from property over the last decade. There is now a property owning bourgeoisie. The last serious correction came when we walked on all fours, many don't believe such a serious crisis will emerge again. There will a lot of anger towards the baby boomers in the future. Hopefully some of us underclass will have the guile to short this correction and take those repossessed houses for a knock down price from our little overlords.

In reply to post 102,
I personally would wait at least 18 months.The housing market will crash.My house is under offer at the moment and I plan to rent for at least twelve months and put my cash into a 12 month savings account,once sold.I believe I will see more and more bargains coming onto the market during this time, as people will be unable to hold out in the hope of selling at the present unsustainable prices.
There will be losers but also winners.I think a correction to more realistic house prices is a good thing and long,long overdue.

I'm sorry,
TRILLIONS in losses not billions is the reality when it all play's out, eventually the truth of how deep and widespread the corruption goes will raise it's ugly head for ALL to see, my heart goes out to all those at the bottom of the heap who are losing everything they have SLAVED for.
Decide for yourself how relevant this is....

Its very relevant Mark No 124. This is the real truth of the situation that the media is again not reporting to the general public. I wish that this Robert Preston would look at the website himself and investigate the story and report the real truth for once.
www.worldreports.org
Read it folks and have your eyes opened.

The Rich idiots at the top fund the governments to allow them to run the show. They then sell in appropriate products to the poor idiots at the bottom, until a system reset is generated.

The Rich get away scot free, the government gets fired at the next opportunity & replaced by a another bunch of rich lackies, the poor idiots at the bottom lose everything & the wealth moves up the ladder.

In the 70's they rich had 80% of the wealth, in the 2000's the rich have 97% of the wealth, anyone spot a trend ?

#124 & #125

That just looks like a cheap conspiracy theory. Stick to the economics of the situation.

What is needed is the election in the USA of Hillary Cinton and her husband. That will bring in the expertise to the financial markets and world order because they have the knowledge, the understanding and the network to draw the best people in the world to help in all of these critical decisions.

A lot of this blame can be put on the Bush administration creating TRILLIONS in debt to the U.S. and its loss of creditability of America.

Sell your dollars and purchase Euro's.

D

Robert,

It would be interesting to calculate from SEC and other disclosures what Citi's profits from this business were in each of the last five years.

Bonuses paid by investment banks, which may be many times annual salary, typically reward profits made in the last financial year only. A "retirement" strategy is therefore to pursue a short-term run of profits that is bound to be unsustainable, through expanding assets or inflating prices. The millions that you make before you are fired or resign will be enough to keep you on the golf course or the yacht marina for the rest of your life.

As an investment banker, I saw one of our star fund managers do exactly this in the internet bubble. His fund went from second best-performing in the market to bottom percentile in a year. It was composed of a few highly priced and closely-related stocks, whose market price was pushed up largely by his own actions in buying more shares with the money flooding in from investors. He was paid ten times his previous bonus a few months before it went sour.

I am prepared to bet that decision makers at Citi were similarly rewarded for boosting short-term profits through unsustainable practices.

Robert,

If liabilities have been moved off balance sheet into SIVs by banks? Can anyone tell me who feels the loss when they get wound up or lose significant value?

Seems like smoke and mirrors......

No doubt a blogger from the FSA or Bank of England can explain?

Chuck Prince got his money in the end. that's what matters....

Quote : "I am prepared to bet that decision makers at Citi were similarly rewarded for boosting short-term profits through unsustainable practices.

you are so right have you seen the golden handshake the outgoing boss of Citibank received .!! ??

This in stark contrast to prime mortgage borrowers.

Remember when confidence was the name of the game? Overconfidence is just as damaging as under except that it takes longer to show on the bottom line when it comes home to roost, like now. How can confidence be restored to the world economic system in time to prevent disorder on a massive scale? This needs to be addressed at the highest level - G8 anyone?.

The whole Subprime fiasco reminds me strongly of the collapse of the Japanese property bubble in the early 1990s. Tehn, the Japanese banks were lending gratuitously to any project that involved real estate, firmly believing (with 50 years of continuous rise in property price to back them up) that the land price will continue to soar, even when Tokyo alone was valued higher than all of California.
Then, the bubble burst in 1990, and all the major Banks were left with tens of billion (dollars) of bad debts, and Japanese stock market didn't hit the bottom until 2002.
So, I think Dow Jones is likely to halve in 3 years, or Dollar will hit 50 yen mark within the same period (effectively halving its value).

Another angle to this..I helped build an online CDO knowledgebase for a major rating agency about 2 years ago. This agency rates the various debt tranches being offered to the market by the CDO Managers - mostly small shops with expertise in one thing - financial engineering. This was an incestuous society because the managers needed the rating and the agencies needed the business...and the investors had to buy this because everyone was buying..so all objectivity and caution was thrown to the wind. Now everyone has to pay the price. Funny thing is if you're a top executive..you get paid a handsome bonus when the company does well but even more money when you're sacked! How is that for a just dessert..

One can only conclude that not only had the financial institutions taken their eye off the ball but they were playing without one. Then when they realised the situation and found the ball it had gone flat. So, it's back to using the good old apple. Solid healthy core with plenty of meat on it with not a maggot in sight which will look great once the bruising has gone. What's more, those financial institutions could well learn from the farmers who grow their apples for the local consumer and sell it at the farm gate knowing that if he looks after his consumer and not sell them maggot infested apples they'll start buying apples again and he'll be able to sell them cheaper. Simple and always works whatever you grow. Having said all that, maybe I'm being disrespectful to the maggot. I should really have referred to that lesser known parasite that has recently found infamy, the "blood sucking amoral".

"If things look too good to be true, they (almost certainly) are

If you allow substantial amounts of poor credit risks to arbitrage off your higher credit risk rating, you do so at your peril

If you run a substantial portion of a loan book by funding short and lending long, you risk losing everything

Risk ring-fencing is all"

Fundamental, Basic, financial advice, given to me, in writing, as a Bank Clerk 35 years ago. Not on a first Degree course, not on an MBA course. In a UK High Street Bank branch

What were the Board members (let alone the management and Credit Approval staff) of the financial institutions involved thinking, to allow this to happen..? Oh, now let's guess...

Bonuses..?

Prosecutions, or closing of ranks..?

I'd guess the latter

Can I get my two cents in, after reading most of the comments, okay just a dozen or so. The only analogy that comes to mind is an analysis of a civil war in Central America I read. Unlike the industrial revolution when people flocked to the cities for work, someone pointed out that in the eighties a wave of advertizing reached the country side which prompted people to move to the city with expectations of easy economic reward. In time I think they found a transmitter in the US.

In a way you can argue that the banks made it to easy to borrow, but at the same time, the Fed policy towards wage inflation. How did policy makers envision redemption, in a credit society when wages can't even keep up to the cost of living? How can bank execs approve a campaign where they encourage you to borrow so you can fund your yearly RRSP contribution and than use your tax papers to determine your credit rating? Oh and let's not forget that if you need to dip into your savings prior to retirement you are slaped with a penalty.

What I don't understand in all this, is if the banks made these loans, disbursed money, who got the money?

#62#70, some facts.

Northern Rock has no problem attracting it's customers. It is losing 拢2billion in deposits per week, so thats plenty of visits. However it is still writing new loan-business. This new business is funded (whether directly or not) by the loans from the Bank of England.

To check my facts I did a simple Google for Northern Rock. The top sponsored link was:

Lowest Rate Loans 4.5%
Northern- Cheap Loans From 拢10,000.
Apply Now for a Free Quote.
NorthernRock.Uk-Loan-Deals.co.uk

Retrying the original query returns no sponsored links. [NR lawyers perhaps, and a reprised rate...?]

The source of the FT report can be found via a German faux politician's website. ;)

#70. The 拢40billion can be calculated thus. Exposure of BoE 拢24-30 billion, plus guarantee of NR deposits 拢10-20billion. [The latter figure is obviously falling on daily basis!]

So this underlies my point. So what is your point-of-view...?

As a simple soul, I've been puzzled about this affair since it first made news. Why do financial institutions issue sub-prime mortgages in the first place? Is it in the hope that they will gain through re-possession? It certainly can't be in the expectation of receiving regular high interest payments! And why do such esoteric and incomprehensible entities as "Hedge Funds" purchase these debts? I'm an atheist; but I do recall the fuss that Christ is said to have kicked up in the temple. I've always had the utmost contempt for people who enrich themselves immensely by effectively buying and selling money. It should have remained what it was meant to be - a means of buying and selling commodities. Now we have the absurd situation in which no one appears to know who "owns" these sub-prime debts. No doubt the fund managers will find some new alchemy and turn them into gold (for them)

Financial insititutions sell sub prime loans with the hope that borrowers would default at some point for non payment due to higher rate, and the banks can sell their property at higher price. Clearly evil intention is in their mind. But then you can not fool all people all the time, can you? The banks are caught at this point of time due to falling house prices in the USA.

Greedy fat cats should take the blame, surely they know it is misleading to provide mortgages to people with poor credit history. What did they not think it would eventually show up. Sub-prime mortgages is the second running of Enron.