The crisis in the global economy and the near collapse of the international banking system have damaged almost everyone. Very few organisations have benefited – yet ethical financial institutions are actually in a stronger position today than they were before the crisis unfolded.
While member-owned and other ethical institutions have maintained sustainable business practices, restraint and sound risk management, most of the large banks have been reckless with their savers’ money. As a result, more customers have moved their deposits into mutuals and ethical institutions.
Across the world banks have engaged in selling and buying financial products that even many of their directors failed to understand. Probably none of the banks fully recognised their risk exposure.
It is now widely accepted that the packaging-up of sub-prime mortgages and their onward sale and re-sale was a major factor in the seizure of the financial markets. The original mis-selling of those mortgages to people who could not afford the repayments was just as crazy.
But let’s not just blame reckless salesmen in America. For months now, the Financial Services Authority has been banning and fining mortgage brokers for behaviour that was at best highly improper. Take the actions of one East London ‘accountancy firm’ – it obtained mortgages for clients by falsifying their income claims and, in one instance, lying in a statement by claiming that the client was actually an employee.
Mortgage mis-selling went beyond the sharp practice of a few brokers. Self-certification by borrowers became common – and lenders should have doubted the information provided. Some banks engaged in reckless buy-to-let lending. They conned themselves into believing their loans were safe because of the security of apparently fast rising property assets – yet property prices fell, especially on the newly-built apartments that were favourites for buy-to-let investors.
The business practices of Northern Rock were at the most foolhardy end of the market, but illustrate the folly most of the banking sector gave into. Northern Rock loaned as much as six times borrowers’ salaries, while Bradford & Bingley offered up to 130% loan to value. Both banks had to be bailed-out by taxpayers – not surprisingly in retrospect.
With the value of homes the loans were secured on falling in value by as much as 50%, the balance sheets of many mortgage lenders now look very weak – and not just those banks that had to be rescued. Worse still, Northern Rock borrowed 75% of its lending on the inter-bank market. When a building society, the Rock had been required to fund at least half of its lending from members’ deposits – preventing unsustainable expansion.
While Northern Rock blamed its collapse on the seizure of the inter-bank lending markets, the truth is that its business plan was fundamentally wrong. As Professor Willem Buiter of the London School of Economics observed: “It is by no means obvious that Northern Rock suffered just from illiquidity rather than from the threat of insolvency. The organisation has followed an extremely aggressive and high-risk strategy of expansion and increasing market share, funding itself in the expensive wholesale markets for 75% of its total funding needs, and making mortgage loans at low and ultra-competitive effective rates of interest.”
Professor Buiter added that a business that borrowed at a higher rate of interest over the long-term than it earned on its investment is “unlikely to be a long-term viable proposition”. Quite so. But the directors of several banks – particularly the demutualised building societies – seem to have been so caught-up chasing growth that they forgot the principles of how to make a profit.
Credit card lending has been little better – though the impact has yet to bite. Card issuers competed in their willingness to lend at levels beyond borrowers’ capacity to repay. Some even sent out blank cheques that seemed to have ‘spend me’ written on them.
All told, bad lending and investment practices around the globe generated losses estimated by some bankers and analysts at around £3,000bn. Yet banks’ write-downs have not even reached a third of this level, so there is a lot of pain still to come. According to former US president Bill Clinton, around half of the world’s wealth disappeared in this crash – at least in terms of market value.
But an overview of the credit crunch needs to reflect not merely the crisis within the financial systems of the United States and the United Kingdom. The financial systems of the world are now heavily interdependent. Within the global trading structures both the US and the UK have become less important as manufacturers. True, their service sectors remain powerful – but over-dependence on financial services is one of the reasons why the UK is facing such a severe depth of recession.
In these globalised markets, China, in particular, has become more wealthy – creating an annual trading surplus of hundreds of billions of dollars. Meanwhile, the United States has a severe trade and fiscal deficit. The United Kingdom is on the verge of a crisis with an already enormous fiscal deficit and a more modest trade deficit.
One interpretation of the crisis is that the decline in US and UK manufacturing wealth has led to a heavier reliance on debt, at government, corporate and individual levels. That debt has now become unaffordable and must lead to a decline in the real standards of living for most people in the US and the UK. If this analysis is correct, it has major implications for banks and their lending policies, as well as for policy-makers and households.
For the UK Government, the public debt is potentially crippling. It now stands at something like £17,000 per taxpayer – and going up. The banking bail-out cannot yet be called a success and further rescue packages may be needed for much of the manufacturing sector, housing associations and privatised public services. In all these sectors, some operators have borrowed excessively and, now, unaffordably.
At some point there has to be a correction to the failings that helped create the crisis. There has to be a big reduction in debt levels for individuals, companies and the Government. Personal savings need to increase again – they fell in the UK in recent years from about 7% of household earnings to just over 2%. That decline coincided with many corporate and personal pension schemes massively losing value, creating a potential crisis in retirement for much of the UK workforce.
This whole gamut of industry failures mean that banks and building societies will need to develop alternative business models – with less focus on credit card lending, investment banking and private equity lending and more concern about customers’ ability to repay. Successful banks will include those who are best able to trade on their trust, integrity and ethics. It will not be easy for the sector as a whole. But in a weaker industry, the enlarged Co-operative Financial Services is in an excellent