Bill Gleeson: City Whizzkids lack commonsense

Sep 24 2008 by Bill Gleeson, Liverpool Daily Post

I’M NO City whizzkid. If I was, I wouldn’t be sitting here writing this. I would be far too busy counting my fat bonus while showing no concern whatsoever for you or your savings.

But I’m not a whizzkid, so I have a few questions. For example, who thought it was a good idea to lend billions to vast numbers of people who weren’t good for the credit?

It seems straightforwardly a bad idea, yet many American banks did exactly that, granting mortgages to millions of people with a poor credit status.

And who thought it was a good idea for a bank to lend long against short-term funding?

The centuries-old banking model saw savers lodging deposits in return for a small interest payment. Banks, in turn, lent that money to borrowers at a higher rate of interest. Had they stuck to this model, there would be no credit crunch today.

The problem was that banks’ growth was constrained by the amount of money deposited with them. In an age when there are more borrowers than savers, demand for credit was surging, while deposits remained too thin to fund the increasing demand for borrowing.

So the banks employed a bunch of Ivy League MBAs who thought it would be clever to “leverage” more lending business out of existing resources.

Leveraging is something they learned about at business school.

It goes like this. When a bank sells a mortgage to a homebuyer, it gets back a guaranteed income stream of thousands of pounds a year.

When it lends to one million mortgagees, it can safely expect to receive billions back in interest and monthly repayments. Over 10 or 20 years, this inflow can tot up to hundreds of billions of pounds.

About 10 or 15 years ago, banks decided to use this guaranteed income to back bonds issued to investors such as foreign banks or sovereign wealth funds. The money received from bond sales was then lent to more homebuyers.

And so the cycle started over again and growth in the lending business looked as if it could continue forever.

But there was a snag. Mortgages have a long term, say 25 years. Bank bonds have a short term, say five years.

And what happens if investors begin to think mortgage-backed bonds are not a good thing any more and refuse to renew them when they expire?

Answer: you get a credit crunch. Maybe that question doesn’t form part of MBA exams.

That’s why Northern Rock had to be rescued a year ago.

It is what was beginning to happen to HBOS and is the reason why Alliance & Leicester is now safely in Spanish hands.

And am I missing something else?

Many of the individuals who dreamed up this silly system of mortgages and bonds with mismatched terms have earned tens of millions of pounds by way of salary and bonuses while coming close to wrecking things for the rest of us.

Perhaps, now the model is proven to have failed, they should be asked to give their bonuses back.

BUT not only are they not being asked to return the money, some have been offered even more pay to stay in their posts. Barclays is planning to pay huge sums to “key” staff at the bit of Lehman Brothers it is buying to ensure it can retain their services.

Surely it would be better to let them go than risk allowing them to do it all over again.

Or maybe I could study an MBA in whizzkiddery and then do the job for half the money.

I couldn’t do a worse job, could I?