Financial crisis or banking scandal?

Le Monde, 9/10 September 2007

By Eric Le Boucher

Doubtless, a raise of interest rates by the European Central Bank (ECB) would have triggered a financial panic, so apoplectic have been the markets since the beginning of the summer. Nobody wishes to see that, least of all the board of governors in Frankfurt, the real economy would have suffered heavily from it. But how sour the decision must have been! The ECB, which wanted to raise its rates, lest inflation reappear, decided not to go ahead in order to help financial institutions which, the ECB is aware of that, have had an unbelievably irresponsible behaviour. It is quite grudgingly that it grants impunity to profiteers, robbers, speculators and fools.

The crisis is not the consequence of a harmful “financialisation” of the economy. Modern finance, liberalised, globalised, has immense virtues. In this case, and to address the heart of the matter, it facilitated worldwide the financing of housing. Restricted loans, miserly granted, and controlled by public bureaucrats, were replaced by private competition which in turn lead to lower rates and more flexible contracts. It is certainly not France, where the Council in charge of monitoring fair competition recently denounced the archaism and “lack of scruples” of the entire real estate profession, which can give lessons.

In the United States, the housing financing revolution, for the past ten years, has made it possible to launch 2 million new dwellings per year; many Americans with small means were able to become owners. The crisis will not throw them all in the street.

But it is a fact that profiteers sold for a very high price loans called “subprimes” to households who could not afford them, promising them the moon (no down payment, no interest payments during an initial period…), assuring that the price of their home would go up, and on the other hand hurrying to sell (securitize) these highly profitable loans to various financial funds. Lending on one side to young couples whose risks were difficult to measure, they resold the loans on the other side at prices which were not those observed on any market but were calculated according to mathematical models. Then, the models became more and more complicated, and the system developed. These profiteers are institutions specialised in subprimes, sometimes large banks.

The robbers are those who lent money knowing damn well that they were applying the system in regions suffering from industrial decline. The desire of households to renovate their homes so as not to appear to be losing their middle class social status made easy victims of them.

The speculators were the hedge funds, who bought massively these high yield credits (enabling the profiteers to keep on lending) to mix them together and with less flamboyant ones like money market securities. To shake well is advisable in order to dilute the risks, but it creates molasses nobody can analyse; what is sure is that they incorporate subprimes in unknown proportions and their risks are evaluated using models the equations of which are obscure. After the “junk bonds” here are the “lying credits”, to use a poker simile.

This financial fog is sliced up in tranches called structured investment vehicles (SIV), the banks hogged upon. Flush with money (earning whatever they wanted with the basic client, you and me), they bought these apparently gilded products on the basis of their past yields, and often these were recorded outside the balance sheets of banks [i.e. were resold again but the banks retained some liabilities?].

What lit the wick was when the American real estate market took a downturn, a couple of years ago. Poor households were incapable of meeting their payment obligations [and they had been borrowing more and more, backed by the increasing value of their home; when their home value began to decline they could no longer do that, and sometimes were called to make “margin payments” to reduce the lender’s risk]. How many will they be in the end? Two millions, three millions? Nobody knows. How many subprimes are concerned? Nobody knows. How many SIV? Even less people know! How many banks? That’s where the problem lies.

One discovers with amazement, in this crisis, that the biggest and most respected names of the planet scandalously ignore what’s in their books. Their traders, who kept assuring they knew, don’t know either. The models no longer function. These institutions, pillars of the system, guarantors of its solidity, are no longer reliable. World finance has the virtue of being very efficient when everything goes well, but as soon as the real economy sees a downturn, it takes a spiral plunge.

All banks are not fools. Many cautiously stepped away from the dangerous products. The weakest ones (the German for example) staid as long as possible in the market, way too long. By the way, one notes that it is the Europeans who financed their homes to Americans, and it is they too who will now wipe out their bankruptcies. All the banks are infected, but, for each of them, to what degree is absolutely unknown. Whence the panic.

This month, many monetary SIV come to maturity [those who receive money selling these complex loans will have to pay back the principal. Le Boucher’s explanations about the exact role of banks are confusing: did they sell or buy SIV?]. Banks know they will have to shell out a lot of money, but they are incapable of telling how much! They borrow billions to central banks and, stricken by horrible worries concerning their own health and that of their colleagues, they refuse to lend one another. Hence a sudden rise of the rates on the interbank lending market which is a big handicap for the real economy. A fear that is stupid, exaggerated, but which sheds light on the weak trust bankers have in themselves. It is reassuring…

People so handsomely paid made stupid mistakes; they deserve no impunity whatsoever. They must clean their stables, estimate immediately the size of their losses, let it be known, resume normal credits to the real economy and take measures to prevent a new crisis. Otherwise it will be necessary to impose such measures on them.

Eric Le Boucher

Translation André Cabannes