Financial crisis or financial sting ...

Right now the world is going through financial turmoil, if not a financial meltdown. Billions of dollars have been wiped off the share markets, banks are going broke or being “rescued”, super funds have taken an enormous knock and there is now serious disruption to the supply of finance, severely affecting businesses of all kinds.

The problem is worldwide, and while almost the entire Western world is in recession it is not yet openly admitted by our elected representatives. Also, what isn't spoken of a great deal is just how we came to be in this mess. The emphasis seems to be on how quickly it can be corrected and while that of course is absolutely necessary, if we are to find an enduring solution we have to know the cause of the problem.

It would appear the problem has been in the making for at least 10 years and even then would never have been possible but for changes to our financial systems made over many decades before that. In short, what has happened is that there has been an inordinate increase in the supply of cash readily made available to the market place; a level of cash that the economics of the community could simply not support.

In 2006 the United States Reserve Bank ceased publishing the figures relating to the available money supply, signifying there was at least some awareness, at that level, that there was an overheating. This excess in available cash materialised in the level of consumer and government spending; significantly by way of credit card debt, mortgages, re-mortgages and reverse mortgages.

In order to facilitate a continuing supply of all this debt much of it was bundled and packaged up and sold all over the world as things such as structured investment vehicles (SIV's), credit default swaps and Collateralised Debt Obligations (CDO's) to mention only some of the most common.

All these financial vehicles would have been sound if the communities’ capacity to pay the debt had been adequate. But many of the bundled mortgages were what we now know as “sub-prime” loans, where the lenders should have been aware, with due diligence, the loans would never be repaid. We can all remember the description of these loans when they were being drawn e.g. “Low Doc”, “No Doc” and worst of all the NINJNA loans: “No Income, No Job and No Assets.”

Even at the time of their issuance, these loans were known to be questionable debts that should not have been created in the first place. So, it is not hard to conclude that there was little regulation and no effective oversight at all over the issuance of these loans. Having them bundled would not likely have improved their quality, but somehow ratings agencies were able to rate them as suitable for an unsuspecting investment market, whatever that particular rating was.

In addition, there was the sheer size of the volume of these mortgages. It would appear as though everyone who put his or her hand up was given a loan. Now of course it has all come to grief, the suppliers of the money have lost their equity, those who brought the bundled packages of SIV's are out of pocket, and the home “owners” are out on the street.

A similar thing has happened with credit cards. Obtaining a credit card is less than a matter of making an application as free applications turn up in the letter box each week. Credit card debt is at frightening levels and while this may be tolerable, if not desirable in good times, it is a disaster in bad times when employment gets tighter and jobs are lost.

The consequence of all this is that the banks and other financial institutions, having both bought and sold these bad debts, are now in trouble themselves. Banks throughout the Western world are falling like ninepins despite substantial propping up by Governments. Credit is becoming short to the point where businesses of all sorts are suffering even from a shortage of “carry on” money, wages bills, inventory and the like.

The situation has reached the stage where serious inconvenience, to say the least, is being caused. At this point it is interesting to note that it is only the Western European and US banking systems that are in trouble. The Islamic banking system remains sound, which tends to indicate that the fault in the West lies in the banking system.

So, the question arises as to just who it was that allowed all this to happen, and there is no doubt that the ball falls squarely in the court of the credit and bank regulators. There is no other place for it to go; it was their responsibility and they dropped (or threw) the ball. What’s more, the regulators seem to have done it in unison and on a worldwide scale.