12th January 2011
The furore around bonuses – while immensely justified – is, in my view, a distraction from the real threats facing the financial system. While attention is focussed on bonuses, the government’s failure to get a grip, to break up and regulate (through capital controls) the financial system as a whole is downplayed or ignored by the media, politicians and the public. And while like many others, I enjoyed watching Bob Diamond being tortured by a House of Commons Select Committee – I also felt that it helped distract attention from the role that politicians played in giving Bob Diamond the kind of unfettered regulatory freedom he relishes – with which to wreck our financial system. Let us never forget: bankers did not de-regulate the financial system. Politicians, civil servants and central bank regulators – egged on by neo-liberal economists – de-regulated the system.
In my last post I referred to the Bank of England’s recent Financial Stability Report, and concerns about the Credit risk faced by UK banks. The BoE refers to “the interconnectedness of European banking systems”…and notes that “UK banks have claims of almost £300 billion on France and Germany, whose banking systems are more heavily exposed to the most affected (by the sovereign debt crisis) economies.” Then there’s the UK banking sector’s exposure to Ireland – and as we all now know, Ireland’s economy is deteriorating under the impact of the misguided cuts-driven ideology of its leaders and economists. RBS has the biggest exposure with about £54bn in loans,a third of which are tied to residential mortgages (sub-prime mortgages?) through its Ulster Bank subsidiary. The next biggest lender to Ireland is Lloyds Banking Group with about £27bn of loans, £11bn of which are related to commercial lending and property.
But in my view the greatest concern should be UK bank exposure to the US. I wanted, earlier, to alert readers of this blog to a very important case decided in the US courts on 7th January – one that I and many others believe have severe repercussions for banks that engaged in reckless lending, then securitised those loans, without proper documentation and records.
Now the banks are going after borrowers that have defaulted, but have inadequate records and documentation to testify to their ownership of property titles. (Just as an aside: in my work with poor country sovereign debtors it was frequently the case that creditors in rich countries could not provide adequate documentation or records of their lending. This did not prevent creditors ganging up at the Paris Club of OECD creditors and demanding repayment from low income country governments – who were seldom party to the original private sector loan anyway….Unfortunately, there is no international law governing international lending and borrowing, so poor country governments (for which read taxpayers) were bulldozed into coughing up…even in the absence of evidence of a loan.)
Now ordinary American homeowners have been victims of the same cavalier attitude to contracts. US Judges in the lower courts initially tolerated the lax approach by banks to creditor/debtor contracts. They played along with creditors, and hoofed people out of their houses (foreclosed on them) at (almost) the whim of their lenders. (This is now known in the US as ‘foreclousure-gate’).
But no more. Judges have started demanding that banks provide documentation proving ownership of loans, and therefore of the collateral the loans are guaranteed against.
Because mortgages were ‘sliced and diced’ and then parcelled up and passed along in the securitisation process, proving ownership is tricky, to put it mildly. Borrowers’ lawyers were inordinately slow in waking up to the fact that creditors were salvaging losses even in the absence of this fundamental tenet of US bankruptcy law, but have finally understood the implications for their clients.
Thus the Ibanez case against a bank, launched in defence of borrowers. The judge’s decision was delivered on 7th January this year, and will prove, I believe, to be of monumental importance to borrowers and banks, and ultimately to the stability of the financial system.
Why? First, because the judge voided the seizure of property, because of the absence of proof of ownership. When borrowers defaulted on their loan payments, banks could get their hands on assets (like property) that loans were made against – even without proof of ownership. These assets were then flogged off, and the banks have in most cases retrieved part, if not all of their losses. They then returned the assets to the residential or commercial property markets. In other words, they both recouped losses, and kept a flow of largely lower-priced properties returning to the US property market.
The Ibanez decision slows all this down. First, banks without documentation may not be able to pursue claims on their borrowers, leading to further bank losses. Second, properties will not be returned to market, refreshing the market from below, for first-time buyers for example. Instead defaulting owners will be allowed to remain in them. Third, banks will now be much more cautious about providing mortgages to new borrowers. Cumulatively, these will impact negatively on both the banking system, but also on the residential and commercial markets in the US.
Then there is another threat to the banking system on the horizon: resets. This refers to the habit of making loans to people who can’t afford to pay for them, by offering low ‘teaser’ rates as inducements. With time, the banks call a halt to the teasing game, and demand payment at full rates. At this point, mortgages are ‘reset’ – i.e. the interest rate on the mortgage is hiked up – to rates that may ultimately bankrupt borrowers, and in many cases are unpayable by impoverished/unemployed/maxed out borrowers.
Graham Summers of Seeking Alpha has produced a graph, which shows that in 2011 about $35 billion worth of US mortgages are due to be ‘reset’. Summers notes that this year’s resets parallel those of 2007-2008, which led to the implosion of the banking sector in 2008. “From a mortgage rate reset perspective, 2010-2011 looks virtually identical to 2007-2008” he writes.
Add to all this a second important fact. Thanks to de-regulated capital controls (de-regulated by politicians) banks are globalised – at least when they are apparently solvent. Of course, when they fail, all talk of globalisation evaporates into thin air. Instead they are nationalised. Bob Diamond, now head poncho at Barclays, is part of a globalised bank, deeply inteconnected to borrowers in Europe, Asia – and the United States.
So there are dark clouds on the horizon for Bob Diamond and his fellow bankers…However, thanks to the weakness of politicians and to the generosity of bank shareholders, bankers’s pockets will be well stuffed, to help them weather the crash. But how about yours?