I have read four / five books on 2008 credit collapse / Lehman crisis. I was wondering what Financial Fiasco by Johan Norberg, will offer. Initially after 10 to 15 pages, thought of leaving the book developed. Suddenly a passage appeared and I was blown away.
This book is worth reading to understand how
the Governments, Regulators, Bankers, Credit rating agencies and public in
large were responsible for the credit crisis.
Takeaways from the book is listed below:
A Shocking Truth
The toxic seed called non-recourse mortgage.
A specifically American
phenomenon contributed to making so many potential buyers willing to take a
chance. In many parts of the United States, there exists something called a ‘‘nonrecourse
mortgage,’’ meaning that a home loan is linked to the home, not to the person
who has taken it out. The home is collateral for the loan, and the home is the
only thing that the lender can get back if the borrower decides to stop paying.
People can thus buy houses that they cannot really afford on the assumption
that they will be able to negotiate a better deal on interest rates later
(lenders are often willing to lower the rate rather than risk having to take
over the house) or that prices will rise so that they can sell at a profit. In
most countries, homebuyers who stopped paying their loans would be saddled with
a mountain of debt; but in about half of the U.S. states, buyers can return the
keys to the bank and walk away debtfree. As it also became increasingly common
that households did not even have to put down a deposit, they stood to lose
nothing at all by taking a wild gamble. In some states with nonrecourse
mortgages, including California, lenders do have a theoretical possibility of
going to court and requesting more money from a defaulting borrower if the
selling price does not cover the loan, but this is a long and costly process
that is typically used against borrowers who have large assets.
Culprit for Low Interest Rates
If there is one person
responsible for the low interest rate it is Alan Greenspan.
Alan Greenspan is Jack Welch.
In December Mr Greenspan was
made a Freeman of the City of London. One of the traditional perks of this
honour is that he can be drunk and disorderly without fear of arrest. The snag
is that his policies have also encouraged drunk and disorderly asset markets
and intoxicated consumers. When the party ends, Mr Greenspan will not be there
to clean up the mess. But end it surely will.
Perils of printing money
The printing press may look
less intimidating than the taxman, but in practice it is worse. Creating more
money not only entails an indirect tax in that it reduces the value of
citizens’ savings but also, and more importantly, undermines the price system
by giving businesses incorrect information about demand. The additional money
created does not end up everywhere at the same time but percolates into the
economy in certain places, where it leads to price increases, which businesses
interpret as an increase in demand, causing them to hire more people and step
up production. Only after a while do businesses realize that the prices of
everything else have also risen and that their costs are increasing even though
they are not selling any more than their competitors. In fact, the price
increase did not indicate an increase in demand, only a deterioration in the
value of money. As a consequence of these incorrect market messages, resources
have thus been brought to places where they should not have ended up, meaning
that the businesses now have to cut down on production and lay off people.
Problem with American Capitalism
In the debate about how Fannie
and Freddie inflated the housing bubble, the right has claimed that they were
government corporations, whereas the left has argued that they were private
businesses. But as we have seen, they were in fact an entirely different
animal— a hybrid of public and private. The technical name for the hybrid that
they represent is government-sponsored enterprise (GSE). A GSE is potentially
the most dangerous type of enterprise since it may allow private owners to take
any risks they can imagine, pocket any profits for themselves, but count on
taxpayers to take care of any losses. Fannie and Freddie have been privately
owned, but with a political mission and with an implicit federal guarantee in
case they should fail. That guarantee has made their business concept a
lucrative one.
Noble Laureate – Not better than us
In 2002, Fannie paid the Nobel
laureate Joseph Stiglitz, the future federal budget director Peter
Orszag, and economist Jonathan Orszag to conduct a study that found that there
was ‘‘extremely low probability’’ that Fannie and Freddie would become
insolvent. The study talked about scenarios with a likelihood of one in more
than 500,000 and claimed that the risk to the government was ‘‘effectively
zero.’
As late as July 2008, Paul
Krugman, a leftwing economist who would soon win the Nobel Prize, attacked
the critics of Fannie and Freddie, pointing out that the duo had nothing to do
with risky lending and had not made a single subprime loan.43 Krugman may have
been mixing things up: It is true that Fannie and Freddie did not lend to
subprime borrowers, because they did not lend at all; but they did buy loans,
and a growing share of those loans were subprime.
Central Bank
Central Bank is referred to us lender of last
resort. One of the reason is explained well:
The bank has the capital, but
it lacks liquidity.
Above happens when there is run
on the banks.
Disaster created by CDO
If a household runs into
trouble in a state that allows borrowers to return the keys to the bank and
walk away, the mortgage is usually renegotiated. It is better for the bank to
have someone living in the house, who may be able to pay back the loan in the
longer term, than to be forced to take over the house and try to sell it just
when prices are lowest. But the securitization of mortgages had led to an
unexpected consequence: The original lender no longer owned the loan, because
it had been repackaged and sold and then chopped up and sold as part of a
collateralized-debt obligation. Households in default no longer had an
individual lender to negotiate with, which made more and more of them just
abandon their homes and either buy something cheaper or start renting.
The CEO’s ignorance with fat pay
Citigroup’s Charles Prince
(the man who stood accused of being unable to tell a CDO from a shopping list)
found out for the first time at a board meeting in September 2007 that his bank
was sitting on $43 billion in various types of mortgage-backed securities. He
asked the person responsible whether this was a problem and was told that no
major losses could be expected. Only two months later, however, the bank
estimated its subprime losses at $10 billion. Prince chose to step down—taking
$38 million in bonuses, stocks, and options with him.
UK and how it misused
legislation
The British government also
froze Landsbanki’s assets in the United Kingdom. The method it chose probably
set a world record for abuse of legislation. It applied an anti-terrorism law
enacted in 2001 that was designed to freeze the assets of foreigners planning
to damage the United Kingdom or its economy. Icelanders, whose country
habitually tops international rankings of freedom, democracy, and
noncorruption, could suddenly visit the website of Her Majesty’s government and
find themselves listed alongside terrorists and rogue states: al Qaeda, the
Taliban, North Korea, Iran. . . . And as if this was not enough, Prime Minister
Gordon Brown also mistakenly said that the British government would freeze any
Icelandic assets it could lay its hands on and demanded that Iceland compensate
British savers in a way that would slap a burden of debt per capita on it, not
dissimilar to that imposed on Germany at Versailles.
Blackmailing the US President by Economist
Paulson and Bernanke had
secured support for their proposal earlier that day in the Roosevelt Room, a
classic meeting room in the West Wing of the White House with no windows but
fake daylight coming from a false skylight. This meeting, in the words of one
of those present, ‘‘scared the hell out of everybody.’’ The Treasury secretary
and the Fed chairman had told President Bush about the panic in the credit
markets, explaining that if he did not sign off on the biggest bailout in
history, the United States would be hit by a crisis bigger than the Great
Depression. The president had been speechless, almost stunned, for a moment.
Then he had sprung into action.
How Banks preached but not
practised
When 21 banks that had
received at least $1 billion each of taxpayers’ money were asked by the
Associated Press what they had done with that money that they otherwise would
not have done, not a single bank gave a straight answer. Several said they did
not know. The Morgan Stanley representative would reveal this only if she could
remain anonymous, and the person from New York Mellon Corp. replied, ‘‘I just
would prefer if you wouldn’t say that we’re not going to discuss those
details.’’ It is not a wild guess that the banks themselves would never grant a
loan to someone who came strolling into one of their branches and gave that
answer to the question of what he or she intended to do with the money.
