The start of my university life back in September 2007 coincided almost perfectly with the emergence of the dreaded credit crunch. Walking down Northumberland Street to see countless people queuing outside of Northern Rock provided me with a great source of entertainment. I saw it as a massive overreaction made by people that consider the scaremongering of the media to be gospel truth. To an extent, I was correct; government policy protected the first £75,000 in a person’s bank account. To actually learn the extent of the problems the economy faced on a global scale is quite terrifying, and utterly infuriating.
The level of confidence in the marketplace before the financial crisis was incredible. The house market was booming, credit was cheap, and everything was rosy. Collateralised debt obligations were a big source of this increased liquidity in the market, which promised a source of cash depending on the rating assigned by the credit rating agencies. The rate of return in the AAA rated assets were so high, even banks were utilising these options.
Incredibly, these banks that were supplying long term mortgages were investing in assets that depended on the success of the mortgages they were issuing. Confidence was so high in these assets, banks built up assets around these CDOs. The problem arose when the house market began to decline, which saw the increase on defaults on mortgage payments. All of a sudden, these ‘safe’ assets became far less secure.
The cash shortages created a chain reaction that went on to cripple the banking sector, leading to panic amongst the public that their hard earned saving were at serious risk. Suddenly cash became a rare commodity and successful businesses were finding it increasingly difficult to fund their operations as a result of this shortage. The decision made by the UK government to offer a bailout option to the banks illustrates how severe the situation became, with the bailout dwarfing the annual cost of running the NHS.
The use of the word ‘confidence’ in this blog to describe the mood towards the marketplace is perhaps a poor choice. Confidence implies a belief in the ability to succeed, yet the banks ability to succeed was so heavily hinged on the housing market and CDO’s, that the word ‘arrogance’ seems more appropriate. The importance of planning, spreading risk and assuring cash is always available has been emphasised at every aspect of my business education. How is it that bankers were so blind to this?
The arrogance in assuming the bubble could never burst, that market value will continue to increase is beyond belief. To not consider the possibility of a problem emerging in the future as a result of ‘putting all your eggs in one basket’ is madness. To find a source of this particular financial crisis and focus on avoiding that particular mistake again is to miss to the point in my opinion however.
Maybe there will be greater regulation in future regarding the assumed security of investment assets, but in 10 years time, house prices will still demand staggering mortgages, banks will still take out loans to fund these mortgages and the world will run on the assumption that credit will be available to them to get by.
It is frustrating to think that we, the taxpayer are the victims in this financial crisis and I sincerely doubt we will ever get so much as a ‘thank you’ from Northern Rock or RBS. It is scary to think that we appear to have applied a band aid to a broken leg in making no drastic changes to the regulations surrounding business. Maybe we will learn from our mistakes and prosper from a more restrained credit system. I worry however that we will continue to make the same fundamental mistakes in future. Maybe the next time we see a credit crunch, the ramifications could be far more serious than public spending cuts and increases in tax.
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