Banking Crises: The past should inform the future. But does it?

In July 2006, I made a presentation in Toronto at the World Future Society’s General Assembly. There I predicted the subprime crisis, plus the future of the financial industry. Importantly, I needed to get my presentation approved in November 2005 and thus began preparing it in the summer.

Sadly the signs of this crisis were already evident.

  1. Banks violated the cardinal rule of banking-that is that anyone buying a home needs a 20% down payment or a guarantee from the FHA, the VA or private mortgage insurance. That “rule” came from the bank failures of the depression.
    Saying that, banks loaned their clients part or all of their down payment, leaving the banks ripe for default.
  2. Significant refinancing of debt
  3. Interest only mortgages for everyone (these mortgages are designed for the rich)
  4. Variable mortgages with teaser rates that escalated.
  5. Appraisals created to meet the price paid for a home. These appraisals were nicknamed “drive by appraisals” because appraisals really were not made.
  6. Predatory loans victimizing the poor

The Federal Reserve could have curtained these practices. It did not. I actually wrote Mr. Greenspan, but his correspondence was screened by the Fed’s PR department. To say that Greenspan and others in the Fed were (and are) isolated is an understatement.

The subprime crisis differed greatly from the S&L/Mutual Savings Bank collapse. We had significant inflation and these organizations were deregulated with no new regulations put into place. These industries never understood (or closed their eyes) to the truth that you cannot loan money long (for mortgages) but borrow money short (paying interest on deposits) in an inflationary world.

In part this is the problem that relates to the recent collapse of SVB. A year and a half ago, banks made investments in low interest corporate and government bond. When the Fed began raising interest rates because of a misunderstanding (from my perspective) of inflation, these bonds lost value. Some banks had too much invested long term and their investment portfolios plummeted. When there was a “run” on the bank, like SVB and others, the banks needed to sell bonds at a loss.

The banking system required a mark to market. In essence this mean that a bank needs to reduce the value of their bond portfolio to what the market dictates. What the bankers ought to have done is to reduce these number of bonds held long term.

What stopped the decline of banks? It was simple. The Fed declared that bonds could be valued at what was paid for them (normally par) and that these bonds could be given as collateral to the Fed to borrow money. This stopped the panic, but it is not a long term solution.

A collapse? Not, really. But the inability of bankers to adjust to risk and look to what could happen to the situation and take short term losses needs to be explored.


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