The Economic Crisis - Should We Blame The Banking Sector??

                                                             

In 2007, panic flooded the financial market as banks were verging on collapse. This called for huge Government bailouts for banks such as Northern Rock, to protect the country and economy from financial ruin. I don’t think anyone could have predicted the enormous knock-on effect this would have on all sectors within the UK. Even at present day I can’t walk around Newcastle or my hometown without seeing how this ‘domino effect’ has badly hit our country. Derelict shops and offices, continuous promotions and sales and high levels of unemployment are just some of the negative effects to have impacted on our economy.

Up until now I don’t feel like I have been affected but, as a final year student the prospect of finding a suitable graduate job looks pretty bleak. Every day new reports and statistics highlight how directly graduates are being hit, with the BBC (2012) recognising that graduates are more likely to work in lower skilled jobs than 10 years ago.

So whom should we blame for this financial fiasco? Since 2007 bankers and the banking industry has seemed to pick up the majority of bad press, with scathing attacks on the extravagant culture and arrogant attitudes of those working within the sector. But are they really to blame or have the press set about using them as a scapegoat? 

During the periods of 2002-2007 the economy was financed through cheap debt.  There was an explosion of ‘Mega Deals’ particularly by Private Equity Firms as many businesses decided to fund their activities through loans. Furthermore the availability of low interest rates in many developed countries (particularly within the US and UK) encouraged confidence within the market. It doesn’t take a genius to work out that sooner or later flaws would begin to appear and these good times just couldn’t last.

The US Sub-Prime Mortgage Market was hugely irresponsible and accused of ‘predatory lending’, without any regard to their clients ability to repay the loans. They used brokers who earned a percentage of every loan they sold, therefore the incentive was to sell rather than consider whom they were selling to. Whilst viewed as hugely unethical, I have wonder over the stupidity of those customers willingly accepting loans that surely they knew they would not be able to repay. Also if banks new that they could get away with it why would they stop, their aim was to make money whether that be through ruthless means or not. Therefore I think that the US Government should accept some responsibility. They should have intervened to protect those who didn’t have the financial knowledge or experience to understand the true consequences of repaying the loan.

After learning about ‘Collateralised Debt Obligations’ (CDO) in the lecture I think this had a huge impact on the financial crisis. Once again the greed and total disregard for consumers shone through as bankers ‘stuffed CDO’s with riskier assets like subprime mortgage securities, rather than traditional bonds’ (The New York Times, 2012).  So what was the process and how did it go so wrong?

Sub-rime loans were repackaged and resold, and to spread the risk 30-40 different loans were repackaged together. The thinking behind that was, not every one within that package would default at the same time, and therefore there would be a constant inflow of payments. These packages were then classified with different credit ratings. But like anything everyone wants the best, so the primary were snatched up first and so on and so on. What wasn’t thought through was when it was decided that to sell on those packages still left, they would create a secondary pool. Initially viewed as an excellent idea, soon became a disaster when the repackaged loans were given the same credit ratings as those in the primary pool.

             PRIMARY CDO’s                                                                  

                                                                                                                               SECONDARY CDO’s

The market was flooded with CDOs, and what was meant as a strategy to diversify away from risk actually created it. The pooling of risk should have signified that even in a bad year an AAA investor would have been assured some kind of return. However the lack of transparency within the CDO market meant that investors were lured into buying what they thought to be AAA credit rated loans but were in fact AAA secondary, offering little security.

I have primarily looked at the role of bankers within the credit crisis, but arguably there are many contributing factors and numerous events that have caused a knock on effect. Economists have tried to identify what the major cause of the economic crash was but have found it difficult to identify the pinnacle point.

  

I personally believe that the banking sector have a lot to answer for. I can understand why media has targeted them; they have caused public outrage and distrust. Their refusal to acknowledge any harm, and disrespectful attitude has infuriated people. Have they damaged their reputation beyond repair? Only time will tell. But what I think is important to take from this is, whilst banks might have been acting unethically Governments stood back and permitted such behaviour to carry on and go unpunished.