Fraud, Folly & Central Bankers
By Adrian Ash
September 13, 2007
If it's a fraud to borrow
what you cannot repay, it's folly to lend what you'll never get
back...
"IT IS A FRAUD to accept what you cannot
repay," claimed Publilius Syrus back in the first century
BC.
But Syrus was merely a freed Roman slave, and a
hack writer of Latin maxims to boot. What would he know about
collateralized loan obligations? No less, perhaps, than today's
team at the Bank of England in London.
"British venture capital heavyweight John
Moulton told a reporter," says Sean Corrigan of Diapason
CM, "that at a recent breakfast meeting with Bank of
England officials, none of them knew what a 'CLO' actually
was..."
Now, I wouldn't know a collateralized debt
obligation if it started weeding my lawn. Nor would The
Economist magazine, not judging by its most recent stab at
explaining this haute finance caper to its readers worldwide.
The Financial Times has been lost on all things
"collateralized" since it first tried to cover the CDO
market in Jan. 2005.
But unlike the policy wonks on Threadneedle Street,
financial hacks aren't paid to cheer Ben Bernanke in Jackson
Hole while defending financial stability back home. Nor is it
their job to underwrite those investment-banks lenders who grew
rich from the Great Credit Fraud of 2002-2007...issuing loans to
debtors with no serious hope of repayment.
"It is too soon to quantify the impact on the
economy as a whole," said Mervyn King, governor of the Bank
of England, in an open letter to the British Parliament sent on
Wednesday this week.
"In the short term, some corporate loan rates
will rise in line with inter-bank rates. Banks that are unable
to sell pools of loans that they had securitised, or who need to
support off-balance sheet vehicles, may cut back on new
lending."
What's a central banker to do? "The provision
of liquidity support [by the BoE] undermines the efficient
pricing of risk by providing ex-post insurance for risky
behaviour," says Dr.King, entirely guiltless in getting us
all here in the first place.
"That encourages excessive risk-taking, and
sows the seeds of a future financial crisis."
No fooling!
Thus the Trimmer's choice today: make free with
financial support for the country's biggest banks...or let the
market "reprice" their risk-taking and take a gamble
on the nation's financial stability instead?
Put another way – and expressed so succinctly by
the Mayfair hedge-fund blogger at FinTag.com
– Dr.King's choice is just the same as Ben Bernanke's:
"Put rates up and win a Nobel Prize in
Economics. Put them down and get a lucrative job at Lehman.
Leave them as they are and look pathetically weak."
In which case, a pathetic job back-office job at
Lehman Bros. looks the most likely reward...
"Mass delusions are not rare," wrote
Garet Garrett, nearly 2,000 years after Publilius Syrus
scratched out his maxims in Latin. In Garrett's 1932 tome, A
Bubble that Broke the World, the editor of the New
York Tribune noted how mass delusions "salt the human
story...
"[But] a delusion affecting the mentality of
the entire world at one time was hitherto unknown. All our
experience with it is original."
Garrett was speaking of the late '20s bubble on
Wall Street, but his words do more than just echo today.
"This is a delusion about credit," he went on.
"And whereas from the nature of credit it is to be expected
that a certain line will divide the view between creditor and
debtor, the irrational fact in this case is that for more than
ten years debtors and creditors together have pursued the same
deceptions.
"In many ways, as will appear, the folly of
the lender has exceeded the extravagance of the borrower."
Skip forward to early autumn 2007, and has the
folly of lenders outweighed the extravagance of borrowers once
again?
Well, in June this year, some 30% of first-time
homebuyers in Britain resorted to an "interest-only"
mortgage, just so they could make the monthly payments and grab
the keys to the door. That might sound like extravagance.
But fewer than one-in-three of them presented an
investment plan to their lender with a view to ever repaying the
principal...leaving one-in-five of ALL first-time buyers paying
the interest alone, with nothing set up to cover the base debt
itself.
On the part of the lenders, that sounds like folly.
Five years ago, just one-in-twenty of Britain's first-time
homebuyers opted for interest-only home loans with no plan for
repayment.
"The market has it wrong in that it calls this
the subprime crisis," says Barry Wilby, former manager at
Oppenheimer Funds, the $250 billion asset management firm.
"I think it's really a crisis in the underwriting and
packaging of debt. That means it has implications for the
extension of credit, because of the trust that people will have
in institutions."
"It's a big psychological problem for capital
markets," Wilby warns, thinking no doubt of the spike in
interbank lending interest rates – now at fresh two-decade
highs just shy of 7% here in London – "which will result
in a slowdown in credit extension which I think will result in
the slowing down of the global economy."
Credit extension in the UK looks set to slow –
and slow fast. The Bank of England might not know a
collateralized loan obligation when it trips over one. But it
said Tuesday that the average variable rate mortgage issued in
August rose by 0.25% to a nine-year high of 7.69%.
"Fear of retailing bloodbath when interest
rates hit home," screams The Times in response.
JJB Sports, a major High Street retailer in the UK, has cut its
full-year forecast by one quarter. The CEO of Next, another
leading clothes store, warns the real crunch could hit just as
Christmas arrives.
So while borrowing what you cannot repay is indeed
fraud, the scam of limitless consumer spending now looks
thoroughly spent. Lending what you cannot hope to get back, on
the other hand, remains pure folly.
And now that game is up too, you might want to
check just who owes what to whom in your stock-market portfolio.