Could the credit crunch have been foreseen?

I sold all of my shares in the summer of 2007 on fears of the sub-prime crisis. I am still irritated because the FTSE rose a further 700 points from August and peaked in October 2007. The fear of sub-prime risk was sufficient in mid 2007 to make me sell so why are so many journalists saying that no-one could have foreseen the crisis?

The subprime crisis "hit" in the UK in February 2008 with the Nationalisation of Northern Rock (BBC 2008) and FTSE shares started to nosedive after May 2008. So who foresaw the crisis?


On February 21st 2007 Business Week warned of a spread in the risks associated with sub-prime repayment failures to the financial system in general (Business Week article)

The Economist magazine, perhaps the most influential economics journal, ran an article every few days on the coming storm throughout 2007 (A list of a few of the articles is appended)

On 9th August 2007 Business Week reported that the subprime crisis was going global (See Business Week article.

On the 21st November 2007 the BBC gave a clear description of the crisis to come. See BBC Article which has the predicted crisis outlined with copious data and graphs showing the coming disaster.

On December 2007 the IMF reported that there was a crisis in the subprime sector that was threatening the entire financial system. See Dodd's IMF Report 2007.

On 7th September 2008 the US Government rescued Fanny Mae and Fredddy Mac. See BBC Report.

In other words everyone saw the crisis coming a year before it fully hit the fan!

Why journalists are giving Britain's Gordon Brown such an easy ride when he was one of the architects of the crisis is a complete mystery. Are they ignorant of the past?

There was an entire year when the world sat on its hands, hoping that the crisis would pass but even before 2007, when the global crisis was clearly coming, there was plenty of warning of a debt bubble.

On the 9th August 2005 the BBC ran the headline House prices too high - Prescott. So even in 2005 it was obvious that there was a credit bubble and the government knew there was a credit bubble. Of course, everyone knew that house prices were getting far too high all through the "noughties". If you want clear evidence look at the ratio of house prices to income and it is obvious to anyone that this ratio left the realms of credibility in 2004 (also see Nationwide historical data, Halifax data). In 2004 the ratio of price to income exceeded 4.5 which is a level that has always been associated with a housing boom-bust cycle, the stable long term ratio being about 3.5.

So, could the UK government have foreseen and averted the current crisis in the UK? The answer is clearly "yes". In 2004/5 they should have prevented banks and building societies from arranging home loans where the borrower's income was less that 25% of the value being borrowed. In 2007 they should have insisted that British banks limit their exposure to "collateralised debt obligations" - the Spanish acted against this and their major banks are now some of the strongest in the world (see Note 1).

I introduced this article by saying that I was irritated by missing the top of the Stock Exchange bubble. That said, I made a good profit anyway and minimised risk. As a private investor I had the option of taking a risk or going for stability and security. I chose stability and security. The British electorate need to decide whether they want governments that provide a stable and secure environment or governments that operate a roller coaster of high risk policies.

On the 20th June 2007, when the Economist and other leading economics journals were literally screaming warnings about the coming economic catastrophe, Gordon Brown responded by saying that he was dedicated to "enhancing a risk based regulatory approach" and would not react to the regulatory failures that had led to corporate failures over the previous decade (Mansion House speech 2007). Just for reference, consider the following headline in the Economist of 21st June 2007, the day after Brown's speech: "The subprime meltdown. A prominent hedge fund's implosion revives fears about the poisonous influence in America's subprime-mortgage market". Brown was extraordinarily negligent.

He said in his Mansion House speech of the 20th June 2007:

"So I congratulate you Lord Mayor and the City of London on these remarkable achievements, an era that history will record as the beginning of a new golden age for the City of London."

"And I believe it will be said of this age, the first decades of the 21st century, that out of the greatest restructuring of the global economy, perhaps even greater than the industrial revolution, a new world order was created."

Why has no-one made him eat his words?





Note 1: "According to the Bank of Spain (November 2007 bi-annual report), Spanish institutions have developed a less complex securitization model than their British and American counterparts, have securitized only what are (in theory) good quality assets (94% have triple A rating) and have favoured the maintenance of some part of the risk within their balance sheets. This, it is argued, has lead them to pursue a more rigorous credit policy than the British or US banks, but when we look at the rate at which the Spanish loan portfolio has expanded, we might like to raise an eyebrow or two in the face of this argument. In the strict sense of securitization, 20.9% of mortgage loans were securitized in 2006 (in the form of MBS). Combining the two securitization techniques (MBS and covered bonds), this proportion reached 37.3%." (See Training Session on the Spanish Bank Bailout Plan. Edward Hugh).





References

Business Week (2007) Fears Reignite for Subprime Lenders. Business Week February 21, 2007 http://www.businessweek.com/investor/content/feb2007/pi20070221_154714.htm

Business Week (2007) Subprime: The Ugly American Hits Europe. French bank BNP suspends subprime-linked funds. Europe's central bank responds; stocks tumble. Business Week August 9th. http://www.businessweek.com/globalbiz/content/aug2007/gb2007089_266456.htm

BBC (2008) US rescues giant mortgage lenders Sunday, 7 September 2008 http://news.bbc.co.uk/1/hi/business/7502310.stm

BBC (2007) The downturn in facts and figures 21st November 2007. http://news.bbc.co.uk/1/hi/business/7073131.stm

BBC (2008). Northern Rock to be nationalised BBC 17th Feb 2008 http://news.bbc.co.uk/1/hi/business/7249575.stm )

Dodd, R. (2007) Subprime: Tentacles of a Crisis. Finance and Development. December 2007, Volume 44, Number 4. http://www.imf.org/external/pubs/ft/fandd/2007/12/dodd.htm

Economist Articles:

(Just a few to show the atmosphere when Brown made his speech).
# FINANCE & ECONOMICS: Stockmarkets
Turmoil in the markets
What lies behind the latest upheavals
Jul 27th 2007

# FINANCE & ECONOMICS:
Market.view Not so creditable
How the subprime sickness might spread
Jul 22nd 2007

# FINANCE AND ECONOMICS: Debt markets
Another pounding
Problems in America's housing market begin to undermine confidence in the global credit bubble
Jul 12th 2007

# FINANCE AND ECONOMICS: Debt ratings
AAAsking for trouble
Not all triple-A ratings inspire total confidence
Jul 12th 2007

# FINANCE AND ECONOMICS: America's mortgage giants
Fannie and Freddie ride again
The subprime mess provides an opportunity for Fannie Mae and Freddie Mac to salvage their reputations
Jul 5th 2007

# FINANCE AND ECONOMICS: Credit markets
You only give me your funny paper
Debt markets turn grouchy as creditors ask for more
Jun 28th 2007

# FINANCE & ECONOMICS: Market.view
Unsinkable junk The corporate-default rate must rise—but when?
Jun 24th 2007

# FINANCE AND ECONOMICS: The subprime meltdown, continued
Bearish turns
A prominent hedge fund's implosion revives fears about the poisonous influence in America's subprime-mortgage market
Jun 21st 2007

Mansion House Speech 2007. http://www.hm-treasury.gov.uk/press_68_07.htm

Nationwide historical house price data. http://www.nationwide.co.uk/hpi/historical.htm