The Credit Crunch

Question: Which literary character is a Collatorised Debt Obligation (CDO)? Obvious answer: Faustus. Listening to a recent Radio 4 documentary on the crisis in the international banking markets, the Mephistopheles of the recent Credit Crunch is the financier who has concocted clever ways of wrapping up essentially bad or high risk debts into attractive packages, and selling them to a banking system lusting not for anything so beautiful as Helen of Troy, more that end of year bonus and swanky basement conversion to their house in the suburbs. Whispering in the ear of bankers in the bars of the city, the economist has proposed:

But now thou must bequeath it solemnly,
And write a deed of gift with thine own blood;
For that security craves Lucifer.

Unfortunately, that "security," or CDO seems to have been not so safe after all. As several bankers in the programme rued, we have been here several times before since the 1930s, and failed to learn from each crash, always believing "this time, we're cleverer than the previous lot. Except, of course, we're not." The burning of books (or the run on the bank) ensues.

Our Chorus for the complexities of the money market is John Lanchester, who in a brilliant explanation of "Cityphilia" in the London Review of Books allows us "to wonder at unlawful" (well, almost) "things":

A well run bank is a machine for making money...Imagine, for the purpose of keeping things simple, a country with only one bank. A customer goes into the bank and deposits £200. Now the bank has £200 to invest, so it goes out and buys some shares with the money: not the full £200, but the amount minus the percentage which it deems prudent to keep in cash, just in case any depositors come and make a withdrawal. That amount, called the ‘cash ratio’, is set by government: in this example let’s say it’s 20 per cent. So our bank goes out and buys £160 of shares from, say, LRB Ltd. Then LRB goes and deposits its £160 in the bank; the bank now has £360 of deposits, of which it needs to keep only 20 per cent – £72 – in cash. So now it can go out and buy another £128 of shares in LRB, raising its total holding in LRB Ltd to £288. Once again, LRB Ltd goes and deposits the money in the bank, which goes out again and buys more shares, and so on the process goes. The only thing imposing a limit is the need to keep 20 per cent in cash, so the depositing-and-buying cycle ends when the bank has £200 in cash – all the cash there is – and £800 in LRB shares; it also has £1000 of customer deposits, the initial £200 plus all the money from the share transactions. The initial £200 has generated a balance sheet of £1000 in assets and £1000 in liabilities. Magic! In real life, it’s even better: the UK cash ratio is 0.15 per cent, so that initial £200 would generate £133,333 on both sides of the balance sheet.

I though I had a handle on the way the stock markets work, but it appears not. Enter, yours truly, the clown. Having recently acquired some inheritance, I decide to invest rather than paying off my student loan, and trot into the Co-Operative bank, they being the most ethical of a pretty bad bunch. The happy consultant grasps my hand, and thrusts in my face a series of graphs and charts that flow inevitably upwards towards monetary heaven, promising a 10 - nay 20 percent - return on my investment, staggered to receive greatest tax benefits, risk spread - like a low fat version - across different environmental and ethical funds. I turn to leave with a guide tucked under my arm, and swear as I do that the consultant is secretly congratulating himself on another sale:

when thou took'st the book
To view the Scriptures, then I turn'd the leaves,
And led thine eye.

Luckily, I am not so blind as to fail to read the small print. Wherein I discover how banks, even the nicer ones like the Co-Operative, make so much money. Thank you for your deposit, Mr. Faustus. Now, we'd just like to chip off 1.5% here (a management fee, you understand); oh, and we'll take 3% of whatever you gain; and how about 0.1% (just for the hell of it). So if I invest £3000, by the end of the first year I will have lost about £285, and over five years for every pound of my money I risk, and assuming I do gain with an upturn in the markets, the bank will get themselves the same amount again.

Count me out of this opportunity (yes, that's right, the markets being so low and volatile at the moment, this is a great time to invest, Sir!). This scholar wags his philosophical finger, and heads over to National Savings and Investments.

Labels: collatorised debt obligation, credit crunch, Politics, stock market

1 Comments:

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4:53 am  

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