Bank stuff

By | May 20, 2008

This is the column from two weeks ago but it sooo unoriginal I didn’t post it for shame. For the record though it should go up…

The Anglo-Celt reported on a meeting of the Kilnaleck Debating Society last week. One member asked for an explanation of the sub-prime crisis. He was told it was when banks lent money to people who had never repaid a loan in their lives. The meeting of this informal group which alternately masquerades as the Kilnaleck Philosophical Society took place in Brady’s Bar on the Main Street of the Cavan town. The newspaper account added that the barman offered his view. “It’s like me loaning €1000 to the local alcoholic who last week couldn’t pay for a pint and a packet of fags”.

If only the world’s bankers had the same sense as the humble barman in Kilnaleck. I should declare that the sage behind the bar and the reporter for the Anglo-Celt are one and the same: my Uncle, Peter Brady, a former Cavan Man of the Year no less. But you don’t need to be a person of such high standing to get the point. Terms we never heard of a year ago, like “sub-prime” and “credit crunch” have created a global financial storm.

The mess is not the result of a natural disaster, a mysterious economic bubble that burst or the fall-out from terrorism. It’s solely due to bankers behaving pretty stupidly. Some lent money to high risk borrowers and others rolled all the bad loans together, insured the risk and sold it up the money chain to other bankers. The bad debts were gradually transformed into A-rated financial instruments which were absorbed into pension funds. Have you checked the value of your pension fund recently? I sincerely hope you are not retiring this year.
The bonuses and dividends earned by all this activity paid for a lot of yachts and condos in the past ten years. Now we’re paying as the banks levy charges on their customers and increase mortgage interest rates.
Just last week, AIB increased the surcharge it imposes on people who overdraw their current accounts without permission. I’m not an AIB customer but you could say I have a flexible attitude towards my overdraft, so I can sympathise with those similarly afflicted. Someone with an unauthorised overdraft will end up paying 27.9pc in interest on the money they overdraw without approval. It’s not quite a pound of flesh, but Shylock wouldn’t be out of place on the board of AIB.
Still, if the bank is reduced to penalising its customers so onerously, you’d think they must be in trouble. Last year the AIB had revenues of €4.87 billion up 12% from €4.33 billion the previous year, despite the ‘adverse changes in worldwide banking’ referred to in its annual report. From these revenues they earned a pre-tax profit of €2.5 billion for 2007. That was down 4% on 2006. Oh dear, tough times.
The Bank of Ireland is having a torrid time too. In the year ending March 2008 it is believed they only earned €1.77 billion down from €1.95 billion in the previous year. If you’re a BoI customer you’d better watch out. With such disastrous results, they’ll be forced to charge you a vital organ if you miss a car loan repayment.
So what’s new? Banks like maximising profits. The problem is the effect their practices have on the entire economy in good times and bad. During the property boom, house prices escalated out of all control. Buyers blamed everyone from auctioneers to the government but neither auctioneers nor politicians set house prices. The price of a house is entirely dependent on the amount of capital available to the purchaser. If the bank is willing to provide more capital to anyone who wants it, then house prices will keep rising. And so they did.

The government was happy enough since they earned significant income from VAT and Stamp Duty. Occasionally they’d come under pressure to act to control prices but they claimed they were helpless as they had lost control over interest rates to the European Central Bank.

While the government was busy blaming “Europe”, banks and building societies carried on and without any apparent regulation introduced the 100% mortgage and the 40 year loan. No wonder house prices increased.

But in the past few weeks something odd has been happening. Although ECB rates have held firm at 4% since last June, Irish lenders have been quietly increasing your mortgage rates. What happened to Europe’s influence? Turns out lenders can increase rates anytime they want. This paper reported last week how some banks are even altering the terms of popular “tracker” mortgages. These products guarantee that your interest rate won’t increase unless the ECB rate does.

With the credit crunch in full swing, lenders have decided to dump the ECB linked product. Permanent TSB : the biggest lender in the country and IIB Homeloans have started the ball rolling by changing the terms of tracker loans.

More important than the ECB is the rate at which banks lend money to each other: the Euribor. Since banks consider each other a risk these days that rate has increased. That’s why when the ECB is holding steady and there are even predictions of a cut later in the year your mortgage is increasing. “Europe” can do what it wants and the lenders will carry on maximising their revenue from their borrowers.

When I asked one expert why the government and banks didn’t act together to increase rates during the property boom he said that would have been collusion which is illegal. When lenders act in unison to reduce rates its called competition. When they copied each other and increased them in recent weeks, that was an industry response to the global lending environment. In other words it’s fair and legal if the end result suits them. It’s only illegal if the result suits the national interest.

It’s hardly shocking that banks behave like this. But that’s why we have regulation. It’s the government’s job to make them behave in order to protect individuals and the economy as a whole. They could control the amount of money they lend customers through enforced income stress tests. They could also ask them not to leave laptops with detailed personal information about their customers lying around.

Domestically and internationally, there has been a collective failure of regulation with severe consequences. From sparking a global recession or allowing dictators to keep their billions in Swiss banks, banks do great wrong while governments stand back : until the crisis occurs and taxpayer funds are need to save the Northern Rocks. As Michael Glos, Germany’s Economy Minister put it last month

“It really is quite strange when those who tend to describe too much state intervention as the basic evil of the social market economy start calling for the state to act,” he said. “Privatising profits and nationalising losses — that’s not on.”
Unfortunately for Glos and for taxpayers and banking customers around the world, it is very much on.

21 thoughts on “Bank stuff

  1. Andrew Lawlor

    When it was rapidly becoming obvious to everyone that the property boom was reaching the top of the cycle I lost count of the estate agents or auctioneers on radio telling us that everything ws going to be fine. Just keep buying the houses, they told us, I think that, after a slight reallignment, we are going to see some seious growth next year. Etc. etc. Blah blah blah. Keep buying the wildly over-priced houses and we’ll keep taking our 2%. What about all of the estate agents who are also agents for mortgage lenders? Did they warn people of the madness of 100% loans and 40 year motgages? Not on your nellie. The estate agents were in the thick of it, creaming their profits just like the banks.

    I don’t have a particular problem with banks or estate agents making profits. Much as I don’t have a problem with M&S or Dunnes Stores maximising their profits on the strong Euro by not reducing prices when Sterling takes a nosedive. What does bug me, though, is people banging on about it as if they are being abused by some Mugabe like dictatorial regime. Consumers have a choice. Even with banks they have a choice. Nobody put a gun to anybodys head and told them that they had to buy a house. Nobody forces anyone to buy a blouse that is 25% more expensive in Dundrum than in Durham. Caveat emptor. I am sick of profit being labelled as immoral. Profit drives the free market. Greed, yes greed, drives profit. If people want to live in a socialist utopia let move to a modern progressive nation like Cuba.

  2. enf

    If Mystic Meg told you that a tall dark stranger was going to whisk you off your feet would you believe her?

    I agree with Andrew up to a point. Let the buyer beware but I would put forward that Cuba has the worlds best health service and if your health is your wealth…

  3. Andrew Lawlor

    Ah, good man, enf. The old Cuban health service chestnut. What kind of health service do you think we could afford in Ireland if we only had to pay our consultants €100 a month? Not to mention the whole no voting ’cause I’m president for life, or at least until I hand the presidency to my brother, thing. In fact, the more I think about it the better it sounds. Who needs democracy when you have your health.

  4. Gordon

    The Cuban economy and the way of life associated with it is as much due to the American embargo as any ideological design. As it is, our future sustainable, non gaz-guzzling life style will, by necessity, be closer to the Cuban than the contemporary, and irresponsible, Irish way of doing things.

    Opting out of competitive consumption, and using the full force of consumer’s power to punish rip-off atrists where it hurt’s – in the wallet, wuold be a good start.


  5. enf

    Well having no democracy is slightly better than being dead.

  6. Andrew Lawlor

    I have spent a little while searching for the resultsof the recent general election in Cuba with no success. Perhaps Gordon or enf could supply us with that information. The Cuban way of life, as Gordon so quaintly puts it, is dictated by the ruling junta. I suggest that any or all of those fans of the Cuban way of life should move to Cuba and start up a political party in opposition to Raul Castro and see how long it takes for them to ‘disappear’. Communism/socialism has been tried over and over for nearly one hundred years and it has never worked. Whenever people have been given a choice they have chosen parliamentary democracy. Let us suppose that the US embargo of Cuba never existed and free and fair elections had been held every five years, do you think that the Castros would still be ruling the country? Cuba is a prison. Citizens are denied the most basic of human rights, the right to self detrermination and even the right to leave the country. In every apartment block there is at least one government lackey spying on the neighbours and aiding the suppression of opposition. Hundreds of Irish people holiday in Cuba every year and return with tales of the wonderful people, the fantastic culture and beaches while choosing to ignore the fact that their choice of holiday destination helps to keep a dictator in power. Maybe next year they should try two weeks in North Korea and leave a personal cheque made out to the glorious leader Kim Jong-il. Maybe we could run a golf classic for Robert Mugabe’s Zanu PF to help him fight the upcoming presidential run off against the dastardly democrats of the MDC. Parliamentary democracy may not be a perfect system, but it will be my choice every time.

  7. enf

    And this is different to Ireland in the 1950’s and 1960s in what way exactly? Tyr to oppose Dev and the Church than and see what happened to you.

    All I was saying is that they have a lauded health service and I got a rant about dictatorship. Take the health service of France or Denmark then if that makes you feel better.

  8. Pete

    I think the Cuban discussion is a bit off-subject.

    Andrew is absolutely right – it was not banks who drove the price of houses into the stratosphere, it was the people who bought houses at these crazy prices.

    If the banks want to lend huge amounts of money to people who can’t possibly pay it back, then that’s their business decision, from which they should profit or loss, depending how their bet works out.

    But, as that German guy said, “Privatising profits and nationalising losses — that’s not on.”. Let the banks go bust – new, better ones will start up in their place. Or if the taxpayer must bail out the existing banks, do it by nationalising them, and get rid of all the clearly incompetent people who created this mess.

    During the early 1990’s property crash in the UK, when people were wailing about how “the government should do/have done something”, John Major made himself unpopular by saying “The government is not responsible for peoples stupidity”.

  9. enf

    I love rants. I will take any health service that won’t kill me.

    We had a bank go bust. Well it wasn’t allowed to.b AIB went bust in the early 80s after buying Insurance Corporation of Ireland. We the taxpayer had to bail them out. But of course we got a jackboot in the face after they got this bail out.

  10. Tomaltach

    I think it’s important to remember that the subprime lending aptly described by your good uncle didn’t really happen in Ireland. Yes, there were 100% mortgages and high salary multiples, but that is an order of magnitude short of the kind of lending in the US which essentially threw money at people who had proven difficulties in their credit worthiness.

    So it’s not so much that we had a sub-prime crisis here, but that we are suffering the effects of the crisis on global credit markets which are hitting out banks.

    It’s true the government could have, and there are good reasons to argue, should have tightened some rules relating to lending. In other words, perhaps those people who are badly stretched now should have been denied the opportunity to buy.

    But two thinks should be noted I think.

    First, the government did intervene in the housing market in a whole range of complicated and very signfiicant ways.

    Second, those interventions were not always coherent nor did they always have the intended effect.

    Recall the Bacon reports. 1, 2, & 3 running from 1998 to I think 2000, maybe later. These advised the government on how to tackle the rocketing house prices. (The average price in Dublin had reached an incredible £99k or Eu128k! Terrible!). But the growth rate was enormous and touched 20%. Bacon proposed a whole host of measures – from adjusting stamp duty to favour first time buyers, or just home buyers over investors (remember the 2% speculative tax), changes to captial gains tax to make the land market operate freer, faster planning rules, and so on. The list of areas is actually quite extensive. And to be fair, the government put most of the measures into effect. There were side effects, the disincentive to investors drastically cut the supply of rental accommodation – recall the soaring rents in Dublin especially around 1999/2000. I recall flat hunting then. It was insane. (in fact Bacon 2, acknowledge this and reversed some of the measures to tip the balance back a bit to address the rent issue).

    But essentially Bacon addressed both Demand and Supply side measures. In the end, I personally believe, it was the supply side measures which had most effect. Demand control is of limited use. If you cut stamp duty, you still have the same number of purchasers, actually more initially, chasing the same number of goods. This pushes the price back up to where it was before cutting. And so on. But undoubtedly some of the supply side measures did kickin – larger zoning chuncks, more serviced land, tax breaks for certain developments, captial gains etc. This is evident in the output increases from 2000 to 2006 where annual output grew from about 50,000 to 90,000.

    In fact, it is possible to argue that, because supply of houses lags the state of the market (it takes time to but land, get planning, build), this leads to inevitable supply overshoots. So, even if interest rates hadn’t turned north due to the credit crisis, there may well have been an adjustment, whereby the supply would drift back to more sustainable levels. Certainly when the credit crisis triggered a reduction in demand, the scale of overupply quickly revealled itself.

    Given the complexity of the market then, I’m not sure if cutting the 100% people, who were always a minority of buyers, out of the market would have had a huge effect. The head of steam was already built up.

  11. Sarah Post author

    amen on crazy people, but crazy banks did lend the money.

  12. enf

    This was a global phenomenon and not restricted to the Emerald Isle.

    Allowing the development spread out so wide is going to bite us in the ass for decades to come. Servicing these “communities” is going to cost a fortune.

  13. Pete

    >amen on crazy people, but crazy banks did lend the money.

    Banks are just groups of people. Now these people must suffer the consequences of their mistakes. If they don’t, they’ll have no reason not to just go on doing more of the same. To put it another way – if we bail them out, they’ll screw us again. If we don’t, they won’t (at least not for a while).

  14. Tomaltach

    You’re right – if we bail them out, they’ll screw us again. But if we don’t we’re f**ked. They are gigantic pumps that keep the economy supplied with large amounts of its life-blood, money. If they fail, the whole thing dies. That is why in Britain and America, the two countries in the world where, arguably, the ideology of keeping the state out of business is strongest, the state has intevened to apply the defibrillator to important banks.

    In Ireland the banking sector is notoriously uncompetitive. For depositors, current account holders, and small business, the bulk of the business goes to. two giant banksYear in year out the competition authority hammers on about the banks – and makes recommendations (some of which have been accepted, such as making it easier to change bank). But some of which are rejected, such as changes in control of the clearing system. There is also a stickiness in banking that applies in few other areas : in banking, perhaps above other areas, a strong brand and a reputation for reliability (though not, it appears security!), weigh heavily in people’s minds. All of which acts a s an intangible barrier to entry for new banks. Slowly this is changing. And I dream of the day when people will change banks as quick as they change barbers.

  15. enf

    2 big banks. 2 big parties. No change on either side. Sound familiar?

  16. Electron

    I always think of the parable of the sower when the sup-prime lending thing comes up – it was an interesting, albeit expensive, experiment. Advertising is not much different, sometimes it would be cheaper and equally as effective to simply throw money at passers by, but then, there’s always that one ad that works magic.
    The 100 Euro to the alcoholic is a childish view of money in an economy – follow the trail of that 100 as it trickles down through the economy and perhaps it yielded ten fold in someone’s hands – Economics is an nondeterminist Science.
    Probability is the name of the game, but perhaps these bankers just pushed it a bit too far.

    “a sower went out to sow his seed: and as he sowed, some fell by the way side; and it was trodden down, and the fowls of the air devoured it. And some fell upon a rock; and as soon as it was sprung up, it withered away, because it lacked moisture. And some fell among thorns; and the thorns sprang up with it, and choked it. And other fell on good ground, and sprang up, and bare fruit an hundredfold. And when he had said these things, he cried, He that hath ears to hear, let him hear.”—Luke 8:4-8

  17. Sarah Post author

    As the benefits of the 100 being spent multiply, so do the repercussions of the failure to repay it. As we are now witnessing.

  18. enf

    Ah yes. The bible. As written by Eddie Hobbs.

    The real way banks screw you is by the public not understanding what they are getting into.

    For example when you buy a car on finance you are buying a loan and getting a free car. The dealer gets a kickback when you buy the car from the finance house and your interest is calculated on the Rule of 78 principle where you pay the bulk of the interest off at the start before touching the principle.

    The banks rely on the unsophistication and vanity of their retail customers. They also rely on the Irish social norm of not complaining or if they do complain it is meek and passively to their friends in the pub. The customer wants a new Mini. They couldn’t care less what the interest rate is. All they care is that everyone thinks they are doing well with the new Mini. The dealer is delighted with his four grand tip for you being vain and the bank is laughing up its sleeve after making you shell out for the interest first.

    Rolling over a car loan into another new car after a year is another act of vain financial suicide. The car may be brand new and the bank happy to lend to you but you are paying through the nose for a new loan and to reset the clock again and start repaying more interest.

    And we have a terrible habit here of letting loans lapse for a month or two. You have 5 days grace before the payment is marked “late” and if you miss a month you get a 1 against your ICB rating. Too many of these and lenders will close the door to you.

    I worked in a bank. I got calls from people in real distress 5 years ago. “Yiz have lifted too much money from me account”. What the F*** is a balloon payment?” “one dealer called me and said his customer had abandoned his car and threw the keys in the door at him. And people in tears on the phone after being refused a loan. Looking at their accounts you could see they weren’t making payments. And this was in the boom times. God only knows what horrors lie beneath these days. One slip and a lot of people are in the shit house. Lose your job and the mortgage and car payments and childcare all get too much.

    This wasn’t a major bank. Well not major in Ireland. But they were targeting a specific area of the market. The mid to low working class who wanted a car or a conservatory or a holiday. The very people that don’t read the fine print. The people that just want the car and to hell with the consequences.

    The banks know what they are doing. They are professional gamblers. We are the mugs.

  19. Electron

    Sarah, it wasn’t only the sub-prime borrowers that started this current crisis, it was the middle classes releasing equity in their over valued homes and living the life and the banks pulling one over on each other when selling on debt. – that’s where the real problem lay. The sub-prime borrowers may have reneged on their repayments obligations, but they still had an asset of reasonable value. The Banks selling on overpriced debt to each other, were really pushing the boundaries and this is what brought down the house of cards.
    Enf, I’m amazed that you are surprised with the behaviour our Banks – we live in a capitalist society and this is what capitalists do. Someone has to push for more demand if we are to have growth and without growth everything suffers.

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