This piece first appeared in the money section of the Saga website on 19 March 2008
The text here may not be identical to the published text

 

The music stops

A bank collapses. Another follows. Inflation rises. Currencies fall. House prices drop. Mortgages default. Interest rates tumble. Credit dries up.

Welcome to the transatlantic economy.

No need to understand collateralised debt obligations, total return swaps, or synthetic securitization. All we have to know is that they are some of the complex bets banks have dreamt up. At first to make money off each other. Competing not on price but on being cleverer – or luckier – than their rivals.

But later to reduce the risk of these gambles by using even more complex deals to bet against themselves. So whichever way the result went they wouldn’t lose as much. All the time trying to make a turn at the expense of their competitors. And using our money to do it.

Like any house of cards the trillions of pounds worth of deals done every day need a firm flat base to stand on. In banking that base is provided by trust. A banker’s word is his or her bond. When they promise to honour a debt they can be believed.

Not any more. Banks have stopped trusting each other to honour their side of these complex bets. Not because they think their colleagues are lying – though some lies have undoubtedly been hidden deep inside complex financial instruments. But because a promise to repay a debt is only as good as the assets which will be used to keep it.

If the bank turns round and finds the goods it relied on were in fact lent to someone else who went to the cash machine to get the money they owed only to find that the overdraft had been cancelled because when that bank went to the vaults for its currency it found the whole lot had been used as collateral against a bet on the value of mortgage payments that were now in default on a house that could not be sold….well you get the picture. And once banks stop believing that ultimately there is something real to meet the final debt at the end of these complex and artificial bets then the whole edifice comes tumbling down.

And the fear is that this is not a house of cards at all. It is a game of musical chairs played by people sitting not on seats but on each other’s knees. When the music stops if anyone finds air beneath them the whole circle collapses however carefully the rest of them have aimed. Bringing our mortgages, our credit cards, our loans – and the pensions and savings that depend on them – down with it.

This week the music stopped. Pray they all find a knee.


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