QE For Ten Years: Saving the Banks and Smashing Society

My last blog began with a second reference to the ten years that have elapsed since the collapse of Northern Rock told the public - and the unobservant Econocracy - that there was a crisis already well developed in the world of banking. More than a year before the Northern Rock event hit the British system, the USA had had its own crisis in the collapse of several institutions which the Clinton regime had induced to accept 'sub-prime' mortgages. The term sub-prime was not in common currency in the UK, and the USA was far away, so not much notice was taken of those events even in the London money market.

Within the US financial system, it had slowly become apparent that the sub-prime mortgages had been sold on [in the manner described yesterday] as parts of securities which were just bundles of debts where the borrowers would [in the main] carry on making the payments they were contracted to make: thus the buyer of such a security was effectively buying a cash-flow of future payments. The original lender of the money would retain the duty to collect the payments and pay the interest on the security, and there would be an allowance for the proportion of the borrowers who would default on their payments. So the original price of the security was based on a supposedly objective view of what it would yield to its owner during the term for which it was valid. On that basis, the security could be sold on, for inclusion in larger or more inventive types of security. The sub-prime mortgages were a category where the borrower was very likely to default, and the continuing decline of the old industries in what were quickly becoming known as the 'rustbucket' areas meant that many families lost their main earnings and could not afford the repayments. Defaults on payments of sub-prime mortgages seemed, at first, an American problem: but during 2007 an increasing proportion of securities traders became worried about UK securities that included packages of mortgages issued by banks and building societies whose lending had become [by all historic comparison] reckless.

Among these was Northern Rock, which was borrowing credit in the wholesale market [see last two blogs in this series for details] in order to lend to new customers. The lending was reckless: more than 100% of the asking-price for the house was available to clients who were taken at their word as to how much they earned. This sort of lending [in which the Rock was only the most conspicuously adrift from traditional caution] led to clever traders realising that securities based on Northern Rock loans, and securities containing a 'repackaged' share of Northern Rock, may not perform as promised. So the wholesale market stopped buying Rock securities: and the Rock had no ready money in its tills beyond the usual daily turnover. Hence, as customers heard the rumours and queued with their documentation to demand their own money, the firm failed and [as explained previously] the government instructed to Bank of England to provide the money that the customers were demanding. After the crisis the residue of the Rock was sold off: its trading branches were taken over by Virgin Money and most of them are still trading, and the mortgage debts were sold to firms that managed the run-off so that most of the securities that the Rock had sold were successfully [and profitably] carried forward to their terminal dates.

Behind this happily makeshift resolution of the crisis caused by one smallish [albeit prominent] firm, the financial markets as a whole were beginning to panic about the multi-trillion pound market in securities that had been built up by 'innovative' firms that had been making their own paths to untold wealth by taking the fullest advantage of the market freedom created by the Thatcherites on the urging of the Econocracy in 1986. Within a year of the Northern Rock crisis, there was an emergent crisis throughout the market. Nobody could be sure which securities contained how big a proportion of debt that might become 'sub-prime' if the root provider of the cash flow failed. So the Bank of England was instructed to copy the US Federal Reserve, which had already begun an indefinitely large open-market operation which it called QE: Quantitative Easing. Though the detail is mind-bogglingly complex, the principle is simple. The banks were told to form an orderly queue, and slowly to arrange their portfolios of securities so that they could present government bonds at the Bank of England which would [in essence] 'print money' with which they bought the government securities [and just kept them in their vault, metaphorically]. Thus any bank could get cash by selling government securities to the Bank, and use that cash to fund the orderly winding-down of the 'assets' in the market. Those that were considered 'toxic' were disposed of cheaply, and holders of the rest of the mass of securities could resume trading, albeit cautiously. Nobody realised, when Britain adopted QE in 2008, that the queue would continue shuffling to the Bank asking for cash until now: but that has happened. it has saved the banks and the wholesale securities trade that lies behind the banks; but it has been ruinous to the economy in which human beings depend, and to the society that binds humans into a community. This is the subject for the next blog.