Why are banks failing? What has happened?

GeorgeHowell

sadabbott wrote: »

Ok OK - we have gone a bit off topic.

Why are we in the state we are in?

Ok treating it as a serious question ...

Banks, especially in the US, but here too, lent money without adequate collateral -- eg :- >=100% mortgages, self-certification, politically correct lending to minorities, and lending to people who have no hope of paying it back. They did this primarily so that middle ranking and senior executives could show large forthcoming paper profits on their activities and thus generate large bonuses for themselves -- bonuses seem to drive all banking behaviour now. Then the price of property slumped -- it happens from time to time. So the usual assumption that you just reposess where you have to, and then raise more than the loan was worth in the first place went out of the window. Because all the banks were doing this to some extent, and all had undeclared bad debts on their hands, they became wary of lending to each other in case the one they were lending to was in even worse do-do than they were and might default on the loan. Without banks lending to each other they can literally run out of money -- as happened to Northern Rock, and when that happens a crisis of confidence sears through the financial sector like wild fire. Governments are trying to fix it by pumping huge amounts of money into the banking system so that no bank runs out of money, but there is opposition from those who do not wish to risk taxpayers' money in order to bail out the greedy, incompetent, irresponsible bankers who got us into this by chasing their obscenely large bonuses.

opinions4u

A bank lends £100bn out.

£40bn may come from savers and business deposits.

The other £60bn comes from wholesale markets (investment banks for example).

Some of the £100bn lending doesn't get repaid. The security for those loans has fallen in value.

£20bn of the £60bn is due for renewal on the wholesale markets. The investment banks refuse to renew as they feel the risk is too high.

The bank still has £100bn of loans, but only £80bn to fund them with. The game's up.

I've rather simplified it, but hope it helps!

sadabbott

So this money that the government lends or pumps into the banking system. Why not just print it - the cost of that is minimal.

LucyTheDwarf

And hyperinflationary. Read up on Germany, Weimar Republic inflation 1923.

cheerfulcat

sadabbott wrote: »

Ok so some people bought houses and paid too much. That happened before.

Why are the banks in trouble? What has happened?

What happened was that rather than the lending banks holding the loans they had given out on their own books, they sold them on. Lower-quality loans, instead of being kept separate, were mixed in with higher quality ones to give them a higher rating ( make them look safer ), so buyers of these loans paid more for them than they should have.

Things seemed fine until house prices started to tumble; at this point the people who had bought the loans realised that they had no idea what the possible default rate might be. There is a further complication in that various Acts over the past year or so have required holders of these loans to value them properly on their books - since it is nearly impossible to do so, they have had to be written down ( given low or no value ). There is extra trouble because there was quite a bit of leverage involved in the whole structure.

This is an ultra-simplified version, btw...

What is going to happen?

We'll muddle through, just like we always have. A lot of people will lose a lot of money and a few will make shedloads. The poor old taxpayer will as usual get stuck for the damage.

Is this going to end in the destruction of capitalism and a resurgence of communism?

No chance.