tag:theconversation.com,2011:/africa/topics/subprime-2580/articlesSubprime – The Conversation2018-04-19T10:50:24Ztag:theconversation.com,2011:article/939002018-04-19T10:50:24Z2018-04-19T10:50:24Z2008 financial crisis still seems like only yesterday for single women<figure><img src="https://images.theconversation.com/files/214856/original/file-20180414-570-i6t6p1.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">A woman walks by the New York Stock Exchange. </span> <span class="attribution"><span class="source">AP Photo/Richard Drew</span></span></figcaption></figure><p>For many Americans, the financial crisis that plunged the global economy into recession a decade ago may seem like a distant memory. </p>
<p><a href="https://www.federalreserve.gov/releases/z1/20180308/z1.pdf">Household net worth</a> – the difference between assets and debts – reached a record US$98.7 trillion in the last quarter of 2017, up from $56.2 trillion in 2008. </p>
<p>Yet net wealth, by itself, masks a lot of information that could signal troubling trends. For example, this measure doesn’t tell us which households are getting richer. It also doesn’t reveal how much borrowing is fueling these ostensibly swelling balance sheets. </p>
<p>More specifically, it doesn’t show that for households headed by women, particularly poorer ones, the financial picture is still very cloudy. That’s in part because, as my soon-to-be-published research shows, low-income single women borrowed a lot more than single men in the years leading up to the crisis. And their indebtedness relative to their income and wealth remains far more elevated than is the case for pretty much everyone else.</p>
<p>This is especially worrying because female-headed households are vulnerable to begin with – and so are at risk again if <a href="https://theconversation.com/recent-stock-market-sell-off-foreshadows-a-new-great-recession-92471">another crisis looms on the horizon</a>. </p>
<h2>Why debt matters</h2>
<p>To understand why debt is so integral to household financial health, it’s helpful to look at what happened during the 2008 financial crisis. </p>
<p>Overall household debt grew dramatically in the early 2000s, driven in large part by the <a href="https://files.stlouisfed.org/files/htdocs/publications/review/06/01/ChomPennCross.pdf">subprime mortgage</a> boom. This borrowing eventually reached levels that proved to be unsustainable and, after interest rates began rising in 2004, forced millions into <a href="http://money.cnn.com/2006/09/13/real_estate/foreclosures_spiking/index.htm?postversion=2006091508">foreclosure</a>.</p>
<p>While things have recovered, the significant gains in net worth are illusory, in part because <a href="https://www.washingtonpost.com/news/wonk/wp/2017/12/06/the-richest-1-percent-now-owns-more-of-the-countrys-wealth-than-at-any-time-in-the-past-50-years/?utm_term=.ba02d0976df1">they have gone disproportionately</a> to the richest households. Moreover, they have been financed through a lot more borrowing.</p>
<p>Total household debt reached <a href="https://www.newyorkfed.org/medialibrary/interactives/householdcredit/data/pdf/HHDC_2017Q4.pdf">a record $13.15 trillion</a> at the end of 2017, up about $2 trillion since the most recent trough in 2013. Nonhousing debt like credit cards and student loans made up most of the increase. </p>
<p>To understand why net worth is misleading, consider two households with identical net worth of $10,000: One has $15,000 of assets and $5,000 of debts, while the other has $10,000 of assets and no debts. </p>
<p>Whether the $5,000 turns out to be unsustainable or not depends on the household’s ability to service the debt and pay down the principal. If its income becomes insufficient, the debt will accumulate, and eventually the family will have less and less money for the necessities of life – as occurred during the financial crisis. </p>
<p>Sustainable debt can quickly become unsustainable if a household suffers what economists call a “shock,” or any unexpected change to the family’s ability to make ends meet, like losing a job or caring for a sick relative. And some households are more vulnerable, or <a href="https://economics.mit.edu/files/5998">financially fragile</a>, than others. </p>
<p>Unpredictable shocks can push such households over the edge.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/214855/original/file-20180414-540-xpgtw0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/214855/original/file-20180414-540-xpgtw0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=399&fit=crop&dpr=1 600w, https://images.theconversation.com/files/214855/original/file-20180414-540-xpgtw0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=399&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/214855/original/file-20180414-540-xpgtw0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=399&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/214855/original/file-20180414-540-xpgtw0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=501&fit=crop&dpr=1 754w, https://images.theconversation.com/files/214855/original/file-20180414-540-xpgtw0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=501&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/214855/original/file-20180414-540-xpgtw0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=501&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Households that are financially fragile are more vulnerable to unpredictable shocks such as medical bills or job loss.</span>
<span class="attribution"><span class="source">kudla/Shutterstock.com</span></span>
</figcaption>
</figure>
<h2>The feminization of poverty</h2>
<p>Female household heads are particularly at risk to shocks because of their greater economic insecurity and may be more likely to use high-cost borrowing to make ends meet. </p>
<p>For a start, single women’s median wealth is <a href="http://www.mariko-chang.com/AFN_Women_and_Wealth_Brief_2015.pdf">one-third that of single men</a>. And single women – mothers in particular – <a href="http://poverty.ucdavis.edu/sites/main/files/file-attachments/policy_brief_stevens_poverty_transitions_1.pdf">have more frequent and longer poverty spells</a> and <a href="https://statusofwomendata.org/explore-the-data/employment-and-earnings/employment-and-earnings/">higher unemployment rates</a> than other households. They also experience <a href="https://www.americanprogress.org/issues/economy/reports/2017/04/27/431251/single-women-face-greatest-risk-economic-insecurity/">high levels of economic risk</a> from shocks such as divorce and unexpected care obligations. On top of all this, the social safety nets such as federal welfare programs that used to support female-headed households <a href="https://www.thenation.com/article/the-american-social-safety-net-does-not-exist/">have been weakened</a>. </p>
<p>Economists have also pointed to evidence of a “<a href="http://www.tandfonline.com/doi/abs/10.1080/10511482.2011.615850">feminization of high-cost credit</a>,” particularly among women of color. That’s because low-income single women’s economic vulnerability and historically limited access to traditional credit products have made them <a href="https://www.journals.uchicago.edu/doi/full/10.1086/675391">targets for predatory subprime lending</a>. In a 2006 sample of mortgage borrowers, more than <a href="http://www.tandfonline.com/doi/abs/10.1080/10511482.2011.615850">half of mortgages</a> owned by black single women were subprime, compared with 28 percent for non-Hispanic white single male borrowers. </p>
<h2>Pushed into the red</h2>
<p>My research, which will be published in the Forum for Social Economics, shows that female-headed households experienced a concerning increase in two major forms of borrowing leading up to the financial crisis: mortgage and educational debt.</p>
<p>Controlling for other household characteristics such as household size and marital status, I examined differences in the growth of average mortgage and student debt among single female- and male-headed households in three time periods: the late 1990s, the credit expansion of 2002 to 2007, and the post-crisis period of 2008 to 2013. I also compared differences between incomes below and above the median, which varied from $24,000 in 1995 to $35,000 in 2007.</p>
<p>My most significant finding is that average mortgage debt for households headed by lower-income unmarried, divorced or widowed women increased substantially during the credit expansion – rising from about $9,800 to $16,600 after adjusting for other household characteristics – while similar households led by single men showed no statistically significant change during the period. This gender gap persisted during the recovery; debt for men and women changed very little through 2013. </p>
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<p>One explanation is that lenders saw poorer single women – and <a href="http://www.tandfonline.com/doi/abs/10.1080/10511482.2011.615850">women of color in particular</a> – as a largely untapped market in their rush to originate all the high-interest loans that they could. <a href="https://consumerfed.org/pdfs/WomenPrimeTargetsStudy120606.pdf">Other research</a> has found that women were more likely than men to receive subprime mortgages. </p>
<p>In terms of student debt, I found that the average single woman borrowed an extra $2,000 or so during the lead-up to the crisis, compared with an increase of only $775 for men. This was particularly prevalent among younger single women. After the crisis, when many people went back to school because there were so few jobs, female-headed households increased their student debt by an additional $3,400 on average, while men borrowed an additional $2,800. </p>
<p><iframe id="N1F4t" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/N1F4t/3/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<p>One reason for this is likely that <a href="https://iwpr.org/publications/single-mothers-overrepresented-profit-colleges/">single mothers</a> are overrepresented at for-profit colleges, where students are <a href="https://files.consumerfinance.gov/f/201207_cfpb_Reports_Private-Student-Loans.pdf">three times more likely</a> than their peers at nonprofit universities to hold costly private loans. Another is that <a href="https://www.aauw.org/research/deeper-in-debt/">more women</a> were studying at college.</p>
<p>One important caveat to my data. My data show only averages over time, not how the fortunes of particular borrowers changed. In other words, I can only show trends, not whether individual households are in fact better or worse off than they were at different points in time.</p>
<h2>Wealth and financial fragility</h2>
<p>Of course, debt isn’t always a bad thing. Many households use debt to acquire assets to improve their financial situation down the road.</p>
<p>Homeownership is an <a href="https://www.nbcnews.com/feature/in-plain-sight/american-dream-home-whats-middle-class-without-house-n296346">important way</a> to build wealth, so it’s not altogether a bad thing that a record share of unmarried women <a href="https://www.nytimes.com/2017/09/28/realestate/most-unmarried-homeowners-are-women.html">owned their own homes in 2006</a>. Similarly, educational investments lead to long-run payoffs that far exceed tuition costs: Someone with a college degree <a href="https://www.aeaweb.org/articles?id=10.1257/jep.26.1.165">is estimated</a> to earn one and a half times as much as a high school graduate. </p>
<p>Still, there are good reasons to question whether all that pre-crisis borrowing really improved households’ financial health. In my own research, I found that lower-income women’s debt-to-wealth ratio doubled from the late 1990s to 2013. It turns out, the wealth created by the surge in female homeowners simply vanished when the housing bubble popped. </p>
<p>Today, as borrowing again crescendos, there are good reasons to worry that the next bursting of a debt-driven bubble is right around the corner. And when it happens, once again many low-income single women and their dependents will be among the worst hit.</p><img src="https://counter.theconversation.com/content/93900/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Melanie G. Long does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Single women borrowed heavily in the run-up to the financial crisis, ensuring they suffered the most in its fallout. Will history repeat itself?Melanie G. Long, PhD Candidate in Economics, Colorado State UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/501702015-11-24T12:44:46Z2015-11-24T12:44:46ZSubprime 2: the return of the killer mortgage<figure><img src="https://images.theconversation.com/files/102186/original/image-20151117-4964-e997vn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The crisis has changed its colours</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/75535370@N06/6786867942/in/photolist-bkJtow-mmZbQ-ocrvxo-8myVPM-31Rkvu-6TEmFW-to5BL-c2shLQ-rPjEM7-booRtp-KKEMW-nDdnqZ-wyb6ms-pbNTfb-odK4Lb-bW9n8L-s7bbn-nD8B5K-sxKqu1-byqYRj-8UChpa-wyi7XR-bN11on-5ZmcxT-jYqT-2RiHb-r9YCG-38o6UD-o7EJmq-iGwqiQ-8Vz3MM-64abMf-bHY5Hc-6jyHz1-dz2LNr-pjTWKH-huJPMC-huJD7E-pWGJ5M-3VCCA-mi1k6B-7BCrQE-fmUWNy-b1xas-c2uMzA-dfrJuR-fjZwJ3-cB4ag7-8FjpUK-bfZ8di">Carly-Jayne</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span></figcaption></figure><p>The subprime mortgage market brought the world to its knees, so what on earth are we doing inviting it back to the party? </p>
<p>It was the packaging and reselling of this low-rated debt from US home-owners that sparked the global financial crisis. But now there is increasing evidence that such products are becoming popular again, both in the UK and the US. So how scared we should be? </p>
<p>Following the 2007-2008 crisis, demand for subprime mortgages fell away – unsurprisingly. This was partly because regulators set <a href="https://en.wikisource.org/wiki/Housing_and_Economic_Recovery_Act_of_2008">much tougher rules</a> around who could have them. They also tightened mortgage requirements, paying closer scrutiny to potential borrowers’ earnings and deposit sizes. Subprime mortgages are primarily aimed at people who have poor credit ratings because of past loan defaults, and consequently enjoy limited access to the conventional mortgage market. </p>
<p>With that in mind, it is perhaps not a huge surprise that demand is returning, along with a willingness to pay the extra interest rates – about 8% – in order to get on the property ladder. There’s also a touch of optimism at play here – the UK and US economic environments have improved, with higher growth and rising house prices.</p>
<p>Consequently, we are getting a gradual <a href="http://www.theguardian.com/money/2015/oct/30/sub-prime-mortgages-make-surprise-comeback-in-the-uk">expansion of firms in the UK</a> offering specialist subprime mortgages to people who have an impaired credit history. The same trend has been seen in the US. There has been an increase of about 30% in the number of first mortgages being offered to borrowers with <a href="http://uk.reuters.com/article/2015/09/21/equifax-credit-report-idUKnPn8VGKYM+9f+PRN20150921">low credit scores</a>. Subprime lending is also causing <a href="http://www.wsj.com/articles/total-u-s-household-debt-rises-to-12-1-trillion-in-third-quarter-1447948826">concerns in the car market</a>. </p>
<h2>All in the name</h2>
<p>In both countries, however, there are a number of differences between the subprime markets now and those of the early 2000s.</p>
<p>First, they are no longer called subprime mortgages; the emphasis is now on the target market, such as borrowers with low credit scores. In addition, this time providers are demanding much higher credit scores than in 2005. It is also specialist financial institutions getting involved, rather than high street banks. And <a href="http://www.theguardian.com/money/2015/oct/30/sub-prime-mortgages-make-surprise-comeback-in-the-uk">they emphasise</a> that funding is limited to borrowers who can prove their poor rating is due to a “one-off” event, such as an illness. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/102190/original/image-20151117-4964-1pvzony.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/102190/original/image-20151117-4964-1pvzony.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/102190/original/image-20151117-4964-1pvzony.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/102190/original/image-20151117-4964-1pvzony.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/102190/original/image-20151117-4964-1pvzony.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/102190/original/image-20151117-4964-1pvzony.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/102190/original/image-20151117-4964-1pvzony.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/102190/original/image-20151117-4964-1pvzony.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Making the sums work.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/ansik/304526237/in/photolist-sUM3n-2m2qz-4nffv9-bgfJs6-qDYNjU-hFghFE-5479uK-ucnpR-37HMKg-r12qc4-4H1juM-6yvjme-jusv8v-7vBmWZ-9Pcixd-8uiEZh-biaBRX-9jeqKN-biaCV6-tpkfA-bkJRub-cGfaG5-57R2QV-6Y3eoz-62kgKT-4BzjB-nhpFZA-shxyY9-qDd1aC-qoVw9f-7Dq5pp-ipmbn-5WKb9m-9VwGaa-wu7Say-4J3U45-f3MmR6-8LFbhE-bnZQ8Z-8S2oTS-5Xcyed-3q2LA8-gumt7v-rrLy7G-o9QQQL-5T6oV9-zvQSes-9VCot1-akJDDr-2WdaSy">Anssi Koskinen</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p>But whatever the new safeguards, why are banks and other providers keen to lend money to people who, on the face of it, look like bad bets to pay it back? </p>
<p>The rapid expansion of the subprime sector started in the US in 1992, when the <a href="https://research.stlouisfed.org/conferences/gse/Weicher.pdf">Federal Housing Enterprises Financial Safety and Soundness Act</a> was made law with the aim of boosting the mortgage finance available to lower-income families. This included setting targets for the proportion of mortgages available to them. </p>
<p>After 2001, interest rates in the US and UK were cut aggressively, which both encouraged the growth of subprime mortgages and meant that returns on savings and other investments fell. As long as <a href="http://www.economist.com/blogs/graphicdetail/2015/11/daily-chart-0">house prices increased</a>, as was the case until 2006, the subprime sector flourished. Even if the borrowers lacked income to pay the mortgage, they could raise cash by re-mortgaging their homes based on their increased value.</p>
<h2>This time it’s different</h2>
<p>Of course, we now know how this chapter of the story ends. After 2005, interest rates began to increase, leading to falls in house prices and the consequent collapse in confidence of the subprime sector as a whole. This resulted in an inevitable rise in mortgage defaults. </p>
<p>The even bigger problem then was that this subprime debt had woven itself into the fabric of the wider financial markets and had been incorporated into debt products bought and sold by investors who didn’t know what they had. Cue the <a href="http://news.bbc.co.uk/1/hi/business/7521250.stm">global financial crisis</a>.</p>
<p>Now, much of the problem was in the packaging of the debt by banks, of course. But policy makers today still need to be wary of a subprime sector – and indeed a buy-to-let sector – which increases the riskiness of the housing market as a whole, especially given recent <a href="http://www.independent.co.uk/news/uk/home-news/levels-of-uk-household-debt-at-record-high-says-think-tank-10295579.html">increases in household debt</a> and <a href="http://www.bankofengland.co.uk/publications/Documents/news/2015/022.pdf">increased volatility in the market</a>. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/102199/original/image-20151117-4983-10qqos4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/102199/original/image-20151117-4983-10qqos4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/102199/original/image-20151117-4983-10qqos4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/102199/original/image-20151117-4983-10qqos4.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/102199/original/image-20151117-4983-10qqos4.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/102199/original/image-20151117-4983-10qqos4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=502&fit=crop&dpr=1 754w, https://images.theconversation.com/files/102199/original/image-20151117-4983-10qqos4.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=502&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/102199/original/image-20151117-4983-10qqos4.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=502&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Up in lights. Debt is growing.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/jeremybrooks/2284314486/in/photolist-4tRH7w-7KDKrA-6x73SZ-5DPMur-9UbZAB-roYBh5-aVzbSH-7YrXap-e5FTUX-dxu2Xs-4J7r3Z-7RcXa8-n6cS1-awe4HH-eZcxju-4Ebdck-5wrddH-8DVz6X-8otdFt-5Q4Wjo-8U3eUf-n6d4U-9e77GX-5fNtRM-ef1bq1-fJPAR-56WS5d-n6d3d-n6d2u-n6d2R-9fP19u-n6cUP-n6d3s-n6cWi-n6cWC-n6d3V-n6d1x-n6d15-n6cVo-n6d1n-n6d1U-n6d2h-8qMq3f-ak6gLM-bMgrPD-9fZJh-bcouQx-oJkNmp-n6d5a-6hKB9p">Jeremy Brooks</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc/4.0/">CC BY-NC</a></span>
</figcaption>
</figure>
<p>It won’t have escaped your notice that we are again in a world where interest rates <a href="http://www.bankofengland.co.uk/boeapps/iadb/Repo.asp">are at historic lows</a>, which in theory encourages the expansion of the housing market beyond what is sustainable. If UK and US interest rates were to rise suddenly, this sector could again spark consequences for the wider financial system.</p>
<h2>Protection racket</h2>
<p>It is hard to ignore the catastrophic history of the subprime mortgage sector, but the recent recovery should not be as problematic. First, regulators are more aware of the potential problems. They have developed a system of <a href="http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2013/qb130301.pdf">macroprudential regulation</a> which means that the regulators assess the levels of risk across the financial system in total, rather than on a bank-by-bank basis. </p>
<p>The lending standards and risk management involved are much more stringent than ten years ago. Overall regulation of the financial sector has also increased, with the <a href="http://www.bis.org/bcbs/basel3.htm">new Basel III Accord</a> which requires banks to hold more capital and should help to insulate them from financial shocks in the future. </p>
<p>Few people have a good record for predicting what crisis the markets will next offer up, but it is rarely the same as the last one. Subprime mortgages do increase the risk in the housing market and may well lead to troubled moments for individual creditors. But the banks have surely been schooled in the dangers of flogging off this debt on the sly – and, even if they haven’t, the increased regulation and macroprudential policies should act as a capable backstop to prevent grander, systemic troubles arising.</p><img src="https://counter.theconversation.com/content/50170/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Bruce Morley does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The loans that plunged the world into financial chaos a decade ago are beginning to appear again. Just how scared should you be?Bruce Morley, Lecturer in Economics, University of BathLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/346372014-12-01T10:47:45Z2014-12-01T10:47:45ZWhat will the next financial crisis look like – and are we ready?<p>The subprime crisis and the subsequent failure of Lehman Brothers came as such a shock – and the <a href="http://business.cch.com/images/banner/subprime.pdf">repercussions</a> were so severe that when the time came to mount a response, policy makers were as surprised as the rest of us and woefully unprepared.</p>
<p>In the six years since Lehman’s collapse, much effort has gone into thinking about the next crisis and about how to strengthen financial rules and practices so that the fallout is contained. Has this effort been productive? Will the repercussions of the next crisis be less damaging?</p>
<h2>Another banking crisis?</h2>
<p>The answer, as with many things economic, is: it depends. It depends in particular on the form the next crisis takes. Most obviously, that crisis could be sparked by the collapse of a large bank, similar to <a href="http://www.theguardian.com/business/2008/dec/28/markets-credit-crunch-banking-2008">bank failures</a> in the US and other countries in 2007 and 2008. Banks are highly leveraged, and information about their underlying condition can be difficult to obtain. This means that they are always at risk of going bust. </p>
<p>Governments have therefore focused on making the banking system <a href="http://www.bbc.co.uk/news/business-20811289">more robust</a> and better able to withstand the failure of a large financial institution. Banks are now required to hold more capital so that they have a larger cushion to absorb losses from the collapse of one of their number. They are now subject to liquidity requirements to ensure that they have adequate resources if the interbank market, on which they borrow overnight, dries up. </p>
<p>Regulators have taken steps to remove the expectation of a taxpayer bailout and reformed compensation practices in the hope that this will deter excessive risk taking. Bank failures will still happen, but these are among the reasons to hope that their repercussions will be less severe. </p>
<h2>Another euro crisis?</h2>
<p>Alternatively, the next crisis could be sparked by doubts, like those of 2012, about the <a href="http://www.theguardian.com/business/debt-crisis">survival of the euro</a>. An election in one or another European country could bring to power an opposition party committed to abandoning the euro. </p>
<p>Greece’s opposition left wing party, Syriza, is <a href="http://www.policy-network.net/pno_detail.aspx?ID=4763&title=Syrizas-run-for-government-and-the-next-Greek-crisis">likely to form</a> the next government in Athens if parliamentary elections are held next spring. Marine Le Pen is currently a leader in the French opinion polls and has vowed to take the country out of the euro in her first day in office. </p>
<p>If one country was seen as about to leave the euro, the expectation would quickly develop that others would follow. The result could be panicked runs on banks and financial markets Europe wide.</p>
<p>Here, leaders are clearly better prepared than in 2012, before European Central Bank President Mario Draghi <a href="http://www.thisismoney.co.uk/money/news/article-2844695/ECB-president-Mario-Draghi-vows-takes-prevent-euro-decline.html">vowed</a> to “do whatever it takes” to maintain the integrity of the euro area. In a panic, we now expect the ECB to immediately flood financial markets with cash. It would buy every security in sight if doing so was necessary to hold the eurozone together. An isolated exit from the euro would still be disruptive. But there is reason to think that the fallout could be contained.</p>
<h2>A crisis of geopolitics?</h2>
<p>The next crisis could also be sparked by a geopolitical event: worsening conflict in Ukraine or the Middle East, or a naval clash between China and another country bordering the South China Sea. These kinds of events inevitably disrupt financial markets. </p>
<p>But they are more likely to create problems for other countries than for the United States, which remains the world’s only <a href="http://seekingalpha.com/instablog/12713201-rossaldridgelasvegas/3491705-world-liquidity-makes-us-stocks-only-safe-haven-confirmed-by-ross-aldridge-in-las-vegas-nevada">true haven</a>. Geopolitical turmoil is likely therefore to create flight toward US markets, not away.</p>
<p>But there is also the danger of a crisis originating in the United States itself. The US is seen as a haven because its financial markets are so liquid – because it is possible, in other words, to buy and sell government and corporate securities at low cost in virtually unlimited quantities. </p>
<h2>Making things worse</h2>
<p>But recent financial reforms like the Volcker Rule and changes in capital requirements for banks have made it more expensive for US financial institutions to hold inventories of bills and bonds. Consequently, if there is a sudden movement out of those instruments by the same money managers that have the movement in, their prices could implode. </p>
<p>Liquidity premiums – the extra yield investors demand to own a security when it can’t be converted easily into cash – would explode, and exchange-traded funds with positions in such assets could find themselves unable to redeem their shares. Officials like Mark Carney, governor of the Bank of England, have been warning of this danger in the hope that warnings will lead investors to be better prepared. Perhaps those warnings will have some effect. Time will tell.</p>
<p>But these, to <a href="http://www.brainyquote.com/quotes/quotes/d/donaldrums148142.html">invoke</a> Donald Rumsfeld, are the “known unknowns.” These are the crisis risks we perceive and for which we are attempting to prepare because they resemble crises past. </p>
<p>There have been bank failures before. The eurozone had a near-death experience in 2012, as I describe <a href="https://global.oup.com/academic/product/hall-of-mirrors-9780199392001?cc=us&lang=en&">here</a>. The sudden surge in yields of which Carney warns would resemble the liquidity crisis that resulted from the failure of the mega-hedge fund Long-Term Capital Management in 1998. These types of crises are likely to be manageable precisely because they have a history.</p>
<p>More dangerous are Rumsfeld’s “unknown unknowns,” the financial crises that come from unanticipated sources. History provides no guidance about their form; all we know is that there will be some. And the other thing financial history tells us for sure is that their impact will be severe.</p><img src="https://counter.theconversation.com/content/34637/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Barry Eichengreen does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The subprime crisis and the subsequent failure of Lehman Brothers came as such a shock – and the repercussions were so severe that when the time came to mount a response, policy makers were as surprised…Barry Eichengreen, Professor of Economics and Political Science, University of California, BerkeleyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/328502014-10-14T13:49:23Z2014-10-14T13:49:23ZThe main reason markets are falling? The future looks gloomier than it did before<figure><img src="https://images.theconversation.com/files/61545/original/p25zggyn-1413213399.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Red ink is suddenly back</span> <span class="attribution"><a class="source" href="http://www.shutterstock.com/pic-105189368/stock-photo-stocks-price-in-downtrend-mode-indicates-global-economy-enter-recession.html?src=ayr8Sj_H9qYsGh-dA2yZug-1-3">Kenishirotie</a></span></figcaption></figure><p>After a relatively benign period, market upheaval has returned. The main stock market indices <a href="http://www.theguardian.com/business/live/2014/oct/13/stock-markets-fall-growth-concerns-ftse-dax-business-live">have been falling</a> across Asia, Europe and the US, while safe-haven assets like gold have been on the rise. This follows a slow drip of bad economic news, not least the <a href="http://www.bbc.co.uk/news/business-29517657">sharp fall</a> in German industrial output in August. More recent has been the <a href="http://www.imf.org/external/pubs/ft/survey/so/2014/NEW100714A.htm">latest</a> “World Economic Outlook” by the International Monetary Fund (IMF), which makes sober reading. </p>
<p>The agency has downgraded the forecasts for global growth that it made in April and July. Lurking in the background is an <a href="http://www.voxeu.org/article/geneva-report-global-deleveraging">underlying global debt problem</a>: the slow, costly process of de-leveraging in the US and Europe and the (arguably unsustainable) accumulation of both public and private debt in emerging market economies, notably China. </p>
<p><strong>IMF economic forecasts for 2014</strong></p>
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<a href="https://images.theconversation.com/files/61675/original/y3wxt8d4-1413281110.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/61675/original/y3wxt8d4-1413281110.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/61675/original/y3wxt8d4-1413281110.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=364&fit=crop&dpr=1 600w, https://images.theconversation.com/files/61675/original/y3wxt8d4-1413281110.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=364&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/61675/original/y3wxt8d4-1413281110.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=364&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/61675/original/y3wxt8d4-1413281110.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=457&fit=crop&dpr=1 754w, https://images.theconversation.com/files/61675/original/y3wxt8d4-1413281110.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=457&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/61675/original/y3wxt8d4-1413281110.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=457&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="attribution"><span class="source">IMF World Economic Outlook</span></span>
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<p><strong>IMF economic forecasts for 2015</strong></p>
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<a href="https://images.theconversation.com/files/61676/original/ycqynkst-1413281175.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/61676/original/ycqynkst-1413281175.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/61676/original/ycqynkst-1413281175.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=365&fit=crop&dpr=1 600w, https://images.theconversation.com/files/61676/original/ycqynkst-1413281175.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=365&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/61676/original/ycqynkst-1413281175.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=365&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/61676/original/ycqynkst-1413281175.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=459&fit=crop&dpr=1 754w, https://images.theconversation.com/files/61676/original/ycqynkst-1413281175.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=459&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/61676/original/ycqynkst-1413281175.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=459&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="attribution"><span class="source">IMF World Economic Outlook</span></span>
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<h2>Debt damage</h2>
<p>As most people with a passing interest in the financial crisis know by now, our economies got into trouble through debt. Banks over-extended themselves, which forced governments to build up big deficits to bail them out. As we saw in 2007-08, the global nature of the financial system demonstrated that a “local” crisis such as the <a href="http://news.bbc.co.uk/1/hi/business/7073131.stm">US sub-prime collapse</a> can have much wider consequences. </p>
<p>In the aftermath of that crisis, financial institutions have had to reduce the amounts that they are lending – but at what cost? New lending has gone down. Weak firms and households have become bankrupt (though not banks, importantly). Firms and banks have hoarded cash and liquid assets. Weak countries have teetered on the edge of default. </p>
<p>Among the knock-on effects, there have been falls in aggregate private investment in new projects and for funding research and innovation. Workers have had to accept cuts in real wages, while unemployment has gone up. Some of the new unemployed have become “self-employed” and a greater proportion of employed have moved into part-time or <a href="http://www.cipd.co.uk/hr-resources/research/zero-hours-contracts-myth-reality.aspx">“zero-hour contract” jobs</a>. All these changes in the labour market have led to lower aggregate consumption. Lower investment has adversely impacted on the productive potential of these economies.</p>
<h2>The QE experiment</h2>
<p>Quantitative easing (QE) was part of the strategy for preventing these consequences from being even worse, after it became clear that ultra-low interest rates alone were not going to provide enough stimulus. QE consists of central banks temporarily “creating” money with which to buy assets from banks as a way of improving the banks’ balance sheets. </p>
<p>This puts a floor on the money supply and prevents deflation, while propping up share markets and other asset prices (because it essentially gave banks extra money to invest in those assets). It was also supposed to help lower the cost of borrowing for firms and households as a means of stimulating the economy, though this is debatable – <a href="http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb110301.pdf">some studies suggest</a> that QE can lower the long-term interest rate, and hence the cost of borrowing, but the actual the cost of borrowing from the banks hasn’t fallen. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/61677/original/jftv4mnf-1413281442.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/61677/original/jftv4mnf-1413281442.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/61677/original/jftv4mnf-1413281442.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=355&fit=crop&dpr=1 600w, https://images.theconversation.com/files/61677/original/jftv4mnf-1413281442.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=355&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/61677/original/jftv4mnf-1413281442.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=355&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/61677/original/jftv4mnf-1413281442.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=446&fit=crop&dpr=1 754w, https://images.theconversation.com/files/61677/original/jftv4mnf-1413281442.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=446&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/61677/original/jftv4mnf-1413281442.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=446&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">The QE habit.</span>
<span class="attribution"><a class="source" href="http://www.shutterstock.com/cat.mhtml?lang=en&language=en&ref_site=photo&search_source=search_form&version=llv1&anyorall=all&utm_source=sstkimages&utm_medium=onsite&utm_campaign=search&safesearch=1&searchterm=quantitative%20easing&show_color_wheel=1&orient=&commercial_ok=&media_type=images&search_cat=&searchtermx=&photographer_name=&people_gender=&people_age=&people_ethnicity=&people_number=&color=&page=1&inline=190580492">Maltz90</a></span>
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<p>On its own, QE cannot kick start investment and growth. You still need people and businesses willing to borrow the money and invest it. For this to happen, expectations about the future prospects of the economy have to change. And this does not occur overnight. We have only just begun to see this kind of economy-wide shift in the US and UK after a number of years of QE. </p>
<p>In the absence of private sector investment happening more quickly, public sector investment has played a key role in stimulating growth. Arguably QE in the US and UK <a href="http://www.bankofengland.co.uk/research/Documents/workingpapers/2012/wp466.pdf">has reduced</a> the cost of public-sector borrowing to historical lows. This has made it possible to cut back deficits at a slower pace. It has also strengthened the economic case for ramping up investment in public goods such as infrastructure, higher education, training and skills, basic research and green technology. </p>
<p>QE ends in the US this month, closing six years of money creation worth about US$3.5 trillion (£2.2 trillion). It has already ended in the UK, where the Bank of England’s equivalent injection was £375 billion. Japan has also been in QE mode since last year, printing ¥76tn (£440 billion) in 2013 and targeting ¥60tn-¥70tn (£350bn-£400 billion) each year thereafter. The European Central Bank <a href="http://uk.reuters.com/article/2014/09/05/uk-ecb-qe-idUKKBN0H01C320140905">is now also</a> going down the same route. The hope is that the balance sheets of the eurozone banks improve and that firms and households borrow more, enabling the region’s economies to exit their current stagnation. </p>
<p>Time will tell how much stimulus we see in Europe and Japan, and indeed whether the US/UK cessation endures. If global growth starts to falter and this has a negative effect on US and UK growth and/or leads to more severe volatility in stock markets and asset prices – much of what the IMF is predicting, in other words – we might see the return of QE in these countries. </p>
<p>Indeed <a href="http://www.ft.com/cms/s/0/c64c6944-51f8-11e4-b55e-00144feab7de.html#axzz3G6otQcqH">there is an argument</a> that ending QE in the US, by lowering available liquidity, has already had an impact on stock and asset prices in emerging markets. Equally, however, this could be being caused by pessimistic expectations about the future prospects for their economies. </p>
<h2>Longer outlook better, but also worse</h2>
<p>It’s not all doom and gloom, though. Eventually economies will start to grow again. Asset prices will recover as investors with cash and liquidity snap up bargains. We will also eventually see growth from the underlying forces of technological change and innovation, such as new measures to lower the relative cost of energy. It is extremely difficult to say with any certainty when this will happen. I would imagine that we are talking about between five and ten years’ time. But what kind of growth and at what cost? Who will benefit? And will the underlying structural features of the current economic order, which lead to instability and new crises, simply go away?</p>
<p>The stability of our economy might remain the key policy concern in the short-run, but there are plenty of other longstanding issues. To name only a few, there is wealth inequality, the environment, ageing population and the sustainability of the welfare state. Outside the West, the key challenge remains generating and sustaining rates of growth adequate to meet rising aspirations and reduce absolute poverty. </p>
<p>The core test of any economic system must be the extent to which it leads to the satisfaction of human wants from a global and inter-generational perspective. By this test, the current economic order is an abysmal failure. There is a narrow window to seize the opportunity for change but old habits die hard. There is a great hunger and potential for change, for example through grassroots movements, in various shapes and guises, that explore, and seek to mobilise support for, <a href="http://occupywallst.org/">alternatives</a> to the current economic order. </p>
<p>And without a reconfiguration of the institutional foundations of the current economic order, the opportunity to put economies, globally, on a sustainable, equitable, stable footing could be lost.</p><img src="https://counter.theconversation.com/content/32850/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Sayantan receives funding from ESRC.
</span></em></p>After a relatively benign period, market upheaval has returned. The main stock market indices have been falling across Asia, Europe and the US, while safe-haven assets like gold have been on the rise…Sayantan Ghosal, Professor of Economics, University of GlasgowLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/88712012-08-16T20:37:05Z2012-08-16T20:37:05ZThere are predators in our own backyard, but where are our financial watchdogs?<figure><img src="https://images.theconversation.com/files/14324/original/5pxjxy34-1345099630.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">A former mortgage broker - who is now facing fraud charges - has blown the whistle on predatory lending practices in Australia's financial services industry.</span> <span class="attribution"><span class="source">Image from www.shutterstock.com</span></span></figcaption></figure><p>The level of sub-prime mortgages in Australia may be far in advance of what was previously assumed and provided for by banks. The story was <a href="http://www.abc.net.au/news/2012-08-13/mortgage-broker-blows-whistle-on-big-banks/4195920">broken on the ABC</a>, and covered <a href="http://www.smh.com.au/business/a-costly-six-degrees-of-separation-20120413-1wynu.html">elsewhere</a>. The revelations centred around two personalities: Kate Thompson and Denise Brailey.</p>
<p>Kate Thompson was a licensed mortgage broker at Mortgage Miracles in Western Australia. A highly regarded and award-winning broker, Thompson disbursed a veritable torrent of credit from bank and non-banking lenders to clients wanting funds to buy property, making around $5 million a year from upfront and trailing commissions. She is now facing fraud charges for what amounts to predatory lending: providing credit to people with little to no expectation they will be able to repay the entirety of the loan. This fraud was achieved by fudging the income and assets of clients, making them appear much wealthier on paper than was the case. Soon to face the State Administrative Tribunal in Western Australia, Thompson will provide incriminating evidence that predatory lending is widespread throughout the industry.</p>
<p>Denise Brailey is the President of the <a href="http://www.bfcsa.com.au/">Banking & Finance Consumers Support Association</a>, an organisation dedicated to protecting the public against predatory financiers. Having worked in this field for the last twenty years, criminologist Brailey has seen first-hand the financial and social wreckage wrought by a multitude of scams and predatory lending.</p>
<p>Last week, Brailey gave explosive <a href="http://parlinfo.aph.gov.au/parlInfo/download/committees/commsen/112965af-6f32-4291-aa97-a23457bc2a37/toc_pdf/Economics%20References%20Committee_2012_08_08_1265.pdf">testimony before the Senate</a> Economics References Committee alleging wide-scale fraud from banks to brokers.</p>
<p>While her testimony, which covers the period of 2008 to the present, was largely about low-doc loans, her claims extend into the mainstream of full-doc mortgages.</p>
<p>Certainly, what emerges is a shock to those who believe the claims of the RBA and regulatory agencies that Australia’s banking and financial system is a picture of prudence and reticence. </p>
<p>The term “non-conforming” denotes a mortgage to an owner-occupier or investor where the loan value does not match the fundamental borrower criteria of tangible assets and income. Low-doc loans are provided to those who have difficulty in proving their income, mainly the self-employed.</p>
<p>In the desire to create bank assets, loans were granted to almost anyone who asked for them. For instance, it was recently revealed that three years ago, <a href="http://www.heraldsun.com.au/news/national/elderly-sent-broke-by-over-the-top-loans/story-fndo45r1-1226447127770">Westpac granted a $440,000 loan</a> to a 98-year-old pensioner.</p>
<p>Brailey testified about the way these loans were conceived. Clients would approach a broker and complete a small form, detailing their current assets and income. Through an online “service calculator” created by the banks, the broker would enter clients’ details and create a highly-inflated figure. Amazingly, this would include the imputed rent (the rent that owner-occupiers pay themselves), even if the property being purchased was a vacant block of land.</p>
<p>Anticipated increases in the value of the clients’ principal place of residence - essentially, estimated unrealised future capital gains - are counted as current income. Banks’ own lending criteria suggests that for a low-doc loan to be approved, a person needs to have an ABN for a minimum of two years. Unbelievably, for those without an ABN, the banks were teaching brokers how to go online to create an ABN for a client within a day, often without lenders mortgage insurance (LMI). This was done in the back office after the form was signed, without the clients’ knowledge.</p>
<p>As the form passed through the back channels from broker to bank, the three pages morphed into a higher number, typically 11, up to a total of 39. These extra pages detailed the figures provided by the service calculator. Borrowers, however, never get to see these extra pages, and Freedom of Information requests do not work on the private sector. When asked, banks and their law firms send borrowers on a merry-go round between them, and of course, low and moderate-income borrowers don’t have the financial power to sue the banks to get them. Once the figures have been fudged, the loan is approved and the bank grants the mortgage to the client.</p>
<p>Brailey says she has over 4,000 documents relating to borrowers’ loan applications and emails between the brokers and banks, clearly showing how incomes and wealth were grossly inflated. And this practice is continuing. Brailey contends that of 400 loan applications she has gathered in the last six weeks, not one was free from tampering. </p>
<p>Appallingly, both banks and brokers targeted a segment of the population they called ARIPs: asset-rich, income poor. They identified pensioners, the disabled, retirees and single mothers in this group. Incomes of $40,000 were transformed into $180,000 through accounting manipulation.</p>
<p>Interestingly, the banks provide generous commissions for the mortgage managers, originators and introducers, culminating in the broker at the end of the line. This happens to be a highly inefficient method of allocating mortgages to borrowers, as banks could simply hire more loan officers instead. The reason for this chain, Brailey testified, is to create “<a href="http://www.bfcsa.com.au/images/6linkschain.pdf">six degrees of separation</a>” between the banks and brokers, in order to protect banks by outsourcing responsibility to the brokers to ensure they, not the banks, get the blame for fraud.</p>
<p>Why are banks lending out enormous amounts of credit to anyone who asks for it? The likely cause is the escalation of residential property values over the last 15 years, requiring larger mortgages for property purchases. </p>
<p>To maintain profitability, banks have to keep issuing ever-more credit. Unsurprisingly, the stock of mortgage debt has increased from $180 billion in 1996 to over $1.2 trillion today or <a href="http://www.marketsandmoney.com.au/images/dr20120319b.jpg">85% of GDP</a>, a tremendous financial burden.</p>
<p>The other question is where the regulators have been in all of this. In 2005, Brailey met with Australian Tax Office investigators, but she contends her claims were referred to the Australian Securities and Investments Commission, which did not pursue them. As the financial regulator, it must investigate fraud, especially when substaintial evidence is provided. Accordingly to Brailey, however, “ASIC will not enforce the law. It has decriminalised that which parliament deemed criminal activity.”</p>
<p>The Reserve Bank of Australia, while not strictly a regulator, has substantial political and economic clout. In its <a href="http://www.rba.gov.au/publications/fsr/2012/mar/pdf/0312.pdf">latest Financial Stability Report</a>, one of the risks it sees is falling asset prices may expose credit quality problems - in other countries. The RBA concludes that Australia’s financial system is stable (just as it did before the global financial crisis in 2008).</p>
<p>The Senate’s report will be an interesting read, though only time will tell how this scenario will play out.</p><img src="https://counter.theconversation.com/content/8871/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Philip Soos does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The level of sub-prime mortgages in Australia may be far in advance of what was previously assumed and provided for by banks. The story was broken on the ABC, and covered elsewhere. The revelations centred…Philip Soos, PhD Candidate, Swinburne University of TechnologyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/58722012-03-16T00:23:13Z2012-03-16T00:23:13ZA toxic relationship: business media, Goldman Sachs reveal bottom line on business morality<figure><img src="https://images.theconversation.com/files/8657/original/4k3k7svj-1331852378.jpg?ixlib=rb-1.1.0&rect=27%2C14%2C955%2C542&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Greg Smith's expose on Goldman Sachs could reframe the debate on regulatory reform - but is business media on board?</span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>The worst damage to the Goldman Sachs franchise from the <a href="http://www.nytimes.com/2012/03/14/opinion/why-i-am-leaving-goldman-sachs.html">extraordinary attack</a> on its corporate culture by a mid-level former employee comes from its clinical execution. </p>
<p>With exquisite timing, Greg Smith’s opinion piece for the New York Times coincided with the early release by the Federal Reserve of <a href="http://blogs.wsj.com/deals/2012/03/13/stress-tests-official-statements-from-banks/">stress test reports</a> into the American banking sector. They appeared to show a sustained if <a href="http://www.nasdaq.com/article/citi-among-3-big-banks-failing-feds-stress-test-20120313-01383">patchy</a> recovery.</p>
<p>In the immediate wake of the announcement, Goldman Sachs shares surged by 6%. JP Morgan, another strong performer, increased by 7%, its performance buoyed by a planned dividend increase and a ramping up a share buy-back program. </p>
<p>Greg Smith’s very public resignation from Goldman Sachs through the opinion pages of the New York Times <a href="http://www.dailymail.co.uk/news/article-2115352/Greg-Smith-Goldman-Sachs-sees-2bn-wiped-market-value-trader-attacks-firms-toxic-culture.html">punctured a rally of questionable value</a>. </p>
<p>Reducing capital requirements at this stage remains hotly contested. It also reopened debate on whether <a href="https://theconversation.com/risks-or-rewards-what-the-volcker-rule-means-for-wall-street-5503">ostensibly stricter regulatory oversight</a> has effected lasting change on Wall Street.</p>
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<span class="caption">Goldman Sachs are playing down Smith’s explosive allegations.</span>
<span class="attribution"><span class="source">AAP</span></span>
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<p>Smith certainly didn’t think so. “I can honestly say the environment is now as toxic and destructive as I’ve ever seen it,” he wrote. “To put the problem in its simplest terms, the interests of the client continue to be sidelined in the way the firm operates and thinks about making money.”</p>
<p>Goldman Sachs, understandably, downplayed the standing of the complainant. It disputed that a systematic ethical malaise existed within the bank. In a memo to staff, the firm noted “it is unfortunate that an individual opinion about Goldman Sachs is amplified in a newspaper that speaks louder than the regular, detailed and intensive feedback you have provided the firm”.</p>
<p>This misses the point.</p>
<p>The power of the attack has little to do with its veracity. Its strength derives from its initial placement in such a prestigious outlet, its timing and subsequent viral social media dissemination. Not since the infamous depiction of Goldman Sachs as a giant “<a href="http://www.rollingstone.com/politics/news/the-great-american-bubble-machine-20100405">vampire squid” by Rolling Stone</a> has a banking and financial regulation story attracted such public interest. As such, it has the capacity to reframe debate on what constitutes corporate and regulatory purpose. </p>
<p>The controversy highlights the constellation of interests at play in the dynamics of financial regulation. It also reflects the critical intermediating role played by the media. Regulatory strategies focus on competing (if partially understood) narratives, one of which gains media and, therefore, political, traction. It is essential to “own” the media agenda, a fact reluctantly acknowledged by Goldman Sachs. </p>
<p>The firm has received backing from within citadels of business journalism. That an investment bank ever was or should have been seen as a “Make-A Wish Foundation” reflects, according to the <a href="http://www.todayonline.com/Commentary/EDC120316-0000029/Yes,-Mr-Smith,-Goldman-Sachs-is-about-making-money">Bloomberg editors</a>, stunning naïveté on the part of Mr Smith. </p>
<p>“If you want to dedicate your life to serving humanity, do not go to work for Goldman Sachs. That’s not its function, and it never will be,” wrote the Bloomberg editors. “Go to work for Goldman Sachs if you wish to work hard and get paid more than you deserve even so. (Or if you want to make your living selling derivatives but don’t know what a derivative is, as Smith concedes in passing that he didn’t at first.)”</p>
<p>In shooting the messenger, Bloomberg forces as much consideration of its editorial priorities as on the problems of ascertaining the extent to which Goldman Sachs has effective mechanisms to ensure cultural values are embedded in practice. The fact that the article is signed by the editors makes the intervention even more extraordinary. It raises even more questions about the purpose of business journalism than a <a href="http://www.youtube.com/watch?v=fQQfzXQ6UjA">now notorious on-air 2009 rant</a> by Rick Santelli.</p>
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<p>The excited CNBC correspondent, cheered on by traders at the Chicago Mercantile Exchange, had maintained that those caught up in the sub-prime crisis were “losers” and that government intervention served only to sully the American dream of free markets. Santelli later claimed to be the progenitor of the Tea Party Movement. It is implausible that the Bloomberg editors have such crass ambition. The article does, however, suggest that spoiling an undoubted coup by the New York Times may have unintended consequences. These include critical reflection on whether the broader financial community, including the business media, recognise that prior acceptable practice is no longer acceptable. </p>
<p>The conventional legal, regulatory and policy wisdom is that conflicts of interest within financial services are permissible if managed. This approach had been falsified long before Mr Smith’s intervention; so too has confidence in reliance on internally evaluated compliance systems. It has become a critical imperative for both regulator and regulated to create systems of oversight that embed integrity into an organisational design framework that can rebuild trust. </p>
<p>The legal frameworks that underpin compliance and risk management systems need to be buttressed by warranted commitment to ethical aspiration. Absent such an integrated approach, we risk repeating past failures of both corporate governance and regulatory design. The policy problem is how to render this operational in a systematic, dynamic and responsive way.</p>
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<span class="caption">‘Not Make-a-Wish Foundation’: Goldman Sachs has been defended by US business media giant, Bloomberg.</span>
<span class="attribution"><span class="source">AAP</span></span>
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<p>At corporate, professional and regulatory levels the oversight framework needs to be mutually reinforcing. It needs to be capable of evaluating the calculative, social and normative reasons for behaving in a more (or less) ethically responsible manner. What is also apparent, however, is that those rules and procedures cannot be vouchsafed by allowing the communities of practice themselves to set what constitutes best-practice and monitor effectiveness. Instead, the oversight regime necessitates reciprocal obligation from each institutional actor to maintainence of the integrity of the governance arrangements of the frameowrk as a whole.</p>
<p>Disputes over interpretation can and should be resolved in a manner that is proportionate, targeted and ultimately conducive to the building of warranted trust in the operation of the financial sector. It is against these more demanding criteria that policy reform proposals must be judged. </p>
<p>It is against these criteria that the Goldman approach and its jusitifcation by Bloomberg is so dispiriting. Yet it is only against these criteria, however, that warranted trust can be assured. The goal for regulator and regulated alike is for substantive compliance, demonstrable ethical commitment, effective deterrence, enhanced accountability and reduced risk. It is something that Bloomberg editors as well as banking executives should concentrate on. </p><img src="https://counter.theconversation.com/content/5872/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Justin O'Brien receives funding from the Australian Research Council on a range of grants related to financial regulation and corporate governance. The CEDAR framework to financial regulation is detailed in a portal hosted by the Centre for Law, Markets and Regulation (<a href="http://www.clmr.unsw.edu.au">www.clmr.unsw.edu.au</a>) </span></em></p>The worst damage to the Goldman Sachs franchise from the extraordinary attack on its corporate culture by a mid-level former employee comes from its clinical execution. With exquisite timing, Greg Smith’s…Justin O'Brien, Professor of Law, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.