As this is my first column, I thought it best to lay down some ground rules. Please do not approach me for a loan. It is not that I don’t want to help but, frankly, I have no knowledge of your credit history. I cannot assess whether a reader in Brasilia is more likely to repay the loan than one in Dublin.
Banks constantly boast about their risk-management systems. I have yet to meet a banker who does not claim to have the world’s most efficient system. Not only can it confirm my suspicions about that Irish reader, it can also predict the exact point at which he will default. Yet still events occur that demonstrate the fundamental flaw in these state-of-the-art systems: they are only as good as the information they receive.
The sub-prime crisis initially sounded like a disaster at a second-rate burger joint, but has rapidly turned into the financial equivalent of mad cow disease. Lending money to borrowers who have a poor track record of managing their finances is a tricky proposition at the best of times.
But with interest rates at an all-time low and credit flowing through the system at a rate of knots, bankers forgot the basics. Last year American mortgage lenders agreed more than $600 bn of sub-prime loans, roughly equivalent to the GDP of the Netherlands. Sub-prime loans comprised 20 percent of the total mortgage book against just 7 percent six years earlier.
What changed in the intervening period? Admittedly, the average level of compensation increased by more than 7 percent and the total number of jobs rose to an all-time high of 135.2 mn, altering the risk profile of some would-be borrowers. But the changing economic environment cannot on its own account for the transformati on of so many people into good risks. The mortgage lenders didn’t seem to care, however.
Lending money to people with poor credit records without checking statements of their financial or employment status as, for example, HSBC has admitted to doing, is like asking an alcoholic to pop out and buy a bottle of gin for you. It is reckless, and will inevitably result in a massive hangover for one or both parties.
And then to offer a further loan (second lien) to borrowers already struggling to meet the payments on their first one is merely the next step on a four-day bender.
This lack of basic credit checks and accurate information rendered the risk-management systems useless. For the moment, the lenders’ shutters are pulled down as they reevaluate the situation. Lessons should be learned, because lending money is, after all, a sober affair.
