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Monday, July 14, 2008

Ruined Reputations

The US, with characteristic speed and vigour, moved to steady the finances of Freddie Mac and Fannie Mae yesterday.

The LA Times reported:

"Acting to prevent a severe disruption of the mortgage market, the federal government stepped in Sunday with plans for a sweeping aid package designed to bolster confidence in battered home-loan giants Fannie Mae and Freddie Mac.

The Bush administration said it would ask Congress to authorize the Treasury Department to lend Fannie and Freddie more money than current limits permit and buy stock in the two companies.

Also Sunday, the Federal Reserve agreed to permit the companies to borrow directly from the central bank, as investment firms were allowed to do after the near-collapse of Bear Stearns Cos. in March. The money would tide Fannie and Freddie over while the administration and Congress rush the emergency measures through
."

This action provides an opportunity to reflect on what the British authorities and Bank of England would have done under similar circumstances. To some extent we already know, using Northern Rock as an example, they would have done very little and it would have been too late.

Our monetary authorities have been proven to be asleep at the wheel and, like rabbits frightened in the headlights, frozen with fear when confronted with a serious issue that needs resolute and muscular action.

As I recently noted, leading British banks have met with the Bank of England to ask for more help in stabilising the lending market; the £50BN injection, made earlier this year by the Bank of England, was simply not enough and the actions taken by the Bank and government since then have been too cautious and slow to have any meaningful impact on the confidence of the banks.

However, let me make it clear, whilst the inaction of the monetary authorities has contributed to this crisis the primary blame can be laid at the feet of our "respected" banks.

They willingly chose to buy and sell toxic sub prime debt from the US, in the hope that they could make a fast buck. The sub prime scheme was a classic pyramid selling scam, so long as you could keep selling the debt on without it crystallising the pyramid would keep growing. However, as with all pyramid scams, there is always an end.

Either the directors of our banks were incredibly stupid and did not know/understand what they were buying/selling (what were the risk and compliance departments doing during this period?), or they knowingly participated in the pyramid scam in the full knowledge that at some point it would collapse.

Either way, the reputation of the banks and those who run them has been ruined; it will take many years for the banks to restore their reputations.

The reputations of the British government, monetary authorities, financial services industry, City of London and banks have all been ruined by this scam.

Lessons will need to be learned and senior people removed from office if trust and confidence are ever to be restored.

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