Mark Bathgate

Saving the world | 5 December 2009

The further revelations about the astonishing costs of the bank bailouts so far indicate just how much taxpayers’ money is now being used to plug the holes in the banking system.  A key cause of the bank crisis is explained by the above IMF graph, charting the decline of some of the trillions of AAA structured credit assets created during the boom.  AAA means “extremely strong capacity to meet financial commitments”, but now over 80% of the US AAA Collateralised Debt Obligations (CDOs) created between 2005 and 2007 are rated BB or lower, somewhere between junk bonds and default (and in some cases almost entirely worthless).

In terms of getting things totally wrong this is hard to beat. The belief in the end of boom and bust was shared as readily by the large investment banks and credit ratings agencies as it was by Gordon Brown, creating near endless amounts of “risk free” debt providing rocket fuel for property lending, private equity deals, and naturally, bonus pools. Chopping debt into lots of little pieces and putting it back together again offered a fat fee at ever turn.
 
For debt that was meant to be of such high quality, banks were exempted from holding capital in reserve against the prospect of any future losses. As Vince Cable brought to light earlier this year, these were such good bets that British banks and building societies hoovered them up – the extra yield for seemingly no risk proving an irresistible lure. Purchase of these kind of assets was one of the key mechanisms by which UK banks became so exposed to asset price bubbles and losses around the world. It was concern about the true nature of these assets – brought about by the collapse of IKB

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