Tuesday, October 11, 2011

So Why Have Banks Made So Many Bad Loans?

Anyone who wants to understand our current banking crisis, or prevent future ones, needs to understand how banks managed to get so much worthless paper on their books. The stories differ a bit from country to country, but there is probably some underlying theme. I can think of a few candidates, which are by no means mutually exclusive.

(1)Bankers were making big bucks, and confident that they could find another sucker for the crappy financial instruments they were constructing.

(2)They imagined they were protected by the credit default swaps and other crappy financial instruments they sold each other.

(3)All that money Alan Greenspan threw in the water produced a feeding frenzy and everybody went nuts.

(4)They really believed, as Alan Greenspan claims to have believed,that the financial law of gravity had been repealed and housing prices could go on rising forever.

(5)Bankers foolishly trusted foolish governments.

(6)Many bankers were just making sensible loans that exploded when the economy did.

(7)They were counting on being bailed out by governments.

(8)Bankers simply didn't have enough skin in the game. Playing with other people's money means that you can bet the long shots and maybe make it big.

Any more? Take exception to the above?

I tend to believe all of the above except (4) and(7). The most dramatic fact we have is that we keep seeing this same movie. Something about human nature and the nature of banking makes this kind of man made catastrophe a regular feature of capitalism.