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About Me

Darren Winters is a self made investment multi-millionaire and successful entrepreneur. Amongst
his many businesses he owns the number 1 investment training company in the UK and Europe.
This company provides training courses in stock market, forex and property investing and since
the year 2000 has successfully trained over 250,000 people.

Thursday, 29 May 2014

The Financial Crisis and UK Bank Scandals

In September 2007 the UK banking industry began exhibiting symptoms of the financial crisis that started in America in 2006. Northern Rock was in trouble and had to ask the Bank of England for help. When news of this got out customers started queuing around the block to withdraw their money. In 2008 Northern Rock was nationalised, and in 2012 it was bought by Virgin Money.

Today the banking industry can be seen to be on the road to recovery. But on that road there have been potholes of controversy. I'm thinking Libor, excessive bonuses, payment protection mis-selling and foreign exchange manipulation, to name a few.

But before we look at those in a bit more detail, let's quickly recap on the financial crisis and what it did to UK banking. To do that we need to start in the States.

In 2006 American banks started seeing a rapid rate of default against sub-prime mortgages. These mortgages were granted to high risk customers, many of whom didn't understand what they were getting into, and had difficulties repaying the loans. The banks must take some responsibility for their loose lending principles. For instance, they were happy to lend to NINJAs - customers with No Income, No Job or Assets. And they also offered 'teaser' type mortgages, with an initially low interest rate that was hiked up sharply a few months later. With such a rate of default the price of houses dropped substantially, and your average American became poorer, with many becoming homeless.

Banks tried to mitigate their risk by selling bundles of mortgages to secondary buyers such as investment banks. In a process known as securitization, those secondary buyers might once again re-package the mortgages and sell them as bonds or as something called a Collateralised Mortgage Obligation. Essentially investors in these products are being paid with the interest generated by the underlying mortgages. But as defaults increased the value of these securities decreased.

Banks tried to cover their risk on these CMO's by buying insurance against default, using an instrument known as a credit default swap. The sellers of these swaps then covered themselves against the risk of the swap they'd just sold by buying yet another credit default swap. It was getting complex. When mortgage defaults caused a drop in the value of collateralized mortgage obligations, the credit default swaps had to pay up, and banks started seeing significant losses. The reduced liquidity led to a freeze in trading of CMO's, then the banks stopped lending to each other altogether.

Enter Northern Rock, who needed this short term lending to maintain business as usual. We know what happened to them subsequently. Banks all over the world were suffering losses by this stage, and headlines were made when US bank Bear Stearns had to go to the Federal Reserve for funding. They were taken over by JP Morgan shortly afterwards. Then the floodgates opened, with the bankruptcy of Lehman Brothers in 2008 prompting a consolidation of banks (Lloyds bought HBOS, Bank of America bought Merrill Lynch). The whole financial system was under such a strain at this point that government intervention was required.

The UK government propped up Lloyds/HBOS and RBS with around £37 billion of taxpayer's money. Interest rates were cut from 5% in September 2008, and by March 2009 they were at 0.5%.  At the same time guarantees were given to savers that their deposits up to £50,000 would be covered (now £85,000). In 2009 further government support was needed, and according to The Independent the bill was up to £850 billion by December of that year. The Bank of England began its quantitative easing program in March of 2009 to pump more money into the system, and since 2010 some stability has returned to the banking sector.

Of course businesses suffered from the lack of lending during the crisis, and ordinary people were affected as a result. The public trust in banks took a knock, and people were less than pleased that it was billions of pounds of their taxes that bailed out the 'irresponsible bankers'.

Public perception has continued in a negative vein, fed initially by the revelation that banks continued to pay exorbitant bonuses on both sides of the Atlantic during the bailout period. In the U.S. it was reported that nine banks paid out $32.6 billion in bonuse in 2008, while at the same time receiving $175 billion in government aid. In the UK around £12 billion was paid in bonuses in 2008. The continuing disquiet about the level of bonuses paid led to the European Union legislating a cap on bonuses. However, banks and other financial institutions in the UK have been creative about getting round the cap, by in some instances increasing share allocations and raising the basic salary of their top executives.

The mis-selling of payment protection insurance goes back over ten years. The banks found these a very profitable product as they only ever paid out on around 15% of policies sold. These policies pay the borrower's premiums if he/she is ill or loses their job. The complaint against the banks is that the policies were expensive and often sold as part of the package, without the customer's knowledge. In 2006 the FSA began imposing fines for mis-selling, and since then the claims have snowballed. The banks have been forced to put aside billions of pounds to meet them.

Then in 2012 the Libor scandal hit. Libor is the interbank lending rate, and was set on a daily basis by a panel of banks in London. It transpired that some banks were manipulating the rate to gain a trading advantage, or to give a false impression of creditworthiness. Europe and America were affected, with various lawsuits being brought in America against banks on the grounds that mortgage payments were too expensive, or in the case of local authorities that payments on bonds they had bought were too low. Barclays, to name just one bank, was fined hundreds of millions of dollars and lost a CEO, Bob Diamond, as a result of the scandal. After investigations and suggestions of reform, the Libor rate is now no longer administered by the British Bankers Association, but by a new independent administrator appointed by the FCA. The irony is that Libor manipulation probably goes back 20 years and seems to have been regarded as almost a business as usual activity.

If that wasn't enough, in mid 2013 allegations surfaced of another manipulation, this time of the daily foreign exchange rates. Forex traders across several banks were allegedly colluding to set a daily benchmark rate used by corporate customers. Again, this is something that may have been going on for ten years or more. As a result the banks concerned are under investigation and several traders have been suspended. Mark Carney, the Governor of the Bank of England, told a Treasury Select Committee in March that the allegations are "as serious as Libor, if not more so".

Just a selection of questionable banking practices then. In the last five years there were also money laundering offences, credit card insurance mis-selling, rogue and insider trading - the list goes on. If money wasn't devalued by inflation I'd just convert all my assets into cash and stick it under the mattress. Maybe I'll be offered a collateralized mortgage obligation instead - who could resist? 

Darren Winters


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