The most immediate 21st Century threat from some City firms to Londoners – and to the UK and global economies - came not from tax evasion and money laundering but from risk, bonuses and greed, writes Paul Coleman.

   From 2000 onwards, bankers took increasing risks with investors’ and customers’ cash to reap higher profits for the banks and bigger personal bonuses for themselves.

   Rising bonuses significantly raised property prices, lowering quality of life opportunities for Londoners on average and lower incomes. Such inequality had grown steadily since ‘Big Bang’.

   But the high risk financial fuse for dire and immediate economic and social consequences was lit at the turn of the 21st Century.

Securitisation

Until the late 1980s, London banks and UK mutual societies exercised caution about how much and to whom they lent. Homebuyers, for instance, would repay their mortgages to a local lender over decades.

   But London began to grow as a major hub of a new system of ‘securitisation’ at the start of the 21st Century. Securitisation linked US, European and UK homebuyers and lenders with investment banks and investors.

   Digital technological advances led London-based investment banks to engage heavily in various forms of speculative and, hopefully profitable, ‘derivatives’. These included: futures (profitably buying commodities or currencies in the future at a fixed price), options (profitably agreeing an option to buy rather than buying itself), and swaps (agreeing to swap an instrument at a set price, again, hopefully profitably).

Financial WMDs

By the late 1990s, such derivatives had already grown into a $50 trillion annual market. The US ban on derivative regulation fuelled their global expansion and nurtured their refined speculative risk.

   Free market ideologists, like former US Federal Reserve boss Alan Greenspan, said wealth generated by unregulated derivatives would render financial institutions safe and boost global investment.

   Top world investor Warren Buffet warned in 2002: “Derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”

“Basically, they accused me

of being a Luddite”

CDOs

Under securitisation, lenders no longer bore the risk if a homebuyer could or would not re-pay a home loan. Via securitisation, lenders bundled and sold mortgages to investment banks.

   In turn, the banks combined mortgages with commercial, car, student and credit card loans into derivatives known as Collateralised Debt Obligations. Investment banks then paid ratings agencies to evaluate CDOs. Agencies were not liable if their ‘AAA’ highest possible ratings proved wrong.

   Banks sold ‘AAA’-rated CDOs to other investors. Pension funds invested working peoples’ savings into CDOs because of the ‘AAA’-rating. But these CDOs were chiefly based on higher interest sub-prime loans to financially insecure American homebuyers at high risk of default.

Dangerous world

Bankers in banks, financial conglomerates and securities firms took massive derivative risks with investors’ money to generate short-term profits and win themselves life-changing personal bonuses. But the financial products they created were unregulated.

   In fact, regulation was illegal.

  Banks were vulnerable to loss but carried no liability for any loss of investors’ money.

   Bankers were not personally accountable.

   Nobody in finance or government was on the hook.

‘Luddite’

Bankers, governments and ‘light touch’ regulation had turned financial services in cities like London into a highly risky sector with dangerous consequences for the world. International Monetary Fund chief economist Raghuram Rajan warned bankers such high risk profiteering could destroy their own firms and cripple global finance.

  Rajan recalled how bankers and their political backers responded to his warning: “Basically they accused me of being a Luddite.”

© Paul Coleman LONDON INTELLIGENCE 2012

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