Tuesday, March 25, 2008
Credit Crunch lesson 1: Lend with Funding
In my humble opinion, the introduction of CDOs just over 20 years ago led to today's credit crunch. It introduced a “don't-care” attitude among retail banks as they could now give a mortgage with minimum due diligence, sell-off those mortgages to their own special purpose vehicles or to an investment bank's one and then use the same funding to sell some mortgages. At some point in the last two last years, most banks had 100% mortgages. Eventually, there was no one to sell the mortgages to and that’s when things came to a standstill last year. Rating agencies didn't help because they were required to credit rate the CDOs, but did a shoddy job.
With the fiasco still live, many retail banks have reverted to lending mortgages and other products only when hey have the funds to do so. Worryingly,
this now means that Bank of England interest rate cuts are not being passed onto customers as many banks are trying to use interest rates to attract savers. One paradox. Mot savings products in the UK have a cap of £250 per month i.e. if you want to save more than £3,000 a year, you either have to open additional saving accounts or go for a no interest saving account. Unsurprisingly, banks are struggling with funding.