Managing my financial journey
Managing my financial journey

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Managing my financial journey

1.3.3 Collapse! The global financial crisis

In the following video, the build-up to the financial crisis is explored. It contains the observations of Sir Vince Cable, the UK coalition government’s Secretary of State for Business, Innovation and Skills between 2010 and 2015, on the near meltdown of the banking system in autumn 2008.

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Transcript

NARRATOR
Banks were once seen as the cornerstone of modern British society.
Safe, solid and dependable, they provided the capital and security needed to ensure that businesses could flourish and the economy would develop.
But by September 2005, the UK's banks had changed beyond all recognition.
Finance had become so complicated that many people simply didn't understand what they were dealing with.
PAUL MASON
It became too complex, both for the regulatory framework, for the management styles, for the management skills and ultimately for the business model of banking.
NARRATOR
Bankers were gambling without being fully aware of the risks that they were taking.
LORD SKIDELSKY
The failure to distinguish risk which we can measure from uncertainty which we can't is the big failure of contemporary economics.
NARRATOR
The quality of the products being sold plummeted.
PETER HAHN
What we had was alchemy.
We started with high-quality mortgages and packaging them into high-quality bonds.
In the end, what we were packaging was garbage and telling everybody it was gold.
NARRATOR
In the first instance, it led to a credit crisis and our banks being pushed to the very brink of collapse.
VINCE CABLE
We got to a point where there was one evening when banks would no longer lend to each other overnight.
If the government hadn't intervened at that point, with fresh capital for the banks and guarantees, the banking system would have gone - I mean, it was actually that close.
NARRATOR
Then, within a year, a devastating recessionary wave crashed down on the wider UK economy.
KEN JONES
We've not created it. Everybody out there who's worked for a living is wondering what the hell is going on.
NARRATOR
It became harder to get a mortgage; deposits required when buying a house increased and credit got tighter.
These events have changed the way that banks operate, the public's perception of them and the entire landscape of personal finance.
End transcript
 
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The years 2007 and 2008 turned out to be close to catastrophic for the global banking system as the slowdown in activity in economies around the world, combined with the collapse of asset prices (particularly for property and for financial assets such as mortgage-backed securities), resulted in huge financial losses for many financial firms. Those who had been the most ambitious in their lending activities during the years of economic expansion in the 1990s and early 2000s now stood most exposed as economic activity contracted.

A sector that was particularly exposed was the investment banking sector in the USA. As such, many of the investment banks were very active in the aforementioned mortgage-backed securities business. Such banks normally have very limited dealings with individuals in the retail markets. Indeed, restrictions were placed on their ability to take deposits from the public.

As 2008 progressed, it became clear that one of the firms most exposed to the crisis unfolding in the financial markets and the wider economy was Lehman Brothers (commonly known as Lehman’s). The Federal Reserve (the US central bank that performs a similar function to that of the Bank of England in the UK) tried to organise a rescue for Lehman’s, but it quickly became clear that there were no takers for the bank. The Federal Reserve refused a state bailout, with the result that the bank collapsed. Perhaps the decision might have been different if Lehman’s had had a clear interface with retail customers – certainly many individuals were hit by the collapse of Lehman’s, particularly if they had been holding shares in the bank, but there was no large retail customer base that was directly exposed to the demise of the bank.

The collapse of Lehman’s sent shock waves around the global financial services industry because of the widely held (and ultimately false) assumption that it was too big a firm to be allowed to go bust. Shares in banks fell very sharply, and in the UK attention focused on those banks deemed to be most vulnerable to the impaired financial markets and the weakening economy. The two perceived to be most at risk were Halifax Bank of Scotland (HBOS) and Royal Bank of Scotland (RBS). Their plight forced the Bank of England, with the support of the Treasury and the FSA, to intervene on a massive scale. £61.6 billion of emergency loans were provided by the Bank of England to RBS and HBOS at the height of the financial crisis – although this only became public knowledge in November 2009 when the Bank of England reported these details to Parliament’s Treasury Committee.

As the financial crisis deepened, the UK government, together with the FSA and the Bank of England, quickly sought the takeover of HBOS by Lloyds TSB Bank – the latter being perceived as relatively less exposed to the crisis in the financial markets. The resultant merged institution was named Lloyds Banking Group. With a 28 per cent share of the UK mortgage market and a 25 per cent share of the UK personal banking market, such a takeover would not have been allowed by the then Competition Commission (now called the Competition and Markets Authority) during normal financial times. Given the crisis, however, the government allowed the merger to proceed without reference to the commission.

Additionally, the government was forced to provide additional capital for both Lloyds Banking Group (initially taking a 43 per cent share of the new bank and subsequently raising this to 65 per cent) and RBS (taking a 70 per cent share of the bank that was subsequently raised to 84 per cent) in order to prevent any risk of their collapse. These injections of financial support were required because a huge volume of these banks’ assets had fallen substantially in value – these were the so-called ‘toxic assets’. In the case of Lloyds Banking Group, the support was needed to deal with the problems inherited via the takeover of HBOS rather than those of Lloyds TSB itself. The latter had been a very conservatively run bank with relatively little exposure to toxic assets.

The scale of the investment by the government in the country’s financial firms was estimated at £37 billion in October 2008 (HM Treasury, 2008). This was in addition to the provision of short-term loans to financial firms. Additionally, it has had to insure the banks against losses on several billions of pounds of toxic assets in an attempt to salvage the UK banking system and to get the banks into a position where they can start prudent lending again to businesses and individuals.

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