Bad Mortgage Lending and Property Bubbles

For some reason, investing in residential property has often made a fool out of otherwise sensible people (and banks). All too often, they cannot see a bubble until it is about to burst. In this blog post David Lawrenson of mulls over the wreckage.

Every now and then you will read of a banker (or one of their supporters) have a good moan about “banker bashing”.

“It’s gone on long enough, it’s got to stop, let’s all move on” and similar pleas are made, often at the same time as a request that the pesky shareholders waive through a demand to allow a senior executive to have a huge pay rise or bonus (even though profits are all too often still negligible and shareholder value has been decimated).

The answer from lots of people is, “No, banker bashing has not gone on long enough yet” and “Let’s not move on” should continue to be the mantra.

The same response can and should be used about bankers abroad as much as it is here. Take Spain as a case in point.

You may remember how in 2008, the great Spanish bank, Santander, came to the rescue of the folks who had ran Alliance & Leicester and Bradford & Bingley into the ground.

Santander came along on a big white horse and bought what was left of these hapless British banks and we all moved ahead (for a while at least).

Well, good old Santander.

And how did they do this?

Funny Financing and the City of London

Well, in Spain the banks had avoided all the funny financing techniques much beloved by most merchant banks around the world, especially the lads in the City of London who were usually to be found near the front, constantly inventing daft “synthetic” financing techniques such as “Collaterised Debt Obligations” and other ways of making money appear as it out of thin air.

(Speaking of making a things appear as if out of thin air, one merchant bank in particular was very much involved in helping Greece get EU membership using similarly opaque financing techniques that allowed them to fool the civil servants in Brussels and get around EU rules. This merchant bank is right now advising Spain – heaven help us! I think we all know the name of this bank.)

The proliferation of CDOs and the like were of course responsible for the credit crunch of 2008 and helps explain why we are now in the mess we are in. And the fact that Greece was able to cheat on the EU rules has just made a bad situation a whole lot worse.

So, in my view the banks and the sleepy regulators and governments have a lot to answer for and should continue to answer for it for as long as everyone else suffers unemployment, business failure and general misery as a result of the actions of certain banks.

And, no, it’s certainly not yet time to forgive and forget.

Pain in Spain

So, if the Spanish banks avoided all the funny financing stuff, then why is Spain, so, er stuffed now?

Well, some Spanish banks managed to mess things up in a very different way – by lending heavily to the residential property sector.

In Spain, it should have been obvious to anyone with half an ounce of common sense that residential property was becoming oversupplied and in a huge bubble. But this did not stop many of the Spanish banks.

Oh no. On they went, lending right up until the dam burst and house prices collapsed. (Irish banks did much the same thing – lending on new build stock, probably in places like the mythical Craggy Island of Father Ted fame, where no one but a few priests lives or wants to live).

Now the funny thing about investing in property is that sometimes we do get booms and busts, which is fair enough.

And yet, lots of otherwise bright business people, who have made money sensibly in other areas of business life seem to have a blind spot about property. Once a boom in house prices gets underway, they start to think it can never go down.

The fact is it can – and often does. In this way, and in the end house prices behave just like tulips, stuff from the South Seas or the price of Darien stock*. (*If you have never heard of the Darien venture, just ask your friendly educated Scotsman!)

Speech at the Council of Mortgage Lenders

Next week I will be speaking at the Council of Mortgage Lenders buy to let conference.

During my talk, I will mention some of the bad lending that went on around the new-build buy to let arena in the years from 2002-7.

This, of course, was a limited disaster – a problem only for a few building societies (who had to be gobbled up by others mainly as a result of duff lending in buy to let), but also for the investors in these properties.

But a sensible person (and a sensible bank) can avoid bad business in residential property simply by checking that there is not an excess of demand over supply emerging. That’s not actually a very difficult thing to do, unless you are a particular breed of banker, possibly.

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