There is some truth in that answer; but it is not the whole story. The crisis is not the creation of “greedy bankers” and speculators: it is the result of too much debt, after governments and central banks failed to constrain the credit expansion of the early years of this decade. Bankers then irresponsibly exploited the opportunities afforded by an easy credit regime. Wall Street fuelled the demand for high-yield investment products in an era of low interest rates ”” hence the attraction of the sub-prime mortgage market.
But bankers operate by incentives. The real weakness in the banking system lies with those responsible for bankers’ compensation: the shareholders, who own the banks, and the boards, who manage them. Perverse incentives promised huge rewards for those who took risks in the hope of reaping short-term profits ”” but those same incentives did not penalise failure.
Hedge funds are also a focus for criticism, owing to their short-selling of bank stocks (that is, selling stocks they do not own, in the hope that the price will fall and thereby allow them to buy the shares later at a profit). Again, there is some justice in this, but it is not the whole picture. Short-selling is a useful discipline in financial markets. A falling share price may signal that a company management is under-performing or has a bad business model. There are good reasons that the share prices of investment banks are being marked down: many are technically insolvent. But in the exceptional current circumstances, short-sellers are exploiting weaknesses in the financial system with consequences that go beyond their commercial calculation of risk and return. The Financial Services Authority has introduced a ban on short sales of bank stocks, with effect from today ”” some will say, a week too late for HBOS.
But ultimately a rush to blame the bankers or the speculators is misplaced…
[blockquote]The crisis is not the creation of “greedy bankers†and speculators: it is the result of too much debt, after governments and central banks failed to constrain the credit expansion of the early years of this decade. Bankers then irresponsibly exploited the opportunities afforded by an easy credit regime. Wall Street fuelled the demand for high-yield investment products in an era of low interest rates — hence the attraction of the sub-prime mortgage market. [/blockquote]
Banks don’t systemically, abruptly stop lending to one another because there is suddenly “too much debt” out there. Adjusting terms and structure according to debt level [i]is what banks do.[/i]
Banks have systemically, abruptly stopped lending to one another because [i]they don’t know[/i] if there is “too much debt” out there.
Global financial storms come and go. This is the first such storm, however, since the global adoption of portfolio management techniques based on opaque derivatives.