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Banking
Tuesday, April 1, 2008
Banks go nuts

Joel Stern also has a theory about the sub prime fiasco……

“The banks went nuts,” he says, “deciding to lend 100 cents on the dollar. That’s a very bad idea. In other words, the mortgage holder was not asked to put up any money, because the lender thought he would get bailed out by the continued increase in the value of the housing stock.
“I don’t understand why they decided to take the risks they did,” he adds, unless it was anything like the LBOs of the Eighties.
Back then the banks couldn’t get into LBOs (so-called ‘leveraged buyouts’). This is where a lender says to a property agent he does not have to put up any money, not even a 10% as deposit as was normally the case. All he had to do was simply close the deal. There was no discipline in pricing.
To one banker at the time Stern asked the following, “How can you possibly make the loans that you are doing? They are not going to get paid back.
“He looked at me and said, I don’t care. The reason, he said, was because he was evaluated based on loan volume and not loan repayment.
“At all these banks that have been involved in the sub prime problem last year, how were their incentive schemes arranged?” Stern queries. “I am prepared to bet almost anything they were based on loan volume, not loan repayment.”
It seems the same thing happens every 20 years, when the banks go nuts, he comments. “I am guessing but there must be something wrong with the way their employment contracts are being written. The incentives are all cock-eyed.”
When the price of the houses comes down, as they are doing so now, all the buyer has to do is literally walk away from his mortgage. That’s why there haven’t really been that many foreclosures.
 

Copyright © Insurance Times and Investments® Vol:21.3 1st April, 2008
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