Tuesday, 5 May 2009

The root cause of the recession

Paul Sweeney: Too much competition can be bad. It is heresy to most liberal economists, but the low interest rate and liberalisation of markets did generate intense competition between financial institutions which led to this crisis. It happened in the US and it happened in Ireland. In Ireland Seanie Fitzpatrick and his boys in Anglo Irish were so aggressive on lending that the big boys in AIB and BOI got really angry with the loss of market share to this upstart. So the Big Boys decided to loosen the rules on lending to compete with Anglo Irish. So the contagion spread in this fair isle!

In the US, it was even worse. Competition led to some banks inventing new financial products. Is not that what competition is about? It generates innovation and new ideas. Yes… up to a point. Here they created the famous toxic debt and wrapped it up as something really nice with a big bow on it and a “triple A” stamp from the also compromised Rating Agencies.

Part of this story is told in a new book, "Fools' Gold" , by Financial Times writer Gillian Tett.
Tett is an excellent writer and this extract in last Saturdays Financial Times magazine is really worth reading if you want to know what went on the big US finance houses. She tells us what financial derivatives are and much more. Such as why the lack of regulation was so important of the innovators:-

“But within AIG, an upstart entrepreneurial subsidiary was booming. In the late 1980s the company hired a group of traders who had previously worked for Drexel Burnham Lambert, the infamous – and now defunct – champion of the junk-bond business under Michael Milken in the mid-1980s. These traders had developed a capital markets business, known as AIG Financial Products and based in London, where the regulatory regime was less restrictive. It was run by Joseph Cassano, a tough-talking trader from Brooklyn. Cassano was creative, bold and highly ambitious. More important, he knew that, as an insurance company, AIG was not subject to the same burdensome rules on capital reserves as banks.”

Click here to read on……

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