The current problems can be traced back to changes during the Clinton presidency to the Community Reinvestment Act. These were designed to establish a system to rate banks according to how much lending they did in low-income neighbourhoods on the basis that black and Hispanic residents were being discriminated against in receiving a disproportionately small share of mortgages. Banks needed a good CRA rating to get regulators to approve mergers, expansions and even new branch openings. Consequently, a poor CRA rating was a big problem.
But complying with the CRA meant the banks were storing up problems for the future. As long as house prices kept rising, these did not come to the surface but rather than keep all these dodgy mortgages on their balance sheets, the banks found a way to offload some of the unwanted risks they were forced to take. Clever bankers in London and elsewhere collaborated in this by devising the toxic slicing and dicing of mortgage-backed securities.
No one in the US forced our bankers to devise these schemes or buy the resulting securities and it was not only banks piling into mortgage-backed securities. The credit rating agencies were prepared to take money from the MBS issuers to assess them and award many of them AAA ratings without properly understanding the risks.
Many purchasers of these MBS bought them blindly without bothering to understand what they were getting, purely on the back of having effectively outsourced such decisions to the credit rating agency. I wonder how many chief executives who allowed their staff to buy these securities blind would have bought a house for their family without a survey.
The current global problems did start in the US but neither the UK nor the rest of the world were forced to accept any of the risk of these dodgy loans. If they had not done so, even a market the size of the US would not have been big enough to allow the problems to escalate to the extent they did. There would have been serious economic knock-on effects for the rest of the world when the crisis hit but at least we would not have had to bail out our own banks.
The lure of big fees and big bonuses blinded the banks and other investors to the risks. Most people, including the politicians and the regulators (who are appointed by politicians) and who are both paid to understand the risks on our behalf, either failed to adequately understand them or failed to take action if they did. Gordon Brown was responsible for the new UK regulatory structure but it is clear from the G20 spin machine that he does not believe the buck stops at the top.
Ray Boulger is senior technical manager at John Charcol