United Kingdom Banks In Trouble - Above Politics 50

Yes, they report, new wealth has been created. Yet it is only a small few who have benefited from this "more market/less government" line.
Looking at total net worth or gross income over the 1980s and 1990s, each of these studies has found a number of disturbing trends. One of the most distressing is the skyrocketing gap between the top and the growing bottom in all of our societies.
In the U.S., the Economic Policy Institute has found that the richest 10 per cent hold 72 per cent of all wealth, the top 1 per cent more than half of this. By contrast, the other 80 per cent of Americans had only 17 per cent of all accumulated wealth in 2000. Unsurprisingly, the U.S. now leads the way among advanced economies in having the worst rate of inequality.
Similarly, the Canadian Center for Policy Alternatives has reported that currently the richest one-fifth of families hold 76 per cent of all wealth in Canada. By contrast, the bottom half of us had only 5.6 per cent of all accumulated wealth.
And if these figures aren't jarring enough, it seems that things are only getting worse.
During the 1990s in the U.S., the top 1 per cent of earners took home most of the benefits of economic growth, with their incomes growing an astounding 59 per cent.
CEOs saw their bank accounts swell, their average salaries rising from a ratio of 72 times more than the wages of an average worker, to a ratio of more than 310 to 1.
For young families, though, especially young single mothers, things only got worse. In the U.S., a third of single mothers live in poverty, and for the poorest two-fifths of households, incomes fell.

As home prices fall and banks tighten lending standards, people with good, or prime, credit histories are falling behind on their payments for home loans, auto loans and credit cards at a quickening pace, according to industry data and economists.

The rise in prime delinquencies, while less severe than the one in the subprime market, nonetheless poses a threat to the battered housing market and weakening economy, which some specialists say is in a recession or headed for one.

Until recently, people with good credit, who tend to pay their bills on time and manage their finances well, were viewed as a bulwark against the economic strains posed by rising defaults among borrowers with blemished, or subprime, credit.

“This collapse in housing value is sucking in all borrowers,” said Mark Zandi, chief economist at Moody’s Economy.com.

First, let me clarify the question. We are asking what caused the housing bubble, and, by definition, the cause cannot be explained by changes in an underlying market fundamental. I don't mean that we can't point to, say, a rumor that led to a rapid increase in the price of some good as speculators rush in, just that bubbles - by definition - are divorced from market fundamentals.

I think a more interesting question is what sets the stage for a bubble to emerge - what allows the rumor, irrational exuberance, etc., to express itself as a bubble? One thing that is needed is liquidity and credit, some way of substantially increasing demand. This is the air that inflates the bubble. Even if all the other conditions for a bubble to emerge are present, if there is no way to inflate the bubble - no way for speculators to rush in and drive up the price - then it won't inflate.

We already know that there was enough available liquidity to inflate a housing bubble. So something went wrong in these markets that allowed the bubble to emerge and then pop, and this is causing us immense problems right now, but what was it?

I think the most important factors are agency problems, the mis-pricing of risk, and the failure of securitization to distribute risks across the financial system.

With respect to the agency issues, there is a long chain between the home buyer, the mortgage broker, and, ultimately, the sliced and diced complex securities that nobody fully understands. Let's take one step in the chain, that of a a bank or mortgage broker, either one. Suppose they are paid a fee, i.e. by the number of mortgages that pass through their hands each month (as, essentially, they were). The more mortgages they can push through, the higher their income. They are required to meet certain guidelines as they do this, but so long as their income depends upon the number of mortgages passing through their hands and not what happens to the mortgages later on - so long as it is a fee-based system - they have every incentive to push the guidelines as hard as they can and to find a way around them whenever possible.

If mortgage brokers had done their job and only made loans to people who could pay them back (i.e. with "reasonable" levels of default), we wouldn't have a financial crisis. So right away, in nearly the first step of the chain, we have to ask what went wrong, why they were willing to take so many questionable loans. The problem is what economists call an agency issue. The brokers had no stake in the outcome once the mortgages left their hands. The same with banks, all they had to do was process the mortgages, package them up, then sell them and collect their fee.

Think about the incentives here. Suppose you are a mortgage broker and you begin to suspect that the bubble will pop soon, that all this lucrative business might end. To protect the business, should you get worried and start checking mortgages more carefully to make sure that things don't get further out of hand? No, you should accelerate what you are doing, write even more mortgages - nothing you can do can stop the bubble from popping, you are just one of many, many brokers far down the chain - so why not collect as many fees as possible before the gravy train ends? What if everyone thinks this way, and they all rush to sell as many of these things as they can? Mania.