Comments: Rocked by an event that nobody foresaw

Good article.

Just one comment. The Michael Fish forecast is an urban myth. The infamous clip was filmed some time beforehand. And in it, he is referring to reports of a hurricane in Florida and is reassuring a viewer who was due to holiday there. Unfortunately, following the hurricane in the UK, the clip has been taken out of context.

http://news.bbc.co.uk/1/hi/magazine/7042220.stm

Merv seems to have suffered a similar fate. As you say David, no-one could have predicted the events of August 9. But just six weeks earlier in his Mansion House speech, Merv made a few prescient remarks:

"The development of complex financial instruments and the spate of loan arrangements without traditional covenants suggest another maxim: be cautious about how much you lend, especially when you know rather little about the activities of the borrower. It may say champagne – AAA – on the label of an increasing number of structured credit instruments. But by the time investors get to what’s left in the bottle, it could taste rather flat. Assessing the effective degree of leverage in an ever-changing financial system is far from straightforward, and the liquidity of the markets in complex instruments, especially in conditions when many players would be trying to reduce the leverage of their portfolios at the same time, is unpredictable. Excessive leverage is the common theme of many financial crises of the past. Are we really so much cleverer than the financiers of the past?"

Posted by Sell Everything at December 31, 2007 10:16 AM

That's fascinating - I could have sworn that Michael Fish was talking about reports of a hurricane hitting France, not Florida. It appears, too, that we have to take his word for it, no complete video record of his broadcast being available. Spooky - almost like a UFO mystery.

I agree with you about the general warnings about subprime, CDOs, etc. Central banks were, however, happy to merely warn, and regulators were happy to let the markets get on with it.

Posted by David Smith at December 31, 2007 11:15 AM

Yes you are right. The viewer rang in to say they had reports that it was going to hit the UK.

Posted by Pete Balchin, Solicitor at January 2, 2008 08:47 AM

"I agree with you about the general warnings about subprime, CDOs, etc. Central banks were, however, happy to merely warn, and regulators were happy to let the markets get on with it."

Yes, I think you're right David. But it's difficult to know exactly what pre-emptive action could've been taken. Regulators could've tightened up, yes. But you wonder whether banks would've circumnavigated these by inventing even more exotic instruments. And central banks? Well, they could've tightened rates more aggressively in an attempt to curtail credit growth, but that would've been risking the health of the wider economy.

Perhaps they could've done something slightly less orthodox. Tinker with capital adequacy ratios maybe? I'd be interested to hear your thoughts.

Posted by Sell Everything at January 2, 2008 10:18 AM

Hindsight is easy in these matters, so in future regulators will be looking at liquidity as well as solvency and there will be a greater emphasis on international co-operation - both of which should have been in place before. What more could they have done at an earlier stage? Maybe warn a little louder. Maybe lean a little more on the rating agencies. Maybe require institutions to increase their insurance cover. Maybe some of those things Mervyn King told us he wishes he had done. Would it have made a difference? Hard to say.

Posted by David Smith at January 2, 2008 12:19 PM


In times of easy credit and boom, nothing else matters apart from profit profit profit.

When we do eventually look back at all this mess, it will be the most obvious outcome that anyone could have expected.

Lend lots of money to people who have no money/poor credit? What on earth were they expecting to happen? Interest rates to stay low forever? Economies to not dip causing unemployment?

Profit Profit Profit, that's all that matters.

Posted by Dan O'Connor at January 2, 2008 04:31 PM

In times of easy credit and boom, nothing else matters apart from profit profit profit.

When we do eventually look back at all this mess, it will be the most obvious outcome that anyone could have expected.

Lend lots of money to people who have no money/poor credit? What on earth were they expecting to happen? Interest rates to stay low forever? Economies to not dip causing unemployment?

Profit Profit Profit, that's all that matters.

Posted by Dan O'Connor at January 2, 2008 04:32 PM

"But nobody, to my knowledge, predicted that the sub-prime crisis would spread as it did"

Funny how you smacked down a commentator on here back in March for describing the US housing market in freefall caused by subprime rot ("US housing - not dead yet", March 23, 2007). It would seem that some people out there were clearly predicting problems, whether or not you chose to hear them.

You catch a lot of unjustified flack on here, and I don't wish to contribute to that, but saying that nobody foresaw this happening is just a little too far fetched. Plenty of people were shorting Northern Rock prior to August.

Posted by RichB at January 4, 2008 05:42 PM

If you read again what I said in this piece I conceded that plenty of people were worried about the US subprime crisis - more than I was. What I said is that nobody predicted it would spread to the world's credit markets and then to Northern Rock as it did. If you can find me such a prediction, I'd be glad to see it.

I'd take issue even now with the idea that US house prices nationally are in freefall. We're looking at 12-month national falls of 3%-6%, the latter on the more volatile Case-Shiller series. The OFHEO measure probably will not show a calendar year fall for 2007.

Posted by David Smith at January 4, 2008 10:29 PM

Umm, okay, go to www.calculatedisk.blogspot.com orNouriel Roubini's blog for a discussion in the first months of this year of how problems in the US sub-prime market would lead to weakness in the banking sector and a lowering of interest rates by the Fed and other central banks. Did they specifically single out Northern Rock? No, but many other people clearly did as their share price was falling for almost 6 months before they went to the Bank of England for a bailout.

And, as for a "freefall", it all depends on how you define it. There are cities in California where prices have declined by almost 30% in a year. The current nationwide declines in the US property market are unprecendented in modern times. 95% of Americans have not seen declines like this in their entire lifetime. For many people that meets the definition of freefall.

(Btw, OFHEO exludes the majority of houses in California from it's calculations because the median price in the state is significantly above OFHEO loan limits.)

Posted by RichB at January 4, 2008 11:08 PM

I just don't know where you get that from. This is OFHEO's description of the coverage of its index:

"The HPI includes provides indexes for all nine Census Divisions, the 50 states and the District of Columbia, and every Metropolitan Statistical Area (MSA) in the U.S., excluding Puerto Rico. OMB recognizes 363 MSAs, 11 of which are subdivided into a total of 29 Metropolitan Divisions. As noted earlier, OFHEO produces indexes for the Divisions where they are available, in lieu of producing a single index for the MSA. In total, 381 indexes are released: 352 for the MSAs that do not have Metropolitan Divisions and 29 Division indexes. The starting dates for indexes differ and are determined by a minimum transaction threshold; index values are not provided for periods before at least 1,000 transactions have been accumulated."

Case-Shiller is, of course, a more limited index, excluding 13 states entirely from its calculations.

As a matter of interest, which California cities are showing 30% annual average price falls?

Posted by David Smith at January 5, 2008 10:06 AM

David,

Just to remind you that on 21 August 2007 'This is Money' and other articles stated that an unnamed bank had borrowed £314 million pounds from the BOE.

My response was:

"...I wouldn't think its Northern Rock would it?
Not Northern Rock or if it is I should be surprised.

Only about a month ago they were lending 6 times income. Not that there's a sub prime problem here anyway the Council of Mortgage Lenders tell us there isn't.

- Pete Balchin, Solicitor, Bristol, UK

..."

However it may of course have been any of the Sub Prime lenders that I had been watching for some time. The beneficiary of course may have been Barclays even? Or any of the banks.

I think there is much more to play out here in the Sub Prime debacle, could the economist who predicted that we are at the point where the national anthem has only just finished playing be right?

Posted by Pete Balchin, Solicitor at January 5, 2008 12:43 PM

It was, of course, Barclays, as reported fully at the time, and this was well after the credit crisis broke out into the open in full fanfare on August 9. Northern Rock's problems lay in the nature of its borrowing, not its lending.

Posted by David Smith at January 5, 2008 02:18 PM

David, I thought that you would know this, but the OFHEO index only includes houses that have a mortgage purchased by Freddie Mac or Fannie Mae. Those entities are only able to purchase mortgages up to a certain value -- a value that is currently below the median cost of homes in California.

From the OFHEO website:

There are, however, some limits to the coverage of the HPI. The HPI is produced using data on single-family detached properties financed by conforming conventional mortgages purchased by the enterprises. Thus, mortgage transactions on attached and multi-unit properties, properties financed by government insured loans, and properties financed by mortgages exceeding the conforming loan limits determining eligibility for purchase by Freddie Mac or Fannie Mae are excluded.

The figure for 30% decline comes from the California Association of Realtors (the NAR affiliate for the state) and are available on their website. Cities seeing big year over year declines in median price as of November: Brentwood -32%, Inglewood -30%, Pacoima -35%, West Hollywood -35%, Los Banos -29%, Sacramento -21%, North Highlands -38%, Lakeside -40%, Benicia -44%. The NAR methodology has its problems, but these numbers are huge.

Posted by RichB at January 5, 2008 10:06 PM

It is true that the OFHEO index under-represents properties in high-price areas such as San Francisco for the reasons you state and which are well known but it still has significant coverage in California and broader coverage than Case-Shiller.

I find those NAR figures almost impossible to square with its regional data. They imply that prices must be rising very strongly in other parts of the West.

Posted by David Smith at January 6, 2008 12:06 AM

Here's a few (California Association of Realtors):

Statewide, the 13* cities and communities with the greatest median home price increases in November 2007 compared with the same period a year ago were: San Juan Capistrano, 42.3 percent; Newport Beach, 31.5 percent; Santa Monica, 29.4 percent; Mountain View, 18 percent; Cupertino, 18 percent; Truckee, 10.2 percent; Redwood City, 9.7 percent; Yorba Linda, 9.6 percent; Santa Barbara, 7.5 percent; Moorpark, 7.2 percent; San Francisco, 7.2 percent; Pasadena, 7.2 percent; and Los Angeles, 5.8 percent.

Posted by David Smith at January 6, 2008 12:13 AM

If NR's problems lay in it's borrowing. Why could it not simply borrow some more elsewhere? Why did no lender want to lend?

I'd suggest that there were major problems with its lending.

Posted by Piers Ponsenby-Smythe at January 6, 2008 04:19 PM
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