The onset of the Global Financial Crisis can be dated to July 2007, when two Bear Stearns hedge funds holding almost US$10 billion in mortgage-backed securities collapsed. That same month, bankers at Lehman Brothers paid themselves $US5.7 billion in bonuses.
Little more than a year later, Lehman Brothers filed for bankruptcy with debts of $US613 billion. It was the largest bankruptcy in history.
Two months later, Northern Rock became the first British bank in 150 years to fall victim of a bank run. Rescued by nationalisation, Northern Rock's predicament revealed how banks went from prudent lenders of depositor's money to profligate lenders of borrowed money.
Short-term borrowings from international money markets made up 73% of Northern Rock's funds, with just 27% sourced from deposited savings. When the money markets dried up, the bank went belly up.
Over the next two years, it became apparent that most British banks were in a similar position. They too required rescuing by government intervention.
Direct intervention in the financial sector left the British government owning more than 50% of all mortgages and bank retail accounts, together with more than half of all loans to small and medium-sized businesses.
All around the globe, governments went into overdrive to ensure that banks that were “too big to fail” did indeed not fail. Instead, the taxpayers they had been gouging were forced to pay for the banks' failings that, in many cases, were later found to be criminal.
Bank failures are nothing new in the history of financial institutions. During the first four years of the Great Depression more than 9000 banks failed in the US.
One response that has emerged to deal with this situation is to split banks into “good” banks that can keep operating because they can profitably do so by lending deposited money, and “bad” banks that are loaded with debt which can perhaps be paid off over a long period of economic recovery.
The US Glass-Steagall Act of 1933 provided for this “ring-fencing”. The Gramm-Leach-Bliley Act (GLBA), however, repealed almost all of its provisions in 1999.
US economist Joseph Stiglitz is perhaps the most prominent of the many economists to argue that the GLBA contributed to the GFC by creating larger banks that were too big to be allowed to fail, while providing incentives for excessive risk-taking.
But while the banks were happy enough to be bailed out, they have resisted legislative changes that would see banks split into less risky retail banks and more volatile investment banks as this would protect the insured deposits of ordinary savers and small businesses and leave the speculators to take the losses they risk.
The British government has just introduced legislation that will ring-fence six of the big banks, but it does not come into effect until 2019.
In Australia, banking regulator the Australian Prudential Regulation Authority (APRA), has ordered the big four banks to raise capital levels by a combined $18 billion to bring about a small reduction in their leverage and increase their equity.
As of July, the big four banks were leveraged more than 25 times. Between them they have $3.5 trillion in assets that are backed by only $138 billion in shareholders' funds. A small loss on these assets would see them become insolvent.
As with other big banks around the globe, Australian banks have been resisting these modest changes.
This explains Westpac's decision, last week, to increase mortgage rates by 20 basis points.
When Westpac chief executive Brian Hartzer made the announcement last week, together with a $3.5 billion capital raising, he blamed the rise on APRA, “the magnitude of regulatory capital increases and their short implementation timetable [that] has an inevitable impact on our pricing.”
What he did not say is that Westpac already has one of the highest variable mortgage rates at 5.48% (and which is set to rise to 5.68% in November). The standard rates of the other big banks are between 5.38% and 5.45%.
Hartzer also neglected to mention that the consensus among most economists is that lifting capital standards has little effect on mortgage rates. APRA has estimated that the increase in capital that it requires from the big banks for their mortgage lending would only increase their funding costs by between 10 and 15 basis points — and this will not come into effect until July next year.
Will the other big banks also raise their interest rates? The same 20 basis points increase translates into $234 million profit for ANZ, $435 million for the Commonwealth Bank and $234 million for NAB. It is hard to see them passing up the opportunity that comes from being part of an oligopoly.
One person who will not be too inconvenienced by the increase is Hartzer. Even though he is no doubt struggling to pay off the mortgage of his new $12 million mansion in Vaucluse, he will just have to make do as best he can with his new pay package — a miserable $9.2 million this year.