John Lanchester on the crash in the LRB:
Byron wrote that ‘I think it great affectation not to quote oneself.’ On that basis, I’d like to quote what I wrote in a piece about the City of London, in the aftermath of the Northern Rock fiasco: ‘If our laws are not extended to control the new kinds of super-powerful, super-complex and potentially super-risky investment vehicles, they will one day cause a financial disaster of global-systemic proportions.’
The prediction was right, but the tense was wrong. The disaster had already happened, it just hadn’t yet played itself out in the markets. It is doing so now, though. The recipe is starting to become well known, but perhaps it’s worth spelling it out one more time. Financial institutions in the US lent money to people with poor credit histories. This wasn’t a bad thing in itself, indeed it could be seen as an example of capitalism at its most beneficently creative – indigent housebuyers needing loans, financial institutions wanting high-interest-paying borrowers, and presto! a new class of homeowners coming into being. Unfortunately, a lot of the lending was reckless, verging on criminal; for a glimpse at how chaotic and wild-westish the process became, take a look at a book by a former Texas mortgage broker, Richard Bitner, called Confessions of a Sub-Prime Lender.
The invention which made it possible for the lending to become so reckless was securitisation: the process by which loans were added together and sold on to other institutions as packages of debt. This had the effect of making the initial lender indifferent to whether or not the loan could be repaid – he’d already sold the debt to someone else, so he didn’t need to care. These packages of debt were then sold on and resold in the form of horrendously complex and sophisticated financial instruments, and it is these which are the basis of the global jamming-up of capital markets. The interlinked and overlapping loans are so complicated that no one knows who owns what underlying debt, and furthermore, no one knows what these assets are worth.