Looking to the past

My first introduction to banking was playing Monopoly, the popular board game, with my siblings on rainy Sunday afternoons in the early 1980s. I learned two things from Monopoly. First, if one wished to mortgage property, the bank would advance no more than 50 per cent of the property’s value. In other words, the loan-to-value ratio was 50 per cent. Second, the banker, usually my brother, had to be constrained from cheating via a combination of monitoring, punishment and appropriate incentives. Fast-forward several decades and real British banks were granting mortgages with loan-to-value ratios of up to 125 per cent and British bankers, instead of being constrained to behave prudently and cautiously, were incentivised to increase bank leverage and take imprudent risks with other people’s money. The lessons of my youth suggested that such a system was doomed to implode, which it duly did in spectacular fashion in the autumn of 2008.

The portents of the collapse of the British banking system, as well as the breakdown of the banking system in the United States and in European economies, appeared in the summer of 2007, when banks ceased lending to one another. By September 2007, Northern Rock was receiving emergency loans from the Bank of England and facing depositor runs, with long queues of depositors outside many of its branches shown on BBC news broadcasts. It took an announcement by Alastair Darling, the Chancellor of the Exchequer at the time, of a taxpayer guarantee for all of Northern Rock’s deposits and various wholesale liabilities to bring the run on the Rock to an end.