• Here we are on the great ship “Boaty McFinancial Crisis” ready to embark on the last few legs of our cruise through the stormy waters of international finance.

• The gold standard is a very distant memory. Communism is dead, interest rates are low, the Internet and tech advances have driven prices down down down, and financial wizardry is making investors richer and richer.

• It is 2007, and the past few years have been interesting and rewarding, despite (or arguably because of) the many crises that have occurred over the last 2 decades.

• Technological advances globally have had a positive impact on prices of manufactured goods, and interest rates have declined gradually over time.

• In the wake of the Dot-Com and Nine-eleven events, interest rates were cut to stimulate growth. At the same time the US Government introduced policies to support and enable Americans to purchase property. The two Government agencies (let’s just call them Freddie and Fannie) that financed US housing purchases were put into overdrive and the property market started to rise.

• Importantly the US Government had also undone the regulations that separated Investment Banking from Commercial Banking, and as a result, an entirely new market was opened up to Investment Banks and their financial wizards that enabled them to participate in the rising property sector. And participate they did. 

• Property developers sprung up all over the country – from Arizona to Zanesville, and financing agencies were quick to follow.

• And buyers encouraged by low-interest rates began to queue up. Even those that didn’t have jobs, or those that didn’t quite qualify for loans, or those that couldn’t really afford a new home, found it easy to get credit.

• Even if you couldn’t afford the house you could buy it, “safe” in the knowledge that the property could be flipped for a sizable profit long before you even moved into the house, such was the pace of the price escalations.

• The plethora of products available to borrowers was mind-boggling. Zero deposit, zero repayment holidays, and resetting loans all played their part.

• Basically people could buy a home, and not have any initial repayment obligations, then in a short space of time, sell the home to some other sucker and pocket the difference, without even repaying one cent of the obligations, sometimes in the space of days. The new sucker would do the same, and on and on and on. Economic Nirvana had arrived.

• The financing agencies would sell bonds to the Investment banks to raise the cash for the developers, and the Banks would sell packages to Investors to raise the cash for the bonds.

• And the Rating agencies also got in on the act …..rating all these packages, thousands of them, to satisfy investors that their investments met the required standards.

• EVERYONE was happy. Home owners were making money, Finance companies were making more, banks were making the most, and investors were earning high yields even if very little money was actually being repaid. Rating agencies also pocketed sizable fees for rating all of these packages.

• What the banks were doing was akin to making a trifle pudding. They were packaging all of this debt into a layered cake. At the bottom was the broken biscuits and sour cream ….the bad loans that had little prospect of eventually being repaid. But as long as the middle and top layers were edible, the rating agencies were happy to allocate the trifle a Michelin star or two. No one really gets to the bottom of the trifle in any case.

• And then they sold this trifle to Investors all over the world. Pension funds, insurance houses, wealth managers- and the money flowed ….over and over and over again. Trillions of USD earning yields for investors that they couldn’t get in boring Government Bonds  - but amazingly these trifles received the same ratings (or even higher) than Government assets.

• And then – INTEREST RATES BEGAN TO RISE…and so did the sour cream. The unserviceable loans moved from the lowest tier to the middle tier. But still the scam went on. Until it all collapsed into a stinking pile of sourness that impacted the entire global economy.

• Property prices stalled and began to fall….and owners could no longer continue with the flipping. Debts now had to be repaid, and by this time at higher interest rates because the payment holidays had expired. Low and behold, it turns out that surprisingly, unemployed people are unable to service their debt.

• And when borrowers can’t pay, developers can’t pay financiers who can’t pay banks who can’t pay investors, who can’t pay their policy holders.

• A perfect global tsunami had arrived. The global financial system teetered on the edge of total collapse, and the memory of the 1929 depression raised its ugly head.

• Lehmann’s went bankrupt, along with a host of other players in the system, but in truth, the entire system was broken and something had to be done.

• The old playbook was rolled out – the Central Bank Put….but more about that in the next episode...