| The Fall of the House of Credit: What Went Wrong in Banking and What Can be Done to Repair the Damage? |
| Alistair Milne, Cambridge University Press, 2009, 356 pages, £19.99. |
| The financial storm will be remembered not only for the colossal damage it caused, but also as the first such crisis of the modern information age. Consequently there has been no shortage of timely analysis. But the torrent of blogs, comments and opinion has seemed at times an unsightly rush to gawp over the wreckage of discarded debris from this whirlwind. Blame has been attributed to bonuses, regulation, quantitative finance and conflicted ratings agencies to name a few. |
| Andrew Milne's contribution to the debate is clear, insightful, contrarian and unapologetically positive, and stands above many similar books because it marries rigour with accessibility. Written for the intelligent layperson, Milne manages to explain with clarity the workings of structured products and the financial architecture itself. |
| Milne prefers to locate the epicentre of the catastrophe in the maturity mismatch resulting from banks funding long-term assets with short-term money rather than a classic credit bubble. Having set out his view early, he does an excellent job of clarifying why the maturity mismatch was of fundamental importance and why it existed in the first place. |
| Early sections of the book describe the basic ABS/MBS structures. Milne's view of these as useful funding devices is a useful counterpoint to those who argue for the abandonment of these products altogether. However, the story gets suitably gothic when investment banks sought opportunities to earn transaction income from trading in these products rather than merely structuring them for commercial banks. The success of the investment banks' strategy required a continuous source of high yielding product and when safe mortgages had been exhausted, banks created out of the structured products themselves ever more opaque, risky but seemingly AAA-rated products. |
| Milne correctly identifies the opacity, conflicts, remuneration and plethora of other causes as proximate explanations, subordinate to the ultimate cause: banks funding these 'profitable' trading opportunities using short-term funds. The foundations of this strategy require unstinting trust in the inter-bank market because these products are used as collateral in, for instance, the repo market. Once losses in the sub-prime market emerged, there were two direct effects: falls in value of the assets, leading to withdrawal of funding and a breakdown of trust as bankers questioned whether these products were indeed as safe as, well, houses. |
| Here Milne departs from many others and whilst acknowledging that many of the complex products are poor, suggests that their apparent values today are so far from reality that it is evident fear has pervaded the entire banking system. Fear and trust are recurrent themes. |
| This is not just a presentation of theory however. Milne provides context in the form of a short summary of some notable 20th Century banking crises and in a later section of the book explains how a storm became a deluge, linking events across the globe into a coherent narrative supporting his thesis. A chapter on six specific corporate failures adds some big-picture analysis in contrast to the anatomical dissection of structured products that is well handled in early chapters. |
| In later chapters Milne outlines the remedies taken as well as a helpful overview of how Central Banks actually work. Inevitably this section is likely to need revisiting as policy plays out but this is no criticism. Nor indeed should one assume the absence of any mention of the fiscal stimulus is an oversight. Although, given the book is for the lay reader, perhaps some analysis of the link between the financial and real economy is necessary, particularly in view of Milne's call for 'at whatever cost' rescue of the banking system, a call that may jar with popular convention. |
| True to his contrarian form, Milne confronts the view that banks should become utilities, and most interestingly, floats the idea that investment managers and their industry should put dedicated focus to understanding asset quality rather than profitability of banks, correctly surmising that the drive to hit quarterly targets is partly to blame for investment banks' pursuit for yield. |
| The Fall of the House of Credit is a horrific story and even practitioners will be overwhelmed by the catastrophe that plays out in these pages. His view of the banking system as not entirely rotten may not please everyone, but his calls for massive and coordinated action deserve to be taken seriously. |
Nooman Haque
Gatehouse Bank |
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