Monday, July 28, 2008

The Banking Crisis - Where will it end?

There has been lots of discussion about the banking crisis for the past year so let's take a look at some of the primary causes of this crisis and what it will take to end it.

First, the banking crisis was caused by lax lending standards and nothing more. Many people were approved for mortgages they never should have received had banks been following traditional underwriting guidelines. This was caused by the global glut of savings looking for some kind of return, however small, with a secondary cause being that banks were more than happy to loan out the money with little to no research into the actual ability of the borrower to repay. Some pundits have cited over-reliance on standard indicators such as a FICO score but to me that's treating the symptom and not the disease - if people want to receive a loan, they should have some kind of skin in the game in the form of a downpayment.

Another contributing factor was the ability of banks to package these toxic loans into securitized assets that received good ratings from the likes of AM Best and S&P.

The real question is when will this crisis end? It will end when all these toxic loans have been written off the balance sheets of the banks. This will require massive (read: trillions of $$) losses from the banks and the best indicator of this will be when the masses begin to believe that it will never get better and banks are giving out very few loans. I cannot begin to predict when that will happen, but as a SWAG I would say sometime in fall 2009 which gives us another 12 months of interesting lessons in history from which people should, but will probably fail to learn from in the future.

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