Saving NewBank From Failure
(MediaCorp 938LIVE’s Money Talks on Thursday, 16
August 2007, 7.45 am and 7.20 pm)
Most of us put our hard-earned money in a bank for the
convenience and to earn interest. We do this also because we
are confident that the bank will lend our money
This confidence is heightened by the fact that the
Monetary Authority of Singapore, or any central bank for that
matter, will conduct regular checks on these banks.
Because of this, bank failures are a thing of the
past. Today, when we think of a bank, we think of a physical
building, with safety and reliability thrown in.
However, in the past decade, a new kind of bank has
emerged. Let’s call it “NewBank”. It also takes in deposits and
gives out loans. At the heart of NewBank is an elegant
arrangement, whereby loans are financed directly by rich
investors, rather than indirectly by traditional bank
NewBank employs no one directly and is nothing but a
collection of securities or bonds backed by loans and assets.
In year 2005, NewBank issued about US 3,000 billion dollars
worth of securities.
Unlike traditional banks, there are no checks and
controls by central banks over NewBank. Investors, ranging from
hedge funds to wealthy individuals, have, or rather had,
confidence in NewBank because its securities were blessed by
the rating agencies, such as Moody’s and Standard &
All went well till a few years ago. That was when
NewBank started to issue more securities backed by US subprime
loans. These are housing loans to people who should not be
given such loans. The size of these securities has shot up five
times to some US 800 billion dollars today.
When US house prices rose, it was not an issue. But
with US house prices falling, and mortgage rates rising, these
subprime loans are defaulting and registering capital
Investors who had deposited money with NewBank now
want their money back. This has created a 21st-century version
of a bank run.
The massive falls in the global financial markets
recently is due to investors selling other assets to make good
on their losses. Even those who were not exposed to NewBank
The world’s central banks can’t do much to help, like
they normally do when traditional banks fail. Besides having no
control over NewBank, they don’t even know how much of these
securities are leveraged and who owns them. Central banks can
only try to calm investors by keeping down interest rates in
the money markets.
Currently, there is a stalemate in the US 800 billion
dollar market for the securities backed by these subprime
loans. No one dares to buy them. And no one wants to sell them
because it would mean massive losses. In many cases, they have
borrowed heavily against them.
But this stalemate must be resolved soon. Otherwise,
the financial house of cards could collapse. Then the only
parties who could benefit would be those with lots of money and
unaffected by the subprime crisis. These parties could be the
Asian central banks.
To try and prevent such a collapse, the US Fed may
have no choice but to cut interest rates. This could make
mortgage payments easier. And it could revive NewBank from
coma. Certainly, lower rates are what the weaker US economy
needs right now.
Of course, there is the danger that cutting rates
could lead to more reckless lending in the future. But if
nothing is done soon, the collapse could take its course. In
the end, besides Barclays Bank, Asian central banks might be
the new owners of major US investment banks.