Wednesday, 23 May 2012

Health Care Policy: A modern transatlantic comparison.

5th July 1948, the National Health Service (NHS) opens its doors for the first time in hospitals and surgeries around Britain under the supervision of Labour Health Minister Nye Bevan. Following the election of Clement Attlee’s Labour government in 1945 it was agreed that Britain, recovering from its second World War, was in desperate need of social reform, summarised by William Beveridge’s report on welfare. The establishment of the NHS as part of the wider reforms to the Welfare State was initially sponsored by taxation and continues to be so today. Sixty four years later, the NHS is seen as one of the great pillars of British society (Marr, 2007).


The history of modern American healthcare has been somewhat different. Unlike Britain the United States has never and continues not to provide universal healthcare for its population, leaving the market economy to provide health services (Mclintock Roe & Liberman, 2007). However, a recently passed Health Bill has initiated the first phases of compulsory health insurance for all American citizens, a much debated and hotly contested prospect.


Despite these seemingly opposing attitudes to healthcare within the United Kingdom and the United States there is much to compare and contrast as recent, current, and continued policy implementation on both sides of the Atlantic appears to bring the two nations with a “special relationship” closer together.


In July 2010, two months after its election, the UK’s collation government, led by Conservative Prime Minister David Cameron, presented a whitepaper to the House of Commons proposing top-down reorganisation of the NHS. The subsequent Bill, the Health and Social Care Act, was submitted in January 2011 and proposed that the allocation of patient care be removed from NHS Primary Care Trusts and placed in the hands of General Practitioners (GPs). GPs could then choose between a variety of both public and private options on behalf of their patients. The move was described by its supporters as removing the bureaucratic red-tape of healthcare and providing greater options for improved services. The proposal was described by the Daily Telegraph as the “Biggest revolution in the NHS for 60 years”. Andrew Porter, the newspaper’s Political Editor wrote:



“The plan…is designed to place key decisions about how patients are cared for in the hands of doctors who know them… At present, funds are given by the Government to primary care trusts, which pay for patients from their area to be treated in hospital. Under these plans, GPs — who are currently not responsible for paying for hospital referrals — would receive the money instead and pay the hospitals directly.”
          (Porter, 2010)


A second key aspect of the Bill was the revision of the amount of income hospitals are allowed to make from private patients, rising from 2% to 49%. Andrew Lansley, the Conservative Health Secretary described the strategy as positive for NHS patients, he said "If these hospitals earn additional income from private work that means there will be more money available to invest in NHS services” (Briggs, 2011). 


Opposition leaders, including Liberal Democrat members of the coalition cabinet refuted both key aspects of the Bill, describing them as a systematic privatisation of the Health Service, opening the door to American style competition in British health care. Deputy Prime Minister Nick Clegg, leader of the Liberal Democrats, threatened to veto the Bill in the wake of its proposal and vowed there would be no “back-door privatisation of the NHS” (The Telegraph, 2011)  


The Bill was subsequently subject to amendments in both parliamentary Houses, as well as public and professional outcries. One month prior to the Bill’s assent, Dr Richard Nicholl of the Royal College of Physicians (RCP), collected the signatures of 20 RCP members signalling an extraordinary general meeting to stop what he described as a “dangerous” Bill. He said:



"The bill is bad for the country's health and healthcare and will increase inequalities. None of the hundreds of amendments the government has had to table so far deal with the fundamental flaws of the bill"
           (Campbell & Helm, 2012)


As well as criticising the abolition of Primary Care Trusts, Nicholl and other members of the RCP opposed the planned extension of competition within the NHS. Suggesting patients would suffer as a result of coalition plans for hospitals to earn up to 49% of income from private patients. In an interview with the Guardian newspaper Nicholl warned of longer waiting lists for NHS patients as a result of prioritising private patients, Nicholl continues:



“…why the hell are the government forcing this through? Market theory is a disaster in health. People need to stop this bill; it's plain dangerous."
           (Campbell & Helm, 2012)



Following the extraordinary meeting on Monday 27th February 2010, the RCP polled 25,417 fellows and members asking for their opinions on the Health and Social Care Bill, the results proved damning with 6% of respondents declaring their acceptance of the Bill and an overwhelming 69% rejecting it (Royal College of Physicians, 2012). Despite heavy opposition the Bill received Royal Assent in March 2012 and many key aspects of the legislation are expected to be implemented by 2013.


Whilst Britain’s National Health Service appears to be shifting towards increasing privatisation amidst claims of widening inequalities, America is seemingly moving in the opposite direction, all be it from the opposite end of the health care spectrum.


In July 2009, six months after President Obama’s inauguration, Democrat leaders presented a series of proposals on health care reform to the House of Representatives signifying Obama’s intent on change. Significant proposals included the mandatory expansion of health insurance to all American citizens, as well as the establishment of a government insurance plan known as the “public option”. Two federally funded insurance schemes were already in existence; Medicare, supporting the elderly, and Medicaid, supporting the poor. However the “public option” proposed to create a government backed insurance scheme available to all with a view to competing with the private sector. Further proposals included subsidies in the form of tax credits for those most incapable of accessing health insurance and certain reforms of the health industry itself, such as the illegalisation of certain medical insurer activity- such as “dropping” ill patients or denying coverage to those with pre-existing conditions (MacAskil, 2009). The plan also outlined a number of tax increases for both the health industry and wealthy Americans, including a rise from 1.45% to 2.35% of the Federal Insurance Contributions tax for individuals earning $200,000 and couples with incomes over $250,000.


President Obama’s described the proposals as a way of reaching out to the 45 million American’s without health insurance, he said:



"After decades of inaction, we have finally decided to fix what is broken about healthcare in America. We have decided that it's time to give every American quality healthcare at an affordable cost."
           (MacAskil, 2009)


Opposition to reform was led by Republicans throughout Capitol Hill, disapproving of the President’s plans to raise both taxation and public spending in order to alter the American health care model. Senator Jon Kyl of Arizona discussed his party’s opposition with the New York Times stating:



“I think it is safe to say there are a huge number of big issues that people have… There is no way that Republicans are going to support a trillion-dollar-plus bill.”
           (Hulse & Zeleny, 2009)


Professional opposition was also aired by medical experts across the United States. Troy M. Tippett M.D., President of the American Association of Neurological Surgeons stated in December 2009:



"The Senate bill inappropriately expands the role of the federal government in health care decision making, and undermines the doctor-patient relationship that is critical to a health care delivery system that works for patients."
           (Physicians United for Patients, 2010)


Joseph D. Zuckerman, M.D., President of the American Association of Orthopaedic Surgeons reiterated his colleague’s fears:



 "We urge the Senate to take a step back, and make essential changes to this bill before a rush to reform leads to a bad outcome for patients across the country."
          (Physicians United for Patients, 2010)


Despite much opposition and after ten months of hard fought amendment and Democratic compromise in both Congressional Houses, a final piece of legislation was agreed upon and ratified by President Obama in March 2010. The Patient Protection and Affordable Care Act introduced many of the reforms proposed by Democrats almost a year earlier, including obligatory health insurance, medical tax credits for the poorest, increased regulation of the health care industry and higher taxation of the wealthiest to directly support both Medicare and Medicaid.  However, the Bill did not include the “public option” as proposed by President Obama in July 2009, jettisoned by Senate dealmakers to create a passable piece of legislation (Bonnett, 2010) The changes implemented via the Patient Protection and Affordable Care Act 2010 are proposed to extend medical coverage to a further 32 million American citizens. President Obama described the changes as “reforms that generations of Americans have fought and marched for and hungered to see” (Durando, 2010. Sky News’ Foreign Affairs Editor, Tim Marshall summarised the reforms as not being universal, but “the closest America will ever get” (Bonnett, 2010).


Principally, the United States continues along a path of private health care with no universal public insurance policy yet established, whilst the United Kingdom continues to provide healthcare free at the point of access in 2012, as it has done since the dawn of the National Health Service in 1948. However, as we have seen, recent changes in British and American health policy have been both widespread and of great significance, with the United Kingdom entering a phase of partial privatisation whilst the United States has categorically increased access to health care.


As liberal democracies, the political processes of the United States and Britain are open for scrutiny, as are the policies each respective government wishes to legislate. And although both American Congress and British Parliament operate on a bicameral basis, differing challenges were faced by David Cameron and Barack Obama throughout their respective drives for health care reform.


As the first Prime Minister of a coalition government since the Second World War, Conservative David Cameron faced vigorous opposition to his party’s health reform proposals from within his own cabinet. Liberal Democrat ministers, such as Deputy Prime Minister Nick Clegg questioned the degree by which the Bill would privatise the NHS (The Telegraph, 2011). Unlike the United Kingdom, the Executive Branch of American government revolves solely around one man. As such, due to the design of American politics, enshrined in the constitution, President Obama did not face the internal competition his British counterpart did. However, both premierships had to fight to pass legislation once it was opened to the legislature.


Following the general election of May 2010, Conservative MP’s accounted for 305 of the available House of Commons seats, defeating their nearest rivals, and current incumbents, New Labour by 52. The subsequent establishment of a Conservative-Liberal Democrat coalition, with their 57 seats provided a large enough majority to formulate a government capable of passing legislation such as the Health and Social Care Act 2012 (Parliament UK, 2010).  Similarly to the Conservative majority within the House of Commons, President Obama’s Democratic Party also held a majority in the lower-House following his election in 2009. Of the 435 available seats within the House of Representatives, 256 were elected to members of Obama’s party, with 178 in favour of Republican candidates.


Despite similar levels of backing within their respective legislature’s lower chamber, both governments faced different prospects with regards to passing reforms through the upper-House.  Britain’s House of Lords, with a Labour majority, is constrained to rejecting a Bill a maximum of three times in one year (Heywood, 2007). As such its role in the creation of legislation is largely limited to the recommendation of amendments, as was the case throughout the introduction of Cameron’s health reforms. Conversely to the House of Lords, the American Senate is not constrained on its rejection of Bills and as such the importance of its composition is vital to any President hoping to pass legislation. Unlike the unelected House of Lords, where peers are either granted status through birth-right or appointment, the Senate is a fully elected chamber with two senators representing each state (Heywood, 2007). During the period of time immediately preceding the introduction of the Patient Protection and Affordable Care Act in 2010, 57 of the 100 senators represented the Democratic Party as opposed to the Republican’s 41. This slim majority proved to be a key factor affecting the redevelopment of Obama’s original health reform suggestions. Such fundamental changes to the American health system not only split Democrats and Republicans, but also split certain sections of the Democratic Party itself, leaving those responsible with pushing the legislation forward a difficult task. Final key amendments included the abolition of the proposed “public option” and insurances that federal money would not be used to fund abortions.


We can see that the paths of both Prime Minister Cameron’s and President Obama’s health reforms have led through two legislative chambers respectively, however the influences of each nation’s upper and lower Houses have proven to be converse.  Legislation passed within the United States must truly be approved by both the House of Representatives and the Senate, as was the eventual case for the Patient Protection and Affordable Care Act in March 2010.  However, the power divide between Britain’s House of Commons and House of Lords is not so evenly balanced, with the lower elected chamber able to force legislation through due to its neighbour’s inability to consistently reject Bills. 


Furthermore to these two nation’s processional disparities is the composition of the respective Executive branches. As American President, all power of the Executive Branch is vested in Barack Obama, who also acts as Head of State and Commander in Chief of the Armed Forces. All other members of the Executive, including the Vice President, Cabinet and Executive Office are regarded solely as advisory bodies (The Whitehouse, 2012). Unlike the President, Prime Minister David Cameron is not Head of State, and instead, as the leader of the party with the largest majority within the House of Commons following the General Election in May 2010, was asked by the Queen to formulate a government. As Prime Minister he is regarded as primus inter pares or “first among equals” with regards to his role within the Cabinet. He is regarded as the leader of a group of decision makers, rather than acting as the sole decision maker himself (Heywood, 2007). The collective accountability of Cabinet ministers can be difficult enough to galvanise within a single-party government, however Prime Minister Cameron faced a much greater test within the Conservative-Liberal coalition with the debate surrounding health reforms, battling not only to convince Ministers of his own party but Ministers of a party much associated with opposing the privatisation of nationalised services.


Superficially, the American and British political models appear similar as liberal democracies with bicameral legislatures. However, we have discovered many great differences in the operation and mobility of these two nation’s political systems. This trend of partial similarity is something reflected in the comparison of further political concepts within these two countries.


The democratic system of government within United Kingdom and the United States is keenly protected, not only by differing styles of constitution, but also through external participation by both the general public and professional representative bodies, such as Trade Unions, Interest and Pressure Groups.


This interaction, as displayed by both the British Royal College of Physicians and the American Association of Neurological Surgeons alongside the American Association of Orthopaedic Surgeons with regards to their own nation’s recent health reforms exemplifies modern liberal democracy as more than the right to vote. James Laxar writes:



“Essential features of contemporary democracy are the rights to free speech and assembly. Democracy also extends to the rule of law, to the right of those accused of crimes to fair and speedy trials, to freedom from arbitrary detention and the right to legal counsel.”
           (Laxar,p10, 2010)


By upholding the “essential features of contemporary democracy” as described by Laxar, both Britain and the United States allow their own political cultures to flourish.


The protection of democracy is a key similarity when comparing the political culture of these two countries; however there are many great differences also. The great American belief in “rugged individualism”, the notion that citizens thrive with little government interference was summarised by Republican candidate, Herbert Hoover during his Presidential election campaign in 1928, at New York’s Madison Square Garden he said:



“When the war closed… we were challenged with a peace-time choice between the American system of rugged individualism and a European philosophy of diametrically opposed doctrines – doctrines of paternalism and state socialism. The acceptance of these ideas would have meant the destruction of self-government through centralization of government. It would have meant the undermining of the individual initiative and enterprise through which our people have grown to unparalleled greatness.”
           (Cohen, 2008)


Twenty years later following a second World War, actions taken by Britain under the guidance of Clement Attlee and at the recommendation of William Beveridge, establishing the National Health Service, optimised the European-state paternalism discussed by Hoover.  However, although met by some scepticism, one former chairman of the British Medical Association described the move as “the first step, and a big one, to national socialism”, the National Health Service as part of the wider Welfare State in Britain went on to be widely endeared by a nation recovering from the effects of two World Wars (BBC News, 1998).  


The impact of Beveridge’s report on welfare in Britain has gone on to impact the political culture of the United Kingdom throughout the 20th into the 21st century.  Within his article “Attitudes to Welfare”, Peter Taylor-Gooby describes British support for the Welfare State as “strong and enduring in the main” going on to state:



“The NHS, pensions and education command mass support because they meet mass demands.”
(Taylor-Gooby, p77, 1985)  


The defining features of political culture within the United States and Britain have clearly played a key role in the development of health care policy in recent years. Whilst President Obama’s contemporary Democratic Party would widely be regarded as opposed to the hard-line individualism discussed by Hoover, the sentiments displayed by the former Republican President still underline much of the overwhelming American attitude. Similarly, modern British attitudes towards the National Health Service remain widely alike to those surrounding its establishment; supportive of the public model. As such Prime Minister Cameron and President Obama both had to fight to pass legislation largely opposing the views of the popular national political culture.


As such we understand the political cultures of both America and Britain to be of great importance with regards to policy implementation. Summarising Almond and Verba’s study into political culture, Hague and Harrop write:



“Mass attitudes towards government will of course reflect what the government has done in the past but- and here is Almond’s point- these sentiments will in turn affect what the government can achieve in the present and the future. In this way, political culture connects government not just with society but also with its own history.”
           (Hague and Harrop, p105, 2007)


In conclusion, the passing of both the American Patient Protection and Affordable Care Act 2010 and the British Health and Social Care Act 2012 has signified major changes to the health services in the United States and the United Kingdom. Both countries have displayed close similarities within their political systems, models, and cultures, however vast differences have also been apparent between these two liberal democracies from the composition of their legislatures to the wider political attitudes of the electorate.

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Wednesday, 22 February 2012

Subprime Mortgages: How the US housing market brought the world to it's knees.

Subprime mortgages have been described as the spark that lit the fuse to the credit crunch, leading to global recession and a deeper financial crisis that continues to be resolved to this day. As the name suggests, sub-prime mortgages are understood to be less than the best, often referred to as “liar loans” or “Ninja loans”- No income, No job or Asset loans (Cable, 2009). But how could someone with no income, no job or assets obtain a mortgage? The answer lies on Wall Street.

The Community Reinvestment Act (CRA) of 1977 was passed under the Carter administration and sought to impose obligations on banks to lend to lower socio-economic families. As such banks began to take the market share of loans to lower-income families away from government-backed agencies, affording the chance to step onto the property ladder to millions of Americans who never believed they would have the opportunity. The legislation worked well for the next two decades but in 1997 a significant event occurred which would change the mortgage market forever. The American bank, Bear Stearns, created the first securitisation of CRA loans and Freddie Mac, one of the US’ top two mortgage lenders, guaranteed these securities with the top triple A rating. In essence, Bear Stearns had managed to take on a large base of lower income families, repackage the risk associated with their loans and spread it throughout the industry and off of their balance sheet (Gamble, 2009).

In 2001, following the 9/11 attack in New York, Bear Stearns had been trading in CRA securities for four years and various other well respected organisations such as  JP Morgan had done so to, dealing largely in credit default swaps following the end of the dotcom bubble and the Enron crisis. The effects of 9/11 on the US economy had a damaging impact, leading chairman of the Federal Reserve, Alan Greenspan to lower interest rates in the face of crisis as he had done in 1987 (Black Monday) and in 1997-98 (Asian Financial Crisis) (Brummer, 2008). Then came the banks eureka moment; the trading of high yield bonds, largely focused around mortgage based securities, relied on high-risk loans; credit default swaps- the removal of large risks from banks balance sheets- ironically also relied on high-risk loans. This meant that the banks needed a ready supply of high-risk borrowers, but where could they be found? Greenspan’s falling interest rates meant that the base line for adjustable mortgage rates, indexed to the Fed, were also low and the poor neighbourhoods Carter had reached out to in 1977 were filled with citizens eager to borrow, and so the banks had their answer. America’s poorest regions were flooded with irresistible loan offers and so the subprime mortgage was born.

Subprime mortgages were offered to anyone and everyone looking to take a loan. People with poor credit ratings, or unable to prove their income, or pay a deposit were able to borrow sums of money in excess of 100% of the value of their property with seemingly affordable repayments.  Alex Brummer, in analysing the early days of the subprime phenomenon writes:

“It was easy to see why sub-prime was attractive to lenders fed up with low returns. Here was the latest chance to make a lot of money in an otherwise jaded market. Never ones to heed the lesson, the banks, fresh from burning their fingers in the dotcom boom, had marched straight in to the enticing world of sub-prime lending, barley stopping to pass ‘Go’”
(Brummer, 2008, p20)

However, subprime mortgages were never confined to the ghettos of Baltimore or Detroit. The temptation of such large and easy credit spread across all socio-economic groups and millions of Americans who could have obtained a prime mortgage were drawn in to the sub-prime world. They did so because the loans were structured to look so attractive and because 100% of the value of a property is relative to the consumer. Whilst $50,000 dollars is a lot of money to someone living in a $50,000 dollar home, $1,000,000 is a lot of money to someone living in a $1,000,000 home.  Second homes became popular among the wealthy and as many as 13% of all high-rate loans were for properties not occupied by their owners, furthermore a 2007 study showed that 55% of all subprime loans went to people with credit scores high enough to get a better deal- the temptation had proved too much (Brummer, 2008; Wall Street Journal, 2007).

Following a brief period of uncertainty surrounding employment levels in the US in 2001-2002 and the inevitable defaults on mortgage repayment associated with being out of work, subprime mortgages were established as unemployment plummeted post-2004. As such, subprime mortgages gained a prominent role in the market, accounting for 35% of all mortgages in the US. At its peak the value of the sub-prime market reached £6,000bn (Brummer, 2008).

The increasing number of readily available mortgages teamed with low interest rates meant that between 1997 and 2005 property prices rose a staggering 75% in the United States representing some of the highest returns on investment in the marketplace (Gamble, 2009). Greenspan appeared to have masterminded an American recovery post 9/11 and the housing market was testament to that, as was his honorary knighthood for services to economic stability in 2002. The on-going success of the economy led Greenspan, the Fed, banks, and investors to believe that the housing boom would not end, that the markets had become too complex to fail, and that the economy would simply go on growing. Andrew Gamble writes:

“At the height of the boom it seemed possible, against all historical experience to the contrary, that this time it might really last forever. The era of boom and bust had passed away, and the global economy was now so sophisticated, so flexible, so independent, that its break down was now unthinkable. It performed miracles of coordination every day, and the fact that no-one properly understood how they were accomplished only added to the marvel and the mystery.” (Gamble, 2009, p2)  

Greenspan had overseen several bubbles in the market throughout his time as chairman of the Federal Reserve and believed that even if the housing boom was eventually found to be a bubble the banks had become so adept at creating and collapsing them that the results of such would be minimal. Robert Lucas, chairman of the American Economic Association agreed with this sentiment, stating in 2003 that “depression-prevention” was no longer necessary (Krugman, 2009).  

This belief, advocated by not only investors and banks, but also by the regulatory bodies, that the economy would simply continue to drive forward, and at worst would have to jump from one boom to the next, was made possible by the introduction in both the US and the UK of a new financial growth model established in response to the stagflation of the 1970s. The shift from a large manufacturing economy to a services economy on both sides of the Atlantic represented the neo-liberal ideologies of both President Ronald Reagan and Prime Minister Margaret Thatcher and their Republican and Conservative administrations respectively. Both nations’ sought to place their financial industries at the heart of what they hoped would become a globalised economy. They did this through a number of measures most notably the privatisation of much of the public sector, and the deregulation of the private sector, particularly the markets. The overall drive to free the markets and increase availability of credit seemed to have reached its optimum goal by the early millennium. Despite social issues associated with privatisation and market dips in the late 1980s and 1990s, the invisible hand appeared to be feeding anyone who wanted to eat.  

However, the invisible hand of the market did have something propping it up. The credit ratings which banks received became of increasing importance with regards to the amount of credit they could obtain. The very beginnings of the success associated with the subprime mortgage revolution had only been made possible by the triple A rating obtained by Bear Stearns in 1997 on the securitisation of their CRA loans. As such, the securities and credit default swaps conducted by banks relied on good credit ratings to allow them to continue. Payments from banks to credit agencies doubled in the years of sub-prime boom to $6bn in 2007 appearing to indicate a huge increase in the number of high ratings being given to banks (Mason, 2010).

Parallels of what was happening in the United States were also taking place in the other major global financial player it had shared the neo-liberal uprising with throughout the 1980s. The United Kingdom was experiencing a credit explosion and a relaxation on mortgage lending, however banks such as Northern Rock refuted the allegation that many of their mortgages could be described as subprime.  Like other UK banks they were offering special low-start loans, or deals to consolidate credit card debt alongside a mortgage. One example of such offers was Northern Rock’s ‘Together’ mortgage offered to young professionals, often with outstanding student debts. Such offers exceeded 100% of property value, and often rose to 125%. However, Northern Rock along with many banks offering similar mortgages in the UK believed that the annual salary increases and set career paths of such borrowers was enough to justify their loans. 

Despite Northern Rock’s claims that they in no way dealt in subprime mortgages, concerns were being raised in the UK towards the number of loans and mortgages being taken out by consumers who did not have to provide evidence such as proof of income to obtain large funds. A report by leading British academics in 2005 named ‘Lending to Higher Risk Borrowers’ was motivated by a concern over the increasing vulnerability of such borrowers and the sustainability of home ownership to such persons.  The report notes:

“Many of these products are heavily promoted and may encourage people to take on more debt than they can really afford. For example, the willingness to lend without proof of income may encourage borrowers to overstate their capacity to repay”.
(Munro et al, 2005)

As the markets continued to boom on a wave of credit both sides of the Atlantic, the Federal Reserve took the decision in 2004 to begin a rise of interest rates in order to stabilise the American economy and allow growth to continue. This was not an unusual policy and the Fed believed that after fully recovering from the mini recession of 2001-02 a rise was justified and the squeeze on credit would only serve as a positive in the housing cycle. They believed that a slight fall in property prices would bring even more buyers to the market, and as such credit would become more freely available again, and house prices would continue their upward spiral. This process of interest rate hikes was expected to gradually increase mortgage default levels, but only for a short period, what happened however was very different indeed (Gamble, 2009).

Between 2004 and 2007 US interest rates rose from 1% to 7%, a steep but not unfamiliar hike. What was unfamiliar to the market was the type of mortgages that were being defaulted on. The initial increases had minimal effects between 2004-05, however cracks began to appear in 2006 as rates headed towards their peak.  It was at this point that borrowers began to realise that their sub-prime mortgages really were less than the best.

At the beginning of the subprime revolution, many borrowers were enticed by the simplicity of obtaining such funds as lenders offered to take care of all paperwork. This of course appeared to be the easiest options for consumers, many of whom had never borrowed money before, or studied a contract as complex as a mortgage agreement. Borrowers were merely told to sign on the dotted line and their dreams would come true. As such, most borrowers, certainly those from lower socio-economic backgrounds, did not realise the terms and conditions of their repayment plans- duped by short term interest rates known as ‘teasers’. Many believed that these rates would continue throughout their mortgage, remaining low making repayment possible. Typically the teaser rates offered by banks would last for two to three years before increasing to a rate that better reflected the risk associated with such loans. However, between 2001-05 the end of teaser rates had been masked by low interest rates, leading to only a very small increase in repayments. As interest rates reached their peak throughout 2006-07 teaser rates were no longer masked and huge increases on repayment expectancy lead to a huge rise in defaults.

It is at this point that the ‘inverted pyramid’ the financial services had created on the back of subprime lending took its first steps towards collapse. Andrew Gamble writes:

“In ordinary times this would have had serious consequences for a large number of borrowers who could no longer meet the repayments on their loans. But it would not have had wider implications for the whole financial sector.”
(Gamble, 2009, p21)

But this was no ordinary time for lenders, they had proved ingenious at bundling together high-risk loans and securitising them, selling them in to the market as high-yield bonds with the best possible credit ratings. This in turn allowed the banks selling bonds to boost their balance sheets and increase their own lending. Gamble continues:

“In this case, however, far from being sound the bonds were hollow. There were no secure income streams behind them, and once many mortgagees started to default on their loans, the precariousness of the imposing financial structure, which the financial services industry had created, was exposed.”
(Gamble, 2009, p22)

By mid-2007 the severity of the situation surrounding subprime was coming to fruition. Following losses being recorded by specialist US subprime lenders earlier in the year, and the bankruptcy of the second largest of such banks, New Century Finance, Bear Stearns, the bank which started the subprime revolution in 1997 was forced to collapse two of its hedge funds and write off $1.9bn from the value of its mortgage related assets (Kary, 2008; Foley, 2007).  

Inevitably the credit agencies which had afforded the likes of Bear Stearns triple A ratings were called into question. In July 2007 the US financial watchdog published a report suggesting that the scale of new business from 2002 onwards had overwhelmed many agencies and as such they had failed to undertake the correct measures in their risk assessment. Bond issuers paying for their own products to be rated by such agencies also presented a serious conflict of interest, going someway to explaining the aforementioned doubling of payments from banks to agencies during the boom. Agencies such as Standard & Poor’s and Moody’s came to believe that if they did not award the required rating, then the next agency would, receiving a healthy sum for doing so.

Following the collapse of one of the subprime markets leading lenders and two Bear Stearns hedge funds, the severity of these losses was transmitted throughout the financial system during the tail end of 2007. Banks began to realise that they no longer had any means of assessing the value of their assets, they could no longer rely on credit ratings which continued to be undermined by further losses, and as such they began to hoard cash, cutting back on their lending to both consumers and other financial institutes. They could not afford to lend money to shore up others bad debts.  This drying up of liquidity came to be known as the ‘credit crunch’.

In the eighteen months following the collapse of New Century Finance attempts were made to encourage lending, interest rates were dropped by the Fed, but confidence in the markets had been lost, lost not only by banks and investors, but also by the industries indirectly handling funds associated with subprime, such as bond insurers, who in September 2007 would have their credit ratings slashed.  Throughout the months leading up to September 2008 signs suggested that the repercussions of the credit crunch were unlikely to be contained easily; a run by consumers on British bank Northern Rock in late 2007 led the government to insure customers savings and was followed by its nationalisation in March 2008. Shortly after Northern Rock’s bail out, Bear Stearns, the banks at the heart of subprime was bought out by JP Morgan Chase for $240mn. One year earlier it had been valued at $18bn.

What happened in September 2008, the bailing out of Freddie Mac and Freddie Mae, the US’s two largest mortgage companies, for $200bn, followed by the collapse of Lehmann brothers, the 185 year old Wall Street behemoth, sent reverberations around the globe. The credit crunch had taken on a new dimension.  The series of events which followed would lead to a widespread financial crisis and ultimately a global recession (Pallister, 2008; Clark, 2009). 

The subprime mortgage market had played a leading role in the creation of the credit crunch, by definition a mortgage is the largest type of loan any borrower is likely to take, the collapse of a market involving such large sums of money was inevitably going to have widespread repercussions. The dispersion of risk throughout the financial industry in the form of bonds associated with the high risk proved a decisive factor in the severity of the banks’ downfall, acting like a disease, spreading its way throughout the industry.

The neo-liberal market philosophies bestowed upon the American and British populations following the 1970s strived for a market all but free from regulation, a market that would stretch from each corner of the globe and all points in between. It is the globalisation of world markets which has meant the impact of an American crash has been felt the world over.  On a visit to the London School of Economics in November 2008 the Queen is famed for having asked staff why no one spotted the oncoming crisis. The same question has been posed by many since the formation of the credit crunch with some suggesting that whilst profits were rising we were too busy staring at the sky to notice the ground shifting beneath us. Andrew Gamble writes:

“The great booms of capitalism have thrived on exuberance, and the readiness to take risks and to embrace change. The longer a boom lasts the more complacent and careless many people become, from those in charge of government and banks down to the humblest investor. The calculations of risks change. By degrees everyone comes to believe that the boom will last for ever, and that finally, the secret of everlasting growth has been discovered.”
(Gamble, 2009, p37)

The psychology of the boom, as documented by Gamble, appears to represent the series of events which gripped the world of finance for the early millennium. Energised by the world of subprime, investors tirelessly pumped air in to a housing bubble. The air was later discovered to be hot, hot and infected. The bursting of this bubble released a toxic gas around the globe. The stench of which has not yet been removed from the pores of the global financial system.

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