For this explanation forget about banks that lent recklessly. Lets imagine you own a bank only lending at normal historical standards. And lets just talk about mortgages because it is the type of loan the average person is most familiar with.
At your bank you have 1,000 mortgages on the books. The
downpayments are 20% of the home value. You are in a wealthier area so every
borrower has a family income of £100,000 pounds a year, and all your mortgages
begin as £300,000 on a £360,000 property. On the downside because you are so
conservative with your loans, the spreads between what you get money at, and the
rates you charge customers is small.
But change is afoot in the society.
Robotics are taking jobs in factories, computers are replacing the mass cubicle
workers, machinery is advancing and reducing man hours per job, foreign trade is
causing factories to shut down, foreign workers are taking over jobs at
In Britain like clockwork the labour force is shrinking by 125,000
people a quarter. Half a million a year. Since the labour force is around 27.5
million, this 500,000 loss a year is 1.8% of the workforce disappearing a
So of your 1,000 mortgages, 18 a year are eventually defaulting.
Now this is not a problem as long as you can seize the property and sell it for
more than the 300k loan. (Hence the total focus of the UK government on keeping
property price up).
There is another problem, since probably 80% of
those mortgages are based on dual income, there is actually 1,800 incomes paying
your 1,000 mortgages. Without both incomes they cannot maintain the loan. so
1,800*.018=32 a year who will eventually default.
There is an even bigger
problem though. As a surplus of labour builds it eventually drives down the
wages of those who do hold onto their jobs. So a great deal who are holding onto
jobs will be facing loss of overtime, benefits cuts, even wage cuts. And if
severe enough they will eventually fall into default.
with the labour force shrinking and wages falling, the prices on properties will
come down. This is where you lose that cushion of the 20% down payment.
In the future if these trends continue banks will have to charge
much higher rates on even safe loans. Like 8% would allow them to absorb the
losses, run their organizations and still make a return on investment for their
What screws them is they have millions and millions locked
in on huge mortgages at exceptionally low rates. Going to 8% would crush the
housing market, and cause mass defaults on their current mortgage
I think the only option is continual bailouts and gradually rising
rates the banks are charging until the business becomes viable again. Which is
what we have been seeing.