If you are new to this blog, you are invited to read first “The Largest Heist in History” which was accepted as evidence and published by the British Parliament, House of Commons, Treasury Committee.

"It is typically characterised by strong, compelling, logic. I loosely use the term 'pyramid selling' to describe the activities of the City but you explain in crystal clear terms why this is so." commented Dr Vincent Cable MP to the author.

This blog demonstrates that:

- the financial system was turned into a pyramid scheme in a technical, legal sense (not just proverbial);

- the current crisis was easily predictable (without any benefit of hindsight) by any competent financier, i.e. with rudimentary knowledge of mathematics, hence avoidable.

It is up to readers to draw their own conclusions. Whether this crisis is a result of a conspiracy to defraud taxpayers, or a massive negligence, or it is just a misfortune, or maybe a Swedish count, Axel Oxenstierna, was right when he said to his son in the 17th century: "Do you not know, my son, with how little wisdom the world is governed?".

Monday, 13 April 2009

The Turner Review

Lord Turner seems to suggest in his report (The Turner Review), that in the future there should be a regulatory measure based on loan-to-value ratio and loan-to-income.

Let us imagine situation whereby loan-to-deposit ratio is above 100% whilst loan-to-value ratio is whatever the regulator thinks is sensible. Then the supply of credit to the market (compared to cash in banks, i.e. deposits) will grow in an exponential way. It will start creating a financial pyramid (by definition of a pyramid). At the same time, because there will be good supply of credit, value of assets will keep on increasing thereby keeping loan-to-value ratio on a regulatory acceptable level, even suppressing it down. (This is a stage when a bubble will be created.) At some point, that will come fast due to exponential speed of growth of the pyramid (i.e. loan-to deposit ratio above 100%), the market will run out of cash and then the value will collapse. (This is a point when bubble bursts.) The loan-to-value ratio will go steeply up due to the lack of market liquidity. So here we are: the current story will be repeated.

It might be possible to keep loan-to-value ratio at such a level as to keep loan-to-deposit ratio below 100%. (This would an indirect control of loan-to-deposit ratio.) But then why not state precisely: as loan-to-deposit ratio above 100% constitutes a financial pyramid it must be banned. Only in very unusual circumstances, and under a very controlled regime, it might be periodically relaxed to stimulate the economy. But then such actions will come with risk (of ending up with a financial pyramid) and they must be taken as the last resort.

A very similar argument applies to loan-to-income ratio.

The Financial Services Authority are still behaving like a drunk child in the fog … or are in a state of denial the obvious.


  1. I'm not sure I understand the practical interpretation of your views.

    If I take $100 in deposits and loan out $60, you are comfortable that this will not cause a problem. But if I take in $100 in deposits, loan out $60, sell the loan to an investor for $61 (agreeing to service the loan), then loan out another $60 (120% loan to deposit), do you calculate that this is a pyramid scheme?

    If I take in $100 in deposits, and borrow another $60 from a money-center bank, then lend out the $60 plus another $60 from my depositors, do we have a pyramid scheme with 120% loan to deposits, and are on the road to an inevitable disaster?

    And, is the infinite series of events that you postulate a reflection of events in the real world, or only a mathematical calculation.

  2. I do not feel comfortable or uncomfortable with taking $100 and loaning out $60. I am just saying that this ratio, 60%, means that a ratio of banks balance sheets to cash available on the market will always stay finite. In this case for every $250 on the banks balance sheets in terms of loans there will always be $100 cash in circulation. In such case liquidity problems, run on the banks etc are unlikely but still possible. Other types of economic problems are also possible.

    Giving more in loans than you take in deposits (i.e. loan to deposit ratio is above 100%) by a single or a some banks would not be a problem, if that was balanced out by other banks conservative lending and the entire system had loan to deposit ratio below 100%. (As there used to be a very active inter-bank lending we can consider the entire financial system within one currency as one big bank.) However if loan to deposit ratio in the entire financial system is above 100% (which was and I think still is the case) than you have to make up for cash with financial instruments (you consider some of them as good as cash). Initially you provide the market with such increased liquidity, in many instances inflating the value of these instruments which are considered as good as cash. This results in allowing you to give even more loans again inflating the value of financial instruments. This is the process when the pyramid builds up. The balance sheets have a lot of bogus value based on so-called mark-to-market valuation. But in reality, as a basic maths calculation shows, the ratio of banks’ balance sheets to cash (i.e. I mean hard cash not some Tier 1 capital compliant instruments which are not cash) available on the market keeps increasing at exponential rate heading – if not stopped – to infinity. As infinity is not possible, it is never reached. But a collapse happens at a very high value. It is a pyramid and pyramids have been illegal for some years.

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