By Milne A.
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Additional info for The fall of the house of credit
Suppose, for example, that BNP Paribas is making a loan of €12,000 for a car purchase to M. Jacques Laurent, a customer in Lyon. Once the loan is approved M. Laurent’s account in the Rue de la République branch is credited with the €12,000. At the same time the bank has acquired a new asset, the €12,000 loan to M. Laurent. By this routine Where did all the money go? 1 All banks make loans in this way every day. The money may not necessarily appear in the customer’s account as it did for M. Laurent; it might be transferred directly to someone else, for example to a retailer or to the seller of a house.
There are several other important feedback loops in bank lending, feedbacks referred to collectively as the ‘credit cycle’: 1. Lenders interpret low levels of loan default as an indication that their lending is low-risk, when in fact low defaults are due to the economic expansion and the general availability of credit, making it easier for borrowers to pay interest and also to refinance their lending and so stay current on their loans. As credit expansion and income growth slow, defaults rise and lenders suddenly realize that their lending is much riskier than they had believed.
The ability of one bank to sell always depends on the presence of other banks willing to buy. This then set in train the crisis that followed, a crisis characterized by what engineers call a ‘positive feedback loop’, when an initial disturbance has an effect which then feeds back, reinforcing the initial disturbance. 1 illustrates the damaging positive feedback that has undermined the world’s banking system. In this figure there are in Where did all the money go? 1. Positive feedback loops in bank funding and loan markets fact two positive feedback loops, each reinforcing the other.
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