IOU is one of the foundations of the credit industry and for many years that has served the world, for a short time before the world’s banks came crashing down, it seem it was I owe to somebody but who is a unknown. The simple idea is behind the book IOU – Why Everyone Owes Everyone and No One Can Pay by John Lanchester published by Penguin Books, London, 2010. Your favorite bank and other financial institutions are in the business of risk management – ideally taking in deposits and lending out the money and making a spread between the two. Many people have heard that but the reasons financial institutions can make money is leverage – they only have to keep a percentage of capital in cash or cash equivalents. The rest they can lend or the bank’s principal debt are other people’s debts to it. How well they lend is the key to their success – if people can pay back the bank churns out profits; if it gives out money poorly then some good people will have financial troubles.

In the mortgage backed crisis that lowered property prices around the world, the banks seemingly in the interest of gaining greater fees lent more and more money to those who should have never been access to credit first. In essence, the size of the no income, no assets loans grew because of an original good thing. Securitization of real estate loans to become to similar to bonds allowed the banks to make more loans is a good thing. Because people were under the assumption, property values across the world or country never fell at the same time, the loans were given triple aaa ratings. The triple aaa ratings allowed the biggest and conservative institutions to buy the bonds to get a good yield of their investment given the low interest policy of the central banks. The problem was as the quality of the mortgages was getting worse, no one ever lowered the ratings. If you examined the corporate debt aaa ratings now, you will only find a handful, back in 2007 90% of mortgage backed bonds had the ratings. You have to wonder why the others did not get it. Common sense says the percentages of very stable should be low and higher ratings for the majority. This means people knew something but as soon as they sold the bonds to someone else they did little because it was someone else’s problem – similar to the child’s game of pass something around till the clock runs out, whoever holds the item is out.

For a number of years, financial services was seen as solid and respectable, for a few years in the early 2000’s the desire was to make as much money as possible and dam the consequences. Changing regulations to allow more leverage and all was assumed to be good, all that happened is the leverage in the financial industries went up for 1 dollar deposit to 9 deposits on loan to 1 dollar in deposits to 33 on loan. What happens when a default happened? with leverage someone has to put up more capital or reduce the lending and reducing lending considering bonuses are based on it is a difficult thing to do. You can imagine if you have credit cards, the company adds three zeros to it. Some people will do little, but more will use the credit because they can and defaults will be higher.

Linking to dividend paying stocks, in all industries regulation is a key to maintaining stability. All industries have the ability to create new products and services but to maintain proper market asset values (rather than just make up a number which happened)  government regulation is important. You will hear industry talk about cutting government regulation, until the time when something goes wrong and then the industry will say well what was the government doing? It is hard to have it both ways, for dividend stocks we like government regulations which limit the competition.

There are more questions than answers, till the next time – to raising questions.