In the late 1990`s you could buy a house costing 100k and get about 700 pounds per month in rent depending on demand and area. This equates to 700 times 12 of rental income for the year i. e. a 8.4% yield. On top of that the property also went up in value at say 10% and the value of the property moves to 110k. As mortgage interest rates were lower than the yield obtained on the property you were on to a real winner. If you bought a property for 200k you would get a similar story except a 10% increase in property value would be worth 220k making you an easy 20k profit. With low interest rates the whole nation went on a buy to let frenzy.
Not only did investors get in on the act but when we all realized how much our property values were worth we decided to borrow against it to provide a much more luxurious lifestyle.
Then came the financial institutions who realized that if they could borrow billions at 6% and buy out companies whose shares were yielding 8% then they could make millions by just buying back the shares in that company. Even better if the company also had a property portfolio they could sell that and buy back even more shares which could raise the earnings per share even further making the shares more attractive by lowering its p/e value. Everybody was getting in to the act that leverage is the greatest profit making game in town.
Hedge funds needed to make even bigger returns so they used leverage to do that for them. Like everyone else they did not care as credit was cheap. The banks needed to continuously supply all of us with more and more money so they had to get all this money from some where and along came the solution. . . . . . securitisation. Take high risk loans and package them up and sell them to other institutions which provided them with the cash they needed in this credit boom.
The banks had there own little gambling games called derivatives where people could borrow to bet on the stock market. The methods used are not too dissimilar to the methods used by hedge funds to make profits and all this leverage has affected both the hedge fund industry and the banks.
It is easy to blame the city professionals for this credit bust but then what were we all doing borrowing such crazy amounts from whatever institution were offering it.
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