Numbers can be interesting, and there are some very striking ones in Whoops!, an excellent book by John Lancaster – on our current financial predicament. One is that (as of a couple of years ago) the RBS bank group (Royal Bank of Scotland, Natwest, etc., i.e., the one we now own) had £1.81 trillion of liabilities. This is actually a little more than the entire GDP of the UK, which was £1.70 trillion. So the bank owed an amount of money that would take the entire UK one year and 20 days to earn. Wow.
The RBS group then had £1.90 trillion of assets. The equity of a bank, or indeed of you, = (assets) – (liabilities). The RBS’s equity was £0.09 trillion or £90 billion. This is quite small amount of equity.
To get a feel for how small, let us consider someone who starts out buying a first flat, worth say £100,000, and uses £5,000 of their savings plus a £95,000 loan. If they had no assets other than the house (e.g., no car worth anything, no significant savings once the house is bought), then their assets would be £100,000, and their liabilities would be £95,000 – the money owed to the bank. This would leave £5,000 as their equity; the 5% of the flat that they own.
Then their leveraging would be liabilities/assets = 20. This is high, but RBS’s leveraging was 19, only slightly lower. And at its peak in 2008 the Barclays’ group leveraging was an amazing 61! This would be equivalent to a mortgage of more than 98%!
The problem with high leveraging is that even small losses wipe you out. If you had followed Barclays and gone for a 98% mortgage, then if the price of the flat dropped by only 2%, it would wipe you out, as then you owe the bank the whole value of the flat. Any further drop would put you in negative equity.
The irony is of course that banks responded to the financial crisis partly caused by their own over leveraging by getting rid of 100%, and 90% etc, mortgages. On the one hand you can say this is hypocritical, on the other hand if a bank declines your request for a 90% mortgage you can’t accuse the bank of not knowing about the problems of being highly leveraged. It could well be wholly or partly taxpayer owned because of that very problem.
