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Saturday, March 21, 2009

Why Gamble? – The background story

Perhaps before explaining my strategies for beating the banks by gambling £100 I should explain why I would want to try and do so in the first place.

For those of you reading this around the time it has been posted, I would expect you are all too aware of what has been termed by the media as the ‘credit crunch’.  But for those who have either been on another planet for the last year or so, or are reading this in the future with little or no understanding of the current economic climate, I will try to explain some of the background to what I am doing.

The whole ‘credit crunch’ thing is quite complicated, but I will attempt to explain it (as I understand it) in layman's terms and why it has lead to this experiment.  Perhaps the easiest place to start is the beginning of the 21st century.  Banks had lent to what have been termed as ‘sub-prime’ borrowers, essentially people who couldn’t afford to repay their loans and should never have been lent as much as they were lent in the first place.  Between 2004 & 2006 interest rates in the USA increased from 1% to over 5%.  This lead to people who could barely afford their mortgage payments at the low rates, defaulting on their mortgage at the higher rates, and with the property market drying up and property prices falling banks were losing money.

Fast forward to 2007, banks nervous of which banks have lost money to the sub-prime markets put up the rate at which they will lend to each other as well as making less money available.  Some banks had over relied on borrowing money from the markets in this way rather than using customers deposits to fund their lending so when the funds in these markets dry up, the serious trouble starts.  It is this that lead to the run on Northern Rock in the UK and its eventual nationalisation.  Around this time, Bank of England interest rates were 5.75%.

Northern Rock was far from alone with its problems, other banks failed or came close to collapse.  Perhaps the biggest was Lehman Brothers, while in the UK HBOS was merged with Lloyds TSB, and Bradford and Bingley was part nationalised, part sold to The Santander Group.  Governments and central banks around the world pumped money in to the financial system in the hope of stimulating lending while the Bank of England interest rate tumbled to 0.5% in March 2009.  Stock markets also suffered, with the FTSE-100 as I write this around 3800 compared to 5500-6000 about a year ago. 
If you want a bit more information on how this all unfolded, the BBC has a great article here.

So how does this all tie in with me gambling with £100 to beat the banks.  With interest rates at 0.5%, savings accounts offer very little return at the moment with the best buys being around 3% AER, and while the stock market should recover in the long term, it is just that, a long term investment and given its current volatility who knows where it will be in 12 months time.  So I have looked at other ways  of getting my money to work for me came up with the idea of gambling as a means to achieve this.

On my next blog I will give more detail of the strategy I intend to follow over the next year to try and get a better return on my £100 than I would through more traditional investment options.

Sources: -
Bank of England Interest Rates – moneyworld.com
FTSE-100 data – BBC News

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