Not learning lessons from the past

You would expect a book about the 2008 financial crisis by three of the key policymakers dealing with it to aim to explain and justify the actions they took throughout the crisis. Firefighting: The financial crisis and its lessons by Ben Bernanke, Tim Geithner and Hank Paulson does this. But it doesn’t come across as being particularly self-serving. Obviously they make their case in arguing that the counterfactual world would have been far worse. But they also acknowledge the role of luck, both good and bad, and do a good job of explaining the political and institutional/legal constraints on policy responses, and the complexity, speed and chaos of the situation.

The book, which is short, with an interesting series of charts at the back, is a chronological account running from the pre-crisis boom and the relaxation of regulatory constraints on the financial sector all the way to the post-crisis… relaxation of regulatory constraints on the financial sector. It ends up being a pretty uncomfortable read as they authors think the whole shebang could happen again, but with less ability for their successors to handle it. “Somehow,” they conclude, “Washington needs to muster the courage to restock the emergency arsenal with the tools that helped end the crisis iof 2008.”

“Somehow.”

This is a US focused account, and is not trying to be a comprehensive account of the crisis. It zooms out to describe the outlines of events and the policy debates and processes. Major steps – such as the Fed becoming lender of last resort for the world through extending repo lines to foreign central banks (rightly empahsized in Adam Tooze’s Crashed as a significant step) get a sentence. There are some insider nuggets. I hadn’t known that Paulson’s brother had a senior role at Lehman just before it went under, for instance. AIG shareholders and executives do not come out of it well. It is surprisingly well-written for a book jointly authored by three senior economic policy guys.

I guess the hoped-for audience is Congress. The overwhelming message I took away is that the firefighting policy response was massively hindered by a fragmented regulatory landscape and a zeitgeist of not getting in the way of the markets. It is hard to know when the situation is moving from normal if large correction to crisis, but when that point is identified the government has to act swiftly and decisively. Many of the mis-steps identified at the time and withhindsight were due to legal limitations on the power of the Fed or Treasury to act.

Leverage has diminished somewhat (not nearly enough) since the crisis. But as we’re back in a context of a “prevailing mood” of light enforcement, and ‘regulatory arbitrage’ by the finance sector to evade what regulation there is, no greater cohesion among financial regulators in the US than before, and a long expansion with lax credit conditions – oh, and less scope for monetary and fiscal relaxation – this is all pretty alarming. Will it take another financial firestorm for the “prevailing mood” to change. Read Firefighting and worry.

Firefighting: The Financial Crisis and its Lessons

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Crashed

Adam Tooze’s much-praised history of global political economy from the period just before the Great Financial Crisis to the present – Crashed: How a Decade of Financial Crises Changed the World – is indeed a terrific read. It’s a detailed (600+ pages) synoptic account of the political forces that enabled a few dozen banks to entwine the world’s economies in an interlinked web of credit at massive scale, and the political reactions to and consequences of the crisis. One might quibble that some parts of the story are sketchier than others, but then it’s always a good sign to be hankering after more of a book rather than less. Making the parts into a convincing whole is a major achievement.

There are several central points the book emphasises. One is the extent to which the dollar underpinned the whole global financial market construct – and consequently the extent to which the Fed bailed out the whole world after the crisis. Another is busting the myth that the crisis was Anglo-Saxon: the continental European banks were in it up to their eyeballs, with equally ineffective regulatory oversight, such that they too had massive maturity mismatches (like the US banks) and also massive currency mismatches (whereas it was all dollars for the US banks). Tooze is also forensically critical of the lack of a coherent European policy response – both the ECB (especially under Trichet) and the German political establishment come in for particular fire. The policy response to the Greek crisis in particular was abysmal – as was clear at the time. It was always apparent, certainly by 2012, that debt restructuring was essential, and that the bailout was for German and French banks more than for Greece.

The book explores the interplay between the financial crisis and geopolitics, particularly the desire of both China and Russia to ensure the transition – already heralded but revealed by the role of the dollar to be exaggerated – from a unipolar to a multipolar world. Above all, it draws the lines from the possibility of the crisis, and the crisis response, to the current political situation: “Though it is hardly a secret that we inhabit a world dominated by business oligopolies, during the crisis and its aftermath this reality and its implications for the priorities of government stood nakedly exposed. It is an unpalatable and explosive truth that democratic politics on both sides of the Atlantic has choked on.”

Quite so. Here in Brexit Britain, those working in the City have by and large continued to draw their large bonuses, retire early, holiday in exotic places, while post-crisis ‘austerity’ due to the way the crisis torpedoed public finances means many fellow citizens need to use food banks and are seeing local services like social care and libraries starved. Whatever you think about the consequences, the anti-establishment protest vote, in the UK and elsewhere, is entirely understandable. I’ve been completely gobsmacked by how little consequence of the crisis there has been for the financial sector and those working in it. The same went for the rest of Europe, creating “the sense that Europe’s welfare state was being subjected to a relentless program of rollback driven by the demands of bankers and bond markets.”

So too in the US. Tooze describes the election of Trump as the “most disorienting event experienced by the American political class in generations.” It seems likely to me to be even more damaging for the United States than Brexit will be for Britain. Disorienting, but really hardly surprising. It isn’t only the lasting, scarring financial, emotional, health costs the crisis inflicted on millions of Americans (“The grief and distress caused by the crisis were forces to be reckoned with”) but also the way the Fed’s crisis response and the Obama administration programs contributed to polarising American politics. This happened elsewhere, too. Inevitably perhaps, during the firefighting technocratic responses took priority over democratic legitimacy. We see the lasting consequences in the (slightly abstract) disdain for ‘experts’.

Nobody comes out of Tooze’s account particularly well, although some fare less badly than others (eg Bernanke vis a vis Trichet). Some readers will disagree with the economic diagnosis – for there are people who believe the austerity was essential, the fiscal bomb having been detonated by the crisis. There is more sympathy for the Syriza government than many of its interlocutors in Brussels, Berlin and Paris would share. There will be too much detail for some readers – it helps to know what haircuts and CDOs and repos are. Nevertheless, ten years on, Crashed is an essential read to understand the state of the world, and a troubling read, thinking ahead to the next ten years.

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The slow demise of a company town

Amy Goldstein’s Janesville: An American Story is one of the books on the Financial Times business book of the year shortlist & I have quite enjoyed reading it. It consists of reportage over several years (2008-2013) of a small Wisconsin town whose prosperity had long depended on the well-paying jobs provided by a General Motors plant and its suppliers. When the GM plant is mothballed and later permanently closed, the economic fortunes of the town and its families spiral down. As people use up their unemployment benefits and savings, or scrape by with low-paid service sector jobs, families that were solidly middle class find they need to rely on charitable food handouts, or supplies a teacher at school collects for the kids – shampoo, jeans.

The portraits of the individuals are mainly sympathetic – perhaps least so the Republican-supporting bank manager, although the results of her role as a cheerleader for Janesville’s economic future without GM are acknowledged. It is always a shock to a Briton to be reminded that people in the US with no job have no access to healthcare, and that private philanthropy has to fulfil (inadequately) the role the welfare state plays here. The American healthcare debate is, like the gun control debate, absolutely unfathomable to Europeans. There are some interesting insights into the reasons what support there is for retraining fails to achieve its aims – bureaucratic constraints on access to funding and how it’s used. It was also a surprise to learn that the ex-auto workers who had opted for retraining were doing less well, five years later, than those who had just taken the first job they could find and stayed in the labour market. All in all, it’s a sobering tale of the heart being wrenched out of a company town.

Having said all this, I thought the book was less compelling than George Packer’s The Unwinding. The Janesville tales are not set in a wider context of progressive deindustrialisation and the prospects of automation. Janesville is also silent on race, and I can’t decode the names. Unless it’s an all-white town – surely not? – this must be one of the relevant aspects of how families cope after an economic shock? Or subsequent American politics? There was also less insight into family finance than in the recent detailed study of income uncertainty and its corrosive effects in The Financial Diaries: How Americans Cope in a World of Uncertainty, or in Lisa Servon’s The Unbanking of America: How the New Middle Class Survives. (I haven’t read Hillbilly Elegy – should I?)

This shouldn’t put off readers as Janesville is worthwhile, but I’d be slightly surprised if it emerges the winner of the FT prize.

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Global gloom and community currencies

I’m late to Mervyn King’s The End of Alchemy, which as all the reviewers have noted is a very well written and interesting book. It isn’t exactly cheering. On the contrary, it cast me into gloom.

As the final chapter puts it, “Without reform of the financial system, as proposed in Chapter 7 [a set of reforms with approximately zero chance of happening…..] another crisis is certain, and the failure to tackle the disequilibrium in the world economy makes it likely it will come sooner rather than later.” The chapter goes on to say not to worry, there’s something that can be done: forgive Greek debt and break up the Euro (or go for a full political union). Globally, stop struggling with Dani Rodrik’s trilemma of democracy, national sovereignity and economic intergration – King seems prepared to give up on the third leg. Change policies in China, Japan and Germany. In short, just tackle the underlying global imbalances and all the other problems or symptoms – debt overhangs, zero interest rates etc – will resolve themselves. No problem then.

To be fair, King does speak of “the audacity of pessimism”. Trouble is, you need a lot of people to get a lot more pessimistic before such policy changes would come about. As the book also points out, the last time there was such a big re-ordering was after the 1930s and 2nd world war.

More cheering is Dave Birch’s wonderful forthcoming book Before Babylon, Beyond Bitcoin, the latest in the Perspectives series (and the first full-length one). It surveys the history and the future of money. In this blog post, Dave suggests an e-currency for Manchester (and other cities). As in his previous work, Identity is the New Money, Dave points out the close link between money and trust – indeed, Mervyn King makes this point too. So financial stability is a question of communities of trust. It’s more comforting to think about trust from the ground up rather than global imbalances and crises….

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Financial crises, past, recent and future

Very late in the day, I’ve finally read Barry Eichengreen’s Hall of Mirrors: The Great Depression, The Great Recession and the Uses – and Misuses – of History. The subtitle is a concise capsule summary. The book does a neat job weaving between the 1920s/30s and the 2000s, underlining the similarities and the significant differences. There is some nice storytelling as well, particularly in the Great Depression chapters, using colourful figures and their exploits to draw in the reader, starting with the notorious Charles Ponzi but with many others too. In fact, there’s a 20 page Dramatis Personae, so this is no abstract text but a story of actual people doing actual (bad/stupid/short-sighted) things.

Given the number of books already available about both episodes, the added value of this one needs to be in the compare and contrast, and I think it succeeds in this. The common features (apart from human frailty) lie in the dynamics of bubbles, and their roots in periods of stability and optimism; in the global character of financial market reactions and the way decisions that seem either sensible or politically necessary in one country can have immense negative externalities for others; and in the interplay between politics and economics or between democracy and technocracy. Perhaps the most important difference emphasised here is the greater scale and complexity of financial markets now. Even when people are not trying to hide misdeeds, it is not easy to identify dangerous flows or accumulations of risk.

But the book also points to the difference in policy responses: in the Great Depression the answer was more government. Given the way politics has moved, it was not the answer to the Great Financial Crisis. Eichengreen – relatively gently – points to the under-regulation of big banks and other financial institutions in key dimensions, such as the only modestly higher capital ratios and lower leverage; or the failure to reform credit ratings agencies. This gently touch, he argues, reflects the success of the monetary and fiscal policy action to avert another Great Depression: “Thus the very success with which policy makers limited the damage from the worst financial crisis in eighty years means we are likely to see another such crisis in less than eighty years.

Much less, I’d say, given how little has changed.

Anyway, I enjoyed Hall of Mirrors. I think it helps to have read other books on both episodes, as in effect half a book on each of the Great Depression and the Financial Crisis is pretty compressed. A combination of Liaquat Ahamed’s Lords of Finance and John Lanchester’s Whoops! would be perfect preparation (the latter was IOU in the US).

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