I am not sure exactly when I received The Subprime Primer, a slideshow that someone emailed me early in 2008. I do recall thinking it was unlikely ever to be surpassed as an introduction to the financial chain reaction that began as I was writing The Ascent of Money and reached its climax in the months after the failure of Lehman Brothers, the 10th anniversary of which fell yesterday.
Illustrated with foul-mouthed stick men, The Subprime Primer’s 45 slides told the story of how “crappy” mortgage loans originated by “Ace Mortgage Brokers” came to be owned by “First Bank of Bankland, Inc”, which sold them to “RSG Investment Bank of Wall Street”. The “really smart guys” (RSG) were the ones who came up with the plan to “create a new security and use these crappy mortgages as collateral” and then sell the resulting collateralised debt obligation to investors such as the “Norwegian Village Pension Fund”. We all now know how the story ended.
A decade has passed since the escalation of the credit crunch into a global financial crisis and then a great recession. There are four questions we need to address. First, why did it happen? Second, why, in most countries, did it not turn into a full-blown depression? Third, why was the recovery from the crisis so anaemic? Finally, and most importantly, could it all happen again?
Gordon Brown, prime minister when the storm struck, is among those who think it could. “We are in danger of sleepwalking into a future crisis,” he said last week. “There is going to have to be a severe awakening to the escalation of risks, but we are in a leaderless world.” Having sleepwalked into the last crisis — and then prematurely claimed to have “saved the world” — Brown speaks with a certain authority.
Ten years ago I was right to foresee that, bad though things already were in the summer of 2008, they were going to get a great deal worse. A US recession had already begun. Banks all over the world were about to reduce lending to compensate for losses from mortgage-backed securities. I was right, too, that Europe would be at least as badly affected as the United States. There was to be a “great dying” of weak banks and asset managers. Millions of people would lose their jobs, their homes, their savings.
What had gone wrong? In The Ascent of Money I argued that this deepening financial crisis could not be explained simplistically — “It was the greed of the bankers!” or “It was reckless deregulation!” — but required a consideration of six pathologies:
1) The inadequate capitalisation of the banks of the western world;
2) The contamination of the short-term debt market with toxic securities of the sort depicted in The Subprime Primer;
3) Errors of monetary policy by the US Federal Reserve, which turned a blind eye to signs of overheating in the American property market;
4) The rapid growth of the forms of financial life known as derivatives, which added an opaque layer of complexity to the system;
5) The politically motivated campaign to increase the homeownership rate in the United States (and some other countries that also experienced housing bubbles);
6) The unbalanced relationship that had developed between the United States and China, which I gave the name “Chimerica”.
Second question: whom or what should we thank for the fact that the 2010s were not the 1930s — the Federal Reserve? The spirit of John Maynard Keynes? A bit of both would be a fair answer, although monetary policy was used for much longer than fiscal policy. But I would give more credit than most western commentators to China’s massive stimulus programme.
Question three: whom or what should we blame for the fact that the 2010s were also not the 1990s? Why was the recovery that followed the crisis so underwhelming? Is it justified to speak, as the Harvard economist Larry Summers has, of “secular stagnation”? Or was his colleague Kenneth Rogoff right when he argued that such a large financial crisis was bound to result in a prolonged but finite economic hangover?
I am inclined to side with Rogoff in this debate but I would add two further points. First, the EU’s horrible mishandling of the crisis surely acted as a brake on recovery. Second, the administration of Barack Obama did its best to throw sand in the American economic machine in the form of overcomplicated regulation.
Keynesians have claimed the recovery could have been more rapid with even larger fiscal stimulus — the construction of umpteen bridges to nowhere, paid for by yet more government debt. Brown last week endorsed that story. But might it not have made more sense to try tax cuts plus deregulation — the policies belatedly adopted by Donald Trump’s administration last year?
Final question: is Brown right to fear another financial crisis? The answer is yes. The most striking feature of the global financial system is how little it has changed in a decade, despite the promulgation of thousands of pages of new financial regulations on both sides of the Atlantic. Banks are certainly better capitalised than they were 10 years ago. But that’s about it.
There are novelties, to be sure. Ten years ago bitcoin was introduced to the world in a paper published under the pseudonym Satoshi Nakamoto. By 2017 there was enough speculative interest in bitcoin and other cryptocurrencies to produce a spectacular bubble. Yet the bubble burst. Despite the cryptocurrency mania, Planet Finance is still dominated by fiat money created by banks with fractional reserves, long and short-term debt instruments issued by governments and corporations, stocks issued by corporations, insurance policies and mortgages.
The thing to worry about — as in 2008 — is the sheer size of the debt mountain. Relative to global GDP, the financial sector has reduced debt and households have held steady, but the debts of governments and non-financial firms have soared. Total debt is up from 280% of GDP in 2008 to 320%.
If the global financial system has not changed fundamentally since 2008, then it does not take great prophetic gifts to predict another crisis. Financial history has not ended any more than political history ended with the fall of the Berlin Wall.
The next crisis will not be like the last one. History teaches us not to expend too much energy trying to prevent the last crisis from happening again, but instead to ask the broad question: which borrowers around the world have overextended themselves to the point where they will begin to fail in the event of rising real interest rates? And which lenders or investors will be in trouble if the defaults exceed their expectations?
What makes it so easy to predict the next financial crisis is that in some overleveraged emerging markets — notably Turkey and Argentina — it has already begun. Who will be next — South Africa? Brazil? Or the big one: China?
Somewhere, I hope, the author of The Subprime Primer is working on a sequel. The Submerging Market Road Map, anyone?
An updated edition of Niall Ferguson’s book The Ascent of Money: A Financial History of the World will be published in 2019
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President Trump at the White House on Tuesday. (Mike Theiler/Pool/Epa-Efe)
Two years ago, at the World Economic Forum in Davos, Switzerland, it seemed inconceivable that Donald Trump would be elected president of the United States. One year ago, it seemed inconceivable that he would ever come to Davos in that role. This week, the worst nightmare of Davos Man is coming true. President Trump — the personification of all that the “globalists” fear and loathe — is coming to town.
No part of the world — perhaps not even Washington — misses former president Barack Obama more than Davos. Trump wants tighter controls on immigration, and he has only recently referred to African countries in scatological terms. He is openly protectionist and has repeatedly threatened to scrap free-trade agreements such as NAFTA. He has shown little respect for the European political elite that sets the tone at Davos, leaning on them to contribute more to NATO. Above all, the president has come to exemplify the Ugly American in European eyes.
Yet to imagine that Davos is all about liberal principles is to misunderstand it. There’s a reason Obama never showed up. There’s a reason Trump will not be pelted with Swiss rolls when he does.
The forum was founded in 1971 by a bespectacled Harvard-trained German academic named Klaus Schwab with the idea that a regular conference of international business leaders could realize his vision of “corporations as stakeholders in global society, together with government and civil society.” The result has been described as a name-dropper’s paradise, populated not only by the chief executives of multinationals and selected politicians, but also, as the New Yorker’s Nick Paumgarten described the sprawling scene, by “central bankers, industrial chiefs, hedge-fund titans, gloomy forecasters, astrophysicists, monks, rabbis, tech wizards, museum curators, university presidents, financial bloggers [and] virtuous heirs.”
Thanks to Schwab, Davos now truly deserves the name Thomas Mann once gave the mountain that towers above it: der Zauberberg, the Magic Mountain.
Those who mock the World Economic Forum — and there are many, most of whom would drop everything and rush there if they were ever invited — underestimate its power. Think only of Nelson Mandela’s 1992 speech in which he ditched one of the core commitments of the African National Congress’s Freedom Charter: the nationalization of South Africa’s key industries.
But what matters at Davos is not the speeches given by world leaders, much less the panels with worthy titles such as “Rethinking Climate Change and Work-Life Balance in the Sixth Industrial Revolution.” It is the meetings behind the scenes, in the well-guarded private rooms of the resort’s main hotels: meetings like the ones that changed Mandela’s mind on state ownership of the economy. The really interesting question is whether or not Trump and his entourage will be taking such meetings — and with whom.
The media will probably focus their coverage on handshakes and other body language with the other world leaders on this year’s Davos list. Will he and the French President Emmanuel Macron reenact the longest handshake in Franco-American diplomatic history? Will he do the opposite with German Chancellor Angela Merkel, whose hand he declined to shake last year? Will Indian Prime Minister Narendra Modi get some Trump time?
None of this will matter. The real issue is the message Trump chooses to communicate to a global business elite that has an embarrassing little secret they would rather not say too much about: They may hate his tweets and his politically incorrect rhetoric, but they have spent the past year loving his economic policy to bits. Deregulation plus corporate tax cuts have helped to drive the price of nearly every stock represented at Davos to record highs. Forget the public handshakes; it’s the private high-fives that will matter. As I prophesied two years ago: Trump was always going to come to Davos if he was elected president, in order to remind his fellow billionaires that, when all is said and done, he is really one of them.
The reason Obama never went to Davos is that, aside from raising campaign funds from them, he had little real use for businessmen. Trump, by contrast, is a businessman, whose network of business ties — not least to Russia — remains a focal point of an investigation that may yet determine the fate of his presidency.
That is not to say I expect him to turn up at Russian oligarch Oleg Deripaska’s legendary Davos party. But he would not be wholly out of place there: After all, Deripaska employed Paul Manafort before Trump did.
One of my favorite lines about Davos comes from JP Morgan boss Jamie Dimon: “Davos is where billionaires tell millionaires how the middle class feels.” The events of 2016 revealed that Trump knew a lot more than most members of his class about how the American middle — and working — class felt. For that reason, if no other, he can expect more than a cold shoulder from the globalists this week.
A little more than three years ago I made the worst investment decision of my entire life. It was October. “You know, Dad,” my then 15-year-old son said, “you really ought to buy some bitcoin.” Yes, that’s right, bitcoin: the newfangled “crypto-currency” based on some weird thing called blockchain technology, invented back in 2008 by a mysterious individual using the alias Satoshi Nakamoto.
Listen, son, said the omniscient historian of finance, that is no way to invest my hard-earned pounds, shillings and pence.
Son: Dad, what are shillings?
Me: Never mind. The point is that since ancient Mesopotamia, money has tended to be monopolised by states. That’s why the Queen’s head appears on the notes in my wallet and the coins in your pocket.
Son: Actually, I don’t bother with notes and coins these days, I can pay with my phone — look, I’ll show you . . .
Me: Trust me, the governments of the world are not about to let their monopolies on national currencies be undermined by a currency that’s already being used for nefarious purposes by criminals and money launderers.
Son: Yes, but . . .
Me: No buts — and no bits, for that matter — I’m not throwing real money down the virtual drain.
On October 7, 2014 — when something like that exchange took place — the dollar price of one bitcoin was $334. As I write, it is $15,150 (£11,323). Yes, you read that correctly. If I had listened to my son, I would have increased the dollar value of my investment by a factor of 45 — or, if you prefer, I’d have made a return on the investment of 4,436%.
The moral of the story is clear: when it comes to technology, pay heed to teenagers.
It’s never too late to recover from an investment blunder, of course. But now the terrible question arises: what if buying bitcoin now would make me the “greater fool” — the last man in, who gets left holding the bitcoin when the bubble bursts and the price plummets back to $334, if not $0?
That fear is not groundless. Financial history is full of examples of investment manias that at some point turned into panics and crashes. Like the five stages of grief (denial, anger, bargaining, depression and acceptance), there are five stages to most financial bubbles.
1 Displacement: a change in economic circumstances creates new and profitable opportunities. A new financial asset is born.
2 Euphoria: a feedback process sets in: expectations of rising profits lead to a rapid growth in the price of the new asset.
3 Mania: the prospect of easy money attracts first-time investors as well as swindlers eager to part them from their cash.
4 Distress: the insiders discern no future gains can possibly justify the now exorbitant prices and begin to take profits by selling.
5 Revulsion or discredit: as prices fall, the outsiders all stampede for the exits, causing the bubble to burst altogether.
Typically, in other words, the insiders make the money by selling at the 11th hour to the outsiders, otherwise known as suckers. Precisely this fear was what caused me to hold back when my prescient son, now 18, came to visit me in September this year. The price of bitcoin was $3,672 at that point. If I’d taken his advice and bought then, I’d still have quadrupled my money. Did I do it? Is the moon made of green cheese?
The analogy favoured by bitcoin sceptics is the mania for tulip bulbs that swept Holland between 1634 and 1637. Bitcoin is “worse than tulip bulbs”, said Jamie Dimon, JP Morgan’s chief executive, at a conference in September. “It’s a fraud,” he declared.
“Bitcoin is a sort of tulip,” observed European Central Bank vice-president Vitor Constancio at around the same time. “It’s . . . an instrument of speculation for those that want to bet on something that can go up and down 50% or 40% in a few days, but certainly not a currency.”
The Nobel laureate and vituperative New York Times columnist Paul Krugman has been taking bites at bitcoin since December 2013. “Can [it] actually work?” he asked then. “I have to say that I’m still deeply unconvinced.” Ten months later he dismissed “bitcoin fever” as the product of “libertarian anti-government fantasies”.
That should have been my signal to buy. After all, this was the same Krugman who in 1998 predicted that “the growth of the internet [would] slow drastically” as “most people have nothing to say to each other”.
“By 2005 or so,” Krugman famously predicted, “it will become clear that the internet’s impact on the economy has been no greater than the fax machine’s.”
Tulip mania is not the right analogy for understanding bitcoin, any more than the fax machine was the right analogy for understanding the internet. As the South Sea Bubble of 1719-21 revealed, financial innovations are often accompanied in their initial stages by bubbles; the inevitable bust doesn’t necessarily kill the innovation. The price of shares in the South Sea Company may have inflated and then collapsed, but that didn’t spell the end of tradable shares as financial instruments. On the contrary, shares went on to become the foundation of corporate finance.
Something similar, I now believe, will prove to be true of bitcoin and crypto-currencies in general. It’s not so much that blockchain-based coins and tokens will replace the fiat money we have grown accustomed to using since the demise of the gold standard. Rather, there are at least three other uses for the new financial technology that will persist even after this bubble bursts.
First, bitcoin has established itself as a kind of digital gold: a store of value for wealthy investors, especially those located in countries with weak rule of law and high political risk.
Second, “initial coin offerings” that raise money in bitcoin and another big crypto-currency, ethereum, have emerged as a quick and easy way to finance innovation — a digital alternative to issuing shares.
Third, because blockchains are a near-unhackable, cryptographic method for preserving data across a computer network, they can be used for a whole variety of transactions. In future the title deeds for property will take this form. Indeed, this is already happening in the republic of Georgia. Meanwhile, Estonia is planning to store its citizens’ medical records on blockchain.
At some point, no doubt, regulatory changes in the US will deflate the current bitcoin bubble. But they will not halt, much less undo, this financial revolution.
Think about it this way. The maximum number of bitcoins that can be created is 21m. The number of millionaires in the world, according to Credit Suisse, is 36m. Their total wealth is $128.7 trillion. If millionaires collectively decided to hold just 1% of their wealth as bitcoin, the price would be not $15,000 but north of $60,000. If they raised that to 5%, the right price for bitcoin would be above $300,000.
I am not saying this is certain to happen. I’m just saying my teenage son thinks it could.
Niall Ferguson’s new book is The Square and the Tower: Networks, Hierarchies and the Struggle for Global Power (Allen Lane)