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