Failure to Moderate Excess: A Round-Up of Crisis Chronicles

By William Dixon, 21 October 2009


Now the dust has settled on the collapse of the banking industry, William Dixon looks back at some crisis bestsellers and finds their limit in a lack of systemic analysis and insistence on reform

Maybe it will be the credit crunch book industry that brings the economy out of recession. There're certainly enough books on the crisis, but here the focus is on just four. In Gillian Tett's Fool's Gold,  we get an interesting close up on the back room of the crisis, especially looking at the J.P. Morgan team that devised many of the new derivative products. In Philip Augar's Chasing Alpha, we get a slightly wider view that examines how financial institutions and their regulation changed over the years, especially since the 1980s, and up to Brown's support for light regulation. Paul Mason's Meltdown, gives the crucial events of the credit crunch but also gives the wider context of global imbalances as well, with some interesting speculation of the direction we are going in. Then, the book that offers a new theory and ‘meaning' of the crash, George Soros's The Crash of 2008 and What it Means. These are not books that trumpet the crisis of capitalism, although necessarily they are critical. They are worth considering because they come from insiders: Tett is a journalist for the Financial Times and Paul Mason an economics editor for BBC Newsnight. These two, of course, weren't at the coalface, but then, nor were the other two. Soros is of course a trader, while Augar was previously in an investment bank, but their accounts are not of the kind that has started to appear from people caught at the centre, in organisations like Lehman's.

These books give us at least a variety of approaches to the crisis, from Tett's close-up view of the internal workings of JP Morgan's derivative team to Augar's broader view of the changes in the financial institutions within an enabling political environment led by confidence in market mechanisms, while Mason expands further, describing that confidence as market fundamentalism, which he also considers to be a vital element in the wider historical political background going back at least to Thatcher and Reagan's victories. Mason's focus is wider still in looking at the context of the world economy and its gross imbalances. What runs through all of these books is the idea that market fundamentalism is a contributory cause of the crisis and this obviously raises the question of the role of economics in the crisis. Soros's book does have a critical view of economics, with his theory of reflexivity, but this is not adequately developed, as he himself is ready to admit and anyway something close to that theory already appeared in the work of J.M.Keynes (with the idea of a market as a beauty contest).1 The essential idea here is that the price of something depends on what other people think other people will think is the price of something. In terms of the beauty context, I don't predict the winner on the basis of my preferences but what I take average opinion to be. In this view I buy shares because I know others expect prices to rise. Evidently, given the importance of the housing boom, built on just such calculations, this is is not an idea to be dismissed. It's a pity, in Soros's book, that the space is filled out with the tales of what trades he did at particular times. I personally lost interest very rapidly.


Image: Gillian Tett, banker's shadow

Certainly these books have in common that ideas about markets, fostered of course by economics, had some role in the regulatory changes that preceded the crunch. There was a general relaxation of regulations: light touch in the UK with, in the USA, the repeal of the Glass-Steagall Act (i.e. that no bank holding peoples' savings could engage in speculative activity) brought in after the 1929 crash and the consequent Great Depression, to be replaced by the 1999 Gramm-Leach-Bliley Act and in 2000, the Commodity Futures Moderation Act that took so many of the derivative products outside gaming legislation. These changes appear to have put in place a situation allowing ‘unrestrained greed'. Financial institutions, such as investment banks, were able to extend their activities into new areas, producing new products, derivatives, in search of profit without regulatory interference. In 2007, world GDP was $65 trillion, the total value of companies $63 trillion and the total value of derivative investments was $596 trillion, while the total of currency traded was $1,168trillion. Indeed only in the last 20 years has the financial economy got larger than the real. Within that there was the rise, enabled by the new derivatives, of subprime loans going from $80 billion in 2000 to $800 billion by 2005. These figures are mind boggling and we may conclude that this incredible expansion was the result of short term thinking and careless risk taking by agents swayed by their own bonus structures. We are reminded constantly that the bonus culture was at fault in encouraging bad risk taking. Apparently, a bonus culture of short run incentives misaligned individual actions and the longer term good of their companies, at the cost of the economy as a whole. Furthermore, we need only a slight left tending disposition to believe that all this financial stuff is basically fantasy anyway; it's not just that they don't make anything but there are doubts about what kind of service may be provided.

For detail, Gillian Tett's book is a good place to start. As a financial journalist for the FT, and, perhaps of relevance, a trained anthropologist, she follows the team, run initially by British banker Peter Hancock, at investment bankers J.P.Morgan. They were central to the development of the new world of derivatives. We see the financial bods in close up, but things are not quite as expected. Certainly we come across the investment banker who is an ambitious ‘adrenaline junkie' and another, a mathematician, who rides a Harley Davidson, yet both are women. Perhaps not too much is to be made of that. More important though they were part of a team that identified itself as such, generating a real esprit, a point Tett emphasises using a novelistic style at times. They not only enjoyed what they were doing but really believed in it. Of course a key element of the team's enthusiasm was a belief in the effectiveness of free markets. They saw no system on its last legs, but rather were evangelising on behalf of the new market system. They believed that through market products, properly designed, risk could be adequately dealt with. This was not some short run bonus related exercise. Indeed, ironically, the talk of regulatory reform of bonuses would if successful produce just the kind of culture that characterised the derivatives team at JP Morgan. They were involved in innovative research, seeking to create useful products, playing an important role in the development of the Credit Default Swap (CDS) trade. The team were encouraged into such trades because it fitted in with the long term aims of a bank that saw a drawn out decline without innovation of some kind. They weren't paid especially highly - well, compared to their peers anyway. Indeed as they became successful they even turned down predatory high offers from other firms to stay in the team. And what they did, what motivated them, was the transformation of risk. They believed their products could manage risk. If I have liabilities involving some level of risk, but want to reduce my exposure, while you want some product giving you a reasonable fixed income return, I can sell the income bearing risk to you. We needn't sell the underlying asset itself we just do a credit default swap (CDS). I pay you to cover potential default. From initially arranging a deal between appropriate counter parties, who of course need to be located, we eventually devise products that are more readily marketable without having to hunt out appropriate counter parties. Then we have a market in risk. That anyway was the idea.

 Tett tells us how this came about. The aim at Morgan was to devise instruments to deal with debt through the credit default swaps that would free the bank's books of loans (risk) so allow more use of cash for lending. In fact these plans met resistance in Morgan's own organisation from loan officers who saw using CDS as depersonalising the loan book, undermining client relationships. What transformed the internal arguments was the July 1997 Asian Crisis from which the bank suffered large losses. The new CEO, Douglas ‘Sandy' Warner, needed to improve the bank's profits and so backed derivatives. This gave an impetus to the industrializing of CDS, that is to say standardizing them in a way they could more readily be traded, somewhat like stocks. Given that the CDS involved loans, this was a problem since loans were something that had to be assessed; this would be the same if it was a loan being sold on. This kind of assessment would impose costs on the market, slow it down and prevent its industrialization. One solution was to pool risks, rather than swapping one loan at a time, so that different loans were securitized together into a single package. This overcame the need for individual loan scrutiny since with the pooling of loans the law of large numbers comes into play, this was crucial to any kind of insurance scheme. Of course particular loans could default, but over a large number we know, and make sure we know, that the rate of default is, say, 10 percent. We take this into account in devising and then selling (buying) the product, so that within the overall package the defaults are covered by the returns on other loans. Now the customer bank does not need to scrutinise every loan, since it has a model explaining the management of risk within the product itself. We don't know which particular loan will default but we do know that out of a large enough number random variation was ruled out as a determinant of the outcome, and so the overall percentage would be generally consistent. So long as the individual events have independent variety then large numbers remove the costs of judgement while also homogenising the decision processes of banks and other financial institutions.

 This takes us on the track of the industrialisation of CDS. However, there were some problems. One of the points of removing risk from a bank's books was to allow an accompanying reduction in requirement of capital reserves. It freed capital for further lending. In 1996 the Federal Reserve had warned that reduction in reserves would only be possible if risk was truly removed.2 This was something the Morgan team obviously needed to overcome, by a combination of lobbying regulators and devising the products that could persuade regulators to shift their ground. Securitization went some of the way. In addition the security could be taken off the balance sheet into special purpose vehicles (SPV), i.e. separate companies. Morgan paid fees to the SPV while the SPV paid Morgan for any defaults. This SPV could then divide it into differently risk-rated tranches for sale. Now, given the overall risk, the SPV needed to have some cover, funding, for the possible defaults. This could be raised by selling on the tranches of debt. The funding would not need to cover the entire debt since, after all, that was the point, we know for a large number the approximate percentage of defaults. To fund a $10 billion security, Morgan sold off $700 million, taking the debt off their books, so they hoped, for a fraction of its worth. What this left of course was a rump of debt held by the SPV. This was what they would call super-senior debt of low return but low risk. Ultimately if the $700 million was eaten up by defaults Morgan was then liable for the rest of the sum up to $10 billion. But the chances of this were negligible to nothing since it implied the kind of massive defaults that would make any kind of business proposition just look impossible. It was, though, still a worry for regulators that this was uncovered unfunded risk. However, this remaining rump of security was of such low risk return that it was also difficult to sell off the books entirely. Eventually they hit on a solution: insure it. This is where AIG come into the story. A nice bit of virtually risk free business for AIG. They thought. AIG was eventually bailed out for an initial value of $85 billion.

In the end, even without the insurance solution, regulators came round to the Morgan way of thinking and said that reserves could indeed be cut so long as the super-senior risk was rated AAA. This allowed Morgan to develop the business, keeping the rump of super-senior risk on their books without consequence for their capital reserves. These ideas enabled the enormous expansion of what would be called Collateralized Debt Obligations (CDOs). Here we have the basis for originate and distribute banking - what others might call the off-balance-sheet scam. It enabled Morgan, and then of course all banks, to avoid the Basel banking controls on capital adequacy. Even so, within Morgan, they began to worry. As they sold more to clients, the pile left over, the super-senior rump, was just getting bigger. It was already $100 billion for Morgan in 1999. Of course there was negligible risk, but this was still an enormous sum and not only was the market still short of its major expansion, but this was also prior to the major use of derivatives in the selling of mortgages. At Morgan they knew that super-senior risk had, after all, only been modelled. They knew models were not a replacement for judgement, and they knew also that there was a particular problem that was not so easy to model, the correlation of defaults, a problem that could have a very serious impact on the super-senior risk. The normal risk of default was calculated on the assumption of the events having independent variety. Supposing that in fact this assumption did not hold, that defaults were correlated and, if they were, by how much? As Tett explains this, we can work out the risk of an apple rotting but the matter is different once we have a whole load of apples together, then correlation comes in. This was a problem for everyone issuing these derivatives and for anyone with super-senior risk, who was thinking about it seriously, it was sweat inducing. Then, in 2000, a researcher at Morgan produced a model for working out correlation: the Gaussian copula model. It caught on immediately and as Tett reports became the ‘combustion engine of the CDO world.'

With correlation covered, the market could now expand even quicker. Players tended to homogeneity through the use of such models. And what a wonder to behold: everyone was using the same model of correlated risk and acting on it. There's an irony there - it produced a new level of correlated risk. Brilliant. As the inventor said of his model, ‘The most dangerous part is when people believe everything coming out of it.'3 We can ask why people in the market believed, and undoubtedly once we've got past the obvious, but not very fruitful, point that profits were there to be made, we have the widespread belief that markets could solve problems of risk, that appropriate products could be devised. The converted just needed what they believed laid out for them. There is a vicious circle at work here, one that fits somewhat Soros's undeveloped theory of reflexivity, since here the way we understand the market forms our behaviour that is of course part of the market.

Image: Philip Augar, right, thinks cushiness is ok for writers not for bankers

In a sense Tett's book could be seen as a subtle defence of the financial system since part of the drama we see developing is accompanied by scepticism from Morgan and straight warnings from others, about the consequences of what was happening. The focus, in Tett's book, on what JP Morgan did or didn't do gives us a perspective on how others in the markets behaved differently so driving the bubble on to the eventual credit crunch. Seen in comparison with Morgan there is a clearer idea of a real stupidity at the heart of the crisis. JP Morgan, after a brief toe in the water of mortgage backed securities, withdrew from the market since for mortgages there was a lack of proper runs of data on defaults, and, as with corporate loans, no understanding of correlation. Even so, once this market boomed they felt they could be losing out - so reconsidered, only to discover that by their evaluation it wasn't possible to make profit in the market. Alan Winters at Morgan remained baffled by how banks were making money. The people at Morgan were not alone in having worries: for example, economists at the Bank for International Settlements had also warned about the new derivatives world. It is quite wrong to say the crisis was not anticipated; it was, both by theorists who understood that risk was not properly modelled and by practitioners who knew you could never drop judgement. There was a significant, though somewhat marginalised, concern around financial markets. Indeed, one Morgan banker, Andrew Feldstein, left Morgan to set up a hedge fund convinced that banks had miscalculated correlated risk, and so believed that the true risk of CDOs would eventually become clear. As he put it, echoing comments throughout the Morgan story, ‘The models are great, but at the end of the day, in credit, anyone relying on them will lose,' and he added, ‘Those who are successful know this, and overlay their own idiosyncratic views about risk, actual correlation among and between groups of credits and other factors on any model they use.'4 His hedge fund was going to make money out of the fact that idiosyncratic views, lumpy judgement, had been gradually erased, homogenised by economic modelling, from the market.

So people knew something was wrong even if nobody could be sure of the scale of what was to come. Given this, we are posed a real problem: why did the crisis occur? While it is not difficult from Tett's book to construct a tale of error, this would not explain how it could be perpetrated on such a scale and also across so many parts of the financial industry. Both Paul Mason's book and indeed George Soros's have some context for this. Soros's, of course, is right to point to the phenomenon of bubbles, and how they reflect a real aspect of the market reflexivity, i.e. we do not simply understand a market, we also change it because we are part of it. We can see this as a driving force of market bubbles. They're going up so we join in so they go up. What we need here is some understanding of what economist Robert J. Shiller calls ‘new era' stories. Every bubble is associated with its own stories. The dotcom bubble recognised the new economy. After that burst the new era stories started around the objective basis for house price rises. These new era stories can be taken wider than Shiller offers us. We can grasp this by approaching from the issue of regulation, which has become a major talking point in the aftermath of the credit crunch. All these books recognise that there was excess and so think that through some kind of control, stricter regulation, that the system will be able to operate more smoothly, avoiding the bubble that proceeds the crash. This incidentally is in accord with the views of Hyman P. Minsky whose analysis has certainly gained credibility with the onset of crisis.

But here we have a problem, and indeed it's partially recognised by Mason, Tett, and Augar. There already was regulation. Regulation did not fail; it was repealed. Mason argues that if a start to the credit crunch needed to be pinpointed then it would be the repeal of Glass-Steagall. He makes a limited point: the repeal of regulation was just an episode in the building of the bubble. The gradual removing of regulation was part of the broader new era story in which the bubble was produced. A regulation that would genuinely have to fail to avoid the next bubble would be one that says ‘regulation that prevents the bubble should not be changed'. Of course this can't be done. The next bubble when it comes will also repeal legislation or be founded on financial products that evaded the regulation.

In this instance we see that financial players in the USA actively lobbied for regulation to be changed because of the pressure of dealing with low profits. Regulation hindered their activities. The decisive argument revolved around the new methods and products they had created for dealing with risk. These products managed risk and therefore reduced the need for regulation. Such an argument may have held little sway if it had not been for the environment into which they put their arguments. They were catching the tide of Paul Mason's ‘market fundamentalism.' We could make a case here that the credit crunch was born at the fall of the Berlin Wall, indeed, before that, with the triumph of free market positions in Thatcher and Reagan. There was a ready predisposition to treat arguments for light regulation sympathetically. Market fundamentalism was a central element of the new era story. Alan Greenspan was, after all, as Mason points out, a committed disciple of the free market ideologue Ayn Rand. Markets could deliver. Here then was a promise to deliver risk as a product, so creating a robust market system able to withstand shocks. The people making the products were themselves keen advocates of market solutions and the regulators they organised to lobby were to a great degree themselves already converts to the cause. Both regulators and regulated shared the faith, especially in the UK and USA. Evidently, this prepared the way for the new products and provided the common ground that made lobbying regulators plausible, leading eventually to the agreement of regulators to relax the rules.

Mason points to the development of computer technology that enabled not just the new products, but also new models of evaluation. It was possible to create models for modelling risk. In Morgan they picked up and developed a technique for evaluating value at risk, or VaR, for judging what a bank could lose, given different downturn scenarios. As Mason points out if systemic crash were included, the model would produce a stifling timidity so it was excluded. The possibility then is that the model simply allowed an automated approach to risk, that is to say not only devoid of judgement, but also one that tended to homogenise agents in the financial world who would all use the same or very similar models. An aspect of this homogenisation was that it changed how people viewed the relation of markets and regulation. VaR offered bankers clear measures of what was at risk should the market turn. As Tett points out VaR enabled the industry to present a case that it had a credible internal code, reducing the need for bureaucratic interference.5 Indeed the report on derivatives commissioned by the G30, and lead by JP Morgan, had included in its recommendations that VaR be used by all bankers. Despite some setbacks in the derivatives world, in the early 1990s, it was self-policing, for which models such as VaR were crucial, that won the day.

Image: George Soros. 'Why must I be surrounded by fricken idiots?!?'

So every bubble needs its new era stories because it is through such stories that the market becomes sufficiently homogenised for the market to take off. The more technical new era stories need a wider culture, the broad new era story, in which they are understood and taken up enthusiastically. That culture was market fundamentalism, even market triumphalism. It was general. As Mason points out, Clinton's treasury secretary Richard Rubin who relaxed the rules of Glass-Steagall was already negotiating his future job with Citigroup. And why not? This was not a corruption of market fundamentalism but its application. Philip Augar points also to the connections of the ‘Iron Triangle between military suppliers, finance and government' and at the interchange of people between the private sector and regulation, and indeed government. There was something like an irresistible force at work here. Of course there were regulators who saw the matter with a great deal more caution, just as there were those in the banks also who worried about what was happening. The point though, here, is that the generalisation of error depended on market fundamentalism. The error we see was not a mistake, it was a collective triumph, established in the 80s. Politically this would be translated eventually as the neocon doctrine in the Republican party, resulting in the invasion of Iraq.

Of course there were people who recognised there was a bubble but this now takes us to another point about the new era stories. They acquire their own objectivity. It becomes rational to act in accordance with them. If stocks or house prices are rising then just how silly are you to be superior to all this? This was the beauty contest point Keynes made about stock exchanges: you have to second guess what other people think so that those with real knowledge simply don't have the resources to outlast the market, unless of course they can predict the actual moment of downturn, a quite different matter from saying there will be one. Rationality then becomes a matter of jumping on board, but being ready to leap off. The problem is that when everyone leaps off you have the crash you're all avoiding. The same point applies to the banks in this crisis. Imagine, if you will, running a bank and you see other banks freed from capital adequacy controls grabbing market share. Do you just feel superior? How do you explain this to your shareholders, for example, or even to your best staff who see others doing better? For any market participant if you haven't got your feet under the table you're not eating. Of course there were hedge funds who played against the market but they had to be not just exceptions but very good, or lucky, at timing. While some stood out there were real difficulties with such an approach. Augar asks whether it was feasible for the leader of HBOS, Andy Hornby, recruited from Asda, to have questioned the new funding model of British banks that saw them change from funding from deposits to borrowing massively on the money markets. This market funded lending had risen from nothing in 2000 to over £500 billion in 2007! An extraordinary change, but could the boss of HBOS tell his shareholders that he would forgo the market opportunities in consumer lending and mortgages? One has to agree with Augar that the options of escape from the culture were limited. As Augar reports, Chuck Prince of Citigroup, told the Financial Times in July 2007, ‘When the music stops in terms of liquidity, things will be complicated. But as long as the music is playing, you've go to get up and dance. We're still dancing.' That's the point about bubbles there is no rational alternative for the market as a whole, there is no normal. Again, you're either at the table or you're not eating. Augar tells the story of Tony Dye, chief investment officer of the pension fund PDFM, who during the previous dotcom bubble warned of the ridiculous over valuations. Eventually he was sacked - just two weeks before the crash. Of course individuals can dissent, indeed some can make money on it, but in the main there is an intrinsic logic. JP Morgan, after all, in stepping back somewhat from the new activities ended up being merged and, as we've seen, tried to work out a way of getting back into the new market. What helped to make this such an epic bubble was market fundamentalism, blazing a path of universal truth, homogenizing the behaviour necessary for the bubble and leaving its critics marginalized.

Did someone say low profits? Banks looked to reduce regulation in the pursuit of profit. Here was the impulse to new era stories, indeed perhaps not just sufficient cause, but necessary cause. There was a hunt on for returns. Now this takes our view further back from the detailed action. We can see the new era stories in a wider context, and how far back should we stand? Soros sees the last bubble as being part of a superbubble starting in the 80s. Augar has documented in his books the change in the nature of financial institutions that came before New Labour but was ultimately praised by them, especially by Gordon Brown who could hardly overturn the free market consensus. Augar's book examines, in turn, the various elements that made up the financial industries and we see then an overall picture of how the combination of free market forces and the elevation of shareholder value overwhelmed other interests. One example was the private equity firms that started to provide venture capital, but ended up becoming agents of highly debt financed, leveraged, buyouts - hence effectively producing a kind of free market industrial policy. An indicative change could be seen also in the new hedge funds that looked to overturn a culture that had accepted returns that went along with the market in favour of what was called absolute returns. This aggression with a preparedness to use leverage, debt, was crucial to the practice of market fundamentalism and incidentally to the reinvention of the city under New Labour from 1997 onwards. Augar shows that the financial industry went through a significant cultural change, as what seemed like staid methods and approaches were replaced by more aggressive approaches, all justified by the belief in free markets. It was essential that this belief came with the idea that acting for yourself without need for consideration of others would benefit society. Augar, then, is documenting what seems like a moral decline. It should more properly be understood as a moral transformation. The question in any human situation is not whether there is a lack of morality but rather what kind of morality is in place. The moral atmosphere of the new financial world obviously arose from the same market fundamentalism that was so important to the formation of the bubble. For the City this meant the ‘Big Bang', brokered for the Thatcher government by Cecil Parkinson, and bringing to an end the city of the old school tie.

So we find a common theme here that the roots of the credit crunch can be found in the changes that started in the 1970s and that were consolidated in the 80s. For this wider context we do get some clues from Paul Mason's book. He stresses the world imbalances that were an essential aspect of the crunch. He describes globalisation as a process based on structural disharmony in four key areas: saving, investment, trade and government debt, and for each of these areas there was a mirror image in Asia, the root of this being the 1997 Asian Crisis. Debt in the USA was covered by credit in Asia, the trade surplus in Asia and increasingly China was a trade deficit in the USA. We get a sharp picture of these deficits when we consider that the subprime mortgage market was especially strong in Detroit where defaults and repossessions would soar to start off the credit crunch. Of course Detroit was also Motor City, the home of the world's dominant auto industry and home to the 1960s and 1970s factory struggles of auto workers, linking them to Turin, Coventry etc. But it was such cities that were part of the decline.

We see here then some possibility of understanding the relation of the earlier struggles of worker militancy to the later sub-prime world of rising low paid service jobs, chasing standard of living through debt from easy credit, made readily available by funds arising from the surpluses that came from making the stuff that they weren't making anymore in the USA. Detroit epitomises all this. This of course was globalisation. Mason wants to add to the imbalances on the negative side, before he deals with the positives, what he refers to as the spreading commoditisation of life. With that, he says, came rising personal, financial insecurity and crime; he looks to Robert Putnam's modern classic Bowling Alone to substantiate his view of the general decline in community that accompanied commoditisation. On the latter point, though, a story goes missing: voluntary organisations have usually accompanied markets. There have been trustee savings banks, friendly societies, trade unions, co-operatives, as well philanthropic provision of housing and also such moral guardians as the Charity Organisation Society. Victorian England was full of such organisations, and prior to the decline that developed toward the end of the 1970s, they could also be seen in America. We should be aware that what went into decline was usually based around working class organisation. The decline Mason points can be seen in America in what is called the rust belt, the destruction of key industrial areas. The movement of production abroad shows clearly just how limited the views of the 70s and 80s left were; it also showed that there were opportunities for many who had previously been left behind in the rest of the world.


Image: Paul Mason, failing to get a high five on Newsnight

Whatever one might think there are indeed positives here, even though the trick in new production has not exactly been rising productivity, nor even cheaper costs but rather, similar to the banks' liabilities, the movement of costs off-balance-sheet. In other words, health care, welfare costs, environmental costs etc. are paid for in terms of real suffering; it is not cheaper, but a matter of how the balance sheet is worked out. Costs don't just go away they get transformed. Now of course we'd be right to emphasise these off-balance-sheet costs, but we need some caution. Too many anti-globalisation bods would have us living in caves subjected to their own peculiar preferences. Mason is right to point to the fact that there has been real development in countries where it had previously not appeared. More people have had access to wages, even if that also means, necessarily, that the choice once they are kicked off the common land is wages or nothing. It was only recently that urban dwellers reached 50 percent of the world population, some 3 billion people - incidentally, also as Mason points out, the same figure of the world's workforce, doubled since 1979. He suggests we may be stunned to hear that some 3.5 billion now have mobile phones, a mixed blessing for grumps like myself, but crucial to countries without developed infrastructure.

So we should not be too ready to knock the development that went with the imbalances. As Mason says, the positive flip side of commoditisation was the ‘decline of dependency and paternalism in social life.'6 Actually in terms of human development this is something more than a flip side. There is a real demand for wages. Indeed, this provides occasion for struggle in places such as China and these struggles will tend to include the transfer of costs that allowed the development. However, one could ask what this implies about the situation in the USA as key industries were destroyed? We know there has been something of a shift to the south and also a growth of service jobs, but, also, as the growth of consumer debt shows this was no happy development. There was a cultural change, one observed by Shiller, and one that points to the deeper problems that have to be considered: there was a change from the idea of consumer to that of the canny speculator, whether on stocks (dotcom) or house prices. Yet what we have now is more complicated than this because that consumer was originally the independent wage labourer, just the fellow we now find in Asia, dutifully saving, in the absence of welfare, funds that are dispersed to the USA to keep up the debt ridden standard of living that is fostered by financial institutions looking for profit in the absence of traditional productive opportunities. Mason is right to point to imbalances, but they are deeper than he suggests. In the USA in the early 1970s the average wage of CEOs was about 11 times average earnings, now it is about 450 times average earnings, indeed inequality has risen greatly since the 1970s under the ideological blessing of market fundamentalism.

The ideological problems of market fundamentalism can be seen in the actions of Alan Greenspan. He couldn't be closer, as we've seen, to the heart of that market fundamentalism that swept through the USA and of course the UK. Yet as head of the Federal Reserve he had actively kept interest rates low in response to market crashes starting with 1987 and through to the dotcom crash and 9/11. This was the ‘Greenspan put,' protecting the market against price falls, it created a monstrosity: market fundamentalism that saw no downside, a market without bankruptcy - so confidence in markets was backed by intervention. This also meant, and especially from 2000, low priced capital. There had already been a flood of capital into the new economy, but when that crashed with low interest rates there was plenty of liquidity looking for return, and, of course, after the 1997 Asian Crisis, funds were still looking for returns in the USA. It's easy to report that this would eventually move into the housing bubble, but this in itself poses a problem as to why capital did not move into productive investments. Mason's view was that ‘If we step away from the statistics and ask what the imbalances tell us, it is this: that a huge proportion of capital in the world cannot be invested profitably in production.' The result, as funds went into the finance system, was ‘the tendency for capital to flow frantically into one asset bubble after another, with the finance system as the conduit. So the global imbalances and the repeated financial bubbles are two sides of the same coin.'7 Here we see in the broader context the hunt for returns that had motivated financial institutions and how ironic it is that as they chased these returns they were selling subprime mortgages in Detroit where, once, there had been serious investment in the employment of labour. Indeed we should ask why Greenspan persisted with low interest rates thus producing the bubbles when he might have preferred, from a free market view, to let the market takes its course, redundancies or not. But this takes us back to the 70s and 80s when behind the fight against inflation lay the need to deal with the working class. However, what Greenspan was about, despite his rhetoric, was not inflation but deflation, or, rather, fear of deflation that would lock the economy into a new depression and the difficulties of confronting the social consequences in the USA. That would pose a different political problem, one that points to a real dilemma underlying the global imbalances and the tendency to bubbles. For some grasp on this, we could return to that cultural development in the USA: from worker to consumer to clever speculator and object of financial marketing. Only from the point of view of a triumphalist market fundamentalism could this look like anything other than a cultural decline at the heart of the capitalist system, a cultural decline that is likely to be accompanied by tendencies to polarization.

These books all give us useful insights, although with Soros, this is more of a promise to be cashed in at some future event. In the rest we get an increasingly wide scope from Tett, to Augar to Mason. What they all have in common, though, is a belief that some kind of new regulation could be put in place so that some kind of new period of growth can start. The problem is that any solution will be the basis of the next problem. There must be some real basis for reconfiguration of the global imbalances from which the financial bubbles have arisen, but these imbalances are not mere technical problems. They arise from the crisis of the social system in the 1970s. The American ‘rust belt' shows what price capitalism is prepared to pay to disorganise a working class, but the sub prime crisis shows that the solution is just the next problem waiting to happen. The opportunity of China is the opportunity to develop a new working class, except that it depended on off-balance-sheet costs that ruled out consumption and so that takes us back to the USA as the major source of consumption. The system will certainly develop through these various strangulations, it will indeed transform some of them but it isn't about to get out of them. If there is to be a Chinese consumer it would require massive increases in productivity and so increases in education and freedom and so a ‘Chinese dream.' There is absolutely no reason to suppose that even if this can be achieved that it won't simply end up, with some variation, at just the same impasse of the 1970s, minus, though, the option of escaping a western working class by going east. Globalisation is producing what it escapes from. To the east of east is square one.

William Dixon <w.dixon AT> researches the nature of economics, especially in relation to morality, political considerations and the development of society


Gillian Tett, Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe, New York: Little Brown, 2009.

Philip Augar, Chasing Alpha: How Unchecked Growth and Reckless Ambition Ruined the City's Golden Decade, New York: Bodley Head, 2009.

Paul Mason, Meltdown: The End of the Age of Greed, London: Verso, 2009.

George Soros, The Crash of 2008 and What it Means: The New Paradigm for Financial Markets, New York: Public Affairs, 2008.


1For a brief explanation of Keynes' beauty contest, see, ‘All Mouth, No History',

2Gillian Tett, Fool's Gold, New York: Little Brown, 2009. P. 70

3Ibid., 122.

4Ibid., 155.

5Ibid., 39.

6Paul Mason, Meltdown: The End of the Age of Greed, London: Verso, 2009. P. 130.

7Ibid., 70.