Excellent, outstanding post.

My argument is that if we just dust ourselves down and carry on, we’ll have learned nothing and we’ll be back here again eventually.

Much of the problem was a failure of government to identify the risk and take action.

The people who could have averted disaster were too stupid, too venal or too wedded to the thrill of being in with the in-crowd to listen and take the necessary steps.

You don’t mean intellectual titan G Brown?!

You are of course right – while no-one forecast the exact scale of the disaster plenty of people in the City and on Wall Street were warning that things were getting very dangerous at the time when Greenspan was trying to reflate the bubble from 2001 onwards.

“

There was a small band of liberal journalists in Britain that registered the risks that the British and the Americans were taking and remained loyal to social democracy and common sense.

”

But nearly all of them were acting based on political wish-fulfilment, not on reasoned analysis of the risks in the system. Warburton may be an exception, I’m not familiar with his work.

A good indicator of whether a doomsayer is serious is whether they predicted the crises in Germany and Japan (now officially worse than the UK/US crisis), or whether they viewed Germany and Japan as Sensible People Doing The Right Sort Of Stuff Unlike Those Wicked Bankers In London And Wall Street, Who’ll Laugh When We Collapse.

Nearly all of the liberal writers who ‘registered the risks the British and the Americans were taking’ went for the latter.

john b – I know you want to excuse Brown et al. but that’s rather like criticising someone who warned you about driving too fast for not detailing how many people you would hurt when you crashed

Albert Edwards (ex Dresdner now Soc Gen research) was the highest profile London based strategist who was warning early…and about the consequences for Japan, China etc.

Correct in general; but the people who saw it coming – nobody saw exactly when and how it would come – included a fair number of conservative jounalists (who might appeal more to New Labour types) and some solid professional economists.

Who the hell is talking about shrugging and moving on?

You might be able to find some people arguing something like all we need to do is get ourselves back on our feet and carry on, but almost everybody I read/listen to – newspaper columnists, mainstream economists, politicians, is talking about deep systematic reform.

Here is a debate on reform between very mainstream economists at VoxEu. One of my favorite economists is Raghuram Rajan who in 2005 stood up and told Alan Greenspan that the financial system was making the world riskier (there is ungated sample of his work here – you can see the speech in 2005 I refer to in the bibliography)

Markus Brunnermeier from Princeton has written a pretty good diagnosis paper, and has presentation on ideas for reform “new financial architecture” here.

Also, I think if you read any of this stuff, you might come to the view that reducing what went wrong to “too much debt” is pretty inadequate.

cjcjc:

john b – I know you want to excuse Brown et al. but that’s rather like criticising someone who warned you about driving too fast for not detailing how many people you would hurt when you crashed

Or: this is like someone who turns a reliable vehicle into a souped-up deathtrap, hands it on to a new owner, and then blames him when it crashes simply because he was behind the wheel at the time and he thought he could drive it just as fast (if not faster) than the previous owner.

Yes, the crash happened on Brown’s watch – but the fact that the Conservatives built the model than he so uncritically accepted doesn’t get them off the hook. It may also explain why the response of the right (in the US as well as the UK) has been not much more than ‘leave it to the market’.

I think the crash happened because a perfectly servicable vehicle was left in the hands of a moron too busy reading his text messages to spot another vehicle ahead.

Oops, sorry – wrong thread…!

Plenty of people predicted the crash. However in the midst of the feelgood factor generated by an unsustainable credit boom nobody wanted to point out the dangers. Gordon Brown certainly didn’t since he was relying on remittances from the City to partly pay for the expansion in public spending. The mirage of growth, wealth and low unemployment was a central element in the repeated re-election of New Labour. It was the main plank of the 2005 campaign.

When the party is in full swing, with the booze and charlie flowing liberally and the music cranked up to 11, who is going to want to make themselves unpopular by pointing out that everyone is going to feel dreadful tomorrow?

As for the arguments about Japan and Germany these are misplaced. They are contracting because they are export-led economies and the demand from the rest of the world for their high value products is falling rapidly.

However – and this is the key issue – they will come out of the slump much faster and in a much better condition than we will. They will be able too export their way out of trouble eventually. People will want to buy mercedes and toyotas.

Does anybody really think that there is going to a market for structured investment vehicles or any of the other financial services the City specialised in? Does anybody think we will see a return to mortgages of six times annual salary in order to pump up the hosing market again?

The British economy has a fundamental structural. It has a hole where hi-tech manufacuring should be. This was masked by a credit boom but will become ever more apparent in the coming years.

“Does anybody really think that there is going to a market for structured investment vehicles or any of the other financial services the City specialised in?”

umm, perhaps you need to narrow your question a little, because yes there will certainly be a market for, say, debt securitization, credit insurance, and so on. It just needs to work differently.

Ok let me rephrase that.

Do you think that the level of revenue generated by the City in areas such as investment banking will return to something approaching what it was it was in the period 2001-2007?

bubby,

I hope not – I think not – and everybody else seems to be thinking not too …. but it might turn out the system is harder to change than we think.

I’m with john b on this too, partly. Though Dan’s article is fine as it is.

The Japanese and Germans – with strong manufacturing bases, less crazy lending and lots more saving and investment – are also screwed. In many ways they are more in trouble than we are.

Which says that a lot of blaming of Gordon Brown – that he should have done things differently (how, exactly?) is somewhat misplaced. If the financial markets predicted this more precisely, let alone the politicians, we wouldn’t be in this mess.

@8: OT, but the court found Ahmed’s reading of text messages had no impact at all on the crash, which was why his sentence was only 12 weeks instead of several years.

@9: selling real things for imaginary money is arguably even more stupid than making the imaginary money in the first place. Anyway, BMWs aren’t high-tech, they’re 19th century tech; we’re way ahead of the Germans at designing computer software and hardware…

@ 11: the City’s share of the world financial system will remain at 2002-ish levels, although financial services as a % of world GDP will fall back a couple of points

I can’t help thinking that Sunny and John B’s sense of tribal identification with Labour is blurring their judgement.

How much of the British economy is propped up by software/hardware sales? Its incredibly small. Much, much smaller than pharmaceutiles or arms which are our key industrial sectors. Almost insignificant compared to the German or Japanese car industry.

Does anybody really believe the long term future of the British economy is as robust as a manufacturing powerhouse such as Germany?

yes – or at least, I see no reason to believe that manufacturing is a better long term bet than anything else, and it’s possible the UK’s mix of activity will fare better long term. However, there are many other differences between UK & Germany than just manufacturing / services mix. But the real point is that wherever you stand, you ought not have much confidence in predictions about the long-term relative performance of the two economies

Well we will have to disagree on that Luis. I hope you are right and I am wrong but I fear that this is not the case.

I would also point out that many people suspect that hi-tech ‘green industries’ will be a significant growth sector in the forseeable future. No prizes for guessing which countries lead the world in that area.

I don’t doubt that the Tories would have done much different – though they opposed the tripartite system which was apparently forced through over Eddie George’s dead body, as it were – but alas for you, G Brown was in charge as the bubble was inflated and did nothing. He didn’t even realise what was happening. He gave Alan Greenspan a f*cking knighthood for goodness sake.

Jap and German manufacturing is pretty much the innocent victim in all this.

Sorry, I mean *wouldn’t* have done much different…

Re. Luis Enrique’s comments

The crisis we face now is not a liquidity crisis, it is a solvency crisis caused by profligate lending against assets that are now declining in value. You might think it is inadequate to blame the crisis on excessive debt. But excessive debt caused the crisis, so what can I say?

Most mainstream economists (and journalists and politicians) are offering solutions that do not address the core tendency of capitalist economies to succumb to speculative mania. This seems inadequate to me, because it is.

But is there anything so wrong with “mania” – Keynes’s animal spirits?

http://www.slate.com/id/2165929/

What is the alternative? The dead hand of state direction? We know how that works out.

Quite right Dan.

The banks are insolvent and the market knows it. The liquidity crisis flows from this. On top of this the assets that the banks hold are falling in value every day. We are in a spiral. Banks are insolvent and can’t lend at a sensible level. This, amongst other things, leads to a fall in the housing market leading to the assets that the banks are holding being worth even less.

We are in a very, very serious situation.

The taxpayer is already on the hook for over a trillion quid.

That’s before we even take into account the market in derivatives. Barclays alone holds derivatives that have a face value of £29 trillion. No doubt they will say that these are all hedged but considering their financial prudence in other matters do you feel that confident? If only a small proportion of those go bad the consequences are unimaginable.

It is difficult to avoid the conclusion that Gordon Brown has been the worst and most reckless Chancellor in British political history.

Re. cjcjc

I would say -

animal spirits = good, broadly speaking (and inevitable)
mania = bad (and avoidable)

That would commit me to the view that they aren’t the same thing. I think that Keynes is with me on that, and if he isn’t, then he’s wrong.

The alternative to a crisis-prone system doesn’t have to be characterised by central planning. Reform of the economy at the level of the enterprise would reduce speculative opportunities without leading to state domination of investment decisions.

I talk a little more about possible reforms in the Verso article -

http://www.versobooks.com/books/ghij/h-titles/hind_d_threat_reason.shtml

I listened to an interesting Austrian approach to the crisis this week. Essentially, flood the economy with cash until the banks are safe. Then introduce 100% capital reserve requirements for ordinary banks so that they can no longer retain only a fraction of their accounts (if people want to gamble with fractional reserves, that is fine but they have to choose to do it explicitly). Of course, by then our currency might have value closer to the old Franc or the Italian Lira but at least it would be sound from then on!

This is very neat: “You might think it is inadequate to blame the crisis on excessive debt. But excessive debt caused the crisis, so what can I say?” I was about to observe that you seem to be in possession of a much simpler and more confident picture of the crisis than I do … then I had a look at your link, and boy is that true. You know all about the “great machinery of deception in which we live, and which now threatens to destroy our civilization”. I enjoyed Jump You Fuckers. Visionary. There’s no point in trying to interfere with a vision as clear as that. Hello employee ownership, goodbye excessive borrowing!

After every disaster, you can find some people who predicted disaster. But then, after every triumph, you can find some people who predicted disaster.

Often the same people.

Luis,

Isn’t that what they call an ad hominem argument?

I may give silly titles to articles, the blurb of my book may be a little overwrought, but the crisis has still come about because of a speculative bubble in asset values caused by reckless and excessive lending.

Now, by all means explain to me why I have got it wrong, and why everything is much more complicated than I am making out. But you can’t dismiss my central claim just because you think I am a jerk.

Well, you can. But it isn’t exactly a knock-down argument.

Dan,

well, not quite ad hominem, but perhaps partially about form rather than just content. I’ve no beef with the title, by the way, it’s more the grand narrative that explains everything I don’t like. And I’ve about as much chance of persuading you to change your mind as I have persuading Naomi Klein she’s got it all wrong (and I see your ideas as of a similar nature to hers). Heck, I could be wrong – big complicated looking problems don’t necessarily have complicated explanations, and it could be your grand debt story is what it boils down to. If you were inclined to read some of the things I linked to, you could see some of the reasons why I don’t think excessive lending per se is a very satisfactory explanation and rather than try to persuade you myself, I’ll leave you to read them, and perhaps referencing some links in this comments thread too. But here’s where you & I differ – I think its necessary to read economists, you prefer Larry Elliot (again, maybe you’re right, the economists are dupes, and I’m wrong). Obviously we had a housing bubble, obviously the banks worked out ways of making piles of money for themselves in a fashion that brought about ruin. Your not saying anything new there, and having a few of the right ingredients does not amount to having the right recipe. Your ready dismissal of other explanations and your grand story looks to me like somebody who has found `the answer’, and who sees confirmation of it everywhere. But who knows, maybe my grand narrative (there is no grand narrative) is no better than yours, eh?

rats, wrong link. see confirmation of it everywhere

Luis – very well put. I don’t think there is a “grand narrative” but there was clearly a “zeitgeist”.

And the fuel which took it to extremes was provided, ultimately, by the Fed and other central banks, as John “Taylor Rule” Taylor makes clear:

http://www.stanford.edu/~johntayl/FCPR.pdf

I think that a debt bubble is at the heart of this crisis. This debt bubble has the character it has because of changes in income distribution in the US in particular. The removal of restrictions on international capital flows has played an important part in making the crisis more severe, as has the use of highly complex derivatives. But unless you can explain why we shouldn’t think of this as the bursting of a debt bubble, I will continue to think that this is what it is.

The economists you have recommended seem to concentrate quite narrowly on dysfunctional behaviour in financial markets. This doesn’t seem fundamental to me, and I do not think that regulatory reform is adequate as a response.

I don’t disagree about the need to read economists. In my article I quote the work of Paul Krugman, Joseph Stiglitz, Prabhat Patnaik, Michael Wolf, and others. I also make it clear that I have drawn on work by Ann Pettifor and Graham Turner. Both of these last two, and Warburton, showed considerable foresight in predicting the problems caused by excessive lending. By your lights their accounts were simplistic, perhaps, but they had predictive power.

I am very interested in reading anything by any economist, of whatever stripe, who predicted the crisis. They seem like the people whose views we should take seriously now – can you point me in the direction of anyone else like that?

Given that we are dealing with a highly complex event, doesn’t it make sense to start trying to understand it by acquainting ourselves with those who can argue plausibly that they understand it and have understood it for a while?

USA’s FAST ECONOMIC RECOVERY IN 2 STEPS

Step 1 – STOP THE BAILOUTS and FIX THE BANKS
- Solve the loan problem.
- Solve the derivative problem.
- Reassemble whole loan mortgages

The U.S. economy is shrinking fast, because businesses cannot get loans that they need to operate normally. Banks and lenders already own $ billions in bad loans, and they are afraid to make new loans. The government gave $ billions in bailout money for banks to start lending, but banks hoard the money to save themselves.

Our financial system became untrustworthy, because it mixed $ billions in bad loans in with the good loans. Now, banks do not trust any of the loans, and the entire credit market stopped working.

The U.S. economy will continue to shrink until we untangle the loans. Once the bad loans are isolated, they can be fixed one at a time. Then trust will be restored. Credit will flow, and the economy will grow.

So far, our government is spending $ trillions on bailouts and pork projects, out of ignorance and political ideology. The real solution is much less expensive than that.

The USA has fixed this problem before, and it is not hard to fix again. This is how:

A) Start with the Resolution Trust Corporation (RTC), which the federal government setup to solve a Savings and Loan problem in the 1980s.

B) RTC buys up securitized mortgages and derivatives to reassemble whole mortgage loans.
1. “Securitized mortgages” are home loans that have been bundled into large groups and sold to investors. A group of about 4,000 mortgages can be “securitized” and sold just like a stock or bond. Investors like to buy groups of mortgages because they receive all the monthly house payments.
2. Some groups of securitized mortgages were subdivided into smaller pieces, called “derivatives.” However, both of the fancy names refer to mortgage loans.
3. The problem is that many bad loans (with no payments) got mixed in with good loans. That turned the all the securitized mortgages into bad investments, which are ruining our banks. It is a huge problem, and the government has to fix it, before our economy will recover.
4. Total securitized mortgage and derivative market is estimated at $1.3 Trillion by a Professor of Economics at Ohio State University. (Also see the graph from Deutsche Bank at “The Death of Securitized Mortgages” http://www.nakedcapitalism.com/2008/06/death-of-securitized-mortgages.html )
5. Government should buy up securitized mortgages and derivatives at the lowest market price, which is set via a reverse auction. (Google on “reverse auction”.)
6. Squatters, who sit on their mortgage derivatives, in order to extort big $ from the rest of the system, can be forced to sell. (Law is analogous to eminent domain, or sales forced on cybersquatters that registered the domain names of well-established companies.)
7. Government pays mortgage derivative squatters at market price set by previous reverse auctions, perhaps with a penalty to the squatters.
8. Sellers give up all rights. No new law there.
9. Banks, investors, and insurers now have cash instead of questionable mortgage loans and derivatives. So, the banking system is healthy with cash to lend.
10. Credit will flow, and the economy will grow.

C) Government reassembles whole loans from securitized mortgage components and derivatives.

D) Government sorts the newly reassembled whole loans (mortgages) into groups according to risk/quality.
1. Government uses traditional mortgage experts and guidelines to sort the home loans into quality groups, for example, a high quality group would include homeowners with 20% (or more) equity in their house at today’s market price; and house payments that are 25% (or less) of homeowners monthly income.

E) Government (RTC) sells the reassembled whole loans to traditional mortgage banks.
1. This solves the problem of renegotiating home loans with homeowners. Read on.
2. Law must be changed so that reassembled whole loan mortgages cannot be securitized into derivatives, again.
3. An important purpose is to reconnect each homeowner with his lender, and vice versa.
4. It eliminates incentive for mortgage lenders to make predatory and junk loans. If the loan fails, the lender is stuck with a bad loan.
5. Government recovers much of the $1.3 Trillion purchase cost, because government auctions off the reassembled mortgages.
6. The lower quality, more risky mortgages would fetch a lower price at auction.
7. Mortgage companies, that buy the risky loans, will have more room to negotiate with the homeowners.
8. Some homeowner negotiations will not succeed. Those homeowners will move into affordable rentals. (The government does not owe everyone a free house.)
9. Other renters would like to buy those empty homes at reduced market prices.
10. If the government gets stuck with some homes, the government could profit by selling the homes when the housing market recovers.

F) Insurers like AIG may be reorganized through bankruptcy.
1. Securitized mortgage pools never made business sense, unless they were protected by various insurance schemes.
2. Those insurance schemes always were a scam.
3. Insurance only works when most of the insured assets are never hit with a disaster. That is why flood insurance does not work very well. A major flood ruins all the buildings in a large area, all at the same time. So, the insurance company goes broke, and people that bought the insurance are not protected. That is the problem with securitized mortgage insurance. In an economic downturn, the “disaster” hits all the houses at the same time. Securitized mortgage insurance was doomed to fail, and the insurance companies went broke in 2009.
4. Companies that ran the insurance scam may have to go through bankruptcy.
5. Never ending government bailouts for insurers like AIG are just throwing good money after bad. So, stop the bailouts.

This plan is inexpensive, tried and true. It leaves the banks healthy, with cash to lend. It restores trust in the credit markets, so loans will be made. It reassembles mortgage derivatives into whole loans, and restarts traditional mortgage lending. People can get loans to buy homes. Credit will flow, and the economy will grow.*

Step 2 – STOP THE PORK and START THE RECOVERY

*The economy will grow if President Obama’s massive tax, borrow, and spending plans can be stopped, before he creates another Great Depression. Presidents Hoover and Roosevelt already tried to tax, borrow and spend their way out of a recession in the 1930s. Instead, they created the Great Depression, which lasted 12 years. Straight as he goes, President Obama is doing it, again. Nevertheless, cleaning up the securitized mortgage mess is a necessary first step.

If President Obama announced Steps 1 and 2, today, the stock market would go up within hours. Investors love a real business plan, instead of a political pork plan. Millions of people will be wealthier, feel wealthier, and have more money to spend. That will jump start the economic recovery within days.

I agree that there were many economic experts who predicted the economic crisis, and now that we are in the middle of a mess we have to find solutions on how to get out of it. The government should listen to the people who forecasted the economic crisis. CEO Magazine published an interview with the economic oracle, Med Yones, who predicted the economic crisis in detail in January 2007. According to the interview Obama’s policies only lead to the accumulation of more debt and to a delay of the recovery. For more details see http://www.ceoqmagazine.com/2009Q1/economics/financialcrisis/index.htm