Two new books dissect the credit crash—and find there's a lot more to it than bad subprime loans
The Trillion Dollar Meltdown:
Easy Money, High Rollers,
and the Great Credit Crash
By Charles R. Morris
PublicAffairs; 194pp; $22.95
Reckless Finance, Failed Politics, and
the Global Crisis of American Capitalism
By Kevin Phillips
Viking; 239pp; $25.95
Are you confused about how so much American debt could vaporize so fast, threatening to take down the global financial system? Are you wondering what should be done to prevent another systemic crisis in the markets? Are you puzzled over what it all means? Two recent books offer answers to these vital questions. Both place the credit crash in historical context. Each author believes Wall Street and the financial community have far too much power. More controversially, both argue the fallout will result in a dramatic transformation of the U.S. economy.
The Trillion Dollar Meltdown by Charles R. Morris deserves a spot on any bedside reading table. Morris, a former banker and sometime writer for The Atlantic Monthly, more than accomplishes his stated goal of telling his story "briefly and crisply." For instance, he manages to make clear both the mechanics of slicing and dicing collateralized debt obligations (CDOs) and why these and similar securitized credits and derivative securities went spectacularly bust. Bad Money by political analyst and author Kevin Phillips is more ambitious, tracing the current "global crisis of American capitalism" to the politics of peak oil, the rise of financial mercantilism, the triumph of market fundamentalism, and even the spread of religious conservatism. But Phillips' take is less persuasive overall, partly because he doesn't allow much nuance. It's the more restrained and focused Morris who ends up delivering the truly profound account.
Morris puts to rest any lingering notion that the credit crisis reflects merely an inflated housing market, let alone a simple subprime problem. He estimates that writedowns and defaults of residential mortgages, commercial mortgages, junk bonds, leveraged loans, credit cards, and complex securitized bonds could reach $1 trillion. (The International Monetary Fund recently picked that number for the global write-off.) The figure could double or triple should there be widespread market panic. Little wonder that the Federal Reserve Board has been working so hard to stave off financial contagion. "Credit is the air that financial markets breathe, and when the air is poisoned, there's no place to hide," writes Morris.
In essence, Morris traces America's credit madness to the rise of Chicago School free-market capitalism, best represented in the work of late Nobel laureate Milton Friedman. That ideology supplanted Keynesian liberalism, which gave government a key role in achieving low inflation, low unemployment, and fast economic growth. It's hardly accurate to say that a simple unleashing of free-market capitalism led to the improved economy of the '80s and '90s, Morris shows, but he appreciates the power of markets to nurture financial innovation and business productivity. Now, though, he believes Chicago free-market ideology is washed up, like Keynesian liberalism before it. "The current conservative, free-market cycle...seems to have long since foundered in the oily seas of gross excess," writes Morris.
Beneath the free-market paradigm, three trends conspired to create the great credit bubble. First, residential mortgages, leveraged buyouts, and other loans gravitated away from banks to global capital markets. Second, the securitization of everything meant that lenders ceased to care whether loans were good or not; they thought only about pocketing enormous fees. Third, portfolio managers' increased reliance upon quantification left them with a flawed image of reality—artificially tidy and apparently risk-free. A final culprit: former Fed Chairman Alan Greenspan, whom Morris faults for cheerleading the deregulated financial markets, allowing easy money to flourish, and failing to disabuse Wall Street of the notion that the Fed will always bail out the financial markets.
Morris manages in a mere 194 pages to explicate the forces behind the origins and popping of the credit bubble and other recent market manias, the decline in the value of the dollar, and the emergence of sovereign wealth. He also takes a stab at what might come next: a long-term decline of the U.S. economy, especially if political leaders and financial elites try to mask how deep the credit crisis runs. However, Morris holds out hope that better days lie ahead if elites exercise leadership in the mode of '80s Fed Chairman Paul Volcker, who slew inflation and restored trust to the U.S. economy. Nevertheless, Morris anticipates a nerve-wracking denouement.
Even readers who don't agree with Morris' sentiments can profit from his insights. That's less true with Phillips. Yes, he's a clever wordsmith with an astute sense of political power, especially regarding the nexus between finance and Washington. But it's annoying how much he mentions his previous books. Moreover, he has no appreciation for financial innovation. But at least his theme is clear: The financial disaster, he suggests, signals the moment when America begins to follow other imperial powers, such as Rome, Spain, and Britain, into long-term decline.
The debate about the political significance and economic implications of the credit crash are just beginning. To varying degrees, these books stake out the arguments for returning to a world where finance serves society rather than the other way around.
Roller Coaster Tales
Financial booms and busts are among the most engaging—and tragic—stories in economics. A wry, well-told account of manic investors is Edward Chancellor's 1999 Devil Take the Hindmost: A History of Financial Speculation (Penguin). A classic is Charles Kindleberger's Manias, Panics, and Crashes: A History of Financial Crises (Wiley). Kindleberger offers an insightful theory to explain the episodic emergence of speculative excesses and their depressing aftermath, a financial pattern that's only too familiar.