The credit crunch

Ten years ago this month, the world was rocked by a fi­nan­cial crash that still re­ver­ber­ates to­day. We asked three eco­nomic his­to­ri­ans to re­flect on the events of 2008 and con­sider how his­tory will re­mem­ber the cri­sis

BBC History Magazine - - Contents -

Martin Daun­ton, Scott New­ton and Linda Yueh ex­plain what caused the fi­nan­cial cri­sis of 2008 and its sig­nif­i­cance to­day

Com­ple­ments the BBC Ra­dio 4 se­ries The Age of Cap­i­tal­ism

They’re among the most en­dur­ing im­ages of the 21st cen­tury: shell-shocked mar­ket traders look­ing on in hor­ror as tril­lions are wiped off share prices; peo­ple queu­ing round the block to with­draw sav­ings from North­ern Rock; Lehman Brothers em­ploy­ees stream­ing out of Ca­nary Wharf, boxes of pos­ses­sions in hand, now ef­fec­tively job­less. Be­hind those im­ages lay the great­est jolt to the global fi­nan­cial sys­tem in al­most a cen­tury – a jolt that pushed the world’s bank­ing sys­tem to­wards the edge of col­lapse.

The 2008 fi­nan­cial crash had long roots but it wasn’t un­til Septem­ber 2008 that its ef­fects be­came ap­par­ent to the world. Within a few weeks, Lehman Brothers, one of the world’s big­gest fi­nan­cial in­sti­tu­tions, went bank­rupt; £90bn was wiped off the value of Bri­tain’s big­gest com­pa­nies in a sin­gle day; and there was even talk of cash ma­chines run­ning empty.

In the short term, an enor­mous bail-out – govern­ments pump­ing bil­lions into stricken banks – averted a com­plete col­lapse of the fi­nan­cial sys­tem. In the long term, the im­pact of the crash has been enor­mous: de­pressed wages, aus­ter­ity and deep po­lit­i­cal in­sta­bil­ity. Ten years on, we’re still liv­ing with the con­se­quences, as our ex­perts make clear.

What do you see as the main causes of the 2008 crash? Scott New­ton: The im­me­di­ate trig­ger was a com­bi­na­tion of spec­u­la­tive ac­tiv­ity in the fi­nan­cial mar­kets, fo­cus­ing par­tic­u­larly on prop­erty trans­ac­tions – es­pe­cially in the USA and western Europe – and the avail­abil­ity of cheap credit. There was bor­row­ing on a huge scale to fi­nance what ap­peared to be a one-way bet on ris­ing prop­erty prices. But the boom was ul­ti­mately un­sus­tain­able be­cause, from around 2005, the gap be­tween in­comes and debt be­gan to widen. This was caused by ris­ing en­ergy prices on global mar­kets, lead­ing to an in­crease in the rate of global in­fla­tion.

This de­vel­op­ment squeezed bor­row­ers, many of whom strug­gled to re­pay mort­gages. Prop­erty prices now started to fall, lead­ing to a col­lapse in the val­ues of the as­sets held by many fi­nan­cial in­sti­tu­tions. The bank­ing sec­tors of the USA and the UK came very close to col­lapse and had to be res­cued by state in­ter­ven­tion.

Martin Daun­ton: The cri­sis had two ma­jor causes – weak reg­u­la­tion of fi­nan­cial in­ter­ests and in­sti­tu­tional flaws. Ex­ces­sive fi­nan­cial lib­er­al­i­sa­tion from the late 20th cen­tury, ac­com­pa­nied by a re­duc­tion in reg­u­la­tion, was un­der­pinned by con­fi­dence that mar­kets are ef­fi­cient. This re­placed the scep­ti­cism of [in­flu­en­tial in­ter­war econ­o­mist] John May­nard Keynes that economies are in­trin­si­cally un­sta­ble.

The crash first struck the bank­ing and fi­nan­cial sys­tem of the United States, with spill-overs into Europe. Here, an­other cri­sis – one of sov­er­eign debt – arose from the flawed de­sign of the eu­ro­zone; this al­lowed coun­tries such as Greece to bor­row on sim­i­lar terms to Ger­many in the con­fi­dence that the eu­ro­zone would bail out the debtors. When the cri­sis hit, the Euro­pean Cen­tral Bank re­fused to resched­ule or mu­tu­alise debt and in­stead of­fered a res­cue pack­age – on the con­di­tion that the stricken na­tions pur­sued poli­cies of aus­ter­ity.

Was the crash a nat­u­ral con­tin­u­a­tion of pre­vi­ous global trends, or a de­ci­sive break from them? Linda Yueh: Crises oc­cur fairly reg­u­larly through­out his­tory, but this one was un­usual in that it threat­ened the en­tire sys­tem.

MD: I see the cri­sis as a cul­mi­na­tion of pre­vi­ous trends. In many ways, it arose from the overly con­fi­dent be­lief that mar­kets are pref­er­en­tial to reg­u­la­tion. Such an as­sump­tion was a ma­jor fea­ture of the last quar­ter of the 20th cen­tury, both at the In­ter­na­tional Mon­e­tary Fund and the US Trea­sury.

It is dif­fi­cult to give a pre­cise date for the trans­for­ma­tion, but it arose from a com­bi­na­tion of a re­liance on com­mer­cial banks to re­cy­cle petrodol­lars after the oil shock of 1973; the con­fi­dence of the Thatcher and Rea­gan govern­ments in mar­kets; a trans­for­ma­tion in eco­nom­ics; struc­tural changes in the world

econ­omy with the rise of multi­na­tional cor­po­ra­tions; and the growth of transna­tional banks, lead­ing to greater flows of cap­i­tal around the world.

The speed and sav­agery of the crash ap­peared to take the world by sur­prise. Was it un­usual in be­ing so sud­den and so un­ex­pected? SN: The crash caught econ­o­mists and com­men­ta­tors cold be­cause most of them have been brought up to view the free mar­ket or­der as the only work­able eco­nomic model avail­able. This con­vic­tion was strength­ened by the dis­so­lu­tion of the USSR, and China’s turn to­wards cap­i­tal­ism, along with fi­nan­cial in­no­va­tions that led to the mis­taken be­lief that the sys­tem was fool­proof.

It was more sud­den than the two pre­vi­ous crashes of the post-1979 era: the prop­erty crash of the late 1980s and the cur­rency crises of the late 1990s. This is largely be­cause of the cen­tral role played by the banks of ma­jor cap­i­tal­ist states. Th­ese lend large vol­umes of money to each other as well as to govern­ments, busi­nesses and con­sumers. Given the ad­vent of 24-hour and com­put­erised trad­ing, and the on­go­ing dereg­u­la­tion of the fi­nan­cial sec­tor, it was in­evitable that a ma­jor fi­nan­cial cri­sis in cap­i­tal­ist cen­tres as large as the USA and the UK would be trans­mit­ted rapidly across global mar­kets and bank­ing sys­tems. It was also in­evitable that it would cause a sud­den dry­ing up of mon­e­tary flows.

MD: There was a com­pla­cent as­sump­tion that crises were a thing of the past, and that there was a ‘great mod­er­a­tion’ – the idea that, over the pre­vi­ous 20 or so years, macroe­co­nomic volatil­ity had de­clined. The vari­abil­ity in in­fla­tion and out­put had de­clined to half of the level of the 1980s, so that the eco­nomic un­cer­tainty of house­holds and firms was re­duced and em­ploy­ment was more sta­ble.

In 2004, Ben Ber­nanke, a gov­er­nor of the Fed­eral Re­serve who served as chair­man from 2006 to 2014, was con­fi­dent that a num­ber of struc­tural changes had in­creased economies’ abil­ity to ab­sorb shocks, and also that macroe­co­nomic pol­icy – above all mon­e­tary pol­icy – was much bet­ter in con­trol­ling in­fla­tion. In con­grat­u­lat­ing him­self for the Fed’s suc­cess­ful man­ag­ing of mon­e­tary pol­icy, Ber­nanke was not tak­ing ac­count of the in­sta­bil­ity caused by the fi­nan­cial sec­tor (and nor were most of his fel­low econ­o­mists). How­ever, the risks were ap­par­ent to those who con­sid­ered that an econ­omy is in­her­ently prone to shocks.

How closely did the events of 2008 mir­ror pre­vi­ous eco­nomic crises, such as the Wall Street Crash of 1929?

“There was a com­pla­cent as­sump­tion that fi­nan­cial crises were a thing of the past, and that volatil­ity had de­clined” MARTIN DAUN­TON

SN: There are some par­al­lels with 1929 – the most salient be­ing the reck­less spec­u­la­tion, de­pen­dence on credit, and grossly un­equal dis­tri­bu­tion of in­come. How­ever, the Wall Street Crash moved across the globe more grad­u­ally than its coun­ter­part in 2007– 08. There were cur­rency and bank­ing crises in Europe, Australia and Latin Amer­ica but th­ese did not erupt un­til 1930–31 or even later. The US ex­pe­ri­enced bank fail­ures in 1930–31 but the ma­jor bank­ing cri­sis there did not oc­cur un­til late 1932 into 1933.

LY: Ev­ery cri­sis is dif­fer­ent but this one shared some sim­i­lar­i­ties with the Great Crash of 1929. Both ex­em­plify the dan­gers of hav­ing too much debt in as­set mar­kets (stocks in 1929; hous­ing in 2008).

MD: Crises fol­low a sim­i­lar pat­tern – over­con­fi­dence suc­ceeded by col­lapse – but those of 1929 and 2008 were char­ac­terised by dif­fer­ent fault lines and ten­sions. The state was much smaller in the 1930s (con­strain­ing its abil­ity to in­ter­vene) and in­ter­na­tional cap­i­tal flows were com­par­a­tively tiny.

There were also dif­fer­ences in mon­e­tary pol­icy. By aban­don­ing the gold stan­dard in 1931 and 1933, Bri­tain and Amer­ica re­gained au­ton­omy in mon­e­tary pol­icy. How­ever, the Ger­mans and French re­mained on gold, which hin­dered their re­cov­ery.

The post-First World War set­tle­ment ham­pered in­ter­na­tional co-op­er­a­tion in 1929: Bri­tain re­sented its debt to the United States, and Ger­many re­sented hav­ing to pay war repa­ra­tions. Mean­while, pri­mary pro­duc­ers were se­ri­ously hit by the fall in the price of food and raw ma­te­ri­als, and by Europe’s turn to self-suf­fi­ciency.

How suc­cess­fully did pol­icy mak­ers ap­ply the lessons of those pre­vi­ous crises to the events of 2008? LY: My re­cent Great Econ­o­mists book de­tails how, in 2008, Ben Ber­nanke and other cen­tral bankers drew on the wis­dom of econ­o­mists like Mil­ton Fried­man (1912–2006), who stressed the im­por­tance of util­is­ing mon­e­tary pol­icy in such episodes. Pol­i­cy­mak­ers also ap­plied the in­sights of econ­o­mists such as Irv­ing Fisher (1867–1947) to avoid the debt-de­fla­tion spi­ral. This spi­ral was a hall­mark of the 1930s and is still plagu­ing Ja­pan after its early 1990s crash.

SN: Ini­tially, pol­i­cy­mak­ers re­acted quite suc­cess­fully. Fol­low­ing the ideas of Keynes, govern­ments didn’t use pub­lic spend­ing cuts as a means of re­duc­ing debt. In­stead, there were mod­est na­tional re­fla­tions, de­signed to sus­tain eco­nomic ac­tiv­ity

“There are par­al­lels with 1929 – reck­less spec­u­la­tion, de­pen­dence on credit, and un­equal dis­tri­bu­tion of in­come” SCOTT NEW­TON

and em­ploy­ment, and re­plen­ish bank and cor­po­rate bal­ance sheets via growth. Th­ese pack­ages were sup­ple­mented by a ma­jor ex­pan­sion of the IMF’s re­sources, to as­sist na­tions in se­vere deficit and off­set pres­sures on them to cut back which could set off a down­ward spi­ral of trade. Together, th­ese steps pre­vented the on­set of a ma­jor global slump in out­put and em­ploy­ment.

By 2010, out­side the USA, th­ese mea­sures had been gen­er­ally sus­pended in favour of ‘aus­ter­ity’, mean­ing se­vere economies in pub­lic spend­ing. Aus­ter­ity led to na­tional and in­ter­na­tional slow­downs, no­tably in the UK and the eu­ro­zone. It did not, how­ever, pro­voke a slump – largely thanks to mas­sive spend­ing on the part of China, which, for ex­am­ple, con­sumed 45 per cent more ce­ment be­tween 2011 and 2013 than the US had used in the whole of the 20th cen­tury.

How far was the cri­sis re­spon­si­ble for the po­lit­i­cal, so­cial and eco­nomic un­cer­tainty we are ex­pe­ri­enc­ing now? SN: The cri­sis was the im­me­di­ate cause. But the so­cial ten­sions, eco­nomic dif­fi­cul­ties and po­lit­i­cal in­sta­bil­ity ev­i­dent across much of the de­vel­oped world have been long in the mak­ing. Dur­ing this era, govern­ments, sup­ported by cheer­lead­ers in the uni­ver­si­ties and the me­dia, have pri­ori­tised free mar­kets and pri­vate profit above the re­duc­tion of in­equal­ity, the wel­fare of the com­mu­nity and the pur­suit of growth for so­cial pur­poses.

LY: It has cer­tainly added to the eco­nomic un­cer­tainty. Just as in the af­ter­math of pre­vi­ous se­ri­ous eco­nomic down­turns, we are now wor­ry­ing about a slow growth fu­ture. The term sec­u­lar stag­na­tion, which was first used in the 1930s, when econ­o­mist Alvin Hansen warned about a slow growth path after the Great De­pres­sion, has been re­vived by the econ­o­mist Larry Sum­mers when dis­cussing eco­nomic growth to­day,

But we can har­ness this un­cer­tainty. A se­ri­ous episode that breeds doubts about the eco­nomic con­sen­sus is also an op­por­tu­nity to re­fash­ion the mar­ket econ­omy for the re­quire­ments of the 21st cen­tury.

How do you think his­to­ri­ans in 50 years’ time will look back on the fi­nan­cial cri­sis of 2008? MD: They will see a story of hubris fol­lowed by a fall. Quan­ti­ta­tive eas­ing worked in stop­ping the cri­sis be­com­ing as in­tense as in the Great De­pres­sion. The in­ter­na­tional in­sti­tu­tions of the World Trade Or­gan­i­sa­tion also played their part, pre­vent­ing a trade war. But his­to­ri­ans might then look back and point to griev­ances that arose from the de­ci­sion to bail out the fi­nan­cial sec­tor, and the im­pact of aus­ter­ity on cit­i­zens’ qual­ity of life.

What we can­not tell now – but his­to­ri­ans in 50 years’ time will know – is whether Don­ald Trump sparks an all-out trade war and de­stroys mul­ti­lat­eral in­sti­tu­tions. Or will his brand of na­tion­al­ist pop­ulism be re­jected as a prob­lem and not the cure, fol­lowed by a turn to more sen­si­ble poli­cies aimed at re­mov­ing both greed and griev­ance?

SN: To quote [for­mer Chi­nese premier] Zhou En­lai, “it’s too early to say”. Much will de­pend on the un­fold­ing de­vel­op­ment of China. It seems pos­si­ble that the cri­sis is the pre­lude to the dis­in­te­gra­tion of the ne­olib­eral or­der. But, if so, will its re­place­ment be char­ac­terised by eco­nomic con­flict be­tween un­sta­ble na­tions gov­erned by na­tion­al­ist dem­a­gogues? Or, fol­low­ing an in­ter­lude of in­sta­bil­ity, will it spawn a new so­cial and eco­nomic golden age, akin to the 30 years of eco­nomic pros­per­ity fol­low­ing the end of the Sec­ond World War? Cur­rently, the for­mer seems more prob­a­ble. But his­tory can play tricks on those at­tempt­ing to pre­dict the fu­ture. In­ter­views by Rob At­tar

“The fall­out from the crash of­fers an op­por­tu­nity to re­fash­ion the mar­ket econ­omy for the re­quire­ments of the 21st cen­tury” LINDA YUEH

Traders on the floor of the New York Stock Ex­change after the clos­ing bell on 29 Septem­ber 2008. A record 778 points were wiped off the Dow Jones that day, as the 2008 fi­nan­cial cri­sis pushed the world’s bank­ing sys­tem to the edge of col­lapse

John May­nard Keynes in 1940. By the 2000s, many econ­o­mists had re­jected his view that mar­kets are in­her­ently un­sta­ble

Ben Ber­nanke, for­mer chair­man of the Fed­eral Re­serve, has gar­nered crit­i­cism and praise for his role in the 2008 crash

Un­em­ployed men queue at ‘Big Al’s Kitchen for the Needy’ fol­low­ing the Wall Street Crash of 1929. The kitchen, run by the gang­ster Al Capone, fed about 3,500 peo­ple a day

Guangzhou’s thriv­ing shop­ping dis­trict. A surge in Chi­nese spend­ing in the post-crash years may have saved the west from a slump, says Scott New­ton

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