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After the Fall: Ten Years After the Crash

Linked by Paul Ciano on September 17, 2018

John Lanchester, London Review of Books:

Some of the more pessimistic commentators at the time of the credit crunch, myself included, said that the aftermath of the crash would dominate our economic and political lives for at least ten years. What I wasn’t expecting – what I don’t think anyone was expecting – was that ten years would go by quite so fast.

The most important component of the intellectual landscape of 2008 was a widespread feeling among elites that things were working fine. Not for everyone and not everywhere, but in aggregate: more people were doing better than were doing worse. Both the rich world and the poor world were measurably, statistically, getting richer. Most indices of quality of life, perhaps the most important being longevity, were improving. We were living through the Great Moderation, in which policymakers had finally worked out a way of growing economies at a rate that didn’t lead to overheating, and didn’t therefore result in the cycles of boom and bust which had been the defining feature of capitalism since the Industrial Revolution. Critics of capitalism had long argued that it had an inherent tendency towards such cycles – this was a central aspect of Marx’s critique – but policymakers now claimed to have fixed it. In the words of Gordon Brown: ‘We set about establishing a new economic framework to secure long-term economic stability and put an end to the damaging cycle of boom and bust.’ That claim was made when Labour first got into office in 1997, and Brown was still repeating it in his last budget as chancellor ten years later, when he said: ‘We will never return to the old boom and bust.’

I cite this not to pick on Gordon Brown, but because this view was widespread among Western policymakers. The intellectual framework for this overconfidence was derived from contemporary trends in macroeconomics. Not to put too fine a point on it, macroeconomists thought they knew everything. Or maybe not everything, just the most important thing.

It’s been said that the four most expensive words in the world are: ‘This time it’s different.’ We can ignore the lessons of history and indeed of common sense because there’s a new paradigm, a new set of tools and techniques, a new Great Moderation. But one of the things that happens in economic good times – a very clear lesson from history which is repeatedly ignored – is that money gets too cheap. Too much credit enters the system and there is too much money looking for investment opportunities. In the modern world that money is hotter – more rapidly mobile and more globalised – than ever before. Ten and a bit years ago, a lot of that money was invested in a sexy new opportunity created by clever financial engineering, which magically created high-yielding but completely safe investments from pools of risky mortgages. Poor people with patchy credit histories who had never owned property were given expensive mortgages to allow them to buy their first homes, and those mortgages were then bundled into securities which were sold to eager investors around the world, with the guarantee that ingenious financial engineering had achieved the magic trick of high yields and complete safety. That, in an investment context, is like claiming to have invented an antigravity device or a perpetual motion machine, since it is an iron law of investment that risks are correlated with returns. The only way you can earn more is by risking more. But ‘this time it’s different.’

The thing about debt and credit is that most of the time, in conventional economic thinking, they don’t present a problem. Every credit is a debt, every debt is a credit, assets and liabilities always match, and the system always balances to zero, so it doesn’t really matter how big those numbers are, how much credit or debt there is in the system, the net is always the same. But knowing that is a bit like climbing up a very, very long ladder and knowing that it’s a good idea not to look down. Sooner or later you inevitably do, and realise how exposed you are, and start feeling different. That’s what happened in the run-up to the credit crunch: people suddenly started to wonder whether these assets, these pools of mortgages (which by this point had been sold and resold all around the financial system so that nobody was clear who actually owned them, like a toxic version of pass the parcel in which nobody knows who is holding the parcel or what’s in it), were worth what they were supposed to be worth. They noticed just how high up the ladder they had climbed. So they started descending the ladder. They started withdrawing credit. What happened next was the first bank run in the UK since the 19th century…

That was the first symptom of the global crisis, which reached the next level with the very similar collapse of Bear Stearns in March 2008, followed by the crash that really did take the entire global financial system to the brink, the implosion of Lehman Brothers on 15 September. Because Lehmans was a clearing house and repository for many thousands of financial instruments from around the system, suddenly nobody knew who owed what to whom, who was exposed to what risk, and therefore which institutions were likely to go next. And that is when the global supply of credit dried up. I spoke to bankers at the time who said that what happened was supposed to be impossible, it was like the tide going out everywhere on Earth simultaneously. People had lived through crises before – the sudden crash of October 1987, the emerging markets crises and the Russian crisis of the 1990s, the dotcom bubble – but what happened in those cases was that capital fled from one place to another. No one had ever lived through, and no one thought possible, a situation where all the credit simultaneously disappeared from everywhere and the entire system teetered on the brink. The first weekend of October 2008 was a point when people at the top of the global financial system genuinely thought, in the words of George W. Bush, ‘This sucker could go down.’ RBS, at one point the biggest bank in the world according to the size of its balance sheet, was within hours of collapsing. And by collapsing I mean cashpoint machines would have stopped working, and insolvencies would have spread from RBS to other banks – and no one alive knows what that would have looked like or how it would have ended.

The immediate economic consequence was the bailout of the banks.

The first and probably most consequential result of the bailouts was that governments across the developed world decided for political reasons that the only way to restore order to their finances was to resort to austerity measures. The financial crisis led to a contraction of credit, which in turn led to economic shrinkage, which in turn led to declining tax receipts for governments, which were suddenly looking at sharply increasing annual deficits and dramatically increasing levels of overall government debt. So now we had austerity, which meant that life got harder for a lot of people, but – this is where the negative consequences of the bailout start to be really apparent – life did not get harder for banks and for the financial system. In the popular imagination, the people who caused the crisis got away with it scot-free, and, as what scientists call a first-order approximation, that’s about right.

In addition, there were no successful prosecutions of anyone at the higher levels of the financial system. Contrast that with the savings and loan scandal of the 1980s, basically a gigantic bust of the US equivalent of mortgage companies, in which 1100 executives were prosecuted. What had changed since then was the increasing hegemony of finance in the political system, which brought the ability quite simply to rewrite the rules of what is and isn’t legal.

There people going to buy houses for the first time would turn up at the mortgage company’s office and be told: ‘Look, I’m really sorry, I know we said we’d be able to get you a loan at 6 per cent, but something went wrong at the bank, so the number on here is 12 per cent. But listen, I know you want to come out of here owning a house today – that’s right isn’t it, you do want to leave this room owning your own house for the first time? – so what I suggest is, since there’s a lot of paperwork to get through, you sign it, and we sort out this issue with the loan later, it won’t be a problem.’ That is a flat lie: the loan was fixed and unchangeable and the contract legally binding, but under Maryland law, the principle is caveat emptor, so the mortgage broker can lie as much as they want, since the onus is on the other party to protect their own interests. The result, just in Baltimore, was tens of thousands of people losing their homes. The charity I talked to had no idea where many of those people were: some of them were sleeping in their cars, some of them had gone back to wherever they came from outside the city, others had just vanished. And all that predatory lending was entirely legal.

Normally when I gave the talk people would laugh at the various punchlines, but now there was complete silence in the room – the jokes weren’t landing at all. And yet I could tell people were actually listening. It felt strange. Then the questions began, and all of them were about blame, and I realised everyone in the room was furious. All the questions were about whose fault the crash was, who should be punished, how it was possible that this could have happened and how outrageous it was that the people responsible had got away with it and the rest of society was paying the consequences.

How it’s been working out here in the UK is the longest period of declining real incomes in recorded economic history. ‘Recorded economic history’ means as far back as current techniques can reach, which is back to the end of the Napoleonic Wars. Worse than the decades that followed the Napoleonic Wars, worse than the crises that followed them, worse than the financial crises that inspired Marx, worse than the Depression, worse than both world wars.

Just as grim, life expectancy has stagnated too, which is all the more shocking because it is entirely unexpected. According to the Continuous Mortality Investigation, life expectancy for a 45-year-old man has declined from an anticipated 43 years of extra life to 42, for a 45-year-old woman from 45.1 more years to 44. There’s a decline for pensioners too. We had gained ten years of extra life since 1960, and we’ve just given one year back. These data are new and are not fully understood yet, but it seems pretty clear that the decline is linked to austerity, perhaps not so much to the squeeze on NHS spending – though the longest spending squeeze, adjusted for inflation and demographics, since the foundation of the NHS has obviously had some effect – but to the impacts of austerity on social services, which in the case of such services as Meals on Wheels and house visits function as an early warning system for illness among the elderly. As a result, mortality rates are up, an increase that began in 2011 after decades in which they had fallen under both parties, and it’s this that is causing the decline in life expectancy.

Life expectancy in the United States is also falling, with the first consecutive-year drop since 1962-63; infant mortality, the generally accepted benchmark for a society’s development, is rising too. The principal driver of the decline in life expectancy seems to be the opioid epidemic, which took 64,000 lives in 2016, many more than guns (39,000), cars (40,000) or breast cancer (41,000). At the same time, the income of the typical worker, the real median hourly income, is about the same as it was in 1971. Anyone time-travelling back to the early 1970s would have great difficulty explaining why the richest and most powerful country in the history of the world had four and a half decades without pandemic, countrywide disaster or world war, accompanied by unprecedented growth in corporate profits, and yet ordinary people’s pay remained the same.

It would be easier to accept all this, philosophically anyway, if since the crash we had made some progress towards reform in the operation of the banking system and international finance. But there has been very little. Yes, there have been some changes at the margin, to things such as the way bonuses are paid. Bonuses were a tremendous flashpoint in the aftermath of the crash, because it was so clear that a) bankers were insanely overpaid; and b) they had incentives for taking risks that paid them huge bonuses when the bets succeeded, but in the event they went wrong, all the losses were paid for by us. Privatised gains, socialised losses.

It’s not that there haven’t been changes. It’s just that it isn’t clear how much of a change the changes are. Bonuses are one example. Another concerns the ring-fencing being introduced in the UK to separate investment banking from retail banking – to separate banks’ casino-like activities on international markets from their piggy-bank-like activities in the real economy. In the aftermath of the crisis there were demands for these two functions to be completely separated, as historically they have been in many countries at many times. The banks fought back hard and as usual got what they wanted. Instead of separation we have a complicated, unwieldy and highly technical process of internal ring-fencing inside our huge banks. When I say huge, I’m referring to the fact that our four biggest banks have balance sheets that, combined, are two and a half times bigger than the UK economy.

Shadow banking is all the stuff banks do – such as lending money, taking deposits, transferring money, executing payments, extending credit – except done by institutions that don’t have a formal banking licence. Think of credit card companies, insurance companies, companies that let you send money overseas, PayPal. There are also huge institutions inside finance that lend money back and forwards to keep banks solvent, in a process known as the repo market. All these activities taken together make up the shadow banking system. The thing about this system is that it’s much less regulated than formal banks, and nobody is certain how big it is. The latest report from the Financial Stability Board, an international body responsible for doing what it says on the tin, estimates the size of the shadow system at $160 trillion. That’s twice the GDP of Earth. It’s bigger than the entire commercial banking sector. Shadow banking was one of the main routes for spreading and magnifying the crash ten years ago, and it is at least as big and as opaque as it was then.

The mental image of a market is misleading: the metaphor implies a single place where people meet to trade and where the transactions are open and transparent and under the aegis of a central authority. That authority can be formal and governmental or it can just be the relevant collective norms. There are inevitably some asymmetries of information – usually sellers know more than buyers – but basically what you see is what you get, and there is some form of supervision at work. Financial markets today are not like that. They aren’t gathered together in one place. In many instances, a market is just a series of cables running into a data centre, with another series of cables, belonging to a hedge fund specialising in high-frequency trading, running into the same computers, and ‘front-running’ trades by profiting from other people’s activities in the market, taking advantage of time differences measured in millionths of a second. That howling, shrieking, cacophonous pit in which traders look up at screens and shout prices at each other is a stage set (literally so: the New York Stock Exchange keeps one going simply for the visuals). The real action is all in data centres and couldn’t be less like a market in any generally understood sense. In many areas, the overwhelming majority of transactions are over the counter (OTC), meaning that they are directly executed between interested parties, and not only is there no grown-up supervision, in the sense of an agency overseeing the transaction, but it is actually the case that nobody else knows what has been transacted. The OTC market in financial derivatives, for instance, is another known unknown: we can guess at its size but nobody really knows. The Bank for International Settlements, the Basel-based central bank of central banks, gives a twice yearly estimate of the OTC market. The most recent number is $532 trillion.

We are back with the issue of impunity. For the people inside the system that caused a decade of misery, no change. For everyone else, a decade of misery, magnified by austerity policies. Note that austerity policies were not recommended by mainstream macroeconomists, who predicted that they would lead to flat or shrinking GDP, as indeed they did. Instead politicians took the crisis as a political inflection point – a phrase used to me in private by a Tory in 2009, before the public realised what was about to hit them – and seized the opportunity to contract government spending and shrink the state.

The burden of austerity falls much more on the poor than on the better-off, and in any case it is a heavily loaded term, taking a personal virtue and casting it as an abstract principle used to direct state spending. For the top 1 per cent of taxpayers, who pay 27 per cent of all income tax, austerity means you end up better off, because you pay less tax. You save so much on your tax bill you can switch from prosecco to champagne, or if you’re already drinking champagne, you switch to fancier champagne. For those living in precarious circumstances, tiny changes in state spending can have direct and significant personal consequences.

For students of the subject there is something a little crude about referring to inequality as if it were only one thing. Inequality of income is not the same thing as inequality of wealth, which is not the same as inequality of opportunity, which is not the same as inequality of outcome, which is not the same as inequality of health or inequality of access to power. In a way, though, the popular use of inequality, although it may not be accurate in philosophical or political science terms, is the most relevant when we think about the last ten years, because when people complain about inequality they are complaining about all the above: all the different subtypes of inequality compacted together.

The sense that there are different rules for insiders, the one per cent, is global. Everywhere you go people are preoccupied by this widening crevasse between the people at the top of the system and everyone else. It’s possible of course that this is a trick of perspective or a phenomenon of raised consciousness more than it is a new reality: that this is what our societies have always been like, that elites have always lived in a fundamentally different reality, it’s just that now, after the last ten difficult years, we are seeing it more clearly.

The one per cent issue is the same everywhere, more or less, but the global phenomenon of inequality has different local flavours. In China these concerns divide the city and the country, the new prosperous middle class and the brutally difficult lives of migrant workers. In much of Europe there are significant divides between older insiders protected by generous social provision and guaranteed secure employment, and a younger precariat which faces a far more uncertain future. In the US there is enormous anger at oblivious, entitled, seemingly invulnerable financial and technological elites getting ever richer as ordinary living standards stay flat in absolute terms, and in relative terms, dramatically decline. And everywhere, more than ever before in human history, people are surrounded by images of a life they are told they should want, yet know they can’t afford.

QE, as it’s known, is the government buying back its own debt with newly minted electronic money. It’s as if you could log into your online bank account and type in a new balance and then use that to pay off your credit card bill. Governments have used this technique to buy back their own bonds. The idea was that the previous bondholders would suddenly have all this cash on their balance sheets, and would feel obliged to put it to work, so they would spend it and then someone else would have the cash and they would spend it. As Merryn Somerset Webb recently wrote in the Financial Times, the cash is like a hot potato that is passed back and forwards between rich individuals and institutions, generating economic activity in the process.

The problem concerns what people do with that hot potato cash. What they tend to do is buy assets. They buy houses and equities and sometimes they buy shiny toys like yachts and paintings. What happens when people buy things? Prices go up. So the prices of houses and equities have been sustained, kept aloft, by quantitative easing, which is great news for people who own things like houses and equities, but less good news for people who don’t, because from their point of view, these things will become ever more unaffordable.

In recent decades, elites seem to have moved from defending capitalism on moral grounds to defending it on the grounds of realism. They say: this is just the way the world works. This is the reality of modern markets. We have to have a competitive economy. We are competing with China, we are competing with India, we have hungry rivals and we have to be realistic about how hard we have to work, how well we can pay ourselves, how lavish we can afford our welfare states to be, and face facts about what’s going to happen to the jobs that are currently done by a local workforce but could be outsourced to a cheaper international one. These are not moral justifications. The ethical defence of capitalism is an important thing to have inadvertently conceded. The moral basis of a society, its sense of its own ethical identity, can’t just be: ‘This is the way the world is, deal with it.’

I notice, talking to younger people, people who hit that Napoleonic moment of turning twenty since the crisis, that the idea of capitalism being thought of as morally superior elicits something between an eye roll and a hollow laugh. Their view of capitalism has been formed by austerity, increasing inequality, the impunity and imperviousness of finance and big technology companies, and the widespread spectacle of increasing corporate profits and a rocketing stock market combined with declining real pay and a huge growth in the new phenomenon of in-work poverty. That last is very important. For decades, the basic promise was that if you didn’t work the state would support you, but you would be poor. If you worked, you wouldn’t be. That’s no longer true: most people on benefits are in work too, it’s just that the work doesn’t pay enough to live on. That’s a fundamental breach of what used to be the social contract. So is the fact that the living standards of young people are likely not to be as high as they are for their parents.

From a sociological point of view, the crisis exacerbated faultlines running through contemporary societies, faultlines of city and country, old and young, cosmopolitan and nationalist, insider and outsider. As a direct result we have seen a sharp rise in populism across the developed world and a marked collapse in support for established parties, in particular those of the centre-left.

Electorates turned with special venom against parties offering what was in effect a milder version of the economic consensus: free-market capitalism with a softer edge. It’s as if the voters are saying to those parties: what actually are you for? It’s not a bad question and it’s one that everyone from the Labour Party to the SPD in Germany to the socialists in France to the Democrats in the US are all struggling to answer.

In the developed world, we need policies that reduce the inequality at the top. It is sometimes said these are very difficult policies to devise. I’m not sure that’s true. What we’re really talking about is a degree of redistribution similar to that experienced in the decades after the Second World War, combined with policies that prevent the international rich person’s sport of hiding assets from taxation. This was one of the focuses of Thomas Piketty’s Capital, and with good reason. I mentioned earlier that assets and liabilities always balance – that’s the way they are designed, as accounting equalities. But when we come to global wealth, this isn’t true. Studies of the global balance sheet consistently show more liabilities than assets. The only way that would make sense is if the world were in debt to some external agency, such as Venusians or the Emperor Palpatine. Since it isn’t, a simple question arises: where’s all the fucking money? Piketty’s student Gabriel Zucman wrote a powerful book, The Hidden Wealth of Nations (2015), which supplies the answer: it’s hidden by rich people in tax havens. According to calculations that Zucman himself says are conservative, the missing money amounts to $8.7 trillion, a significant fraction of all planetary wealth. It is as if, when it comes to the question of paying their taxes, the rich have seceded from the rest of humanity.

If changes benefit an economy as a whole, they need to benefit everyone in the economy – which by implication directs government towards policies focused on education, lifelong training, and redistribution through the tax and benefits system. The alternative is to carry on as we have been doing and just let divides widen until societies fall apart.

Some worlds are built on a fault line of pain, held up by nightmares. Don’t lament when those worlds fall. Rage that they were built doomed in the first place.

Paul Ciano

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