Read more: The secret history of the banking crisis
In the summer of 2007, several bank-run hedge funds trading in mortgage-backed securities announced to the startled financial world that they had gone bust. It turned out that the mortgages that backed up those securities weren’t worth what people thought.
The initial result was panic, as financiers confronted the unsettling possibility that other firms might also be holding rubbish, and because nobody could tell who was in trouble, lending dried up—after all, who wants to lend money if you don’t know whether you’re going to get it back again? This shut down the channels of cash that the banks and other financial institutions needed for their daily operations.
Banks couldn’t borrow. They hadn’t gone bust, but were instead being choked by a sudden drying up of liquidity. Liquidity—that odd word was suddenly everywhere. A way of thinking about it is to imagine a cab, licensed, fuelled and ready to go. The driver has money in the bank, so is not broke. But at the last moment the cabbie realises there’s no loose change in the tin under the seat. Cabbies can’t do business without those small amounts of on-hand cash to settle up after each transaction. So the cabbie is stuck because there’s no liquidity. It was the same with the banks.
A small handful of experts, mainly people who had studied the work of the economist Hyman Minsky, saw what was coming. (Minsky had specialised in identifying the moments when markets crack, leading to the dreaded “Minsky moment.”) But the financial sector didn’t see it coming. Neither did governments, nor the regulators whom they had installed to oversee the banks. In the US, Alan Greenspan, the former Federal Reserve Chairman and one of the chief architects of the neoliberal economic order, admitted with thundering understatement before a Congressional hearing that the financial crisis had led him to identify a “flaw” in his personal philosophy. In Britain, the Financial Services Authority gained a reputation in the run up to the crisis for being tough on small businesses and clueless in the face of big ones. Alas, the latter turned out to be the problem.
High finance was an enigma. The Collateralised Debt Obligations (CDOs), Synthetic CDOs, CDOs squared, Collateralised Loan Obligations, Collateralised Mortgage Obligations, Credit Default Swaps, Structured Investment Vehicles, Conduits, Options Pricing Models, Value at Risk measures and credit ratings all looked very impressive: all the more so in that they came encased in layers of reassuring-looking equations, which gave the whole thing the veneer of something approaching science. But it wasn’t science. It was a mess, with a healthy side-order of physics envy. And when US house prices started to fall, it all blew up.
I remember speaking to an old city hand about the CDO craze. “Didn’t understand them, didn’t buy any,” was his answer and as far as philosophies go, it’s a strong one: if you don’t understand what someone’s trying to push on you, if what they’re saying sounds implausible, if the line they’re selling sounds too good to be true, then don’t buy it.
It’s a philosophy worth bearing in mind as Britain once again faces a challenge of staggering complexity, but this time a political, rather than financial one. Again, the salesmen come circling with their easy promises, their reassurances that there is no real downside, their encouragement that we should stake our future on what they have to offer. Central to their salesman’s patter is the idea that the whole thing is straight-forward, that there is no room for doubt, no need to pause for thought. We just need to get on with it.
Beware the people who tell you that complexity doesn’t matter. The central lesson of the Global Financial Crisis is that it does. We forget this at our peril.
Now read: How the financial crash brought extreme polarisation to politics
In the summer of 2007, several bank-run hedge funds trading in mortgage-backed securities announced to the startled financial world that they had gone bust. It turned out that the mortgages that backed up those securities weren’t worth what people thought.
The initial result was panic, as financiers confronted the unsettling possibility that other firms might also be holding rubbish, and because nobody could tell who was in trouble, lending dried up—after all, who wants to lend money if you don’t know whether you’re going to get it back again? This shut down the channels of cash that the banks and other financial institutions needed for their daily operations.
Banks couldn’t borrow. They hadn’t gone bust, but were instead being choked by a sudden drying up of liquidity. Liquidity—that odd word was suddenly everywhere. A way of thinking about it is to imagine a cab, licensed, fuelled and ready to go. The driver has money in the bank, so is not broke. But at the last moment the cabbie realises there’s no loose change in the tin under the seat. Cabbies can’t do business without those small amounts of on-hand cash to settle up after each transaction. So the cabbie is stuck because there’s no liquidity. It was the same with the banks.
"The problem was that the system had become too intricate, too complex—and far, far too large"Warren Buffet’s line that “only when the tide goes out do you discover who's been swimming naked,” was suddenly everywhere—and it turned out that a lot of people had forgotten their swimming costumes. The catastrophe was staggering. The disappearance of Lehman Brothers, Countrywide, Bear Stearns (Stearns being TS Eliot’s middle name) the mind-numbingly huge numbers involved in the bailout of AIG—and the activities of its Financial Products department in Curzon Street—were like a whirlpool of bad news. During the worst of it, it felt like every bank and investment house in the world was at risk of collapse.
A small handful of experts, mainly people who had studied the work of the economist Hyman Minsky, saw what was coming. (Minsky had specialised in identifying the moments when markets crack, leading to the dreaded “Minsky moment.”) But the financial sector didn’t see it coming. Neither did governments, nor the regulators whom they had installed to oversee the banks. In the US, Alan Greenspan, the former Federal Reserve Chairman and one of the chief architects of the neoliberal economic order, admitted with thundering understatement before a Congressional hearing that the financial crisis had led him to identify a “flaw” in his personal philosophy. In Britain, the Financial Services Authority gained a reputation in the run up to the crisis for being tough on small businesses and clueless in the face of big ones. Alas, the latter turned out to be the problem.
High finance was an enigma. The Collateralised Debt Obligations (CDOs), Synthetic CDOs, CDOs squared, Collateralised Loan Obligations, Collateralised Mortgage Obligations, Credit Default Swaps, Structured Investment Vehicles, Conduits, Options Pricing Models, Value at Risk measures and credit ratings all looked very impressive: all the more so in that they came encased in layers of reassuring-looking equations, which gave the whole thing the veneer of something approaching science. But it wasn’t science. It was a mess, with a healthy side-order of physics envy. And when US house prices started to fall, it all blew up.
"It wasn’t science. It was a mess, with a healthy side-order of physics envy"The problem was that the system had become too intricate, too complex—and far, far too large. When the crisis hit, the Royal Bank of Scotland had a balance sheet of £2.2 trillion, an amount larger than the UK’s entire GDP. It was too unwieldy a structure to be kept under human control. According to the Bank for International Settlements, by the end of June 2007, the total value of outstanding derivatives in global markets was $516 trillion. Numbers like that are so vast as to be meaningless.
I remember speaking to an old city hand about the CDO craze. “Didn’t understand them, didn’t buy any,” was his answer and as far as philosophies go, it’s a strong one: if you don’t understand what someone’s trying to push on you, if what they’re saying sounds implausible, if the line they’re selling sounds too good to be true, then don’t buy it.
It’s a philosophy worth bearing in mind as Britain once again faces a challenge of staggering complexity, but this time a political, rather than financial one. Again, the salesmen come circling with their easy promises, their reassurances that there is no real downside, their encouragement that we should stake our future on what they have to offer. Central to their salesman’s patter is the idea that the whole thing is straight-forward, that there is no room for doubt, no need to pause for thought. We just need to get on with it.
Beware the people who tell you that complexity doesn’t matter. The central lesson of the Global Financial Crisis is that it does. We forget this at our peril.
Now read: How the financial crash brought extreme polarisation to politics
