The decade which began in July 1997 saw a global financial system that generated more wealth for more people for a much longer period of time than any other in financial history.
But ten years later, in a seemingly sudden move, there was a flight of capital and a collapse of the global banking system. What went wrong? Did anyone see it coming? What lessons can we learn from this?
And is it really all that bad?
Fooled Again is not a history book, but it looks at the history of recent financial management, mismanagement, extraordinary risk and greed, flows of global capital and international toxic balance sheets to identity the key lessons to be learned from the global financial crisis.
Taking a considered and long-term view, Meyrick Chapman gives an immensely readable and insightful view of what really happened and shows us why not all crises are bad, and why the events of 2008 and 2009 may ultimately benefit us.
The book will be ordered into three main sections, some divided into chapter-length subsections:
1. The constants of banking crises,
2. The unique circumstances of the current crisis, and their lessons
3. The costs and the benefits of the financial disruption
Epigraph: A hundred years ago, the electric telegraph made possible - indeed, inevitable - the United States of America. The communications satellite will make equally inevitable a United Nations of Earth; let us hope that the transition period will not be equally bloody. Arthur C. Clarke, First on the Moon, 1970
Introduction: Financial disruption has pervaded the last decade, not just the period 2007/8; the background of recent financial history will be considered, its influence on current disruption and the lessons it delivers. First, the constants of all banking crises are established. Then the unique circumstances that led to the current crisis. The book argues the bubbles and busts of 1997-2007 may be the costs that accompany the benefits of historic expansion of global trade, technological change and freedom that followed the Cold War.
Section 1: Constants
Chapter 1 What happens in all financial crises and why dont we see them coming? Few borrowers or bankers set out to lose money, why do banking crises happen? There are a number of constants to all banking crises including short-termism, leverage, banking competition, inability/ unwillingness to measure accurately credit expansion and real estate booms. The results of banking crises also frequently look similar collateral problems, illiquidity and insolvency and economic downturn. The key to understanding banking crises is not just to identify the constants but to acknowledge the impact of the unique circumstances that preceded the bust. There is little indication that policy makers have yet acknowledged the circumstances that led to the crisis.
Section 2: Specific causes and specific lessons
While some of the credit conditions and the immediate effects of banking crises are broadly similar, the 2007/8 banking crisis was the result of specific and positive global changes in trade and technology together with a number of policy errors. Although the constants can be easily identified, the unique circumstances of the current banking crisis may reveal the limits of reform and may mean amelioration of bubbles and busts is unlikely.
Chapter 2 - Lessons for policy & regulation
This chapter will look at the behaviour of central banks and regulators through the past decade. It will examine Alan Greenspans approach to financial emergencies & innovation/ productivity which then took up the theme of housing growth in the aftermath of the dot com bust. European Central Bank and Bank of England. In background was the lesson of the Bank of Japan of how not to prick a bubble and how not to react to a banking crisis. There will be five subsections:
a. Bank of Japan and pricking the Japanese bubble
b. Basel I & II, rating agencies regulatory innovation
c. Greenspan and dot-com
d. Lessons from the collapse and bail out of Long-Term capital Management LTCM
e. European Central Bank and Bank of England
Chapter 3 Lessons from globalisation
Lessons from globalisation: growth of reserve management as a protection and then a trade tool. Stemming from previous lessons learnt in the Asian crisis of 1997/98. Japanese export of savings due to low returns within Japan. Four subsections:
a. Asian Crisis and the lessons learnt by China
b. Reserve management (hedging an uncertain future)
c. Japanese savings and the lessons from the Other Asian Crisis
d. Large Current Account surpluses created through globalisation often nationalise citizens savings and withhold the reward due to workers.
Chapter 4 Lessons of financial innovation
A feature of many banking crises is a combination of financial innovation and deregulation; this chapter looks at the unparalleled financial innovation that grew out of the work of Merton, Black and Scholes. The chapter identifies innovations that add efficiency and innovations that avoid regulatory control; both were necessary for the 2007/8 credit crisis. Six subsections:
a. Financial innovation: innovations of efficiency and avoidance
b. Merton, derivative laureate
c. Banks and financial innovation the products and how they work
d. Hedge funds competition for banks
e. Were all bankers (hedge funds?) now, interaction with technology
f. Misinterpretation of historic data sets, limited history of data
Chapter 5 Lessons of technological innovation
Technological innovation was necessary for both globalisation and financial innovation. This chapter describes the impact of technology on financial processes and the radical adjustments in understanding that may still be needed as a result.
a. Aid in creating financial engineering, derivatives
b. Greenspans faith in productivity/ American ascendancy
c. Communication technology violation of law of large numbers
d. Increased economic efficiency
e. The impact of the internet its too early to tell!
Chapter 6 Lessons from real estate, housing books and mortgages. Three subsections
a. The conspiracy of mortgage credit politics, housing and profit in America and Europe
b. American subprime, agencies yield demand from investors in a low return world
c. International housing booms in Spain, Ireland and United Kingdom structural similarities, financial links
Section 3: The costs and benefits of financial crises. Are there benefits in disruption as well as costs?
Chapter 7 - Costs and benefits from recent banking crises
Sweden & Nordic banking crisis of 1991 grew out of the collapse of the Soviet Union and a burst of economic and social optimism that followed. The Nordic banking crisis therefore stemmed from a social advance which encouraged unconstrained credit expansion and subsequent collapse. The aftermath led to high unemployment and many bankruptcies. The crisis eventually led to a new era of economic expansion and integration, including the development of Nokia and the integration of Sweden and Finland into the EU in 1995.
Thailand 1997 and the Asian crisis also grew out of radical global liberalisation following the end of the Cold War. The consequences of the Asian crisis, however, left longer lasting damage and fewer obvious lasting benefits compared to the Nordic experience. One reason was the focus of emerging economies shifted to China, the major beneficiary of globalisation. There were long term benefits however, in change to the political structures, expansion of Small and Medium sized business. 1997 Constitution meant both houses were directly elected for first time. Many human rights are explicitly acknowledged. Most open and corruption free elections in 2001 but subsequent reverses followed.
Japan 2003, the long post-war rise in Japanese economic growth and living standards culminated in the Bubble Economy and subsequent prolonged banking crisis. Unlike the Nordic experience, Japan failed to find a new role in the world. The country lost its lead in technology and saw its advantages dissipated. Without thoroughgoing reform, the legacy of Japans financial system encouraged a flight of capital that continues today.
Chapter 8 What can be good about bubbles and bursts?
Information technology and globalisation formed the background of not one but two bubbles; the dot-com bubble of 1999-2001 and the housing bubble of 2003-2006. Increased efficiency and globalisation of trade, reduction in trade barriers lead to an increase in overall human welfare. There are often political advances associated with the bubble period, or the aftermath. The speed with which the credit bubble unwound may be a sign of increased efficiency of markets in processing information, not a sign of increased inefficiency. A bubble may be rational and the disruption of the bust part of the long-term adjustment to new technology, trade or social conditions. A bubble may also reveal the measurement problems associated with any period of novel innovation.
Chapter 9 The inevitable costs of disruption
If disruption is inevitable, the costs of disruption are also inevitable and serious. Costs include local loss of jobs, perhaps loss of entire industries. Contractual trust within a society, which is the foundation of successful society, may be permanently damaged.
Conclusion - Lessons for the future
How may global financial and trade arrangements be changed by the financial collapse of 2007/8? What does it say about our reliance on markets to allocate resources? We may have to live with the disruption and uncertainty inherent in market behaviour. The alternatives may be much worse. What does the banking crisis require from Barak Obama?