Explaining the Mess

The last time I wrote about Niall Ferguson and his new book The Ascent of Money: A Financial History of the World, I mentioned that the book was based on a television series and hoped that the series would air soon in the United States. If I am to believe Robert Skidelsky's review of this book in The New York Review, then the television source is only a two-hour documentary, rather than the sort of extended series developed for John Kenneth Galbraith's The Age of Uncertainty. Nevertheless, the documentary is scheduled for airing on PBS on January 13; and I have already confirmed this on the KQED Web site.

I have not been a fan of PBS for some time. They descended into a hole that was first dug by the Reagan Administration and rarely see daylight any more. Here in San Francisco I rely on PBS for little more than a regular BBC news feed; and that reliability is far from rock-steady. For anything other than straight news, the BBC seems to have found a better (as in better financed) partner in HBO; but HBO has not yet decided to serve as a platform for "television dons." Unless they come up with another cash cow as lucrative as The Sopranos, I doubt that their bean-counters will endorse any such serious commitment to providing educational content. Thus, since I am not sure when, with my current reading list the way it is, I would find time to read Ferguson's book in its entirety, giving it the attention it deserves, and since I was quite taken with the interview he gave on Book TV, I shall probably bite the bullet and give KQED a try for something other than my daily half-hour news fix.

According to Skidelsky, Ferguson's take on our current economic distress is based on a far longer view of history than is within the comfort zone of most media content providers (not to mention our government):

The spread of home ownership in the twentieth century—largely promoted by government in an attempt to make capitalism more popular—made possible a vast expansion of collateralized debt, and was the main stimulus to the development of the conversion of debt into securities.

In other words for most of us, the "ownership" part of "home ownership" is only what I have called in the past a "fiction of convenience." Capitalism did not empower anyone to possess his/her own home; it only created "institutions of debt" whose metaphorical doors were open to anyone, regardless of their financial status. This proposition serves as a prime example of what Skidelsky takes as the primary theme of Ferguson's book:

The large claim Ferguson makes is that we owe our prosperity more to finance than to technology. Throughout history men have been more ingenious at finding ways to make money than to make things.

This throws a new light on the thesis that the "Silicon Valley miracle" was a product of a social network of innovators, venture capitalists, and lawyers by vastly diminishing the significance of the first of those parties. Were most technology evangelists capable of humility, they would recognize this for the humbling insight it was intended to be.

Skidelsky continues his review by exploring the risks associated with the securitization of debt; and this is where the long view of history encounters our present situation with a head-butt worthy of the most vicious rugby player:

Ferguson points out that property "is a security only to the person who lends you money. … By contrast, the borrower's sole security against the loss of his property to such creditors is his income." This is not quite true. The lender's security also depends on the income—actual or expected—of the borrower, because, although the property cannot "run away," it may lose its value, or it may be costly, and even impossible, for the creditor to get possession of it. Ferguson might have told the story of the costly mistake made by France's Credit Lyonnais, which set up its own proprietary credit-rating agency in the late nineteenth century. Its mistake was to rate the credit-worthiness of governments not on their debt-to-income but on their debt-to-property ratios. The imperial government of Russia got top rating, because, despite its disordered finances, of all governments it owned the most property. On the basis of this rating, French investors snapped up tsarist bonds. They lost all their money, not because the property disappeared but because the government did. Credit Lyonnais failed to take into account "political risk."

The tsarist government would now be considered a subprime borrower. Yet today's vastly more sophisticated credit-rating agencies made the same mistake in giving triple-A ratings to bonds that took no account of the income of the borrowers—what the professionals called "toxic waste." Ferguson notes that a disproportionate number of subprime borrowers were ethnic minorities and wonders whether subprime is a new euphemism for black. Both Democratic and Republican administrations brought pressure on lenders to relax their rules in order to spread home ownership—for example, not to press borrowers for full documentation. And indeed home ownership—or bank ownership of homes—did expand greatly in the last ten years. The bubble burst in 2007 when a rise in the federal funds rate from 1 percent to 5.4 percent coincided with the expiring of the enticing "teaser" rate periods that lenders had offered subprime borrowers. Repayments were then set at much higher interest rates and many could not pay.

There is a grim irony in this analysis, which basically argues that the foundations of capitalism have been shaken by the same kind of erroneous thinking through which the Russian Revolution shook the foundations of Credit Lyonnais. This is probably not what Nikita Khrushchev had in mind when he ranted that Communism would "bury" the institutions of capitalism; but the "family resemblance" is striking! The only thing more ironic is that Soviet Communism did not endure long enough to witness this economic crisis and that the "new Russia" is as much a victim of the current situation as is any other industrialized nation.