Tuesday, May 12, 2015

How the sub-prime crisis unfolded

This book review was first published in The Hindu on May 03, 2015

Easy Money — The Greatest Ponzi Scheme Ever and How it is Set to Destroy the Global Financial System: Vivek Kaul
Sage Publications India Pvt. Ltd.
B 1/I-1, Mohan Cooperative Industrial Area,
Mathura Road, New Delhi-110044
Rs 395

The first and second books in the trilogy traced the evolution of money through the era of commodities and even people being treated as money, the rise of gold as money during the World War II, the role of oil, the Gulf War and the dotcom bubble burst.

Kaul continues the journey in this concluding book in the trilogy. The beauty of this trilogy is that it makes boring interesting. The third book is the icing.

After the dotcom bubble burst, one would have thought that central bankers across the world would have learnt from the mistakes of Alan Greenspan, the then [2001] Chairman of the US Federal Reserve. Alas, that was not to be. Greenspan himself continued with the “easy money policy that had created the dot-com bubble...The low interest rate regime created conditions that were ideal for a bubble; the only difference this time around was that real estate replaced stocks as the medium of speculation”. With these lines, Kaul eases into the post dotcom bubble burst era of the building up of the sub-prime crisis.

Greenspan’s warning

The startling revelation is that, just like Greenspan had warned people of the U.S. of “Irrational Exuberance” much before the dotcom bubble burst, he did talk about the housing boom way back in 2002 and that it “cannot continue indefinitely”. But as Kaul points out, he chose to do nothing about it. In fact, the easy money policy continued.

In fact, after the sub-prime crisis, Ben Bernake (Chairman of the US Federal Reserve) continued his predecessor Greenspan’s policy of easy money.

The chapter, “Some are more equal than the others” very interestingly analyses the growing income inequality and ‘borrowing substituting rising incomes’. The book follows on to explain, very rationally, the entire cycle of Chinese exports to the U.S., the consumption of goods by Americans on borrowed money, fuelled by low interest rates, and hence more demand, more exports by China, investing of the earned dollars by China in U.S. financial securities! This cycle kept the interest rates in the U.S. low and at the same time financed the U.S. budget deficit.

While low interest rates were enticing enough to borrow, the financial institutions came up with innovative ideas like 2/28 option ARMs, liar loans, easy lending terms and general thrust to lend to the sub-prime borrowers, resulting in the household debt being 140% of the household income before the sub-prime crisis hit.

How did this happen? Surely someone would have realised the huge risk to the system with such unsustainable debt levels? Why didn’t the banks act earlier? What rocked the party? Why did people start defaulting? In the midst of the crisis, why did the CEO of Citibank get a $95 million severance package when he was quitting? Read the book to know about all these interesting aspects of the crisis. September 15, 2008, the date Lehman Brothers filed for bankruptcy is the date the global markets went haywire and sub-prime crisis became the talk of the global financial system. The foundations of the crisis were laid decades ago, depending on how far back into the history one would want to go. However, how much ever far back one would like to go, there is provision for doing so in this trilogy. Just decide the period and start reading from then on.

Earlier, in Japan

What happened in the U.S. in the 2000s had already happened in Japan in the 1990s. What is needed is that a country not only learns from the mistakes of its own past, but also learns from the mistakes of other nations. This would be very relevant for emerging countries as they would start going through the phases which some of the developed nations have already gone through.

Lastly, it is worth pointing out that the research in the book is up-to-date with references to Thomas Piketty’s, “Capital in the Twenty-First Century”, published in 2014. Events in the global financial system till the first half of 2014 have been comprehensively covered by the book.

In the introduction, Kaul writes that he feels “the best books on the current financial crisis are yet to be written. They will probably start to get published around 2033 (25 years after the current crisis started)”. But till then, for the next 18 years, this might be the best account of the what, why and how of the crisis!


The foundations of the crisis were laid decades ago, depending on how far back into history one would want to go
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