The banks lent money to people who couldn't repay. They failed to realise that they were lending so much to certain sectors of the economy, that the infusion of money made these sectors appear more prosperous than in fact they were. At the same time, banking practice moved on. Banks ceased to lend their own money, or even their customers'. Once they had made a loan, they sold it. Their salesforces pressed banks' new wares on unsuspecting investors in every corner of the world.
Alan Greenspan, chairman of the Federal Reserve Bank for nearly 20 years while all the trouble brewed up, was a man with a convincing demeanour for the role. He was perspicacious and trustworthy. He knew that serious prosperity develops a corrosive underbelly - for instance, more than 10 years ago, he warned that "irrational exuberance" could escalate asset values to an unsustainable level. But he left this premonition in its box, deferring to his over-riding conviction that banks were not capable of self-immolation. He therefore decided against turning off the money supply. Encouraged by his demeanour, most people - including many who were aware that borrowings had swelled to unprecedented levels - judged or assumed that he had probably got it right. Now, it is clear to all that he was a disaster.
There were many gainsayers. I am looking at a BusinessWeek magazine article entitled 'Is a housing bubble about to burst?' This correctly analyses the essential trends that ultimately demolished the US housing sector. The cover date of the magazine is, however, 19 July, 2004, so for all practical purposes, this particular siren was sounded three years early (The IC also questioned Greenspan's record in 2004; see ).
Many, many others voiced similar concerns. Iceland's financial collapse has been widely predicted for at least the last five years. Yet it is in the nature of gainsaying, that until the curtain came crashing down, gainsayers could not be demonstrated to be right. Any investor who had taken a position on the basis of such insights during the first five years in which they began to be widely publicised would have been ruined. As Keynes said: "The market can stay irrational longer than you can stay solvent".
Books that make sense of the crisis
The above is my summary understanding of where it all went so wrong. But it needs a lot of filling out. For that I turned to several new books on the crisis. Professor Robert Schiller, a man now recognised to be considerably more perspicacious than Alan Greenspan, has offered The Subprime Solution (£7.49). His credentials include running seminars at top government financial agencies in the US as early as 2005 in which he "urged them to take prompt action to stop the excess of mortgage lending that was feeding an unsustainable bubble… the reaction I got was that, yes, some of them understood that maybe they should... but it was taking time to arrive at any strong consensus… [but] many of them viewed me as an extremist who deserved a sceptical response". Schiller has had a deep interest in the housing sector for 20 years. He describes convincingly the means by which the madness afflicted all the players, skewering one by one the myths they subscribed to keep the process going. He also helped devise some property price indices which have become a potentially serious tool in housing finance and which he sees as part of the solution to avoiding the problem in future. Other parts of his solution, such as a comprehensive web-based register of individuals' financial profiles, are more difficult to believe in. But the book is a definite must read if you want to understand the crisis.
The gods that failed (£8.99), by Larry Elliott and Dan Atkinson (an interesting liaison - they are, respectively, economic editors for The Guardian and The Daily Mail) have a more populist and wider-ranging perspective than Schiller. Their 'gods that failed' are the swaggering global financial and business elite who have suborned policy-makers the world over to create conditions that suited them and damned everybody else. It's an easier read than Schiller, but possibly more inclined to rail than to explain.
The most intellectually enriching analysis I have found is The origin of financial crises (£10.99) by George Cooper, a hedge fund manager who explains in terms accessible to the general reader how financial markets are fundamentally different from markets for goods, and doomed to pursue irrational exuberance to the point we have now reached. I commend all these books.
Alistair Blair is a past winner of the Business Writer of the Year Award, and has worked in investment banking and fund management.
