The Great Credit Bubble
by Mark Gilbert,
Author of Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable
Where did the money come from? Where did it go? How was this allowed to happen? Who is to blame? These are the key questions surrounding the credit crunch that has engulfed the global financial system.
The answer, in part, is that there wasn't anywhere near as much money as there seemed to be. And because it didn't exist in the first place, the money hasn't gone anywhere. It was all an illusion, although the economic consequences of its disappearance turned out to be very real indeed.
As to how it was allowed to happen and who is to blame, in a sense the honest reply is that we all allowed it to happen, and we're all to blame, either as active accomplices or complicit bystanders. Society as a whole made a collective, unconscious decision to allow the banking system to grow unchecked because the tangible benefits that seemed to accrue from unbridled capitalism outweighed the intangible hazards that might accompany this dangerous test of capitalism's limits.
Consider an analogous bit of history. In nineteenth-century Britain, physicians finally began to understand human physiology, working out the body's geography by mapping veins and arteries, dissecting eyes and hearts, and manipulating bones and joints. The new knowledge promised to usher in a period of unprecedented medical advancement.
Religious beliefs and general distaste, however, meant that few people would send the corpses of deceased relatives to the gurneys of surgeons with eager scalpels. After all, how could a dismembered body pass through the gates of heaven? Surgeons instead dissected the bodies of executed criminals, who lost dominion over their body parts' destination upon conviction.
But -- even fueled by the era's commonplace executions -- supply was insufficient to meet demand. A shadowy secondary market in cadavers developed; those who died in a hospital and weren't quickly claimed by their loved ones moved from mortuaries to teaching hospitals, sold by undertakers and bought by physicians. Even those claimed by family and properly buried could be dug up and sold to satiate the needs of the anatomists.
The authorities -- both legal and medical -- turned a blind eye to the practice of grave robbing, while the general public remained ignorant about how doctors were getting smarter. For society as a whole, it was a win-win situation -- until a pair of entrepreneurs called William Burke and William Hare decided to circumvent the waiting time demanded by nature, started murdering for profit, and brought the whole grisly, underhanded process into the open.
A similar conspiracy of vested interests caused the credit crunch. Any banker, trader, investor, or economist asked to invent the perfect financial market environment for creating global wealth beyond the wildest dreams of avarice would have come up with a list of conditions similar to those that have prevailed for the past decade.
Like those of Burke and Hare, these good times have ended with an almighty bang, not a whimper, wiping out the nest eggs of millions of workers by destroying stock market values around the world, undermining ordinary savers' confidence in the safety of the banking system, and exposing deep fault lines in the philosophy of capitalism. The financial community, through a deadly combination of greed and hubris, fouled its own sandpit. The era of munificent money-making conditions -- regulation and oversight so gentle as to be almost invisible, ever-faster data and information flows, freely available credit at super-low interest rates, unprecedented access to investors all around the world, and oil-enriched buyers of any investment yielding north of zero -- is over.
The global financial authorities -- the elected politicians who decree the legal framework within which finance operates; the unelected central banks charged with tending the economy, the regulators responsible for creating and enforcing safety rules; the money managers entrusted with nurturing the future incomes of widows, orphans, and hordes of other savers; and the people paying themselves millions of dollars to run the investment banks -- all looked the other way. They operated under the belief that the monetary benefits accruing to society from incessant, unprecedented, and essentially unregulated growth in the securities industry more than outweighed any of the attendant risks.
In the U.S., the rising economic tide was seen to lift all boats, underlining the political triumph of capitalism over socialism and communism. In Europe, increased prosperity helped cement the decades-old dream of a common currency, binding nations closely enough to nullify the nagging conflicts that gave rise to two world wars, with the U.K. playing a supporting role as the unofficial treasurer to its continental, euro-embracing neighbors, even as it clung stubbornly on to its own currency. And across swathes of Asia, globalization and growing international trade helped fund the transition from agrarian to manufacturing economies, with governments offering compensatory affluence to avert discussions about democracy and voting systems, thereby blunting the risk of social unrest.
The list of credit crunch perpetrators is long. Realtors appraised houses at fictitious levels. Lenders granted mortgages to people who couldn't pay. Aspiring homeowners bought properties that they couldn't afford, taking on debt burdens they couldn't support. Frankenstein bankers cobbled together nasty parts of different markets, creating instruments they couldn't value or control. Credit rating companies stamped their highest seals of approval on nearly anything and everything that crossed their desks. Traders invented prices they couldn't justify. Investors bought securities they didn't understand. And there are thousands and thousands of fleas on the financial dog; armies of lawyers and accountants earned their livings during the past decade by scrutinizing deals or by getting paid to rubberstamp transactions.
The people in the world of high finance aren't stupid. For at least a decade, the finest graduates of universities all over the globe have been drawn to Wall Street and its counterparts in the world's biggest cities. Little wonder, then, that market regulators struggled to either find or retain talented staff, when the rewards for jumping the fence and becoming a poacher rather than a gamekeeper were so rich. Investment banks and hedge funds became employment black holes, sucking in talent to the detriment of arguably more productive, clearly less lucrative disciplines, such as engineering and science.
The credit crunch wasn't caused so much by a confederacy of dunces as by a silent conspiracy of the well rewarded. And most of the participants aren't fraudsters (albeit with some notable exceptions), nor are they evil or malicious. But everyone involved collectively suspended disbelief, a mass self-induced myopia to the possibility that anything could go wrong, because the financial rewards for playing along were so compelling.
Excerpted from Complicit by Mark Gilbert, with permission of Bloomberg Press (January 2010).
Mark Gilbert, author of Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable, is bureau chief for Bloomberg News in London, has been with Bloomberg News since 1991 and has written a regular column on global financial issues since 1998. He spent more than eighteen months warning about the impending credit crisis, later helping readers disentangle its consequences. He frequently appears as a commentator on Bloomberg Television.