After the Fall

It’s a decade and a bit since the global financial crisis (GFC) began. For the people inside the system that caused this decade of untold misery, there’s been little or no change. For everyone else, it’s been a decade of misery.

By John Lanchester and cross-posted from the London Review of Books

Some of the more pessimistic commentators at the time of the credit crunch, myself included, said that the aftermath of the crash would dominate our economic and political lives for at least ten years. What I wasn’t expecting – what I don’t think anyone was expecting – was that ten years would go by quite so fast. At the start of 2008, Gordon Brown was prime minister of the United Kingdom, George W. Bush was president of the United States, and only politics wonks had ever heard of the junior senator from Illinois; Nicolas Sarkozy was president of France, Hu Jintao was general secretary of the Chinese Communist Party, Ken Livingstone was mayor of London, MySpace was the biggest social network, and the central bank interest rate in the UK was 5.5 per cent.

It is sometimes said that the odds you could get on Leicester winning the Premiership in 2016 was the single most mispriced bet in the history of bookmaking: 5000 to 1. To put that in perspective, the odds on the Loch Ness monster being found are a bizarrely low 500 to 1. (Another 5000 to 1 bet offered by William Hill is that Barack Obama will play cricket for England. I’d advise against that punt.) Nonetheless, 5000 to 1 pales in comparison with the odds you would have got in 2008 on a future world in which Donald Trump was president, Theresa May was prime minister, Britain had voted to leave the European Union, and Jeremy Corbyn was leader of the Labour Party – which to many close observers of Labour politics is actually the least likely thing on that list. The common factor explaining all these phenomena is, I would argue, the credit crunch and, especially, the Great Recession that followed.

Perhaps the best place to begin is with the question, what happened? Answering it requires a certain amount of imaginative work, because although ten years ago seems close, some fundamentals in the way we perceive the world have shifted. The most important component of the intellectual landscape of 2008 was a widespread feeling among elites that things were working fine. Not for everyone and not everywhere, but in aggregate: more people were doing better than were doing worse. Both the rich world and the poor world were measurably, statistically, getting richer. Most indices of quality of life, perhaps the most important being longevity, were improving. We were living through the Great Moderation, in which policymakers had finally worked out a way of growing economies at a rate that didn’t lead to overheating, and didn’t therefore result in the cycles of boom and bust which had been the defining feature of capitalism since the Industrial Revolution. Critics of capitalism had long argued that it had an inherent tendency towards such cycles – this was a central aspect of Marx’s critique – but policymakers now claimed to have fixed it. In the words of Gordon Brown: ‘We set about establishing a new economic framework to secure long-term economic stability and put an end to the damaging cycle of boom and bust.’ That claim was made when Labour first got into office in 1997, and Brown was still repeating it in his last budget as chancellor ten years later, when he said: ‘We will never return to the old boom and bust.’

I cite this not to pick on Gordon Brown, but because this view was widespread among Western policymakers. The intellectual framework for this overconfidence was derived from contemporary trends in macroeconomics. Not to put too fine a point on it, macroeconomists thought they knew everything. Or maybe not everything, just the most important thing. In a presidential address to the American Economic Association in 2003, Robert Lucas, Nobel prizewinner and one of the most prominent macroeconomists in the world, put it plainly:

Macroeconomics was born as a distinct field in the 1940s, as a part of the intellectual response to the Great Depression. The term then referred to the body of knowledge and expertise that we hoped would prevent the recurrence of that economic disaster. My thesis in this lecture is that macroeconomics in this original sense has succeeded: its central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades.

Solved. For many decades. That was the climate of intellectual overconfidence in which the crisis began. It’s been said that the four most expensive words in the world are: ‘This time it’s different.’ We can ignore the lessons of history and indeed of common sense because there’s a new paradigm, a new set of tools and techniques, a new Great Moderation. But one of the things that happens in economic good times – a very clear lesson from history which is repeatedly ignored – is that money gets too cheap. Too much credit enters the system and there is too much money looking for investment opportunities. In the modern world that money is hotter – more rapidly mobile and more globalised – than ever before.

Ten and a bit years ago, a lot of that money was invested in a sexy new opportunity created by clever financial engineering, which magically created high-yielding but completely safe investments from pools of risky mortgages. Poor people with patchy credit histories who had never owned property were given expensive mortgages to allow them to buy their first homes, and those mortgages were then bundled into securities which were sold to eager investors around the world, with the guarantee that ingenious financial engineering had achieved the magic trick of high yields and complete safety. That, in an investment context, is like claiming to have invented an antigravity device or a perpetual motion machine, since it is an iron law of investment that risks are correlated with returns. The only way you can earn more is by risking more. But ‘this time it’s different’…

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