Calling the banking crisis two decades early...
IN NINETEEN EIGHTY-SEVEN, which is now more than twenty years ago, I published a book with James Dale Davidson, writes William Rees-Mogg for Whiskey & Gunpowder.
Some people still remember it for its title – Blood in the Streets – taken from a remark of Nathan Rothschild in 1815, at the time of Napoleon's hundred-day gamble that ended in his defeat at Waterloo.
"The time to buy," said Rothschild, "is when blood is running in the streets." The book attracted a good deal of attention at the time because it forecast the 1987 crash, which is still the largest fall in one day's trading on Wall Street.
I was in New York when the 1987 crash occurred.
I remember an Australian broker observing that he had fought in a foxhole in Vietnam and that he found the 1987 crash more frightening.
Certainly we are experiencing a time of panic now, but there have been panics before. Some of them, like 1987, have had a benign outcome, with a recovery in the months following the panic. James Davidson and I did not forecast the post-1987 recovery; we expected a recession. The recession of the early 1990s duly came, but it was only a recession, not a crash.
Even the ending of the dotcom bubble in 2000 did not produce a crash and certainly did not produce a depression. But the collapse of the US housing and mortgage bubble has proved much more worrying and has already destroyed the independence of Bear Stearns, Merrill Lynch, AIG, Lehman Bros, Fannie Mae, Freddie Mac, as well as in London, Northern Rock and HBOS, with various levels of loss for the shareholders.
When we were writing Blood in the Streets, we did foresee the significance of the housing market. There is a section in the book entitled The Coming Real Estate Crash. Indeed we were able to identify in 1987 several of the weaknesses of the world's political economy.
No, it is not much help forecasting a crash twenty years ahead of its happening, but there are elements in the analysis we then made which turned out to be valid when the crash occurred. The 2008 crash comes as a natural consequence of long-term systemic failures.
Blood in the Streets was written fourteen years before 9/11. We did specifically refer to the threat to the twin towers in a subsequent book, The Sovereign Citizen. There is also a paragraph in Blood in the Streets in which I think we can take some legitimate pride:
"No V-day over terrorism. Disorder today is far more threatening because of the collapsing scale. As the margins of American power recede at the periphery, the raw power of these groups rises. So does their ability to disrupt arrangements they do not like. They cannot be stopped, as World War II was stopped, by forcing the surrender of a large-scale network of command. There is no single chain of command that has the authority to stop terrorism. Nor can anyone negotiate a compromise to meet demands of many of the small groups now wielding military force."
We did foresee the significance of real estate and terrorism as factors that might undermine the stability of global finance. We also expressed concern about the reliability of the interbank market. "The danger of rapid deflation is more acute than it was in 1929. Why? Look no further than the geometric growth of the $700 billion interbank lending market. Each day US banks are involved in interlocking transactions that total as much as $700 billion. This is the banking equivalent of having hundreds of trapeze artists swinging through the air – to what everyone hopes will be a safe landing.
"If even one bank failed to make good on its commitments, the whole criss-crossing show could come tumbling to the ground. This means that a liquidity crisis and a loss of confidence could contract credit almost instantly – on a far wider reach than in the past."
That is a fair description of what has been happening in the last thirteen months.
We correctly foresaw the bail-out of weakened banks, and the losses for their shareholders. "Remember that a bail-out of the banking system, which the authorities will surely attempt in the event of a debt collapse, does not necessarily mean a bail-out of bank holding companies or shareholders. Depending upon the political climate and administration at the time the music stops, there might even be a de facto nationalization of major American banks – an outcome less far-fetched than it might seem. In a time of crisis, the government may be the only entity large enough to save the vulnerable banks."
Only the Federal Government was big enough to rescue AIG.
Told you so? Two decades too early, perhaps. But the US real estate market, terrorism, debt, interbank lending and nationalization of US banks have all figured in the development of the present crisis. We did not get every issue right, but we did identify in 1987 the underlying insecurity of the global financial system. What we failed to foresee was the timing of the crisis.
We saw its vulnerability, and pointed accurately to its weaknesses, but we did not see that so unstable a system could survive for twenty years of rapid economic and technological change.
Will the central banks now be able to restore confidence after the events of last week? It will be some months, perhaps years, before we know the answer to that question.