Some readers might wonder how a country with a high private debt ratio could reduce that ratio (or to use the technical word, deleverage). In theory, a country with a high private debt–to–GDP ratio could simply be disciplined and grow that debt no faster than GDP. If so, the ratio would improve.
However, that has almost never happened—especially over a long span.
Instead, private deleveraging in a given country has almost always occurred through one of three means: offsetting very high growth in public debt, which brings its own concerns; very high and sustained inflation, which is painful; or a very large net export position, which is hard to sustain without trade repercussions. Private debt deleveraging, absent any of these three things, reduces asset values (since increased debt is a key driver of those values) and has a contracting impact on GDP, bringing duress.
However, this deleveraging could be achieved through a broader strategy of debt restructuring or forgiveness. Yet approaches such as this are highly controversial, politically fraught, and laden with questions of fairness and redistribution—and have therefore almost never been widely used. Nevertheless, in 2009, a broad policy could have been put in place to allow lenders to write down the underwater portion of mortgages on terms that provided relief to borrowers, perhaps in exchange for participation in the gain on any future sale, and at the same time softened the impact to lenders through accounting and regulatory benefits. If implemented, it would have made a profound and positive difference in the pace of recovery and the resulting political environment.
In fact, the long-term secular trend for developed economies is toward ever-higher levels of debt, and this trend appears to be related to increasing inequality. Both are core, fundamental issues for policymakers, which makes the study of strategies for deleveraging all the more urgent. (Note that essentially the same conclusions are true of government debt deleveraging. Political promises notwithstanding, countries almost never grow their way out of high government debt without either very high growth in private debt, very high and sustained inflation, or a very large net export position.)
With what we know of financial crises, they can be foreseen and prevented, through data that are available by quarter, while the boom is growing. Some have asked me, Why bother—shouldn’t we let the free market run its course, and aren’t those who misbehave getting their just deserts?
No. It is never just those who misbehave that suffer the consequences. Thousands upon thousands of innocent people get hurt along the way. It is true that life does go on after a crisis, and solutions, however partial, are crafted. It is true that economies recover and go on, often robustly. It is also true that life is about much more than financial matters. Nevertheless, the effects of a financial crisis are devastating. Lives are ruined. Political parties and governmental systems are often overturned.
At the outset of this book, I contended that lending booms are caused by an intense desire to win, to prevail, and to increase wealth—by a ferocity of ambition that is ever present and incites, compels, and pervades these booms. I contended that this ambition is the equivalent of a computer company’s desire to sell more computers, a coach’s desire to win championships, or, for that matter, a king’s desire to conquer new territories. Yet I would add one thought: because of the lending industry’s scope, its high leverage and inherent risk, its privileged ability to create vast amounts of new money and with it new demand, and its ability to bring the risk of overextension and default to its customers, this ambition in the lending industry can almost uniquely lead to much greater harm than the same ambition in any other arena. That is the message of this book.
It is our responsibility to understand, predict, and prevent financial crises; this is our duty to our fellow citizens and to the well-being of our country.
NOTES
Introduction
1. Carmen M. Reinhart and Kenneth S. Rogoff, This Time Is Different (Princeton: Princeton University Press, 2009).
2. I developed a list of the major financial crises in these six countries over the last two hundred years, starting with seven excellent lists that I modified based on my own research and judgment. These lists come from the following scholars: Carmen Reinhart and Kenneth Rogoff; Moritz Schularick, Alan Taylor, and Òscar Jordà; Christina Romer and David Romer; Luc Laeven and Fabian Valencia; Michael Bordo, Barry Eichengreen, Daniela Klingbiel, and Maria Soledad Martinez-Peria; Gerard Caprio and Daniela Klingbiel; Matthew Baron, Emil Verner, and Wei Xiong.
In their work, Laeven and Valencia develop a useful definition of a financial crisis. For them, a financial crisis includes extensive bank failures or nationalization, extensive liquidity support for lenders, high bank restructuring gross costs, large government credit guarantees or bank asset purchases, and deposit freezes or bank holidays.
In this book, I use the terms financial crisis and banking crisis interchangeably and use them in the general sense of Laeven and Valencia’s definition. The term banking crisis is intended to encompass crises involving all types of lenders, not just banks.
This is not an exhaustive list, but these are the crises that I view as the most major and worthy of study. For example, Rogoff correctly counts the failure of the French Comptoir d’Escompte in 1889 as a crisis. It had a large share of the French banking market, collapsed spectacularly after colluding with another firm to corner the copper market, and was rescued by the French central bank, the Banque de France. But the crisis did not extend far beyond this single bank. Since it does not appear to have been symptomatic of a broader trend in the French economy, I did not include it in my list.
3. Steve Keen, “The Macroeconomics of Endogenous Money: Response to Fiebiger, Palley and Lavoie,” Review of Keynesian Economics 3, no. 4 (2015): 602–11.
4. Hyman P. Minsky, Stabilizing an Unstable Economy (New York: McGraw-Hill, 2008).
5. In addition to private debt, the worksheets for our analysis included, where available, bank balance sheet data, such as loans, deposits, capital, specie (gold and other precious metals), bank failures, charge-offs, delinquency rates, foreclosures, loans from secondary lenders, interest rates, stock market indices, inflation, exchange rates, trade, unemployment, sector spending and debt information, and commodity prices. Databases included data from each country’s central bank, the International Monetary Fund, the World Bank, the Bank for International Settlements, the U.S. Census, and the American Railroad Journal, Moody’s, and Poor’s. Invaluable help has come from the research of the National Bureau of Economic Research and the extraordinary work of Schularick, Taylor, and Jordà. Many studies of historical debt booms only use bank loan data, which is a piece of private debt, but does not capture all forms, such as corporate bonds and nonbank lenders.
6. This is the state many Western economies found themselves in during the years following the 2008 crisis and Japan found itself in after its 1990s crisis because the deleveraging that occurred after these crises was modest. This overhang of debt dampens growth because, with still-high levels of debt, both business and household borrowers use funds to pay interest and principal that would likely otherwise have gone to spending on goods and services. Being highly leveraged also curbs their willingness to borrow more, no matter how attractive the terms.
Chapter 1
1. Adam Hochschild, Spain in Our Hearts: Americans in the Spanish Civil War, 1936–1939 (New York: Houghton Mifflin Harcourt, 2016), 6–8.
2. Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867–1960 (Princeton: Princeton University Press, 1993), 354–55.
3. John Kenneth Galbraith, The Great Crash of 1929 (Boston: Mariner, 1954), 169.
4. According to Robert Fitch in The Assassination of New York (New York: Verso, 1993, p. 57), office vacancy rates ranged between 0 percent and 5 percent in 1929. By 1933, however, that figure had surpassed 30 percent. An astute reader might ask why a time four years past the stock market crash should be emphasized. As Fitch argues—and as Jason M. Barr demo
nstrates in his recent study of Manhattan skyscrapers—real estate development did not slow across all sectors in 1929. In fact, many real estate brokers saw their activity as completely separate (and therefore insulated) from the crash. Therefore, they saw no reason to halt construction. As the United States entered the worst economic depression in its history, the erection of skyscrapers in New York continued on an upward trajectory, ultimately peaking in 1931. See Jason M. Barr, Building the Skyline: The Birth and Growth of Manhattan’s Skyscrapers (New York: Oxford University Press, 2016), 294.
5. Herbert Hoover, “Introduction,” in John M. Gries and James S. Taylor, How to Own Your Home: A Handbook for Prospective Home Owners (Washington, DC: Government Printing Office, 1923), v.
6. Donald L. Miller, Supreme City: How Jazz Age Manhattan Gave Birth to Modern America (New York: Simon and Schuster, 2014), 170.
7. Robert M. Fogelson, The Great Rent Wars: New York, 1917–1929 (New Haven, CT: Yale University Press, 2013), 35.
8. U.S. Bureau of the Census, “Selected Assets and Liabilities of Savings and Loan Associations: 1900 to 1970,” in Historical Statistics of the United States: Colonial Times to 1970, Part 2 (Washington, DC: Government Printing Office, 1975), 1047.
9. Exposing a scandal that had been covered for over seventy years, historian Raymond Vickers retrieved bank documents from the 1920s that demonstrated the ways in which a handful of lenders engaged in large-scale fraud and misappropriated depositors’ funds in order to finance real estate projects. See Raymond Vickers, Panic in Paradise (Tuscaloosa: University of Alabama Press, 1994).
10. Jihad Dagher, “Regulatory Cycles: Revisiting the Political Economy of Financial Crises” (IMF Working Paper WP/18/8, January 2018), 18.
11. Earle Shultz and Walter Simmons, Offices in the Sky (Indianapolis: Bobbs-Merrill, 1959), 154 and 162, quoted in Barr, Building the Skyline, 281.
12. Daniel Okrent, Great Fortune: The Epic of Rockefeller Center (New York: Penguin, 2004), 251–52.
13. Fitch, Assassination of New York, 57.
14. Galbraith, Great Crash, 5–6.
15. Harold Bierman Jr., The Causes of the 1929 Stock Market Crash: A Speculative Orgy or a New Era? (Westport, CT: Greenwood, 1998), 85–102. Bierman also discusses the role of utility stocks in the 1929 crash in an article on the Economic History Association’s website. See Harold Bierman Jr., “The 1929 Stock Market Crash,” EH.net, accessed November 14, 2018, http://eh.net/encyclopedia/the-1929-stock-market-crash/.
16. Forrest McDonald, Insull: The Rise and Fall of a Billionaire Utility Tycoon (New York: Beard, 1962), 124–33.
17. The Federal Trade Commission hearings lasted seven years, from 1928 to 1935, and examined “29 holding companies, 70 sub-holding companies, and 278 operating companies having combined total assets of $19,038,698,378.” The investigation concluded that these assets were overvalued by at least $1.5 billion. See Annual Report of the Federal Trade Commission (Washington, DC: Government Printing Office, 1936), 34.
18. McDonald, Insull, 278.
19. Following the news that President Coolidge would not run for a second term, then Secretary of Commerce Herbert Clark Hoover accepted the nomination at the 1928 Republican National Convention in Kansas City, Missouri. That Hoover’s speech was replete with optimism about the prospect of soon eradicating poverty is ironic, considering the financial collapse a little over a year later and subsequent depression. See “Herbert Hoover’s Acceptance Speech: Formally Accepting the Republican Nomination for President of the United States” (Washington, DC: Republican National Committee, 1928).
20. Infamous for their timing, these pronouncements have achieved an almost mythic status. Repeated across blogs, scholarly and commercial studies, and even in textbooks designed for undergraduates, Forbes and Fisher’s statements have become emblematic of how blatantly out of touch supposed experts can be with financial trends. See Maureen Burton, Reynold F. Nesiba, and Bruce Brown, An Introduction to Financial Markets and Institutions (New York: Routledge, 2010), 300.
21. U.S. Department of Transportation, Federal Highway Administration, “Chart VMT-421C: Public Road Mileage–VMT–Lane Miles, 1920–2013,” last modified November 7, 2014, https://www.fhwa.dot.gov/policyinformation/statistics/2013/vmt421c.cfm; Susan B. Carter (ed.), “Table Df956–963. Railroad passenger and freight operations-per-car and per-train traffic volume, and speed: 1890–1980,” Historical Statistics of the United States, Millennial Edition (Cambridge, UK: Cambridge University Press, 2006).
22. Lendol Calder, Financing the Great Depression (Princeton: Princeton University Press, 1999), 262–90.
23. Not only the creator of the real estate bond market but also the most prominent financier of iconic skyscrapers—including the Westinghouse building, New York Athletic Club, Chrysler Building, and Ziegfeld Theaters—S. W. Straus was also, ironically, a moralizing “thrift” evangelist. His 1920 essay, “History of the Thrift Movement in America,” is a condemnation of Americans’ wastefulness, excess, and overindulgence. Recently, this essay has been made available in an illustrated book format. See S. W. Straus and Rollin Kerby, The History of the Thrift Movement in America (New York: Kessinger, 2010).
24. After evidence surfaced that Mitchell had engaged in illegal transactions, speculating on company stock, and tax evasion, he resigned his post at National City. As a result, he became a convenient target for government officials bent on tightening regulation. The Securities Act of 1933, alongside the Banking Acts of 1933 (popularly known as the Glass-Steagall Act) and 1935, are largely considered to be responses to the kind of behavior Mitchell emblematized. See Thomas F. Huertas and Joan L. Silverman, “Charles E. Mitchell: Scapegoat of the Crash?” Business History Review 60 (Spring 1986), 81–103.
25. Tom Nicholas and Anna Scherbina, “Real Estate Prices During the Roaring Twenties and the Great Depression,” Real Estate Economics 41 (Summer 2013), 306.
26. Ibid.
27. A fairly well-known and oft-cited speech, this excerpt appears in many studies of real estate development during the Roaring Twenties. See Stephen L. Trampe, The Queen of Lace: The Story of the Continental Life Building (St. Louis: Virginia Publishing, 2013), 153.
28. Eugene N. White, “Lessons from the Great American Real Estate Boom and Bust of the 1920s,” in Housing and Mortgage Markets in Historical Perspective, ed. Eugene N. White, Kenneth Snowden, and Price Fishback (Chicago: University of Chicago Press, 2014), page 126, note 15. White, in turn, cites Anna J. Schwartz, “The Misuse of the Fed’s Discount Window,” Federal Reserve Bank of St. Louis Review 74 (1992), 58–69.
29. For more information on Charles Ponzi, see Mitchell Zuckoff, Ponzi’s Scheme: The True Story of a Financial Legend (New York: Random House, 2006).
30. Quoted in “Secretary of Treasury Andrew W. Mellon Looks for Revival of Industrial Activity in Spring and Steady Progress During 1830,” Commercial and Financial Chronicle 130 (January 4, 1930), 21.
31. Robert F. Bruner et al., “Financial Innovation and the Consequences of Complexity: Insights from Major US Banking Crises,” in Complexity and Crisis in the Financial System: Critical Perspectives on the Evolution of American and British Banking, ed. Matthew Hollow et al. (Cheltenham, UK: Edward Elgar, 2016), 28; Encyclopedia.com, “Banking Panics (1930–1933),” accessed November 14, 2018, https://www.encyclopedia.com/economics/encyclopedias-almanacs-transcripts-and-maps/banking-panics-1930-1933; Christopher Gray, “The First Domino in the Depression,” New York Times, August 18, 1991.
32. Referenced in Kenneth A. Snowden Jr.’s essay, “The Anatomy of a Residential Mortgage Crisis: A Look Back to the 1930’s,” in The Panic of 2008: Causes, Consequences, and Implications for Reform, ed. Lawrence Mitchell and Arthur E. Wilmarth (Cheltenham, UK: Edgar Elgar, 2010), 60–61. For a full brief, see Henry Hoagland, “The Relation of the Work of the Federal Home Loan Bank Board to Home Security and Betterment,” Proceedings of the Academy of Political Science 16, no. 3 (1935), 45–52.
33. Natacha Postel-Vinay
, “What Caused Chicago Bank Failures in the Great Depression? A Look at the 1920s,” Journal of Economic History 76 (June 2016), 480.
34. Irving Fisher, “The Debt-Deflation Theory of Great Depressions,” Econometrica 1, no. 4 (1933), 337–57.
35. Federal Housing Finance Agency, Office of Inspector General, “A Brief History of the Housing Government-Sponsored Enterprises,” https://www.fhfaoig.gov/, accessed November 14, 2018, https://www.fhfaoig.gov/Content/Files/History%20of%20the%20Government%20Sponsored%20Enterprises.pdf.
36. Gary Richardson, Alejandro Komai, and Michael Gou, “Roosevelt’s Gold Program,” federalreservehistory.org, November 22, 2013.
37. Timothy Green, Historical Gold Price Table, World Gold Council (London prices converted to U.S. dollars), retrieved from the National Mining Association, “Historical Gold Prices, 1833–Present,” https://nma.org/, accessed November 14, 2018, https://nma.org/wp-content/uploads/2017/02/his_gold_prices_1833_pres_2017.pdf.
38. Carl Mosk, Japanese Economic Development: Markets, Norms, Structures (New York: Routledge, 2008), 136.
39. Takashi Nanjo, “Developments in Land Prices and Bank Lending in Interwar Japan: Effects of the Real Estate Finance Problem on the Banking Industry,” Monetary and Economic Studies 20, no. 3 (October 2002), 120.
40. Charles Kindleberger, Historical Economics: Art or Science? (Berkeley: University of California Press, 1990), 313.
Chapter 2
1. Board of Governors of the Federal Reserve System, “Z.1, Table D.3, Debt Outstanding by Sector,” from Data Download Program, https://www.federalreserve.gov/datadownload/Choose.aspx?rel=Z.1; U.S. Bureau of Economic Analysis, National Data, National Income and Product Accounts, “Table 1.1.5. Gross Domestic Product,” accessed November 14, 2018, https://apps.bea.gov/iTable/iTable.cfm?reqid=19&step=2#reqid=19&step=2&isuri=1&1921=survey.
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