Most Americans are now aware that something is seriously wrong with the real estate market in the United States. In addition, some Americans are also aware that a major investment bank, namely Bear Stearns, recently collapsed and had to be rescued by the Federal Reserve. Are these two events isolated occurrences, or is it the case that there are general problems with the U.S. financial system? If yes, what are these problems? Further, how did matters get to the state in which they now are? The purpose of Charles R. Morris’s The Trillion Dollar Meltdown is to shed light on these sorts of questions.
The book begins with a brief history lesson concerning what it calls “liberalism” and its eventual demise. We are told that the Keynesian version of political economy that was brought to Washington, D.C., by President Kennedy in 1961 was based on the basic precept that an “economic intelligentsia [can] reliably employ government levers to achieve specific outcomes in the real world.” This view of the role of the government gained traction for a while, with all manner of calls for the U.S. to emulate nations like Japan by formulating, inter alia, a clearly articulated industrial policy. However, as the limits of a Japanese-style industrial policy for the U.S. became clear along with the at-best limited role that the U.S. government could play as a “puppet-master,” liberalism was replaced by an alternate paradigm: monetarism. As the author helpfully points out, with monetarism firmly in place by 1980, the “theorists of the free market would get to run their race.”
We are told that although unfettered markets do work, they do so only up to a point. In particular, the lesson we ought to draw from the savings and loan debacle and the leveraged buyout (LBO) boom of the 1980s is that the loose regulation of financial markets poses unambiguous dangers. As Morris colorfully puts it, in “raw markets, the scent of money deadens all other sensory and ethical organs.”
The book does a good job of chronicling the salience of portfolio insurance as a tool for minimizing financial losses in the event of a market downturn. In this regard, we learn that portfolio insurance was one of a basket of hedging and trading technologies introduced by Wall Street to better serve its biggest customers - that is, mutual and pension funds. These arcane technologies were typically created by sophisticated professionals making extensive use of advanced mathematics, derivatives, and computer modeling.
A related move on Wall Street was to create “affordability products” like sub-prime mortgages. The idea here was to make housing available to people who otherwise would have a difficult time buying a home. On a positive note, because of the availability of sub-prime mortgages, the national rate of home ownership increased significantly. However, as is often the case, there can be too much of a good thing. Around 2003, mortgage lenders were running out of people to lend to. At that point, they should have stopped making loans. However, they did not. Instead, they “spread their nets to vacuum up prospects with little hope of repaying their loans.” The sub-prime mortgage crisis began when many such “prospects” began to default on their mortgage payments. In this regard, the extreme leveraging in the financial sector also contributed to the massive losses—frequently in collateralized debt obligations (CDO)—that investment banks such as Citigroup and Merrill Lynch incurred.
Morris does a very good job explaining some key facts about the contemporary international financial system. He notes that our current account deficits are largely being financed by foreigners such as the Chinese. What is particularly worrisome about this is that “large concentrations of cashlike dollar assets [are] held either directly by central banks or other government-controlled bodies.” When trillions of dollars in free cash are at the disposal of governments, it becomes important to know what these governments might do with the cash. This is particularly true because many of these governments holding large amounts of dollars are “in various degrees antidemocratic, repressive, or corrupt, often with shadowy ties to criminal or terrorist organizations inimical to the United States.” This insalubrious state of affairs, contends the author, should greatly concern Americans.
It is certainly possible to quibble with specific aspects of the general story told by the author in this book. Even so, there is no gainsaying the fact that The Trillion Dollar Meltdown is a thought-provoking book that ought to be read by everyone interested in learning about the genesis and the consequences of the contemporary credit crisis.