Sunday, September 20, 2009

The two trillion dollar meltdown - Charles Morris

I had at least three reasons for not reading Charles Morris' The Two Trillion Dollar Meltdown. (1) It is being pumped up as an 'I told you so', and let's just say I am sceptical; (2) It has an over-the-top sub-title that I am not crazy about ('Easy money, high rollers, and the great credit crash'); and (3) A personal tick, I don't like books with a number in their title - they always ends up being too simplistic.

But read the book I did, thanks mostly to a Brick and Rope reader who encouraged me on. Glad he did.

The Two Trillion Dollar Meltdown is (another) story of how the wheels came off the American financial services industry in 2007-2008. Economic historian Charles Morris, the story goes, was running a financial software company in 2005, working with some of the top financial companies. Looking at how his software was being used, and the kind of instruments that were getting popular on Wall St, he got convinced that things couldn't possibly end well. He started writing the book on what was going to go wrong and how things were going to break. By the spring of 2007, reality started overtaking events in his crystal ball. The book was published then under the title The Trillion Dollar Meltdown, with the number being Morris' estimate of the total bill the economy would need to pick up. A year later, when it is time for the paperback to be published, the title has been updated to Two Trillion. Enough said.

In the book, Morris tries something that has become rather difficult to pull off in the polarized times we live in - he tries to walk a centrist path. Not too liberally Keynesian. Not too conservatively Chicago School. That is one of the great strengths of The Two Trillion Dollar Meltdown. The other is Morris' easy felicity with words. The pace is set early. In the foreword, Morris writes -
At its core, [this is] a crisis of the classic 'Argentinean' variety - a debt-fed party, marked by a consumer binge on imported goods, and the strutting of an ostentatious new class of super-rich, who had invented nothing and built nothing, except intricate chains of paper claims that duller people mistook for wealth.
I was hooked. Informed and articulate? Isn't that refreshing?

Morris' broader thesis on American economic history provides the bookends between which he lays out his story of what led to the particular crisis of 2007/8. His thesis is this: The ruling political / economic consensus in America alternates between liberal and conservative in roughly 25-30 year cycles. The liberal, Keynesian view believes in an active role for government in the economy and in a regulatory environment that sets up the rules of the game every player needs to follow. The conservative, Chicago School / Milton Friedman view holds that a free market always finds the best answer and the role of government is to get everything out of the market's way. The long government-centric policy making of the '60s, in Morris' view, led to the 'Great Inflation' of the '70s which Paul Volcker broke with his 'forced recession'. With the election of Reagan in 1980, the Chicago School took over in Washington and what followed was 25+ years of continuous financial deregulation and 'markets know best' thinking in Washington. But, Morris goes on, both schools of thought suffer from a problem - they can't control their own excesses.

In the early days of a cycle, the new ways of thinking are like a fresh breeze that blows away the mythologies of the past. Inevitably, through a kind of Gresham's law of
incumbency, breezes become doldrums, and leaders get trapped in mythologies of their own. Liberal cycles inevitably succumb to the corruptions of power, conservative cycles to the corruptions of money.

In talking about the details of how we ended up here, The Two Trillion Dollar Meltdown has some remarkably simple explanations of the key financial instruments created in recent years - stuff that can easily bog a book down end up being some of the stronger points of this one. I particularly enjoyed Morris' clear explanations of credit derivatives.

So in the end, what does Morris propose? What is the way out? To his credit, he doesn't offer any silver bullet. No sound-bite answers in this book! To begin with, Morris states what he thinks is not the right answer -

The prosperity of the 2000's was fake, based on massive consumer borrowing on bubbly-priced assets. Now consumers are deeply in debt, and the price of the favored assets are falling, while both employment and incomes are falling along with them. Pouring out ever more dollars in the hope of recovering the zing of the old bubble days is exactly the wrong prescription, and risks making eventual outcomes far worse than they need to be.

We need, The Two Trillion Dollar Meltdown suggests, to 'recover balance' between the two economic schools of thought. We need to forget about irrelevant side-shows like regulating hedge funds and go back to the hard basics. Go back, in other words, to the old 'Washington Consensus' that the IMF / World Bank combine so often forced on developing countries. In Morris' words -

It's time that we take the same harsh measures we have long preached to other countries. ... Consumption has to fall, by at least 4-5 percent of GDP, and the money has to be shifted to savings and investment. The hypertrophied financial sector has to shrink drastically. And we have to run down the huge overhang of dollar-based debt by producing more than we buy for the first time in a long time - in effect, by working harder and living poorer.

As a banker, I groan. As a citizen of the world, I say 'Amen'.


  1. At what speed do you read ? When do you get time to work ?
    Unless this last book was a quick 50 pager - and it doesn't sound like one - I suspect your blog has a ghostwriter (who likes reading the same books as you) or you are extremely skilled in the art of boss management.

  2. :) I must admit there is a little bit of your last hypothesis involved here! Work has been lighter than normal recently. I hope it lasts.

  3. Haven't read the book, but seems like he might be making the same mistake that American economists have made for the last 50 years. Felt the same way about Paul Krugman's recent longish article in NYT.

    Seems all American economist can think about is Keynesian or Chicago, with some very minor variations. If they look around with some humility, they will find that some other countries have managed monetary policy and financial sectors far more successfully than the US. And these are not countries which were prescribed this medicine by the US or IMF.

  4. Totally agree with you on the Krugman article (I am guessing you are referring to 'How did economists get it so wrong'). And you are right, Morris explicitly states that the country has been going from one of these philosophies to the other, that we have been on the Chicago end for a while now and 'it is time for the pendulum to swing back' a little. Assumes implicitly of course that the only choice is for a pendulum that goes between these two extremes or picks a point somewhere in between. What other orthogonal models are you a fan of?

  5. I don't know if models or theoretical constructs are the solution - past few quarters seem to suggest that managing the economy is an intuitive, touch and feel, see and react process than trusting a broad theory. The global economy and global finance seems to have moved far ahead of theory. The Chinese seem to be doing a good job of managing their economy, and yet economists do not even know what the Chinese 'model' is. India has also been relatively unaffected by the various crisis in the past 15 years than most countries - we should give some credit there.