The Debt Wars
In ‘Collateral Damaged: The Marketing of Consumer Debt to America’, Charles Geisst, a well known economic historian whose credits include the well regarded and best selling ‘Wall Street: A History’, documents the rise of debt in the U.S.
Starting in the 1920s, Geisst traces the increased use of borrowing and seeks to explain the ‘progress’, if that is appropriate phraseology, of America from a nation of savers into the world’s largest borrower. ‘Collateral Damaged’ is a well researched history of debt in America documenting the key steps in the build-up of borrowing that created the environment for the Global Financial Crisis (“GFC”).
Geisst’s analysis perhaps over emphasises the role of financial institutions as merchants of debt, selling loans to those who cannot afford it. He underestimates some the social factors that underlie the growth of debt including the effect of de-industrialisation of the 1980s and the lack of growth, after adjustment for inflation, of income for many sectors of the economy. It underestimates the effect of job insecurity and the social pressures in an increasingly consumerist society where what we own defines us in the growth of debt. To the extent that people borrowed to purchase real estate or stocks in the hope of gain, George Bernard Shaw’s connection between speculation and wealth, especially amongst those without money, remains relevant: “Gambling promises the poor what property performs for the rich, something for nothing.”
The impact of global capital flows on the creation of debt could have been covered more than it is. The demand for international investors for high quality dollar investments was also crucial in the entire securitisation process that underwrote some of the excessive growth in debt.
If Geisst’s ‘Collateral Damaged’ is a detached history of the conditions that created the debt war, then Ásgeir Jónsson’s ‘Why Iceland?’ is a bullet riddled missive from the frontlines.
Jónsson, the Chief Economist of Kaupthing Bank, the country’s largest bank before its collapse, provides a fascinating insight into how Iceland’s economy was transformed from its fishing and geothermal energy roots into a player in world finance. In the course of this evolution, a nation of 300,00 people created a banking system that had borrowed several times its GDP.
It is unsurprising that Iceland came to be regarded as the country that was actually a hedge fund. Ironically, the very factors which were to lead to its ignominious demise in late 2008 were the very same that made it, at least for a time, one of the global economy’s great success stories.
‘Why Iceland?’ documents Iceland’s collapse in considerable detail using the author’s close knowledge of behind-the-scenes events including the now under investigation meeting in January 2008 when a group of international hedge fund managers gathered in a bar in Reykjavik to discuss Iceland’s economy. The book is well balanced and but sometimes edges into easy answers such as gratuitous blaming foreign banks and hedge funds.
Despite the occasional lapse into economics-speak (apparently Icelandic economics was not different from that practised in the U.K. and the U.S.A.), the book provides an interesting history of the events that led to the collapse of the Icelandic economy. At a fundamental level it provides useful insights into how small open economics in the age of debt both prospered and became over-extended with apparent ease offering useful lessons for those few that are interested.
Iceland’s demise led to some of the worst jokes of the GFC. “Icelandic expertise in C-O-D fishing led to an ill-advised foray into C-D-O investments.” “The capital of Iceland? About Euro 20.” A tongue-in-cheek notice on eBay offered Iceland for sale: “Located in the mid-Atlantic ridge of the North Atlantic Ocean, Iceland will provide the winning bidder with a habitable environment, Icelandic horses and admittedly a somewhat sketchy financial situation.” It also spawned a board game – The Crisis Game.
Perhaps the most memorable thing to emerge from the Icelandic collapse is a term – ‘Kreppa’ economics, sometime shortened to Kreppanomics. ‘Kreppa’ in Icelandic, apparently, means “in a pinch” or “to get into a scrape”. It provided a graphic description of the disastrous meltdown of not only Iceland but also the global economy.
The reality is that the build up of debt at both an individual or country level beyond a certain point is simple Kreppanomics. Current belief in the recovery story and sharp financial market rallies fail to recognise that little has actually changed since the GFC began.
Fundamental failures have not been fully addressed. The required reduction in debt levels has not been completed. Increases in government debt have substantially offset reductions in private sector debt. Instead of dealing with the problem of leverage, the debt has also merely been rolled forward through a variety of clever warehousing structures and the manipulation of accounting rules.
It seems that the world is still practising Kreppanomics and the debt wars are far from over.
© 2009 Satyajit Das All Rights reserved.
Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall).
