IN the end, Merlin turned out a damp squib. This is goodish news, because the deal is based on a faulty interpretation of the crisis. Here are the ten most important causes of our problems.
1) Loose, ultra-interventionist monetary policy from central banks that kept stepping in whenever growth slowed or the stock market fell. Interest rates were kept too low; the belief was that as long as consumer prices didn’t surge, the economy would be stable. The money supply and credit exploded, and investors became complacent, fuelling bubbles.
2) Global imbalances, exacerbated by government intervention: nationalised savings, forex manipulation and sovereign wealth funds in China, Japan and the Middle East, combined with unfunded state pensions and profligate governments in the West. Asia did all the saving and financed budget and trade deficits in the West, which spent too much and didn’t produce enough. Asia purchased trillions of Western assets, especially bonds, pushing down yields and pumping the world full of cheap money.
3) There was no bankruptcy code for failed multinational banking groups. Regulatory stupidity meant that they were treated like ordinary firms: the choice was either a disorganised collapse, or a bail-out. Other network industries – airports, nuclear plants – have long operated under special bankruptcy codes, ensuring an orderly wind-down and handover of assets. Unlike every other private businesses, big banks knew they would never be allowed to go bust. So they took too many risks and leveraged themselves to the hilt, to maximise returns on capital (and hence profit and pay); while lending criteria were slowly loosened.
4) Bondholders knew they would be bailed out. This meant that shareholders had access to cheap, state-insured credit. This promoted leverage to maximise upside; debtholders didn’t care.
5) Depositors knew they would be bailed out by the state so didn’t monitor banks’ soundness. Property investors convinced themselves prices would never fall. Financially illiterate consumers borrowed recklessly.
6) Intellectual errors concerning the modelling of risk, the power of diversification, default chances, complete markets, liquidity and the existence of bubbles. These were caused by the neo-classical general equilibrium paradigm prevalent in universities, central banks and the private sector.
7) One result of 6) was that firms were forced to follow mark-to-market accounting rules. Liquidity problems became a solvency crisis.
8) As a result of 3)-7), institutions held insufficient capital and the wrong kind of capital, a problem compounded by off-balance sheet vehicles. These arrangements were all approved of by international regulators, the Basel accords and accounting rules.
9) US politicians’ promotion of homeownership among groups shunned by lenders. This involved legislation and the use of the state-chartered Fannie Mae and Freddie Mac to promote and securitise sub-prime mortgages. While dodgy loans were eventually embraced by Wall Street, their origin lay in Washington.
10) Other errors: AIG misused credit default swaps, writing insurance against losses yet not keeping enough capital to make good on its promises. Credit rating agencies – whose number was limited by regulators – failed miserably.
None of these points are addressed by Merlin. It deserves to fail.
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