The Ascent of Money
In The Ascent of Money (2009), Niall Ferguson begins by talking about paper money as it exists today. Today we live in a world built on the exchange of money, which would have been impossible without the role of trust or the invention of credit. He follows the birth of credit to 16th century Venice and then Florence, where modern banking was born, and then brings us back to the contemporary period by talking about banks (in the very recent past) willing to give a loan to just about anyone. They came to realize how they could still make money when so many low-income debtors were late on their obligations. Today filing for bankruptcy is commonplace. From 1996-2006, there were between 1 and 2 million bankruptcy cases in the U.S., more often than not because people didn’t fulfill obligations. According to Ferguson, bankruptcy has become as much an inalienable right in the U.S. as life, liberty and the pursuit of happiness. For one, America encourages an entrepreneurship culture, where borne risk takers don’t get wiped out as they learn how to make that first million. It’s a theory that seems to work: the bankrupted today could become the millionaire tomorrow. Because of this, banks count on the fact that a number of their loans will go bankrupt. But, if banks are so used to dealing with bankruptcy, why could so many have collapsed in the past year?
Niall Ferguson takes us to what he calls the “epicenter of the crisis”: the real estate market. He develops a metaphor between contemporary ideas regarding property with the game of Monopoly. Monopoly, Ferguson says, teaches us that it is smart to own property, and it’s smart to lend money to those that own property. There is nothing safer than lending money to those that own real estate. Even if the money runs away, the property won’t. While some say that “property owning democracy” is something the whole world should adopt, others disagree arguing that sub prime borrowers, people who formerly rented, should still be renting! Today we have let our love affair with real estate get completely out of proportion. Today we take the universal right to own our own home for granted.
During the Great Depression for example, there was a divide between those who favored private property and those who favored common ownership. This idea was well illustrated by Diego Rivera’s in his mural of the situation in Detroit. After the 1930’s, Fannie Mae set out to create a nation wide market for loans. By reducing the average cost of a loan, it made owning a home possible for many more Americans. According to Niall Ferguson, it’s not too much to say that America and its suburbs were born out of these New Deal reforms. However, not everyone in America though had an invitation to the property owning party. It was part of the system that divided the city: segregation (direct consequence of federal policy although not intentional). In the 1960’s, this divide was the hidden dimension of the civil rights struggle: blacks were excluded from property owning.
In the years leading up to the financial crisis, G.W. Bush publicly announced that he “wanted everyone in America to own their own home”. So many of the new borrowers had patchy credit history: no property, no job, no credit history was the perfect candidate. How come the lenders weren’t worried that these sub-prime borrowers weren’t going to default? One reason was securitization. Instead of putting their own money at risk, subprime lenders immediately sold them to banks that securitized them. They would be categorized as triple A securities to people far away who would pay an extra hundredth percent in interest. The key to securitization was the distance between those receiving interest payments and those selling them. People receiving the payments had no idea the risk involved.
At the same time, markets were deregulated and new synthetic instruments were designed. As interest rates stayed low, people kept their jobs and real estate prices continued to rise. As prices were going up, people would lend without even asking your income, credit history, or house value. And when the sub-prime mortgage market turns sour, as it did in early 2007, there have been rippleffects throughout the globe. While property was formerly viewed as one of the best forms of investment or “the simplest way of getting rich”, because houses are fairly illiquid, when assets go, you can’t get rid of them quickly. Japan experienced this problem in the 1990’s when the bubble burst after property prices had risen by a factor of three in the 1980’s.
According to Niall Ferguson, “stock markets can be like soap bubbles you never know when they are going to burst. When we think of stock market bubbles, we think of Black Thursday: October 24th, 1929 when asset price deflation was accompanied by the worst depression in history with unemployment reaching 25 percent. Why did the 1929 crash happen and why do stock market crashes happen in general? Much of it has to do with credibility. Often the smartest investors can be culprit of “exalted exuberance”. When there is a build-up of fear, people run; buyers turn to sellers.
One example is ENRON, the most innovative company in America for six years as well as the pioneer of many of the practices still plaguing the market today. As the 5th largest company in the U.S., the diamond of Wall Street, shares of ENRON had gone through the roof. If you came up with a good idea, ENRON would give you the money and you could go for it. With Bush pushing legislation on energy industry privatization through Congress, and the largest gas pipeline in the world was being laid in South America, ENRON stock prices continued to rise.
While ENRON claimed that they played by the rules and always did what they said they were going to do, the ENRON system was an elaborate fraud that had produced inflated stocks. ENRON had removed its debt from the balance sheets and hid it under dubious names; they made actual loses look like profits. They then tried to unload hundreds of millions of dollars while assuring the public that stocks would continue to rise. The day before ENRON’s bankruptcy, final rounds of bonus checks had been given to the best employees. The germ has spread throughout the financial market. The fraudulent processes that propelled ENRON’s fall, the act of hiding debt on balance sheets was propelled across the continent.
With the stock market as it is, more and more investors are turning to the bond market. According to Ferguson, in today’s world, power lies in the men that control the world’s bond market. As the owner of the largest bond trading operation in the world, Bill Brooks is considered the “King of the Bond” market. Bonds are the magical link between financial markets and the world of political power. If you want to get rid of the bond, you just take it to a bond market and sell it. There are bonds out there worth 85 trillion dollars. Because bonds are viewed as a save haven, the fortunes of most of us are linked to the bond market. If the bond market tanks, pensions go down. Just like with the stock market, credibility is invaluable. If Bill Brooks were to lose faith in the bonds, it would hit the market.
What can we do to protect ourselves from stock, housing, and bond markets? Buy a price when it is brought to market at a low price → sign a future’s contract → both parties are better off → the world as a whole is better off with investment encouraged. Ken Griffin with Cididell investment group managed his way through the credit crunch so successfully that. His vast wealth has come vis a vis risk and pricing assets in the face of uncertainty. People who are really good at this have great instinct. They become millionaires like Ken Griffin by buying and selling complex derivatives. At the same time, hedging can also be viewed as a “weapon of mass destruction”. The key is to know how to price an option so that you can buy the stock at today’s price, but in 1 year’s time. To make money from hedge funds, one needs a market full of people who have no idea how to price options.
In our time we have experienced the zenith of global finance: the total value of stocks and bond markets was 119 trillion dollars. By the summer of 2007, it seemed as if the world was “planet finance”. While globalization is something we take for granted, there is a downside. its vulnerability to financial shocks, vulnerability, beyond the control of the powerful. Time and time again it has been pained by blow-ups. Today the West is caught up in a full blown recession while Asia continues to grow. Ferguson has named this symbiotic relationship between America and China as “Chimerica”.