I have been reading Galbraith’s The Great Crash of 1929 and a lot of similarities have struck me, not all of which seem to have been noticed by everyone.
- An increase in the use of new investment vehicles. Investment trusts in the 1920s (they had been rare in the US before then, although popular in Britain), CDOs, hedge funds, and derivatives before the current crisis.
- An increase in the use of gearing in investment vehicles and by investors. Buying on margin then, the use of CFDs and highly geared hedge funds now.
- Widespread use of funds of funds: investment trusts then, CDO squared, funds of hedge funds, and funds of funds in general now.
- A laisser faire attitude among bank regulators. Notable this time round was the ending of legislation and regulation designed in the 1930s to prevent a repeat of that crisis, such as preventing commercial banks from indulging in risky businesses such as investment banking.
- Investment banks with a great deal of influence on government and regulators.
- Deferral to expert opinion: that of fund managers and economists like Irving Fisher (who said share prices had reached a “permenantly high plateau” . This time round the experts ranged from more leading economists (notably Myron Scholes and Robert Merton at Long Term Capital management) to the quants who constructed risk models that told us there was nothing to worry about.
- A related property boom — although that particular problem was far more important this time round.
- Widespread fraud, false accounting, insider trading and other malpractices that were tolerated as long as the good times meant money was still made. With Madoff still the only major figure convicted, I am sure there is a lot more still to come out this time round.
- A relaxing of lending criteria, and a willingness to lend against risky collateral, or to risky borrowers: lending on margin then, residential mortgage lending this time.
In addition to the above, were the usual conditions of a bubble, in particular the various “this time its different” arguments. A particularly bizarre example was Irving Fisher’s claim that prices could be sustained as a result of productivity gains that were in turn supposedly resulted from prohibition. The most detached from reality this time round were probably claims that the British property market would be kept buoyant by immigration (possibly convincing if you get your “facts” from the tabloids and are innumerate).
I am far from sure I have got everything!
Some things were very different. Galbraith claims than Churchhill’s decision (as Chancellor of the Exchequer) to return Britain to the gold standard in 1925 was a major factor in creating the conditions for the crash and the depression. So much for gold bugs’ claims that returning to the gold standard would stabilise the economy!
Another striking difference is in attitudes to speculation. The more Christian morality of the 1920s frowned on making money through speculation, and the idea that “greed is good” would have met with revulsion. The crash has brought back some of this, but not, as far as I can see, among the people who matter, except when it is useful to the populist. Nonetheless there has been a change in attitudes, and we are seeing a return to older attitudes. Perhaps my second favourite Galbraith quote is apt: it has not aged well, and is definitely not feminist, but its point is once again true:
Wall Street, in these matters, is like a lovely and accomplished woman who must wear black cotton stockings, heavy woollen underwear, and parade her knowledge as a cook because, unhappily, her supreme accomplishment is as a harlot.