The End of Banking
The story of the crisis reconstructed in chapters 2 and 3 can, and perhaps should, be seen in a bigger
context. At the end of the Bretton Woods era, when the United States finally went off gold in 1971,
states around the world had to adjust to what Eric Helleiner has called “the reemergence of global
finance.”3 Floating exchange rates, deregulation, disintermediation, and the rest, which made finance
the most profitable sector of the American and British economies by the 2000s, was the new order of
things. But what was it all really based upon? After all, finance is most properly thought of as a part of
the information system of the economy: linking borrowers and lenders while sitting in the middle
collecting a fee. It’s not an industry in the traditional sense, and it certainly should not have been
producing 40 percent of corporate profits in the United States on the eve of the crisis—so why was it
able to do just that?
Global finance made so much hay, not through efficient markets but by riding up and down three
interlinked giant global asset bubbles using huge amounts of leverage. The first bubble began in US
equities in 1987 and ran, with a dip in the dot-com era, until 2007. It was the longest equity bull
market in history, and it spread out from the United States to boost stock markets all over the world.
The smart cash that was being made in those equity markets looked around for a hedge and found real
estate, which began its own global bubble phase in 1997 and ran until the crisis hit in 2006. The final
bubble occurred in commodities, which rose sharply in 2005 and 2006, long before anyone had heard
the words “quantitative easing,” and which burst quickly since these were comparatively tiny markets,
too small to sustain such volumes of liquidity all hunting either safety or yield. The popping of these
interlinked bubbles combined with losses in the subprime sector of the mortgage derivatives market to
trigger the current crisis. A picture again is useful. In figure 7.1 we see these three asset bubbles (Dow
Jones Stocks, S&P’s Case-Schiller Index of Housing, and gold/oil prices) scaled against time.
We can clearly see the bust beginning in housing in 2006 hitting stocks and then commodities.
What we see since then are stocks rising due to central bank liquidity programs providing asset
insurance for purchases of underwater equities. Commodities have also rallied as investors
increasingly piled into them in an effort to find positive yield in a zero interest-rate environment. Real
estate has yet to recover.
Now, take away liquidity support and the hunt for yield and there’s a problem going forward. You
can only generate bubbles of this magnitude if there are assets that are either undervalued, or are at
least perceived to be undervalued, and that can serve as fuel for the bubble. US equities had been flat
for a generation back in the early 1980s. US housing was cheap and patterns of demand were
changing. Commodities used to be a niche market. Finance changed all that, pumping and dumping
these asset classes and taking profits along the way for twenty-five years. It was a great run while it
lasted, but now, after the bust, could it be over?
Sovereigns are stretched, and eventually liquidity support and zero rates will come to an end on
what will be a much weaker underlying economy. Equities will decline in value, commodities too, as
global demand weakens, and housing, outside a few markets, is not going to be increasing in value at 7
to 10 percent a year anytime soon. But deprived of fuel for the asset cycle, all those wonderful paper
assets that can be based off these booms—commodity ETFs, interest rate swaps, CDOs and CDSs—to
name but a few—will cease to be the great money machine that they have been to date. Having
pumped and dumped every asset class on the planet, finance may have exhausted its own growth
model. The banks’ business model for the past twenty-five years may be dying. If so, saving it in the
bust is merely, and most expensively, prolonging the agony. Anticipating John Quiggin’s Zombie
Economics, we may have endured austerity to bring back the nearly dead.
Is there any evidence for this bold conjecture? A bit. Banks everywhere are delevering, which will
reduce lending, hitting growth and thus the volume of business that they conduct. Bank equity prices
and market capitalization have fallen drastically over the past two years. Revenues by asset class are
falling. Underwriting has shrunk and trading is not what it used to be.4 Fixed costs are increasing
while bonuses are shrinking and the sector as a whole is getting smaller.5 Meanwhile, what growth
there is seems to be on the retail rather than the investment banking side.6 But retail depends more
directly on the real economy, which is shrinking because of austerity. In sum, we may have
impoverished a few million people to save an industry of dubious social utility that is now on its last
legs. This is a discomfiting thought that strongly suggests that we really should not have bailed them
after all. And there’s another reason for thinking this way, independent of this: it’s called Dublin.
ound exposure). If the dollar did buy fewer pounds my bond coupon shortfall was made up for by the gain on the dollar vs pound bet, if the bet went against me the pound value of my dollar coupons exceeded my mortgage by enough to cover the loss on the bet.
