UFPPC (www.ufppc.org) Digging Deeper XLVII: May 12, 2008, 7:00 p.m.

Charles R. Morris, The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash (New York: PublicAffairs, [March] 2008).

Foreword. Subprime credit problems first appeared in mid-June 2007. In August, the problems extended “beyond the subprime market” (x). In November, the CFO of Citigroup admitted that the company “did not know how to value its holdings” (xi, emphasis in original). But “subprime is just the first big boulder in an avalanche of asset writedowns that will rattle on through much of 2008” (xii). This is not a market bubble, but a “credit bubble” (xii). Morris estimates “writedowns and defaults” at “about $1 trillion,” based on “quite moderate assumptions” (xiii; see ch. 6). Outline of book (xiv-xv). The challenge is to restore “[t]he transparency and integrity of American financial markets” (xv). Japan shows what will happen otherwise (xvi). This is “not a quickie book,” but is based on research from the late 1990s that led Morris to understand the scope of the crisis (xvi-xviii).

Ch. 1: The Death of Liberalism. “1970s disasters had at least three primary roots—the loss of business vision, demographic shifts, and gross economic mismanagement” (2; 1-14). (NOTE: Morris’s views tend toward socioeconomic Darwinism [3, 21], anti-intellectualism [12, 16-17, 49], and anti-liberalism [7-8, 13, 173]). The U.S. “debased its currency” in the 1970s (10-11). Milton Friedman’s monetarism prevailed, given the bankruptcy of technocratic “Keynesian liberalism” (17-18).

Ch. 2: Wall Street Finds Religion. Success of markets in early 1980s (19-23). Fed chairman Paul Volcker “broke” inflation, 1979-82 (23-27). But the boom in leveraged buyouts (LBOs) and the savings-and-loan debacle showed the limitations of markets (27-31). Clinton

attacked budget deficits and set the stage for the tech (or dot-com) bubble (31-34).

Ch. 3: Bubble Land: Practice Runs. Mortgages were first turned into securities by Larry Fink & First Boston with collateralized mortgage obligations [CMOs] in 1983, but this market collapsed in 1994 (37-43). The 1987 stock market crashed due to general adoption of an idea of “staggering fatuity” (48), portfolio insurance facilitated with “the Black Scholes formula, the most famous equation in the history of finance” (45; 43-48). The Fed forced a takeover of Long-Term Capital Management (LTCM) in September 1998 (49-53). This successfully obscured was “the real scandal: that at the very epicenter of American finance, a tiny group of people were able to borrow hundreds of billions of dollars from banks, and that neither the banks, nor the banks’ regulators, had any idea of how much they had borrowed or what they were doing with it” (53). Revealed by these precursors of the present crisis: that deregulation placed entire economies at risk, that rogue agents accentuate the problem, and that finance is dominated by “mathematical constructs” that can fail in “times of stress” (54-58).

Ch. 4: A Wall of Money. Securitization and derivatives (59-62). The “Greenspan Put” involved guaranteeing that cheap money was available and ignoring asset inflation (63-65). The financier-produced 2000-2005 real estate bubble, acc. to Robert Schiller “the greatest in history” (66; 65-72). Many other forms of collateralized debt obligations [essentially, bets that borrowers will make payments that are turned into

financial instruments] were developed (73-74). With credit default swaps [essentially, insurance against loan portfolio losses], synthetic CDOs or “credit derivatives” were devised—“[v]ery big, very complex, very opaque structures built on extremely rickety foundations” (79; 75-79). Fall 2007 crises show “how deeply American subprime paper had infiltrated global finance” (80-81). Structured investment vehicles (SIVs) [bank-run off-balance-sheet investment funds] in crisis (82-84).

Ch. 5: A Tsunami of Dollars. The U.S. current-account deficit “tilt[ed] into free fall about 1999 . . . The accumulated deficit for 2000 to 2006 is about $4 trillion, financed by foreign borrowers (89; 88-91). Morris regards the “Bretton Woods 2” (BW2) hypothesis, according to which the dollar is able to maintain its position because of the world’s need to lend, as refuted by the dollar’s decline (92-95). Diversification of currency baskets by oil exporters increases pressure on the dollar (96-99). Oil-rich nations are creating sovereign wealth funds (SWFs), which are becoming major economic players involved in international investment (99-104). The significance of these developments is that they mean the Fed is no longer capable of resolving crises that emerge (105).

Ch. 6: The Great Unwinding. Hedge funds (“unregulated investment vehicles that cater to institutions and wealthy individuals” [109]) are the entities that have been investing most in the new debt-based securities (107-09). Morris explains how hedge funds take risky investments off their books not by selling them, but by devising a credit default swap, a debt-based security, that is accepted by another entity, probably a hedge fund, in return for cash (110-11). The exposure of hedge funds, often highly leveraged and not accurately valuing their assets, goes far beyond

subprime paper alone (112-17). Corporate debt (bonds) has also deteriorated in credit quality and now displays many of the features of subprimes (117-21). Credit card debt is securitized and rising (121-22). Commercial Mortgage-Backed Securities (CMBS) stalled in Q3 of 2007 (122-23). The credit ratings granted to monoline insurers, which insure purchasers against principal losses on securities and are often used when municipal bonds are issued, are “absurd” (123-24). Credit default swaps (CDOs) often depend on hedge funds that are vulnerable to a liquidity crisis (124-26). An economic downturn is inevitable (126-28). But something worse, a “credit meltdown,” is possible, given an estimated $1.01 trillion in potential defaults and writedowns ($450bn in residential mortgages, $345bn in corporate debt, $215bn in CMBS & credit card debt—and Morris is unable to estimate monoline downgrades and CDO defaults and writedowns, but calls them “potentially very large”) (129-32). “The stage is set for a true shock-and-awe surge of asset writedowns through most of 2008,” raising the prospect that “the global financial system will be in catastrophe” (133). Morris argues that in terms of Hyman Minsky’s theory of the stages of financial crises, the credit cycle has reached the “Ponzi stage,” in which the latest arrivals “must borrow to meet all their interest payments, so their debt burden continuously increases” until “a disruptive event occurs” (134; 133-36). “In effect, [a relatively small number of institutions, basically the global banks, investment banks, and credit hedge funds] have built a huge Yertle the Turtle-like unstable tower of debt by selling it back and forth among themselves, booking profits all along the way. That is the definition of a Ponzi game” (135-36; emphasis in original).

Ch. 7: Winners and Losers. The “widening disparity of wealth and

income” in American society (139; 137-42). Wealth is increasingly going to “the highest-order intellectual tasks” (145; 142-45 [this section is based on David Autor, Lawrence Katz, and Melissa Kearney, “Trends in U.S. Wage Inequality: Revising the Revisionists,” NBER, March 2007 (182)]. The outcome is not a conspiracy, but “the inevitable outcome of our current money-driven political system combined with ‘the disposition to admire, and almost to worship, the rich and powerful,’ which Adam Smith fingered as ‘the great and most universal cause of the corruption of our moral sentiments’” (147). The U.S. is unique in financing higher education by creating debt (147-50). Bush’s privatization of Social Security plan aimed to direct money to Wall Street (151-52). Financial services “don’t really compete in free markets” (153; 152-55). The U.S. may now be “in thrall to a burgeoning new class of financial speculators,” like those of the 19th century described by Anthony Trollope in The Way We Live Now (156). Or we may be in “the final days of another quarter-century political/ideological cycle” (156; 156-58).

Ch. 8: Recovering Balance. Restoring “effective oversight over the finance industry” must be a national priority (159-62). Bank reform should come first (162-63). An updated version of Glass-Steagall, separating commercial and investment banking, should be considered (163). Health care reform is essential, and government must be involved (163-66). Market fundamentalism of the Chicago School should be abandoned (167-79).

Notes. 14 pp., by chapter.

Index. 10 pp.

[About the Author. Charles R. Morris has been a lawyer and a banker

(Chase Manhattan), and was for fifteen years managing director of a consulting firm specializing in financial services and high-tech that had Merrill Lynch, Apple, and Xerox as clients. He has published in the Atlantic Monthly, the New York Times, and the Wall Street Journal. Morris is Catholic and was raised in Philadelphia. He has also been the secretary of health and human services for Washington State. He is the author of The Cost of Good Intentions: New York City and the Liberal Experiment, 1960-1975 (1980); Iron Destinies, Lost Opportunities: The Post-War Arms Race (1988); The Coming Global Boom: How to Benefit Now from Tomorrow’s Dynamic World Economy (1990); Computer Wars: The Post IBM World (1993, with Charles H. Ferguson); American Catholic: The Saints and Sinners Who Built America's Most Powerful Church (1997); Money, Greed, and Risk: Why Financial Crises and Crashes Happen (1999); The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould, and J. P. Morgan Invented the American Supereconomy (2005); Apart at the Seams: The Collapse of Private Pension and Health Care Protections (2006); The Surgeons: Life and Death in a Top Heart Center (2007). Reviews: Paul Steiger said in the Wall Street Journal called The Trillion Dollar Meltdown “an absolutely excellent narrative of the horror that we have in the credit markets right now.... It's a wonderful explanation of how it happened and why it's so rotten.” Floyd Norris, the chief financial correspondent of the New York Times, called it “brief but brilliant.” Update: In March, Morris told Newsweek that “Home prices will probably fall another 15 to 20 percent” and offered this advice to consumers: “Plan to survive the recession. Ratchet back spending. Your job is at risk. Unemployment is going to go up. Wages will be flat. Start saving.”]