Since the onset of the financial crisis, many authors have dissected the origins of the crash and pointed to reforms necessary to make the system more stable. Matthew Bishop and Michael Green, co-authors of The Road From Ruin: How to Revive Capitalism and Put America Back on Top, take a deeper look. They plumb the historical origins of the current financial crisis, which dates back to the early 18th century, and lay out a new framework through which companies can align their own interests with the public good. Bishop, US Business Editor of the Economist, and Michael Green, a writer and economist based in London, spoke with Daniel Gross. A podcast of their conversation can be heard here.
You write that there is an even bigger problem with toxic assets: toxic ideas. What were these 'toxic ideas,' and shouldn't we just call them troubled or legacy ideas?
Bishop: We decided to write this book because the day that Lehman went bust, Sept 15th, 2008, a whole era in Capitalism basically ended. The system wasn't supposed to come to a horrible crash like that, where the taxpayers all around the world ended up pumping trillions of dollars into the system. We realized that a lot of the stupid behaviors that contributed to the problems of capitalism had been justified intellectually—in academia by the efficient market theorists, or in popular terms, by people like Alan Greenspan saying there couldn't be bubbles. Those ideas had just lost touch with reality. Therefore we had to come up with a better version of capitalism that actually learns from history and learns from the failure of those ideas.
You trace the origins of Too Big To Fail, not to the late 1990s but to Britain in the 1720s. What was the first "too big to fail" institutions?
The South Sea Company, which was in Britain in the early 18th century. It was a trading company that operated in the New World‑what we now call Latin America‑that got a government monopoly, and then bolted on a financial enterprise alongside it. It created a bubble, it went pop, and in the end the British taxpayers had to spend money and bail them.
And of course this was before they had a central bank in England?
This was actually created as a rival to the Bank of England. So actually it took political courage for Robert Walpole, Britain's first Prime Minister, to step in and say this needs to be saved. He had more imagination than Hank Paulson did.
It's not just the bursting of the bubbles, but the reaction to it that gives us the problems, right?
Bubbles frequently do tend to produce some innovation—think of the dotcom companies, or paper money, or the railroads. The danger in the aftermath of the bubble bursting is that people then say that well this was a disaster, we shouldn't have liked this new thing that came along, and we should ban it. Regulate everything, crack down on the market. And that actually turns one bad thing into a worse thing. This is why history is instructive. After the South Sea Bubble financial innovation carried on, and Britain moved on to be the great financial power of the world. The same year France also had a panic, the Law Panic, after which they banned this new fangled innovation called paper money. Of course, the French went bankrupt very soon afterwards.
You cite two government responses to financial crises in recent history: Japan and Sweden. What were the key differences in the two approaches? And where on the spectrum the U.S. is tilting more towards?
In Japan in 1990s, a stock market bubble burst and dragged down the whole banking system. The problem with the Japanese approach was to deny there was a problem going on. So those rotten assets that the banking system festered, and the government did nothing to get things going again, and you got this decade of stagnation in Japan. The Nordic countries‑I think because they were smaller economies‑went in quickly, nationalized and cleaned up the banks. And Norway in particular re-privatized the banks for a profit. Sadly I think that the U.S. approach would be much more like Japan. There's been a bit of denial. And the huge error was not nationalizing the banks. If you take the banks into public ownership, the public gets a share of the upside when they recover. Whereas now we are trying to claw money back from the taxes which will distort all the incentives in the system. With the TARP program, they tried to achieve the same effect as nationalization while doing it out through the backdoor. And the consequences were that the taxpayers got a very bad deal. Ultimately Goldman Sachs made a huge profit, most of that went to bonuses to people in Goldman Sachs, whereas if it had been nationalized, a larger chunk of that would have come back to the taxpayers.
You note that regulations are always done in a kind of chaotic way after a crisis, and that frequently makes thing worse. The way I see it, when you look at the measures put into place throughout the New Deal, the SEC and the FDIC‑those were the basis for the recovery of the markets which helped finance the U.S. as it grew to be a huge economy.
One of the periods the administration does need to study is the 1930s, and Roosevelt's first term in office. Roosevelt did some things really well, and some were less effective. He got elected on a very conservative agenda which he quickly abandoned and went for the New Deal, which was quite radical. Obama I think probably stuck too long in his previous agendas and should have gone a very different direction and addressed the economic crisis much sooner. Secondly, I think FDR was very good at explaining to the public what he was doing. Obama again hasn't really done very well on that front.
To a large degree, the financial sector got the precise amount of regulation that it wanted‑and then proceeded to blow itself up. And then when we say clearly we need new regulations, then the sector protests. Has there been a time when the financial sector has blown itself up and then given some good ideas about how they should be regulated?
One of the great episodes of the financial sector saving itself was the 1907 crash, when JP Morgan was the man who saved the day, and in some ways fixed a hole in the U.S. system in not having a reserve bank. It was the realization that it wasn't going to work that led to the creation of the Federal Reserve. Actually the banks really pushed forward for the creation of the Federal Reserve when it was stuck in Congress. But I don't think we're getting a lot of imagination from Wall Street now. Time and time again we hear Wall Street say [it doesn't want] more changes to regulations, as if nothing happened two years ago and that was a perfect system.
You wrote a book a couple years ago called Philanthrocapitalism—which urged businesspeople to reimagine their callings and mode of operation, to align their own interests with those of the public good. How has the crisis affected this trend?
I think this new model of capitalism has greater urgency now. There are leaders out there who now feel the need to demonstrate that they are for the public good, something that they didn't have to feel before. One of the challenges we throw out is that we need to move capitalism away to this obsessive shortermism. I think the slavery to short term share price is what got us into this mess. Philantrocapitalism is this idea that you should start asking questions like should we be pursuing environmentally friendly strategies. Milton Friedman would argue that business is business and the short term share price is the best guide—that too has been discredited by this crisis.