The downside of easy money

EASY MONEY
The Greatest Ponzi Scheme Ever and How it is Set to Destroy the Global Financial System
Vivek Kaul
Sage Publications;
360 pages; Rs 395

The first signs of the sub-prime crisis surfaced in the United States towards the end of 2007. By the middle of 2008, the crisis had morphed into a full-blown financial catastrophe. Stock markets around the world tanked. Lending collapsed.

The world economy may have been on the brink, but the publishing industry saw a boom. Books on the crisis typically fall into two categories. The first off the presses were the journalistic accounts, of which Andrew Ross Sorkin's Too Big to Fail proved a durable success. Later came the more thought-through academic analyses such as Raghuram Rajan's Fault Lines.

Easy Money falls somewhere between these two categories. And though much has been written on the subject, Vivek Kaul, who is a columnist at Firstpost.com, manages to engage the reader. He tries to weave together detailed findings into a coherent narrative and present it in a manner that is easy to understand - even if his explanations are occasionally open to interpretation.

As the title suggests, Mr Kaul zeroes in on the all-too-familiar culprit of the crisis - the access to easy money - and lays the blame for it firmly at the door of the central banks. He repeats the accusation that the United States Federal Reserve under Alan Greenspan left interest rates too low for too long after the dotcom bubble burst at the start of this century, which, inevitably perhaps, created a bubble in the real estate sector.

In the Fed's defence one could argue that the policy of keeping interest rates low was partly influenced by the prevailing economic conditions. After the 2001 recession, gross domestic product (GDP) growth recovered quickly, but jobs were harder to come by. It was probably this concern over the labour market that led the Fed to pursue a loose monetary policy. Although Mr Kaul does acknowledge this, he brushes aside the lack of consensus among economists on whether the Fed helped create the housing bubble and the banking crisis.

The chapter on inequality is especially well written. Mr Kaul successfully highlights the compulsion of the electoral cycle to keep the cheap credit tap open. "A politician needs to plan and think for the long term for the good of the people he represents. But at the same time he needs to ensure that his voters keep re-electing him," he writes. Borrowing heavily from Professor Rajan's Fault Linesf, he argues that politicians bowing to electoral compulsions addressed the issue of rising inequality "by making sure that easier credit was accessible to their voter".

Though the book does examine the issue of inequality in some detail, it is disappointing that it fails to explore in detail the broader economic shifts in the labour market that have taken place in the US economy over the past few decades, which led to the rise in inequality and the fall in opportunities. The stagnation of median wages and the hollowing out of the middle classes, issues that lie at the heart of the debate on inequality, receive only cursory mentions. The essential debate on the inequality of opportunity, an issue that has taken centre stage in American politics, is not touched on here.

Where the book excels is the way complicated products, such as credit default swaps (CDSes) and adjustable rate mortgages (ARMs), which exacerbated the crisis, have been explained. Mr Greenspan once famously remarked that some of the complexities of some of the instruments that were going into collateralised debt obligations bewildered him. But Mr Kaul has managed to explain them with lucidity.

The chapter "Easter without a Good Friday" brilliantly exposes how the ratings business worked. How "unsafe" products, which should ideally have been rated below investment grade, were passed on as "safe" AAA-rated products and then sold to gullible investors across the world. For a layman, it provides a clear account of how the ratings business worked, how skewed the incentives for the rating agencies were and how the game was essentially rigged.

But it is perplexing that the repealing of the Glass-Steagall Act of 1933 is mentioned in passing. The Act, which was passed during the Great Depression, made banking "boring", by separating commercial (that is, retail) banking from investment banking. This important piece of legislation was replaced in 1999, effectively ending the separation, thereby allowing banks to venture into more risky areas with public money.

The chapter "Print Money, Buy Tomato Ketchup" highlights the inherent contradiction of the current policy stance. As astute observers have also pointed out, policymakers are essentially trying to engineer a consumption boom to get economies out of the current problem, believing it's a problem of aggregate demand, while it was excess debt-laden consumption that landed them there in the first place. Professor Rajan and Luigi Zingales succinctly sum it up: "The way out of the crisis cannot be still more borrowing and spending, especially if the spending does not build lasting assets that will help future generations pay off the debts they will be saddled with."

Easy Money is a cautionary book, written with clarity, reflecting the writer's experience as a journalist. For those well versed with economic policy and financial markets, it is standard stuff. But it is well worth a read if you are a student.