Financial crisis: Bank of England 'did not understand problem' 

• Julia Kollewe
• guardian.co.uk, Monday 22 December 2008 08.26 GMT

 

The Bank of England underestimated the severity of the current financial crisis, according to its deputy governor who has admitted that interest rates are only a "blunt instrument" with which to control the economy.
 

Sir John Gieve told the BBC's Panorama programme, to be screened tonight, that new tools are needed to complement rates. He also admitted that the Bank knew "crazy borrowing" was taking place and the price of houses and other assets was rising unsustainably, but did not fully understand the problem.

 
"We didn't think it was going to be anything like as severe as it's turned out to be," says Gieve, who is in charge of financial stability at the Bank. "Why didn't we see that it was so serious? I think that's because we, perhaps, we hadn't kept pace with the extent of globalisation. So the upswing here didn't involve the big increases in earnings and consumption and activity which we saw in previous booms. We saw the credit, we saw the house prices, but we did see a fairly stable pattern of earnings, prices and output."

 
Explaining why the Bank did not raise interest rates to curb the lending and house price boom, Gieve says: "If we'd used interest rates to try and address this asset-price credit growth, we would have been holding down the level of activity elsewhere in the economy, in manufacturing, in other services, holding down the level of employment at a time when consumer price inflation and earnings were stable and reasonably low. And people would have said, you know, 'this is a wilful reduction in the prosperity of the country'."

 
The Bank cannot just rely on interest rates to control the economy, he argues. "One of the main lessons from this is that we need to develop some new instruments which sit somewhere between interest rates, which affect the whole economy and activity, and individual supervision and regulation of individual banks," Gieve says.

 
"Maybe we need to develop something which bridges that gap and directly addresses the financial cycle and prevents the financial cycle and the credit cycle getting out of hand ... I think we need to complement interest rates, which are a blunt instrument - you set one interest rate for the whole economy - with something which is more financial-sector specific."

 
"This is a major storm we haven't seen the like of for 100 years," he adds. "It would be very surprising if we weren't learning lessons from it and we are."

Gieve also casts doubt on whether the Treasury will get all of the money back that it has poured into the banking sector, pointing to a "level of defaults" in the books of nationalised lenders Northern Rock and Bradford & Bingley, which are now held by the taxpayer.

 
Speaking on the same programme, John Varley, the chief executive of Barclays, predicts that consumers and businesses will struggle to access credit for the next one to two years.

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No Houris Inside Our Jails - Why Kasab must have legal defence and why he mustn't hang

 

Ram Jethmalani

Mohammad Ajmal Amir Kasab does not need a lawyer; someone in this country needs a client. That's why some lawyers seem to be amusing themselves imagining that Kasab sought their services and that they declined only to oblige Mother India. In medieval times, witches were feared, despised and burnt by furious mobs. They never got a fair trial; no one dreamt of giving them one. Prejudice and irrational fear ensured that they got nothing but undeserved punishment. In modern society, the "spy" has taken the place of the witch, with one vital difference. The danger so-called witches posed was entirely imaginary. Some spies do pose a threat. But to argue that a crime is so vile and dastardly that an accused must not be allowed to demonstrate his innocence is bad law. The measure of a civilisation is the way its society treats those it hates. It is the duty of every lawyer to defy a bar association resolution that a particular accused should not be defended. So important is the right of an accused to have the services of a lawyer that our constitution-makers were not satisfied with the right to defence created by criminal law. They made it a fundamental right so that no tyrannical regime could curtail or destroy it. Article 22 declares that no accused shall be denied the right to consult and be defended by a legal practitioner of choice. And the 42nd Amendment of the Constitution, carried out during the Emergency, introduced at least one wholesome provision. The newly-added Article 39-A mandated that the legal system shall provide free legal aid to ensure that opportunities for securing justice are not denied to any one by reason of economic or other disabilities. When Thomas Paine was jailed and tried for treason for his pamphlet Rights of Man, the great advocate Thomas Erskine was briefed to defend him. Erskine, at that time, was the attorney-general for the Prince of Wales. Though he was allowed private practice, he was warned that if he accepted Paine's brief, he would be dismissed from office. Undeterred, Erskine accepted the brief and was deprived of office. His immortal words, which the editor of Howell's State Trials printed in capitals, stand out as a shining light: "From the moment that any advocate can be permitted to say that he will or will not stand between the Crown and the subject arraigned in the Court where he daily sits to practice, from that moment the liberties of England are at an end. If the advocate refuses to defend from what he may think of the charge or of the defence, he assumes the character of the Judge; nay he assumes it before the hour of judgement; and in proportion to his rank and reputation puts the heavy influence of perhaps a mistaken opinion into the scale against the accused in whose favour the benevolent principle of English law makes all assumptions, and which commands the very Judge to be his Counsel." Indian lawyers have followed this great tradition. The Razakars of Hyderabad were defended; Sheikh Abdullah and his co-accused were defended; and so were some of the alleged assassins of Mahatma Gandhi and Indira Gandhi. No Indian lawyer of repute has ever shirked responsibility on the ground that it will make him unpopular or affect the electoral prospects of his party. The Bar Council of India has also formulated standards of professional conduct. Among other things, the resolution says that an advocate is bound to accept any brief; that anyone in need of a lawyer is entitled to one, whether or not he can pay for one; that an advocate shall uphold the interests of a client...without regard to any unpleasant consequences to himself or any other; and that an advocate shall defend an accused regardless of his opinion as to the guilt of the accused, bearing in mind that his loyalty is to the law, which requires that no man should be convicted without adequate evidence. So, no doubt, Kasab has a right to defence. But what will the lawyer do? It does not seem to me possible for any lawyer or even a combination of lawyers seriously to dispute that he committed what he is accused of. The arguable question will be one of sentence—namely the choice between death and life imprisonment. If I were a judge I wouldn't sentence Kasab to death. For it is only in the hell of an Indian jail that he would realise that what the mullahs told him is false. God has no place for him in heaven and probably none exists. His nine dead companions will not, in any event, communicate with him about their sad fate. A long stay in an Indian prison will detoxify him of the superstitions and illusions instilled in him.

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Christianity and Capitalism

 

Time for some morality trades

 
By Christopher Caldwell
 
Published: December 19 2008 19:37 | Last updated: December 19 2008 19:37

 
Is our present financial crisis the result of a mistake or a crime? Is it evidence of incompetence or of corruption? Is its remedy to be sought in committee rooms or in individual consciences? When Rowan Williams, the archbishop of Canterbury, worried aloud this week that the government's stimulus package "seems a little bit like the addict returning to the drug", he revealed that we are fudging these questions.
 
The public has no settled idea about whether the global finance system seized up last summer because it was mismanaged or because it was, in a moral and metaphysical sense, wrong. The archbishop's intervention was a bold one. Much as prelates in centuries past praised Jesus's expulsion of the money-changers from the temple, we pat ourselves on the back for having driven the priests from the bourse. Morality has little purchase on economics nowadays. Maybe it ought to have more.
 
In 1926, R. H. Tawney, the great Christian socialist and economic historian, argued that we were wrong to be so complacent. His history of the Reformation, Religion and the Rise of Capitalism, described the origins of the idea that "business is business", that the economy is a separate compartment that ought to be quarantined from other spheres.
 
At a time when most encounters were face-to-face, it was possible to lead a moral economic life simply by extrapolating from the injunction to love one's neighbour, but a revolution in manufacturing, finance and trade made this extrapolation less possible. "Granted that I should love my neighbour as myself," Tawney wrote, "the questions which, under modern conditions of large-scale organisation, remain for solution are, 'Who precisely is my neighbour?' and, 'How exactly am I to make my love for him effective in practice?' To these questions the conventional religious teaching supplied no answer, for it had not even realised that they could be put."
 
Tawney, an activist in the Labour party, believed the period between Machiavelli and the English Revolution had a lot to teach his own time. Maybe it has more to teach ours, since it was marked by a "sweeping redistribution of wealth" and an "orgy of interested misgovernment", not to mention its "reassertion of the traditional doctrines with an almost tragic intensity of emotion", in the face of a world that was rendering them irrelevant.
 
Contrary to what one might expect, it was over credit, not wages, that the new capitalist classes clashed most violently with the economic morality that prevailed on the eve of the Reformation. Medieval economic morality centred on abhorrence of usury. This abhorrence is a bit embarrassing to modern Christians, who learn about it through the hounding of Shylock in The Merchant of Venice. We tend to view it as a shabby outlet for xenophobia and anti-Semitism. The main moneylenders in the period Tawney discusses were Spanish, Portuguese and Lombard Catholics, abetted by the Church and the Armada. Public outrage was not as benighted or unfocused as it looked. Large enterprises and royal courts borrowed without much difficulty, so preaching against usury did not unduly clog up the financial system – although businessmen claimed that it did. What troubled economic moralists was extortionate lending to desperately poor (we would call them "subprime") borrowers. But the term usury also covered "the man who buys [a thing] in order that he may gain by selling it again unchanged" (which we would call speculation).
 
Usury was a general term meaning "taking advantage". We dismiss those who were obsessed with it at considerable peril to our own business ethics. "If the medieval moralist was often too naïve in expecting sound practice as the result of lofty principles alone," Tawney wrote, "he was at least free from that not unfashionable form of credulity which expects it from their absence or from their opposite." In this light we can see that Fairtrade, promoters of socially responsible investing, activists for sustainable development and the micro credit movement are all groping towards a workable, tolerant, enforceable modern doctrine of usury.
 
Tawney showed that the religious revival of the 16th and 17th centuries ushered in its opposite – an individualism untethered from any social contract. As people grew firmer in their conviction that salvation could be had through God's grace, it became a much less pressing matter whether the public sphere was run on Christian principles. There was a transvaluation of values and with them, of institutions. So feudalism, "once an engine of exploitation, was now hailed as a bulwark to protect the weak against the downward thrust of competition". (Our own attitude to jobs in heavy industry has undergone a similar transformation.)
 
Tawney was not the first to make such arguments but his explanation is uniquely subtle. To simplify, Calvinism both glorified the entrepreneurial virtues and kept them under strict watch. But it turned out you could not do both. Those virtues could only be exercised if they were not universal. "How would merchants thrive if gentlemen would not be unthriftes?" One is reminded of the hedge fund mogul Andrew Lahde who, this autumn, having taken short positions on subprime real estate, wrote a crowing letter to the Ivy League hotshots at Bear Stearns, Lehman Brothers and elsewhere "stupid enough to take the other side of my trades".
 
"An organised money-market has many advantages," Tawney wrote. "But it is not a school of social ethics or of political responsibility." Competition, he added, is not a substitute for honesty. We do not at present have any non-economic ways of discussing economic and financial matters. It appears we are due to get some.
 
The writer is a senior editor at The Weekly Standard

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No questions asked

 

  By Francesco Guerrera, Anuj Gangahar and Deborah Brewster

 
Published: December 19 2008 19:57 | Last updated: December 19 2008 19:57

 
Looking down on a sunlit Manhattan skyline from the seaplane carrying him to work, Bernard Madoff must have felt on top of the world.
 
In the late 1980s, when his morning routine involved a short hop from Long Island to the East River, a stone's throw from his office in New York's financial district, Mr Madoff was just another successful Wall Street operator.
 
A prominent member of the securities industry with deep ties to the wealthy Jewish community that divides its time between New York and Florida, Mr Madoff had an otherwise fairly ordinary lifestyle and could have been forgiven the extravagant touch of an aerial commute.
But after last week, when US prosecutors say he confessed to what could be the largest fraud ever perpetrated, nothing will ever be ordinary again for the 70-year-old Mr Madoff.
 
There will be no more seaplanes after a court ordered Mr Madoff to submit to electronic monitoring and remain in his Manhattan duplex daily from 7pm to 9am. Gone, too, is the adulation of the rich investors who used to beg "Bernie" to take their money – replaced by the shock and pain of huge financial losses and betrayal of trust.
 
As details begin to emerge of a "Ponzi scheme" that is alleged to have swindled up to $50bn (£33bn, €36bn) from investors ranging from HSBC, the giant UK bank, to the charity of Steven Spielberg, the film director, one central question remains unanswered. How could Bernie have duped so many investors for so long?
 
Those who met Mr Madoff during a career that began in 1960, when he founded his securities firm with $5,000 earned installing garden sprinklers and patrolling Long Island beaches, talk of a private, self-effacing man. "The last thing Bernie Madoff wanted was publicity," says one of his fellow travellers on the East River seaplane.
 
Affable and polite but not overly talkative, Mr Madoff was active on the social and charity scenes in Manhattan and Palm Beach – the Florida town that serves as an escape hatch for rich New Yorkers.

Wrapped up: Bernard Madoff returns to his New York apartment on Tuesday after a court imposed a curfew

Yet despite his wealth – he owns a yacht and houses in Palm Beach and Cap d'Antibes in France as well as his Upper East Side apartment – Mr Madoff did not stand out from the crowd of well-off middle-aged people with whom he socialised. "He was low-key," recalls Charles Gradante, a hedge fund adviser who met him regularly on the Palm Beach social circuit. "When I saw him at cocktail parties, he would be in the corner and investors would sometimes go over to him. He didn't have a charismatic presence; he wasn't exuding confidence."
Senio Figliozzi, owner of the Ever­glades Barber Shop in Palm Beach, cut his hair and gave him facials, manicures and pedicures for 17 years but rarely heard him talk about business. He describes Mr Madoff as a "very nice man who was always polite and gentlemanly" and tipped the standard 20 per cent.
 
But behind that everyman persona, Mr Madoff weaved a complex web of connections that lured more and more investors into his fold. Ponzi schemes – pyramid arrangements named after the Italian immigrant to the US who first attempted the scam in the 1920s – are relatively unsophisticated frauds in which the organisers repay old investors not with genuine gains but with funds from new investors. Investigators allege that Mr Madoff's was in operation from at least 2005.
 
If he did indeed craft one, there were no outward signs when, more than a decade ago, Mr Madoff added an investment firm to his brokerage house and later moved to the tall, thin midtown skyscraper known as the Lipstick Building. With a reputation as a leading market-maker – the middle-man between buyers and sellers – on Nasdaq, the stock market he chaired for a few years, Mr Madoff was not unusual in moving from broking to investing.
 
Nor did it seem strange that, as a self-made man of a certain standing in the Jewish community, Mr Madoff's should tap his friends and acquaintances in New York society and Palm Beach's exclusive Country Club.
 
To be sure, Mr Madoff did not move in the top circles of American social life – the parties dominated by film celebrities, tycoons such as Donald Trump or super-rich donors such as Sandy Weill, the former Citigroup chief. His was a more intimate, less flashy group, according to David Patrick Columbia, the editor of NewYorkSocialDiary.com – a tightly-knit community centred on Upper East Side synagogues and charitable organisations.
Many of these pious, often elderly, people looked to increase their retirement nest-eggs without taking too many risks and thought they had found the holy grail in Mr Madoff's enviable record: he consistently beat other fund managers and the market, year after year.
 
"This is a community of affluent Jewish people who basically socialise with each other. They are very philan­thropic and all support each other's charities," Mr Columbia says. "Even though Mr Madoff was not a top member of this community, his business made him the man to know. He became an icon of financial success for them."
 
But after a few years, word of Mr Madoff's ability to generate steady returns, by employing a seemingly simple strategy of buying shares in large companies and selling options on the same names to mitigate risk, began spreading beyond his inner circle. Yet as more and more people wanted in on Mr Madoff's outstandingly consistent performance, he played it cool. "He never pushed investing with him: he would turn people away sometimes or tell them, 'it is not for you', recalls Mr Gradante. "That all added to the mystique and made people want to get in."
 
Barbara Rosenthal, a Palm Beach property agent, says Mr Madoff's standing was such that people felt "you had to be lucky for him to talk to you", while another resident recalls that many people joined the Country Club "so they could meet this guy". Experts on "affinity frauds" say the strong demand for Mr Madoff's services – and the fact that many investors were coming in through "friends" – had a crucial consequence: those who did get in felt they had a special deal and were less inclined to ask questions.
 
But as the friends and family network became inadequate to satisfy investors' craving for a piece of Mr Madoff's miraculous returns, an informal marketing system began to take shape. In Palm Beach, one of the main middlemen for Mr Madoff's business was Robert Jaffe, according to several investors. Dapper and well-spoken, Mr Jaffe got a number of individuals and charities to place their money with Bernard Madoff Investment Securities.
Mr Jaffe is the son-in-law of Carl Shapiro, founder of the Kay Windsor clothing company and a renowned Boston philanthropist. Mr Shapiro's foundation is believed to have lost nearly half of its $345m in assets and both he and his family are thought to have suffered significant losses as a result of the collapse of Mr Madoff's firm.
 
There is no suggestion that either Mr Jaffe or any members of his family knew about Mr Madoff's alleged fraud. A spokeswoman for Mr Jaffe did not return calls.
 
As the years went by without any sign of a dip in performance, the tentacles of Mr Madoff's operations began stretching beyond Palm Beach's manicured lawns and Manhattan's skyscrapers. The long list of potential victims of his alleged actions includes Swiss and Austrian private banks, hedge funds owned by large insurance companies such as MassMutual's Tremont Capital Management, as well as famous names such as Fred Wilpon, owner of the New York Mets baseball team.
 
Other high-profile investors, such as Mr Spielberg's Wunderkinder foundation and several charitable organisations that now face ruin, went in through the more traditional route of their long-standing financial advisers.
 
Some of the funds that fed international money into Mr Madoff's operation were run by well-known financiers such as Walter Noel, the founder of Fairfield Greenwich Group. A Harvard-educated former banker, Mr Noel had the ability to reach investors around the globe, partly thanks to the help of Andres Piedrahita, a well-connected banker who is Mr Noel's son-in-law and runs Europe and Latin America for Fairfield.
 
Fairfield, which is the largest potential victim of Mr Madoff's alleged fraud with some $7.5bn invested in his firm, declined to comment.
Ascot Partners, a hedge fund run by Ezra Merkin, also chairman of GMAC, General Motors' former finance arm now owned by Cerberus, the private equity group, was also an active recruiter of funds for Mr Madoff's enterprise. Ascot and Mr Merkin could not be reached.
 
The "feeder funds", whose returns were augmented by billions of dollars in loans from banks such as HSBC and Royal Bank of Scotland, had a powerful incentive to persuade investors to place money with Mr Madoff: lucrative returns. He forwent the standard 20 per cent cut on profits demanded by most fund managers and, by and large, charged feeder funds only commissions on trades.
 
Crucially, not many of the investors appear to have challenged that unusual structure, let alone Mr Madoff's suspiciously good returns over the years.
Those who did were less than impressed with Mr Madoff's answers. Jim Hedges, an asset manager, said that when they met in the late 1990s, Mr Madoff was unable to explain his winning strategy. "He made little conversation – he looked interested in ending the meeting as soon as possible," says Mr Hedges, who decided against investing.
 
Another hedge fund expert recalls that he once approached Mr Madoff at a party and quipped that his performance was too good to be true. Mr Madoff chuckled and replied: "A lot of people say that."
 
Now, as investors contemplate the ruins of the financial edifice he built, the tragedy is that among that "lot of people", so few paused to ask themselves why.
 

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The devil and Bernard Madoff

By Spengler

Now that the whole horrible truth has come to light, I have no more reason to conceal my true identity. I am Bernard Madoff.

Well, not really. But I wish I were. Few Americans have done more to punish stupidity, pretension and complacency than Madoff, whose apparent US$50 billion swindle calls to mind the caper by Mephistopheles in the second part of Goethe's Faust. The fictional devil persuaded the emperor to issue paper money against buried treasured yet to be discovered.

This month, I cited Benedict XVI's 1985 essay on morality and economics, in which the future pope warned that the decline of ethics "can actually cause the laws of the market to collapse". (See Benedict XVI is magnificently right, Asia Times Online, December 9, 2008). In counterpoint to that message from our sponsor, satanic laughter pealed through the marketplace on December 12, when Madoff's apparent misdeeds came to light. That was just the sort of thing for which God summoned the devil into being, as the Lord explained to Mephistopheles in the prologue to Faust, for man seeks unconditional rest and needs a provocateur as companion. Mephisto is an Old Testament devil, drawn from the Book of Job, who is part of the Divine Court.

Madoff, 70, a former Nasdaq chairman, was arrested by federal prosecutors last week in relation to what he reportedly told his sons was a long-running Ponzi scheme - that is one in which investors are paid high returns from money paid in by subsequent investors.

Most gratifying is the fleecing of the rich and famous - director Steven Spielberg, producer Jeffrey Katzenberg, and even actress Uma Thurman's financier boyfriend Arpad Busson got stung, along with a list of supposedly savvy investment firms. The man deserves a medal. Deplorable, to be sure, is the ruin of hundreds of families who entrusted Madoff with their life savings, not to mention charities and school endowments. Call them collateral damage. I have never been squeamish about killing civilians when urgent military objectives are at stake. We give medals all the time to people who cause innocent death in war. Tough on them if they can't take a joke, as the artillery likes to say about friendly-fire casualties.

The very rich believe what F Scott Fitzgerald said about them, that "the very rich are different from you and me". Serried ranks of lawyers, accountants and financial advisors surround them and keep them from harm. Madoff proved otherwise, making a few of them into paupers and humiliating a very large number of them. Not because of what they do, but because of who they are, the very wealthy consider themselves above the fate of ordinary people. They know the right people, they join the right clubs, and they have access to the right advice. Sometimes it takes a national catastrophe to teach them otherwise. The slaughter of the subalterns in World War I destroyed the flower of the English gentry, and the Russian revolution left counts driving taxicabs in Paris. There was no recuperation from such punishment.

Madoff has given Americans a lesson in humility that is cheap and painless by comparison. America's elite - the people characterized as "one-trick wizards" who lived off leverage (see Obama's one-trick wizards, Asia Times Online, November 25, 2008) - turn up as a self-satisfied, feckless gang of incompetents who could not spot the wolf within their own sheepfold.

After the fact, it is obvious that it was physically impossible for Madoff to produce the returns he reported. "While Mr Madoff's stated strategy was valid, it would have been impossible to execute with the amount of money he was managing ... Mr Madoff's firm couldn't have bought and sold the options he claimed because those totals would have outstripped total trading volume those days," according to the The Wall Street Journal on December 16. Nonetheless, his wealthy dupes believed that he could spin straw into gold year-in, year-out.

If that sounds deluded, what shall we say about hedge-fund investing for the masses, who believed that American home prices would double every 10 years, as the National Association of Realtors continues to claim in television advertisements? Perhaps they should call themselves Sur-realtors. Madoff offered small change compared to Mom and Pop America, who put 10% down on a home that appreciated 10% each year, for an annualized return on capital of 100%.

Americans luxuriated in a trillion dollars a year of capital inflows. The aging savers of Europe and Japan viewed American markets (and American brick and mortar) as a source of returns in a moribund world, while the newly prosperous savers of China and the emerging world saw America as a safe haven. The world threw money at Americans, and Americans threw the money into a housing bubble. The idea was absurd that Americans could fund their collective retirement by bidding up the price of each others' houses and then cash out at the same moment. But it was no more absurd than Madoff's claim to make a steady 10%-15% by trading illiquid stock options.

There weren't a tenth the number of stock options traded to carry out Madoff's putative strategy, as anyone with a complete set of fingers, let alone a pocket calculator, could determine without great difficulty. For that matter, there weren't enough families to keep the home price-bubble going. Americans are retiring faster than they are forming families, and aging Americans whose children have left the home ("empty nesters" ) typically sell large homes and buy smaller ones. A very crude comparison below shows Americans aged 25-50, when they are most likely to raise children and buy larger homes, against those aged over 50, who are more likely to sell large homes.

Demographers have been warning for 10 years of a home price collapse in America's suburbs. Whistleblowers first warned the American authorities about Madoff's machinations in 1999. There is no way to make either case less embarrassing than it is. Among defenders of the market mechanism, there is a half-hearted effort to blame the collapse of the American housing market on the machinations of Democrats and the government-sponsored housing lenders, Fannie Mae and Freddie Mac.

It was disappointing to see the usually astute Michael Novak resort to this fairy-tale in the January 2009 issue of First Things. Novak is an estimable political philosopher - I have cited his work in the past - but he vastly overestimates the extent to which "the political system helped create this mess" by mandating low-quality loans. Novak simply doesn't know the details of the mortgage market; he repeats, inaccurately, what he has heard from Republican apologists in Washington. He attributes part of the problem to the fact that "some too brilliant Wall Streeters got the clever idea of buying Fannie Mae mortgages and packaging them to sell in large bundles". In fact, this bundling began in the mid-1980s and helped finance the quarter-century economic boom inaugurated by president Ronald Reagan.

The problem, rather, was that the investment banks began packaging low-quality "subprime" mortgages with high credit risk, and the credit rating agencies knowingly represented dicey packages as default-proof triple-A credits. The bankers knew they were cheating, as much as did Madoff, and the ratings agencies knew they were selling their soul for revenues, as an unnamed official stated in an e-mail made public by a US congressional committee. They got away with this because the childless dystopias of Europe and Japan needed investments in places where families still were formed, and were willing to ship their money to the American subprime market without asking too many questions, just like Madoff's investors.

There were underlying causes, but the human factor that should have sent up alarm bells simply was not present - not at the Securities and Exchange Commission in the case of Madoff, nor at the Federal Reserve in the case of the banks. The American public got greedy and lazy, and is getting what it deserved. It is comforting that America's elite also is getting what it deserved, thanks in part to Madoff, who ensured that a representative sampling of the very rich learned that Scott Fitzgerald was wrong.

The Federal Reserve's strategy for economic revival reduces to trying to put air back into the bubble, by forcing mortgages rates so low that Americans will return to punting on houses. That goes against common sense, for Americans who have lost their nest egg in the housing market will not soon return, and against demographics. "When the Baby Boomers were young, families with children made up more than half of households ... The Boomers themselves are becoming empty-nesters, and many have voiced a preference for urban living. By 2025, the US will contain as many single-person households as families with children," wrote Christopher Leinberger in the March 2008 Atlantic Monthly, citing academic research that predicted a 40% surplus of large-lot single-family homes by 2025.

Like Mephistopheles' invention of paper money, the Federal Reserve's ballooning balance sheet will not restart the American economy. In Goethe's play, the emperor distributes paper money and finds that his courtiers use it to drink, gamble, or otherwise dissipate more than they otherwise would have. He complains (in lines 6150-54, Walter Arndt's translation):

I hoped for pluck and zest for ventures new;
I should have known you, and what each would do;
For all new bloom of wealth, it's plain to see
That each remains just what he used to be.

America's economy will remain in the monetary equivalent of an iron lung until Americans show "pluck and zest for ventures new", or what John Maynard Keynes called "animal spirits". There is no more trend to ride. Wealth now will require sweat, brains and guts.

Global economy: The age of obligation

By Niall Ferguson

Published: December 18 2008 19:10 | Last updated: December 18 2008 19:10




In the Old Testament Book of Leviticus, God commands the children of Israel to observe a jubilee every 50 years. Nowadays we tend to associate the word with celebrations of royal anniversaries such as Queen Elizabeth’s golden jubilee in 2002. But the biblical conception of a jubilee was more precise: that of a general cancellation of debts.

This point is spelt out in Deuteronomy: “Every creditor that lendeth ought unto his neighbour shall release it; he shall not exact it of his neighbour, or of his brother; because it is called the Lord’s release.”

Such injunctions may strike the modern reader as utopian. How could any sophisticated society function if all debts were cancelled twice a century – much less, as Deuteronomy seems to suggest, every seven years? Yet we know that such general cancellations of debt really did happen in the ancient world. In 1788 BC, for example, about 500 years before the time of Moses, King Rim-Sin of Ur issued a royal edict declaring all loans null and void, wiping out some of history’s earliest known moneylenders.

The idea of a generalised debt cancellation is not wholly unknown in modern times. The late Gerald Feldman, the world’s leading authority on the German hyperinflation of 1923, drew a parallel between the ancient Hebrew yovel and the wiping out of all paper mark-denominated debts as a result of the collapse of the German currency (though, as he was quick to point out, those whose savings were wiped out were far from jubilant).

In the hope of avoiding the mark’s meltdown, the economist John Maynard Keynes had repeatedly called for a general cancellation of the war debts and reparations arising from the first world war. Though no such intergovernmental jubilee was ever proclaimed, debt cancellation was effectively what happened after 1931, beginning with President Herbert Hoover’s one-year moratorium on both war debts and reparations.

As 2008 draws to a close, there are many people on both sides of the Atlantic who yearn for such a simple solution to the problem of excessive indebtedness. Parallels with the interwar period are not inappropriate. It is all but inevitable that we shall see serious political and geopolitical upheavals in 2009, as the recession takes its toll on weak governments (Thailand and Greece are already reeling) and raises the stakes in inter-state rivalries (India-Pakistan). In the words of Hank Paulson, the US Treasury secretary: “We are dealing with a historic situation that happens once or twice in 100 years.” The stakes are high indeed. Has the time arrived for a once-in-50-years biblical jubilee?

Excessive debt is the key to this crisis; it is the reason we are confronting no ordinary recession, curable by a simple downward adjustment of interest rates. It is the reason we still have to fear, if not a second Great Depression, then very likely the biggest recession since the 1930s. We are living through the painful end of an age of leverage which saw total private and public debt in the US rise from about 155 per cent of gross domestic product in the early 1980s to something like 342 per cent by the middle of this year.

With average household debt rising from about 75 per cent of annual disposable income in 1990 to very nearly 130 per cent on the eve of the crisis, a large proportion of American families are submerging under the weight of their accumulated borrowings. British households are in even worse shape.

Looking back, we now see just how big a proportion of US growth since 2001 was financed by mortgage equity withdrawals. Without that as a means of financing consumption, the economy would barely have grown at 1 per cent a year under President George W. Bush. Looking forward, we see just how hard it will be to stabilise property prices and the prices of the securities based on them. Already, at the end of September, one in 10 American home owners with a mortgage was either at least a month in arrears or in foreclosure. One in five mortgages exceeds the value of the home it was used to purchase.


The financial sector’s debts grew even faster as banks sought to bolster their returns on equity by “levering up”. According to one recent estimate, the total leverage ratios (on- and off-book assets and exposure divided by tangible equity) for the two biggest US banks were 88:1 for Citibank and 134:1 for Bank of America. The bursting of the property bubble caused such ratios, which were already too high on the eve of the crisis, to explode as off-balance-sheet commitments and pre-arranged credit lines came home to roost. Only by borrowing from the Federal Reserve on an unprecedented scale have the banks been able to stay in business.

With estimates of total losses on risky assets now ranging from $2,800bn (£1,850bn, €1,960bn) to $6,000bn, a chain reaction is under way that will leave no sector of the world economy untouched. The American economy is contracting at an annualised rate of 5 per cent. Commercial property is following the residential market into freefall. The Standard & Poor’s 500 index is down 43 per cent since its peak in October last year. The market for credit default swaps is pointing to a surge in defaults on corporate bonds. The automotive industry is already (against the will of Congress and the original intention of the Treasury) on life support. The US is at the centre of the crisis but Europe and Japan may suffer even larger aftershocks. As for the much feted emerging market “Brics” – Brazil, Russia, India and China – their stock markets have been dropping like, well, bricks.

What makes this crisis of burning interest to financial historians is the knowledge that we are witnessing a real-time experiment with not one but two theories about the Depression.

On one side, Ben Bernanke, Fed chairman, is applying the lesson of Milton Friedman’s and Anna Schwartz’s A Monetary History of the United States, which argued that the Depression was in large measure the fault of the central bank for failing to inject liquidity into an imploding financial system. Mr Bernanke has not merely slashed the federal funds rate to below 0.25 per cent. He has lent freely to the banks against undisclosed but probably toxic collateral. Now he is buying securities in the open market.

The result has been an explosion of the Fed’s balance sheet and of the monetary base. With assets approaching $2,263bn and capital of less than $40bn, the Fed increasingly resembles a public hedge fund, leveraged at more than 50:1.

How fallow years led to a golden jubilee

Every seven years, God told Moses, the children of Israel should neither sow their fields nor prune their vineyards – a kind of self-imposed recession. After seven such sabbatical years, the trumpet of jubilee should be sounded: “And ye shall hallow the fiftieth year, and proclaim liberty throughout all the land unto all the inhabitants thereof: it shall be a jubilee unto you; and ye shall return every man unto his possession.”

Land that had been sold was to be redeemed or returned to the original seller and the poor were to be relieved: “If thy brother be waxen poor, and hath sold away some of his possession, and if any of his kin come to redeem it, then shall he redeem that which his brother sold ... If thy brother be waxen poor ... then shalt thou relieve him: yea, though he be a stranger ... Take thou no usury of him ...” In addition, Jews who were slaves were to be set free.

To modern eyes, however, the most striking of these divine injunctions was that debts were to be cancelled as part of “the Lord’s release”.

On the other side, Mr Paulson has emerged as an unwitting disciple of Keynes, running a huge government deficit in an effort not merely to bail out the financial sector but also to provide a public sector substitute for sharply falling private sector consumption. Even before President-elect Barack Obama launches his promised infrastructure investment programme, estimates of next year’s deficit run as high as 12.5 per cent.

Once, monetarism and Keynesianism were considered mutually exclusive economic theories. So severe is this crisis that governments all over the world are trying both simultaneously.

Although commentators like to draw parallels with Franklin Roosevelt’s New Deal, in truth the measures taken since the crisis began in August 2007 more closely resemble those taken during the world wars. After 1914, and again after 1939, there was massive government intervention in the financial system. Banks and bond markets were reduced to mere channels for the financing of huge public sector deficits. That is what is happening today, but without the stimulus to manufacturing that the world wars provided. We are having war finance without the war itself.

Yet the effect of these policies is essentially to add a new layer of public debt to the existing debt mountain. Added together, the loans, investments and guarantees made by the Fed and the Treasury in the past year total about $7,800bn, compared with a pre-crisis federal debt of about $10,000bn. The Treasury may have to issue as much as $2,200bn in new debt in the coming year.

For the time being, the distress-driven demand for dollars and risk-free assets is pushing down the cost of all this borrowing. Treasury yields are at historic lows. But it is not without significance that the cost of insuring against a US government default has risen 25-fold in little over a year. At some point, with most big economies adopting the same fiscal policy, global bond markets are going to start choking.

Is it really plausible that the cure for excessive leverage in the private sector is excessive leverage in the public sector? Might there not be a simpler way forward? When economists talk about “deleveraging” they usually have in mind a rather slow process whereby companies and households increase their savings in order to pay off debt. But the paradox of thrift means that a concerted effort along these lines will drive an economy such as that of the US deeper into recession, raising debt-to-income ratios.

The alternative must surely be a more radical reduction of debt. Historically, such reductions have been done in one of four ways: outright default, restructuring (for instance, bankruptcy), inflation or conversion. At the moment, more and more American households are choosing the first as a way of dealing with the problem of negative equity, while more and more companies are being driven towards bankruptcy. But mass foreclosures and bankruptcies are not a pretty prospect.

Inflation, by contrast, is hard to worry about in the short term, not least because the Fed’s expansion of the monetary base is leading to no commensurate expansion of the broad money supply; the banks would rather shrink than expand their balance sheets.

That leaves conversion, whereby, for example, all existing mortgage debts could be wholly or partly converted into long-term, low and fixed-interest loans, as recently suggested by Harvard’s Martin Feldstein. (In his scheme, the government would offer any homeowner with a mortgage the option to replace 20 per cent of the mortgage with a low-interest loan from the government, subject to a maximum of $80,000. The annual interest rate could be as low as 2 per cent and the loan would be amortised over 30 years.

At the very least, this would rescue many homeowners from the nightmare of negative equity. A similar operation might also be contemplated for the debts of those banks that have been partially or wholly recapitalised by the state. This would not add to the federal debt in net terms and would reduce the interest burden, if not the absolute debt burden, of households.

Such radical steps would naturally represent a haircut for creditors, notably the holders of mortgage-backed securities and bank bonds. Yet they would surely be preferable to the alternatives. And they would certainly be a less extreme solution than the general debt cancellation envisaged in the Old Testament.

Financially, 2008 has been an annus horribilis. The answer may be to make 2009 a true jubilee year.

The writer is a professor at Harvard University and Harvard Business School, a fellow of Jesus College, Oxford, and a senior fellow of the Hoover Institution, Stanford

Copyright The Financial Times Limited 2008

100 top sites for the year ahead

 

 

Two years after we last picked the web's cream of the crop, our latest selection finds that location-based services, work-anywhere collaboration and video are prominent

• Charles Arthur, Jack Schofield, Victor Keegan, Aleks Krotoski, Keith Stuart, Greg Howson, Mike Anderiesz and Michael Cross
• The Guardian, Thursday 18 December 2008
• larger | smaller
• Article history

Illustration: Jan Kallwejt

The online world has changed dramatically even since we last drew up a list of 100 useful sites in December 2006. In the interim, there has been a revival of the browser wars - with Google's Chrome and Apple's Safari making surprising inroads into the Windows monopoly, and offering a new vision of what browsing can be like.
Many of the sites listed here were not available when we did our last list; although longevity is a mark of pride online, it is difficult for companies set up in the 1990s to reinvent themselves quickly enough to take advantage of new technologies. Although of course rapid change brings casualties too: it's possible that with all the economic turbulence going on that some of the sites here won't be around in a year from now, or that their now free services will have become paid-for. That doesn't diminish their usefulness, though; it just underlines their determination to survive.
The biggest changes since 2006 have been in the fields of collaborative online services that let people in different locations work simultaneously on projects. Collaboration in 2006 was very much focused on words, but now you can create presentations that look as though they were made with expensive packages. And then you can share those presentations, or look at other work that people have done - and even download them. You can convert files without needing expensive systems. Collaborative working has never been easier, even across different platorms. The web really is becoming the operating system, as the rise of the "netbooks" (aka ultraportables, aka Liliputers) emphasises.
The growth of location-based services - particularly those which you can choose to log yourself in and out of, thus protecting your privacy - has been rapid. A parallel growth has come with the mobile web; there's no escaping the fact that Apple's iPhone has revolutionised how its users, in their millions, think about the internet. For them, it is no longer something that is experienced well on a computer and then badly on their mobile phone; the mobile version of Safari has made browsing on the move an altogether more pleasant experience, which it never was before.
That opens up new vistas: location-aware task managers can adjust the order of your to-do list based on what the GPS unit in the phone is telling you, so that while you're in the supermarket it will remind you about the cereal you need, but in the office it will tell you to send that important memo right away.
Video, of course, is now everywhere. YouTube was already dominant in 2006, but now the BBC's iPlayer is taking over. If it makes its technology available to all, perhaps the UK will become a nation of video makers and watchers.
So here are our 100 revised best sites to see you through the next couple of years. They're organised roughly along those lines.

Blogging

Now as easy as falling off a log.
Bloglines bloglines.com for reading web feeds. Smart and clean.
Wordpress wordpress.com free, and most importantly spam-free, blogging.

Browsers

A newly revived category, thanks to Chrome and Safari.
Chrome google.com/chrome newly out of beta, though Windows-only.
Firefox mozilla.com/firefox infinitely malleable, with fewer security holes.
Flock flock.com with an emphasis on linking to social networks.
Opera opera.com growing in importance for mobiles.
Safari apple.com/safari Apple's contender; a leader in mobile web access.

Cartoons

Everyone needs some relaxation.
Dilbert dilbert.com hi, cube-dwellers.
Alex alexcartoon.com amid the financial crisis, Alex the banker remains reliably self-interested.
Doonesbury doonesbury.com the cartoon you'll also find in that printed newspaper thing.
The Joy of Tech geekculture.com/joyoftech well-drawn, witty near-daily takes on Apple and computing life.
XKCD xkcd.com "Stick-figure strip featuring humour about technology, science, mathematics and relationships."

Create/collaborate

The main change from last time: whatever you want to do, wherever you are.
Dipity dipity.com build timelines and add text, pictures and videos.
Zoho zoho.com everything in one place, from documents to presentations.
Rememberthemilk rememberthemilk.com online task/to-do management.
Netvibes netvibes.com your to-do lists, news, weather and photos on one page.
280slides 280slides.com create presentations online. Very slick.
Zamzar zamzar.com convert files from one format to another.

Gaming

A field where handheld, bedroom and Flash games are becoming mainstream
Eurogamer eurogamer.net reportage, with breadth, if not always depth.
The Independent GamingSource tigsource.com a great place to pick up on tomorrow's breakthrough hits.
Pocket Gamer pocketgamer.co.uk still by far the best site on handheld gaming.
Metacritic metacritic.com/games industry touchstone and useful one-stop buying guide.
Jay is Games jayisgames.com passionate, well-designed and knowledgeable.

Geek squad

Stack Overflow stackoverflow.com where programmers gather.
The Daily WTF thedailywtf.com daily despatches from the coding warzone.
Joel On Software joelonsoftware.com essays by a former Microsoftie.

Government/public services/politics

Streetwire streetwire.org hyperlocal information including planning alerts, crime and public safety, traffic, local news and postings to FixMyStreet.com.
Recycle Now recyclenow.com winner of the Show Us A Better Way competition.
British and Irish Legal Information Institute bailii.org a database of laws. Only survives hand-to-mouth on voluntary donations; where's yours?
What Do They Know? whatdotheyknow.com makes filing a Freedom Of Information request as easy as sending an email. Too easy, some in power think.
Upmystreet upmystreet.com all the detail on your area you could ever want.

Location, location

Services like these blossom with a mobile phone that can access the internet
Dopplr dopplr.com "share your future travel plans with friends and colleagues", then find out if others will be there too.
Qype qype.com localised search for pubs, restaurants, etc; also a bit of a social network.
Loopt loopt.com "transforms your mobile phone into a social compass".
Brightkite brightkite.com a "location-based social network".

Maps

The flip side of location-based services: seeing where you are.
OpenStreetMap openstreetmap.org a rights-free map created by people like you. Remarkably detailed and precise.
Walkit walkit.com walking directions for all sorts of routes.
Google Maps Street View maps.google.com/help/maps/streetview soon to have the UK as well.
Noise pollution map noisemapping.defra.gov.uk how noisy is it in the area around your house?
Where's The Path? wheresthepath.googlepages.com/wheresthepath.htm Let down by OS's absurd OpenSpace restrictions.

Money/finance/ consumer fightback

We all need someone on our side.
Money Saving Expert moneysavingexpert.com does what it says on the tin.
BView bview.co.uk review businesses before you use them.
Say No to 0870 saynoto0870.com direct-dial numbers, not expensive national-rate ones.
Consumer Direct consumerdirect.gov.uk government site for consumers.
Zopa zopa.com a human-centred way to loan money to people in the developing world.

Music

Last.fm last.fm British-made, CBS-owned, music recommendation station.
Amazon amazon.co.uk now has its own MP3 store in the UK as well as the US.
7Digital 7digital.com music downloads in MP3 format - so not tied to iPods.
Passionato passionato.com classical music MP3 downloads, slowly building momentum.
Songkick songkick.com find out where your favourite bands are playing next, based on your music library.
Blip.fm blip.fm be your own DJ and create a social network from your choices and recommendations.

News recommendation

Digg digg.com still the reigning champion.
Reddit reddit.com slightly upmarket from Digg; slightly below...
Techmeme techmeme.com technology news chosen by computer, though it's now adding human editors.
Popurls popurls.com aggregating the aggregators: the web in a window.
Slashdot slashdot.org still attracts a big, and often knowledgable, audience.

Offbeat

The Onion theonion.com still the satirical newspaper of record.
B3TA b3ta.com beyond classification; its forum has spawned many memes... and trolls.
Lolcats icanhazcheezburger.com captioned cats and other animals.
PostSecret postsecret.blogspot.com notes of secrets sent by people who want them posted. So they are.
Passive-Aggressive Notes passiveaggressivenotes.com would it be too much trouble for you to have a look?

Photography

Flickr flickr.com the granddaddy of photo-sharing sites.
Picnik picnik.com photo editing in your browser.
Picasa picasa.com Google's photo organisation and editing tool. Windows only.

Physical from virtual

Moo moo.com Moo business cards have become a calling card in themselves.
Blurb blurb.com coffee-table book publishing of your books.
Lulu lulu.com book, photobook, calendars and other sorts of publishing.
Cafepress cafepress.com badges, T-shirts etc. US-only at present.
Spreadshirt spreadshirt.net design your own T-shirt or sweatshirt and get it printed.

Reference

CIA Factbook cia.gov/library/publications/the-world-factbook all the data you need on pretty much anywhere.
Wikipedia wikipedia.com still a first port of call on most topics.
Rotten Tomatoes rottentomatoes.com check the film you plan to see here.
Internet Archive/Wayback Machine archive.org the web in aspic.
Wikileaks wikileaks.org anonymous source of leaked documents.

Search

Google still dominates.
Clusty clusty.com results in clouds.
CoolIris cooliris.com image-based searching - a new way to use the web.

Social software

Chances are high you're a member of at least one, and perhaps all, of these sites.
Facebook facebook.com virtually everyone's your friend here.
Myspace myspace.com hangout for all the teenagers. And Kirk Douglas.
LinkedIn linkedin.com mainly for business.
Friends Reunited friendsreunited.co.uk the original social network.

Twitter, and associated

Twitter has proved itself over and over this year as a vector for news.
Twitter twitter.com the ur-site, where you can create an identity (or several).
Monitter monitter.com watch keywords on Twitter. A brand, your name, a meme? No login required at present.
Matt themattinator.com post to multiple Twitter accounts. Requires your password; only give if you trust the site.
Twitterfeed twitterfeed.com posts blog contents to Twitter. Requires password; only give if you're sure that you trust the site. We do.
Twitter Grader twitter.grader.com find how you rank on Twitter.

Video

BBC iPlayer bbc.co.uk/iplayer already taking up 10% of UK network traffic.
YouTube youtube.com dominant provider of video content online.
Vimeo vimeo.com better rights control than YouTube and a cleaner interface.
Worldtv.com worldtv.com set up your own global TV channel.
Qik qik.com video-sharing from your mobile.
Joost joost.com internet TV via a browser plugin.
Videojug videojug.com a sort of social network of informational video.
Seesmic seesmic.com short video conversation: another social network.

Virtual worlds/MMORPGs

Runescape runescape.com amazingly successful MMORPG.
Entropia Universe entropiauniverse.com set in a distant future on the untamed planet of Calypso.
Club Penguin clubpenguin.com minigame-tastic virtual world for kids.
Moshi Monsters moshimonsters.com "educational" virtual world for kids.

Visualisation

DabbleDB dabbledb.com create online databases and analyse them.
Google Visualisation tools code.google.com/apis/visualization/documentation/gallery.html dozens of tools for making data more comprehensible.
Many Eyes manyeyes.alphaworks.ibm.com/manyeyes/page/Visualization_Options.html IBM's visualisation tools, similar to Google's.

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