After The Music Stopped

Alan S. Blinder, “After The Music Stopped: The Financial Crisis, The Response, and the Work Ahead”, Penguin Press  (2013) 443 pp.

Alan S. Blinder, Princeton professor, Wall Street Journal columnist, and former vice chairman of the Federal Reserve Board, presents a detailed analysis of the worst economic crisis in postwar American history (2007 et.al).  His premise is that the U.S. financial system has grown far too complex for its own good—and too unregulated for the public good. Most ordinary folks mistakenly think of the financial industry as a sideshow with little relevance to the real economy-- jobs, factories, shops, etc.  But, in fact, finance is more like “the circulatory system of the economic body: if the blood stops flowing, the body goes into cardiac arrest.”  It took the 2007 crisis for the world to discover just how truly interconnected—and fragile—the global financial system is.  Blinder argues that the problem started in the U.S. and was pushed abroad as overrated investment products nearly poisoned them. 

This book details how we got into the crisis and how we got out (how American and international government intervention kept us from a total meltdown). “After the Music Stopped” is an essential history that we cannot afford to forget, because one thing history teaches is that it will happen again.  

(I find it alarming that in the U.S. our congress has taken away many of the tools that got us out of the last crisis.)

My Notes:

Pg. 11:  The total U.S. job loss was just under 8.8 million, over a period during which our economy should have added perhaps 3.1 million jobs just to accommodate normal labor force growth.  So the total job deficit was around 12 million by February 2010-- nearly the population of Pennsylvania. 

Pg. 18:  The housing collapse alone could never have caused a recession as large as the one we experienced.  Housing typically accounts for only about 4 percent of the economy.  So the stunning collapse of home building was not nearly big enough to cause a serious recession.  Furthermore, the U.S. economy did not slip into a recession until the final month of 2007 and did not begin in earnest until September 2008.  Thus two to three years passed between the start of the decline in housing and the serious decline in the overall economy.  During 2006 and 2007, real GDP rose at about a 2.3 percent annual rate, and the unemployment rate barely budged.  Then in February 2008 the twenty-five-month job-losing streak mentioned earlier began and reached a high of 10 percent in October 2009.

Pg. 19:  On September 15, 2008, Lehman Brothers filed for bankruptcy.  Immediately thereafter, the whole U.S. economy fell of the table.  Real GDP fell at a 3.7 percent annual rate.  Then it dropped at a frightening 8.9 percent rate in the fourth quarter, and then at a rapid 5.3 percent rate in the first quarter of 2009.  Job losses, which had averaged 152,000 per month over the first eight months of 2008, leaped to 596,000 jobs per month over the last four, and then to 780,000 a month over the first three months of 2009. 

Pg. 22:  The Great Depression began in August 1929 and ended in March 1933.  It was vastly longer and incomparably deeper than 2007.  But what is often forgotten is that after the U.S. economy hit bottom in March 1933, the climb out of its hole was very rapid.  Real annual GDP growth from 1933 to 1937 was 9.5 percent, which sounds like China today.  The “boom” of course, started from a shockingly low base, and there was misery throughout. The robust expansion the mid-1930s came to an abrupt halt in May 1937—due to mistakes by policy makers, by the way—and the recession within the Depression followed. 

Pg. 28:  Seven key weaknesses predated the fateful summer of 2007 and contributed mightily to the ensuing financial mess:

1.  inflated asset prices, especially of houses but also of certain bond securities;

2.  excessive leverage (heavy borrowing) throughout the financial system and the economy;

3.  lax financial regulation, both in terms of what the law left unregulated and how poorly the various regulators performed their duties;

4.  disgraceful banking practices in subprime and other mortgage lending;

5.  the crazy-quilt of unregulated securities and derivatives that were built on these bad mortgages;

6.  the abysmal performance of the statistical rating agencies, which helped the crazy-quilt get stitched together; and

7.  the perverse compensation systems in many financial institutions that created powerful incentives to go for broke.

Pg. 53:  The inability to roll over short-term borrowing is the modern version of a run on the bank.  Such runs more or less killed both Bear Stearns and Lehman Brothers in 2008, and almost killed Merrill Lynch, Morgan Stanley, and Goldman Sachs.

Pg. 58:  Subprime mortgages constituted 7 percent of all mortgages granted in 2001 but by 2005 subprime lending amounted to 20 percent of all new mortgage lending, and total outstanding subprime mortgage balances had soared to around $1.25 trillion.  Only one of the top ten subprime mortgage originators in 2005 was a regulated commercial bank (Wells Fargo).  Only 20 percent of subprime loans granted in 2005 came from regularly supervised banks and thrifts.

Pg. 67:  Credit Default Swaps (CDS) were the biggest boom-bust story during the crisis.  The notional value of CDS outstanding at year end 2001 were $919 billion.  By the end of 2007, CDS volume topped $62 trillion.  In 2008 it was estimated that about 80 percent of CDS outstanding were ‘naked’—that is, were pure financial bets rather than hedges.  This is a major reason why such a seemingly small corner of the credit markets—subprime mortgages—caused such widespread damage.  The underlying mortgage risk was greatly magnified, not reduced, by trillions of dollars of CDS sitting atop the rickety house of cards.

Thus was the stage set for 2007.  We had a financial system with serious vulnerabilities.  We had deregulation minded regulators who were more enamored of innovation than safety.  We had no federal mortgage regulators at all.  We had a huge and almost entirely unregulated shadow banking system that was growing like mad, both in size and in scope.  We had a wild and woolly world of derivatives into which regulators were not allowed to set foot.  And we had lots of subprime mortgages, already going bad.  And, as it turned out, every American unfortunately and without knowledge or consent, had a stake in the complex gamble.

Pg. 79:  Rating Agencies: to put the rampant grade inflation into perspective, on the eve of the crisis only six blue-chip American corporations—names like GE, Johnson & Johnson, and Exxon Mobil—and only six of the fifty states merited the coveted Triple-A credit rating.  It was the gold standard—and just as rare, at least until various subprime securitized mortgages tranches began getting Triple-A ratings.  We cannot have those desiring ratings directly paying the agencies.  Three different solutions suggest themselves.  One is to have some third party, such as an exchange or the SEC, hire and pay the rating agencies.  Another would be to assign rating agencies randomly, as some courts do with judges.  A third would be to make rating agencies more careful by giving them more legal liability.

Pg. 178:  The $700 billion Troubled Asset Relief Program (TARP) may be among the most successful—but least understood—economic policy innovations in our nation’s history.  Almost all of it has been paid back but only 15 percent of the population realizes this.  Of course it didn’t help that the original proposal contained a highly provocative sentence in Section 8, “Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.”

Also: Troubled assets were not purchased as the bills title would suggest; instead capital injections were made into the financial institutions which was probably the most effective method but not a politically explainable solution.

Current status of TARP taken from Wikipedia:

The TARP program originally authorized expenditures of $700 billion. The Dodd–Frank Wall Street Reform and Consumer Protection Act reduced the amount authorized to $475 billion. By October 11, 2012, the Congressional Budget Office (CBO) stated that total disbursements would be $431 billion and estimated the total cost, including grants for mortgage programs that have not yet been made, would be $24 billion. This is significantly less than the taxpayers' cost of the savings and loan crisis of the late 1980s.