The Fight of the Century

An Exploration of the Great Credit Crash of 2008 and of Political and Economic Ideologues.

15088065

SUBMITTED IN PART FULFILMENT OF THE DEGREE OF LL.M. IN LAW AND INTERNATIONAL COMMERCE AT QUEENS UNIVERSITY BELFAST

SEPTEMBER 2011

ACKNOWLEDGMENTS

To the academic faculty at Queens University Belfast who taught on the Law and International Commerce LLM, to them I extend my most sincere appreciation for first stoking my interest in this area, for sharing their expertise and for reassuring me that this work is a road worth traveling. To Doctor Dieter Pesendorfer for his pertinent and helpful advice and guidance. To Andrew Entwistle and Vincent Cappucci, the founding partners of Entwistle and Cappucci LLP - a securities and class action law firm situated on 280 Park Avenue and within the heart of the New York legal arena - who so generously granted me a five month work placement, my gratitude is immeasurable. My time at the firm has bestowed upon me unrivalled experience and exposed me to some of the most topical and pertinent cases, such as the representation of the New York State Common Retirement Fund in the pursuit of loses as a result of the Merrill Lynch and Bank of America merger in September 2008. Certainly exposure to the intricacies of such litigation granted me with new and insightful perspectives which have heavily shaped my views and comments herein. And likewise to all the staff at Entwistle and Cappucci, who were so good to me, I extend my most sincere appreciation. To my parents, John and Christine, for their unwavering support. To all those involved in the wider discourse on the causes of the financial crisis I pay my thanks and respect for they have shaped my views within. I would highlight that this is an academic position seeking to advance a healthy discussion that can go some way to helping suggest a route towards a future of long term, stable and inclusive economical growth.

ABSTRACT

This study offers an exploration into the contentious causes of the financial crisis as well as considering the principle ideologues of our time, Friedrich Hayek and John Maynard Keynes, who have so extensively shaped financial markets over the past century. In this context this discussion argues that whilst the ideology that advocates free and competitive financial markets (Friedrich Hayek and neoliberalism) has been dealt a heavy blow in the wake of the Great Credit Crash of 2008, the damage is not terminal. Indeed since the causes of the financial crisis are not limited to the failings of Wall Street and high finance, but rather the precipitating factors were wide and multifarious, this paper argues that liberal financial markets, albeit with more sensible oversight, will remain a routine aspect of 21st Century life. Beginning by providing an introduction that chronicles the rising and falling of the great housing bubble of the 2000s, this discussion will then outline and explain the 5 deadly shots that came together to cause the deadly asset bubble. It will then consider the ideology that has underpinned finance over the last number of decades, after which this paper will highlight that in spite of the current state of international finances, Frierich Hayek and his ideology of individualism and liberated markets will prevail. This paper will argue that in going forward and exiting from the crisis it is important that policymakers recognise that there are important lessons to be drawn from the actions that were taken in response to the Great Depression of the 1930s. It is also important that they take insights from the proper consideration of the strong cultural context in which modern America - which so extensively shapes global affairs - was born. From the above and with a number of other considerations it will be demonstrated that despite the deleterious failings of high finance, man and his primal desire to push the boundaries of human endeavour will ensure a long future for free markets and neoliberalism.

Which way should we choose? More bottom-up or more top-down? The fight continues. Keynes and Hayek third round. Its time to weigh in. More from the top or from the ground? Lets listen to the basics Keynes and Hayek throwin down.

Fight of the Century: Keynes vs. Hayek, Round 2.

INTRODUCTION

The return of John Maynard Keynes in the wake of the most damaging financial downturn since the Great Depression has sparked a debate that challenges the legacy of the Great Moderation and the 20 years of calmness that prevailed over the vast plains of global financial markets. Indeed voices have risen from the fallout of the financial crisis that continually clammer that Friedrich Hayek, neoliberalism and free markets, that which has defined the last three decades of Western economics, is not the End of History. The debate has entered mainstream media as epitomised by the financial lyricism of Fight of the Century as seen above, an ideological sparring match that stages a rap battle between the two political and economic ideologues of the 20th and 21st Century. One, Friedrich Hayek the

exemplar of libertarian economics, the other, John Maynard Keynes the man of the big state, government spending and interventionary economics. Indeed prompted by the Fight of the Century the purpose of this monograph is to consider financial markets and the changes that are necessary in order to bring decorum to a world of finance sailing over choppy ideological waters, battered by a raging gale of populist anger. In order to do so it is necessary first to understand what in fact caused the worst financial contraction since the Great Depression. Fittingly the syllables, words, paraphrases and metaphors from henceforth will be the tools at hand as this paper starts on an archaeological dig that seeks to unearth the causes and enter the substratum of the Great Crash of 2008. However, a crisis that was caused by a morbid mix that included a fast and loose monetary policy, a fanciful federal housing policy, widespread irrational exuberance amongst consumers on Main Street, rampant excess by the financial alchemists on Wall Street and recklessness amongst credit rating agencies, this paper wants to dig deeper, down into the cultural form of modern society and into the ideological rhetoric that has shaped modern finance. Ultimately the goal of this paper is to navigate the tempestuous ideological currents and to consider the future of free markets and to pose an answer to the ideological uncertainty.

PART 1

THE GREAT CREDIT CRASH OF 2008

CHAPTER 1: THE TELLING OF A CLASSIC TALE OF BOOM AND BUST

Innumerable jeremiads have been written, told and screened throughout academia, the popular press and the wider media telling a classic tale of boom and bust. Fittingly the following section shall attempt to capture the mood and chronicle step by step the rise and fall of the global economy.

i. A Five Shot Deadly Cocktail Fuels a Housing Bubble

The housing bubble that started inflating in the mid 1990s and carried on until 2006, teetered in 2007 and eventually burst spectacularly on September 15th 2008. A day that witnessed history in the making (Thain, 2009) and an event that saw a billowing real estate bubble spew its toxic financial contents across the globe. Indeed the contents were a cancerous financial contagion that spread across global capital markets in systemic and stratified waves of destruction crippling credit lines, halting interbank lending, freezing assets and setting the fate of the global economy on a knife edge. However how did the lethal housing bubble form in the first place? For over forty years house prices in the post-war period moved in tandem with the overall rate of inflation, but from the middle of the 1990s the two variables diverged and house prices took off on a steady upward trajectory in the absence of any discernible inflationary pressure. Indeed the new trend that saw housing prices outstrip the rate of inflation ensured that real estate prices in the U.S. rose by more than 70 percent between 1995 and 2007.

Figure 1

Source: (Baker, 2010). The 70 percent hyper appreciation of real estate had no correlation to core fundamentals, happening in a world in which income growth averaged just 1.8% annually from 2001 to 2007. In fact, the increase in house prices created more than $80 trillion in additional housing wealth compared with a scenario in which house prices had continued to rise at the same rate as inflation (Baker, 2007). However the causes of the housing bubble and resulting crisis are complex and multifarious. Indeed Gillian Tett (2011) captured the mood and confusion that surrounds the causes of the crisis when she stated that the anger keeps festering, like a boil that cannot be lanced. Yet all too often people and the popular press flog the greed and ruthlessness of Wall Street, international finance and of free markets. But to arrive at such a solution is too facile. Rather the coming together of the housing bubble was a copious blend of a plurality of factors as it is right to say that most historical events, from wars to revolutions, do not have simple causes (Shiller, 2005) Despite the difficulties associated with locating the causes of the financial crisis this paper proposes five principle phenomena behind the housing bubble, a hit list of five deadly shots that came together to produce a lethal cocktail that created the environment for a speculative and deadly asset bubble.

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Firstly, the short-term interest rate policy of the U.S. Federal Reserve helped to nourish an asset boom. Indeed the expansive monetary policy of the Fed that ran from 2001 until 2006 ensured a liquid and free flowing marketplace that facilitated a plentiful and cheap source of credit for the consumer, business and banking. Secondly, it is well documented that increasing homeownership was an explicit goal of the Clinton and Bush administration. Thus this paper will seek to explore the U.S. governments fanciful housing policy that forced banks to loosen their traditionally rigid mortgage lending standards in order that the benefits of homeownership could be enjoyed by the less-thancredit-worthy. Thirdly, increased debt-to-income ratio for consumers and households was a central protagonist in the tale of the Great Crash. Indeed with real estate prices skyrocketing consumers were caught up in the market psychology that house prices would rice ad infinitum and as a result they feel infinitely wealthier and consumed credit at a rapacious pace. It was in the words of Alan Greenspan and later Robert Shiller (2005), irrational exuberance. Fourthly, the modern science of financial alchemy that financialised homes and homeowners as carried out by investment banks on Wall Street converted worthless mortgages into investment grade products that in the end exported the ills of modern finance worldwide and deepened the crisis exponentially. Fifthly, credit rating agencies played a starring role in the warped drama of finance pre-2008 and their actions merit timely consideration. Indeed these independent and wholly unaccountable agencies helped Wall Street banks to complete the process of modern financial alchemy by giving their actuarial stamp of approval to fixed-income securities that were in reality worthless junk. This paper stands by the five crisis causing proponents outlined above. Indeed they came together in a morbid mix and created a reaction that caused the American and global economy to go on overdrive, ensuring a voracious upward inflation of real estate that had no correlation to basic economic indicators. As the bubble grew it spurred on the very factors that caused its genesis in a dangerous and mutually reinforcing positive feedback loop.

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These five factors will be considered later on in the paper as it is first necessary to outline the fall of global finances.

ii. The Great Unwind

The 9th August 2007 is often cited as the day that the financial crisis announced its presence to the world as the aftershocks from the collapse of the subprime mortgage market spread to the world of high finance (Bernanke, 2010a). However it remains that the hazy days of August and September 2007 were only the start of a downward economic spiral as the world would later find out. Indeed things got dramatically worse and by December 2007 the onset of the global recession was official as 73 months of damaging speculative expansion that had been built almost entirely upon fictitious housing wealth, came to an end (The National Bureau of Economic Research, 2008). Thereafter the financial chaos from the collapse of the U.S. subprime mortgage collapse gathered pace and swept throughout global capital markets with devastating effect, hitting Wall Street at the beginning of 2008 and pushing Bear Stearns - the fifth largest investment bank in the U.S. - towards bankruptcy Bear Stearns recorded a loss of $854 million largely attributable to heavy subprime exposure and only survived through a forced marriage to JP Morgan Chase in March 2008 thanks to an emergency $30 billion loan and a deal pushed through by the Federal Reserve and U.S. Treasury. However the market chaos continued as IndyMac, the seventh largest mortgage issuer in the U.S. collapsed under the weight of huge subprime losses in July 2008. And as the page turned to September 2008 one found that life got a whole lot choppier on the high seas of high finance. Indeed the market currents stirred violently on the 6th September 2008 as the U.S. government took control of the two federally chartered and governmentbacked mortgage bond issuers Fannie Mae and Freddie Mac, who like others had suffered monumental losses associated to subprime loans. Around the same time Merrill Lynch - the third largest investment bank in America announced record losses due to heavy exposure to the subprime mortgage market, prompting

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the U.S. Treasury to enforce a shot gun marriage between Merrill and Bank of America late in the day of September 14th 2008. However the nauseating market conditions continued and were exacerbated as the venerable Lehman Brothers the 158 year old and fourth largest investment bank in the U.S. - filed for Chapter 11 bankruptcy proceedings. Indeed the collapse of Lehman Brothers on Monday 15th September 2008 remains a landmark day in which the fate of the world changed forever. A date that will be remembered in perpetuum as the day that saw the unleashing of a financial crisis of planetary proportions and a economic contraction that Raghuram Rajan (2005) rather presciently foretold would be best shared with future generations. Indeed post-Lehman collapse it became impossible to maintain any sort of decorum in the marketplace. The bank was a black hole on the landscape of global finance as exposure to Lehman as a major counterparty in the world wide web of financial markets was huge. The effects on global capital markets were such that it wasnt just banks feeling the nauseating effects from the rolling waves on the high seas of finance. Indeed other major lynchpins of the global economy including huge companies like General Electric and the three principle automotive companies faced imminent insolvency. A day after Lehmans failure Hank Paulson, the U.S. Treasury Secretary, was forced to respond to the dire calls of Mr. Bailout as American Insurance Group, Inc. (AIG) - the worlds largest seller of credit default protection - floundered helplessly in the deadly currents of the capital markets and was thrown an $85 billion lifebelt. Rather pertinently Gillian Tett (2009, p.28) observed that money is the lifeblood of the economy, and unless it circulates readily, the essential economic activities go into the equivalent of cardiac arrest. Indeed after the Lehman debacle global financial markets broke down, credit became near extinct and by the end of the week (the banks) had to be put on artificial life support (Soros, 2010). The global economy was only alive through the direct infusion of sovereign credit by governments around the world and had AIG done a Lehman, the market reaction truly would have been truly apocalyptic. The market chaos nevertheless continued as on the 25th of the same month the Federal Deposit Insurance Company seized Washington Mutual, the sixth

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largest bank in the U.S. and only four days after, Wachovia, the seventh largest bank in the U.S. was sold. By the 30th September 2008 the Federal Deposit Insurance Corporation had placed 171 banks with combined assets of $116 billion on their problem list (Congressional Oversight Panel for Economic Stabilization, 2008) and on the 3rd October 2008 the U.S. Congress enacted the $700bn Troubled Asset Recovery Program (TARP) in order to stave off a collapse of the banking industry and later brought into law the Term Asset Backed Security Loan Facility (TALF) in an effort to ensure the survival of capital markets. Citigroup got a rescue package in November and Morgan Stanley and Goldman Sachs whose share prices halved, were effectively guaranteed by the Treasury and transformed into bank holding companies - entities which are subjected to far stiffer regulation. Indeed their new status guaranteed that they would have access to the full menu of the Federal Reserves lending facilities, including the central banks discount window which would ensure that they would not go down a destructive Lehman path. Bank of America and JP Morgan were shielded from the worst of the depressed capital market conditions thanks to their strong liquidity profile and lower capital ratios. Indeed their survival could be accredited to their large commercial banking presence and stockpile of traditional retail banking deposits which acted as a buffer against the worst that the crisis had to offer. Without the heroics of the bank holding companies JP Morgan and Bank of America, it remains that in all likelihood Bear Stearns and Merrill Lynch would have done a Lehman for which the repercussions would have been unthinkable. In the end the policy activism of the U.S and other governments, with emergency liquidity provision, globally coordinated low interest rates and fiscal stimulus, were successful in stabilising the global economy and went some way towards filling the demand hole. Nevertheless the autumn and winter of 2008 was a time that will always be remembered as a period of unprecedented economic intervention - essentially a period in which governments subsidised where they did not nationalise.

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However the activism of the U.S. and other governments which saved the global economy from extinction ensured the transference of billions of dollars of toxic private debt onto public sector balance sheets. In fact the U.S. Federal balance sheet had begun to look like that of a giant hedge fund. Indeed the U.S. governments budget busting bailouts and fiscal packages, enacted in order to shore up the American and global financial system, left the federal government $7.7 trillion out of pocket. Governments worldwide socialised the toxic losses of private sector actors and in doing so the seeds were sown a sharp and stinging economic contraction, the European sovereign debt crisis as well as the global angst surrounding the levels of U.S. federal debt. Contentious issues that truly threaten the future of the global economy, and moreover contentious issues that continue to sound the death knell of libertarian economic policies. Thus having outlined the rise and fall of the housing bubble and the collapse of international finance it is now appropriate to consider in more detail the 5 deadly shots and precipitating causes of the financial crisis. Only later will it be appropriate to consider the Keynes, Hayek and Eucken and their role in the future of economic policy making.

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CHAPTER 2: SHOT 1, (SADO) MONETARY EXCESS

A Fast, Loose and Dangerous Monetary Policy

The canonical narrative of the Great Crash of 2008 underscores the primary role played by the U.S. Federal Reserves fast and loose monetary policy. Indeed the respected Professor John B. Taylor, an expert on monetary economics, stated that monetary excesses were the main cause of the boom (Taylor, 2009). Rather ironically it was the Feds monetary policy that was a central cause of the Great Depression. Indeed prior to the collapse of the stock market in 1929 the Federal Reserve had increased the money supply from 1921 through 1927 by around 60 percent (Niskanen, 2009). Such an increase in money supply eerily mirrors the expansive policy of the Fed in the years between 2001 and 2006. Indeed for a sustained period both before 1929 and 2007 the federal funds rate was below the general inflation rate and in both instances an asset bubble followed. In 1929 it was a stock bubble and 80 years later in 2007 it was real estate bubble. However what prompted the U.S. Federal Reserve in the early 2000s to take interest rates to such lows? Well the story goes as follows. It is well documented that the start of the twenty first century provided a challenging macroeconomic environment for the markets. Indeed following the rise and collapse of the internet bubble from 1995 until March 2000 stocks plummeted, investor confidence vanished and the markets suffered a mild recession. In addition geopolitical tensions arising from the 9/11 attacks, the conflict in Iraq and the dislocations that followed the Enron scandal further heightened market uncertainty. Fearing that the geopolitical tensions and market turbulence would spill into the real economy the U.S. Federal Reserve made the move to lower the target federal funds rate the interest rate at which banks lend to one another - set by the Federal Open Markets Committee. Thus fear prompted the Fed to drastically cut the target federal funds rate from 6.5 percent in late 2000 to 1.75 percent in December 2001, and down to 1 percent by June 2003, a record

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low. Then in June 2004 the Federal Open Markets Committee started to raise the target rate until it reached 5.25 percent in June 2006 (Bernanke, 2010a). Moreover it must be recognised that the U.S. government had a strong influence over the Feds monetary policy as Congress pushed its affordable housing mandate. Indeed the Fed found itself under sustained pressure from the government to maintain low interest rates, as will be discussed later.

Inflation vs. FFR Graph, (2010).

In any case the most telling aspect of the target federal funds rate is that it directly impinges on consumer and market confidence. Indeed interest rates are a central tool used to control economic activity and a principle tool of macroeconomic stabilisation and by lowering or raising the target rate the Fed can dictate the general ambiance of the marketplace and the direction of the economy. However the Feds laxity from 2001 to 2006 ensured a rich vein of money supply which impinged heavily on the global economy. Indeed John Thain the former CEO of Merrill Lynch was expressing popular sentiment when he stated that there was too much money available for too long at too low a cost (Thain, 2009). By lowering the target rate so extensively and holding it low for so long the Fed ensured that global credit markets were supple, liquidity was ample and the consumer and the marketplace were ready for the taking as they were prompted to buy houses, which in turn raised house prices and led to a surge in housing investment (Rajan, 2010, pp.5).

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The rise in housing demand was also a notable symptom of the tech stock bubble of 2000, for after the collapse the flight to survival and profits went into real estate (Rydstrom, undated). Indeed housing starts jumped to a 25 year high by the end of 2003 and remained high until the sharp decline began in early 2006 (Taylor, 2007). The huge surge in housing demand ensured that there was an incredible inflation in real estate which encouraged further demand which caused an encore of price hikes and a deadly upward spiral as price increases beget further price increases (Shiller, 2005, pp.xvii). Few can deny the repercussions that stemmed from the overly expansive policy of the Federal Reserve and the fact that it was a major factor fueling the increase in housing prices prior to the onset of the current U.S. recession (Lothian, 2009). In any case the writing was on the wall for the global economy when Raghuram Rajan (2005) stated in his now infamous 2005 paper, Has Financial Development Made the World Riskier? that persistent low interest rate can be a source of significant distortions for the financial sector. Likewise Friedrich Hayek had long since written that increased money supply and artificially cheap credit is a recipe that ultimately ends in a boom and bust. However it is quite unsettling to think that the actions taken by the Federal Reserve in 2001 in order to avoid a recession led to the creation of an asset boom and bust that far outstripped that of the tech bubble and its aftermath. Indeed William Fleckenstein (2008, pp.3) stated that Greenspan bailed out the worlds largest equity bubble with the worlds largest real estate bubble. Ultimately it turned out that the Feds crisis averting and accommodative monetary policy was nothing more than a form of sado-monetarism.

i. European Monetary Policy

The creation of a single currency in Europe in 1999 unleashed an age of creativity in Europe. Indeed the common currency heralded a move away from traditional stodgy banking practices and a move towards profitable investment banking and the world of high finance as high financiers from London, Paris, Frankfurt and Edinburg linked up with New York and other centres of international finance.

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Most tellingly by modernising finance Europe aligned its economic and monetary policies considerably with the hegemonic presence of America. Indeed the landscape of low interest rates that reigned in America from 2001-2006 was largely mirrored across the Atlantic as ten European Member States pegged themselves to a single monetary policy from the beginning of 1999. Ekkehard A. Kohler and Andreas Hoffmann (2010, pp.234) observed that the lowering of interest rates was not localised to the U.S. but rather it was a global phenomenon and certainly as Europe unveiled its common currency it followed that European monetary policy became more closely allied with U.S. monetary policy (ibid.) And whilst the European Central Bank (ECB) serves under a single mandate to control inflation - the Federal Reserves role is to maintain price stability and control inflation Europes central bank allowed an asset bubble to inflate that had no correlation to core economic fundamentals. Indeed just as happened in America from 2001 until 2006 the ECB lowered real interest rates considerably and kept them low for some time. In doing so the ECB and its monetary excesses allowed for housing in Europe to inflate to scarily high levels. Indeed The ECBs loose monetary policy helped Portugal, Ireland, Italy, Spain and Greece (the PIGS) and other parts of Europe to go down a path of self destruction. These countries were given access to cheap funding which ultimately fuelled hugely damaging housing and construction booms. The ECB needed to show more restraint for the weaker peripheral economies of Europe who were like kids in an all you can eat candy store. Ultimately the crisis in Europe has shown again the importance of monetary policy and that inaction on the part of central banks goes a long way to fuelling devastating asset bubbles.

ii. Global monetary policy

Moreover from the start of the 2000s central banks all across the globe in a seemingly concerted move lowered interest rates, causing a worldwide monetary expansion for which real world interest rates remained near zero for a long time after 2001 (Kohler and Hoffmann, 2010, pp.227). Indeed it wasnt just the U.S. and Europe that moved lending rates

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close to zero; there was an international conversion to accommodative monetary policy (ibid.). In any case this simply confirms the global hegemonic status and influence of American governance and economic policy. It is a country that has a global reach and when America moves the rest of the world reacts. Indeed the U.S. Federal Reserve is worlds central bank in all but name (Rajan, 2010, pp.227) and it is quite rightly the most important and least understood force shaping the American and global economy (Grunwald, 2009). Thus not only does the Fed control the money supply by setting short-term interest rates that shapes national levels of inflation, employment, the strength of the currency, the spending power of the individual and the outlook of the economy, but it also directly shapes the policies of foreign central banks. Indeed the lowering of interest rates and subsequent boom in housing prices was not restricted to the U.S. and Europe and indeed the real estate euphoria manifested itself in other nations around the globe. Rather the global blanket of low interest fuelled credit expansion across the world and a commensurate housing bubble as asset prices, particularly house prices, in nearly two dozen countries accordingly moved dramatically higher (Greenspan, 2010). In particular Robert Shiller (2005, pp.11) noted that was a globally concerted increase in real estate after 2000. Notably cities in Australia, Canada, China, France, Hong Kong, Ireland, Italy, New Zealand, Norway, Russia, South Africa, Spain, the United Kingdom and the United States (Iceland also) experienced housing booms. Moreover, researchers at the Organization for Economic Cooperation and Development provided evidence from that the greater the degree of monetary access in a country, the larger the housing boom was (Taylor, 2009).

iii. Low Interest Rates Spur on Modern Financial Alchemy

The low interest rates of the U.S. Federal Reserve and of central banks around the world had another gravely ill effect. Namely it pushed investors away from the traditional, prudent and

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more risk-averse techniques of banking and investment, away from equities and towards risky investments in search of yield, leverage and higher returns. Indeed relatively low interest rates worldwide for much of the 2000s drove investors to seek higher yields (Dunaway, 2009). Raghuram Rajan (2010, pp.109) echoed that statement when he stated that low short-term interest rates pushed investors to take more risk. It pushed normally cautious and circumspect investors such as public pension funds, mutual funds, labour unions, insurance companies and foreign investors towards riskier exotic instruments that offered yield enhancement and highly attractive returns, with seemingly little risk. It was the great shift from equities to debt investment, and more specifically the shift en masse towards high-yield and investment grade mortgage bonds. Indeed in order to satiate investors institutional investment managers, normally judicious and conservative money handlers, began to place their portfolios and cash reserves in MBSs and CDOs, moving away from the traditional and prudent investment avenues such as U.S. treasuries, corporate debt, municipal bonds government bonds, investment grade commercial paper and the like. The distaste held by U.S., foreign and European investors for the low returns to be had from traditional vanilla investments of government bonds and corporate debt ensured that once prudent investors inadvertently took on subprime packed mortgage bonds. Indeed it turned out that European and international investors who purchased AAA and investment grade fixed-income securities in reality bought heavily into subprime mortgage backed securities (MBSs) and credit default swaps (CDOs). In doing so they unwittingly tied themselves inextricably to the fate of American subprime homeowners and as a result suffered devastating losses.

iv. A Summation
The unspeakable damage of the Great Crash has taught us a few hard lessons about monetary policy that we must learn from. Firstly, to prevent future asset bubbles central banks need to work by the adage that interest rates should be elastic as opposed to uniform, in that they should undulate, meander and oscillate along the ebb and flow of the business cycle. They need flexibility and adaptability

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as prescribed by the Taylor Rule which warns against the tendencies for interest rates to remain low and stable over a prolonged period. However this goal was not exercised and as a result, the non-elastic and uniformly low interest rates that prevailed during the early 2000s fuelled a killer asset bubble and market hysteria. Thus it is necessary for central banks to continually assess asset prices and their correlation to inflation, core fundamentals and intervene where necessary. Excess liquidity pre-2008 was deadly and had central banks restricted money supply earlier during the asset inflation the devastating highs of real estate would never have occurred. Indeed Ben Bernanke (2010, pp.26) did admit that the Fed could have stopped the bubble at an earlier stage by more aggressive interest rate increases. Certainly Nouriel Roubini (2005) in his famous paper, Why Central Banks Should Burst Bubbles, advocated just such a method in order to combat an asset bubble. In any case we have learnt the hard way that low interest rates held low for a long period are deeply damaging. Moreover Europe has learnt the hard way that European monetary policy is unsuited to the rigours of a multitude of diverse economies. Indeed the ECB policy was found to be appropriate or slightly restrictive for France and Germany, but too loose for Ireland and Spain (Seyfried, undated). Ultimately it is rather easy to conclude that the influence that the U.S. central bank holds on the mood of the global economy is something that is hugely underestimated and in the end the actions and inactions of the Fed between 2001 and 2006 played an integral role in precipitating and maintaining the U.S. and global housing bubble.

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CHAPTER 3: SHOT 2, FEDERAL HOUSING EXCESS

Democratising Finance isnt all its Cracked up to be

Having outlined the damaging role of low interest rates on the global economy it is now appropriate to consider another major factor that helped to precipitate the Great Crash of 2008 and in this instance we will consider the failings of the U.S. federal government. Indeed the financial crisis was one not only of market failure as we will see later but one also of government failure.

Certainly the U.S government was guilty of two major financial crisis-inducing shortcomings that contributed massively to the Great Credit Crash of 2008.

Firstly, successive presidential administrations sought to extend the American Dream by pushing the benefits of private homeownership down market. In pursuing the goal of pushing mortgages to the lower echelons of society the U.S. Congress forced the relaxation of traditionally rigid credit issuing standards and in doing so gave birth to subprime and ARMmortgages (adjustable rate mortgages) and in doing so institutionalised the subprime mortgage market.

Secondly, in an effort to push home starts the U.S. government kept a strong hand over the Federal Reserves monetary policy in order to ensure that the central bank kept interest rates low.

Both of these actions by the U.S. federal government had the most unintended of consequences, rapidly distorting the economy and international financial markets and as such it remains that government excess was one of the 5 deadly shots that came together to unleash a financial crisis of planetary proportions.
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i. Reducing Loan Requirements to Palliate the Poor

Growing increasingly aware of the escalating inequality both in the standards of living and in the levels of income among American citizens - a serious fault line in the American economy the U.S. Congress sought to extend credit to the less than credit worthy in an effort smooth out the disparities and to make the American Dream a reality for those on the bottom rungs of society. Raghuram Rajan (2010, p.42) pertinently discerned that the government policy that pushed for the expansion of credit lines to subprime borrowers ensured that credit expansion was to be used as a populist palliative. Likewise in similar tone Robert J. Shiller (2008, p.23) observed that the extension of credit to subprime borrowers was an attempt towards democratising finance. Indeed the federal housing policy that sought to palliate the poor by democratising finance was first initiated in the early 1990s by the Clinton administration and later carried on as George Bush took office in the 2000s. Howard Bloom (2010, pp.30) was right to observe that Clintons goal was messianic, as it was a goal that sought to lift (the) oppressed masses into the middle class and to give them a stake in the stability of a vigorous, inventive America. Certainly George Bush had a rather ecclesiastical tone when he stated that we can put light where theres darkness, and hope where theres despondency in this country. And part of it is working together as a nation to encourage folks to own their own home (Bush, 2002). Thus in order to meet the hallowed goals of Clinton and Bush, banks soon found their arm wrenched by a wave of legislation, an assortment of policy measures and a number of community organisations that applied heavy pressure in order that they lend to the poor. Certainly banks had been accused for some time of red-lining, or in other words of simply having refused to lend to minorities and those in inner-city and low-income neighbourhoods. However the divine intervention of successive presidents put an end to any such suggestions. Indeed the Community Reinvestment Act of 1977 (CRA) which was revised by Bill Clinton in the early 1990s stipulated that in order to obtain a bank charter from the federal

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government banks had to lend to African Americans, Hispanics and other minorities. It was thus a stick used to beat banks in order to drive up lending in neglected areas. Above all it was a way to get around Americas historically and culturally rooted reticence towards ideas of taxation and redistribution. Certainly for the large part it pleased Democrats as it upped social justice and pleased some Republicans who saw the business and profit aspect of the government program. A mix of big business and social justice interests were thus merged in order to give the poor a taste of the American dream through buying houses and starting businesses. However the federal housing program which gave birth to adjustable rate mortgages (ARMs) and subprime loans helped to extend loans to people that should never have been given access to credit. Indeed encouraged by the government-loosened mortgage standards many hundreds of thousands of subprime borrowers took on loans, and with the wide spread assumption that house prices would rise indefinitely many more joined them. Indeed over a trillion dollars was channeled into the subprime mortgage market, which is comprised of the poorest and least credit worth borrowers within the United States (Reinhart and Rogoff, 2008a). However the idea that real estate values would rise forever was a raw economic fallacy and once house prices began their decline in 2006, subprime, ARM and NINJA (no income, no job or assets) borrowers all defaulted on payments en masse. This had the most severe repercussions on high finance and international capital markets. Thus due to the heavy involvement of government in urging the relaxation of loan standards and the creation of subprime loans it is right to say that the subprime crisis lay right at the heart of the American political system.

ii. Government Push for Low interest Rates to Kick Start Housing Starts
As a result of the federal housing policy the low interest rates of the U.S. Federal Reserve between 2001 and 2006 had strong undertones of government intervention. Indeed such was the desire of the U.S. government for increased housing starts that pressure (was) applied all the time by Congress (Rajan, 2010, pp.108).

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Whilst the disparities in the levels of U.S. income were hidden for a while under the world of low interest rates and reduced lending requirement as well as the smoke and excitement of rising real estate, in the end the credit rise and collapse was a huge fault of the fanciful housing policy and the governments meddling in the affairs of the Federal Reserve.

iii. A Summation
Attempts to democratise finance and to palliate the poor in the U.S. by expanding credit to citizens sitting on the periphery of society is commendable but history tells a story that should warn against such economic policies. After all it was the massive extension of credit by rural banks in the 1920s to farmers coupled with other extraneous factors which contributed to the stock market Crash of 1929. Indeed both the Great Depression of the 1930s and the Great Recession of 2008-2009 have shown that populist credit expansion went too far (Rajan, 2010, p.43) and in the case of mortgage issuance the US government has learnt a little late in the day that homeownership, for all its advantages, is not the ideal housing arrangement for all people in all circumstances (Shiller, 2008, p.6). Certainly extending credit to the poor appeared a simple and effective way to address the growing inequality. However such activity caused major distortions to the financial sector and in the end the U.S. found out that it was an extremely costly way to redistribute (Rajan, 2010, pp.43). The federal housing policy was one of good intentions yet it was utterly fanciful and what started as a government effort to improve the prospects for home ownership through a policy of easy money end(ed) up having unintended consequences that will leave many Americans economically scarred for the rest of their lives (Thornton, undated). And whilst it is right to say that there are plenty of culprits, it remains that the story the global financial crisis was partly one of Bushs and (Clintons) own making (Becker et al., 2008).

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CHAPTER 4: SHOT 3, CONSUMER EXCESS Irrational Exuberance

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To pin the blame for the financial crisis solely on the backs of bankers, credit rating agencies or the like is not the correct response nor is it constructive. As outlined earlier, such a response would be too facile and indeed to take such a stance would be to absolve the rest of us of our responsibility for precipitating the crisis (Rajan, 2010, pp.4). And rightly so as it was your greed and mine (Bloom, 2010, pp.31) that contributed to the manic housing and spending euphoria. Ultimately consumers were part of a morbid mix that caused a financial catastrophe. Indeed the coming together of the financial crisis was a subtle but deadly chemistry and the role of the consumer on Main Street cannot be underplayed. At the end of the day people decided to take out credit cards and home loans, monumental household debt was selfinduced. No one was forced to take on a mortgage or mortgages, credit cards or consumer finance. Consumers willfully consumed huge amounts of credit before the crisis and thus implicated themselves in the fall of global finances most seriously. Main Street was greedy too and the greed was good, while it lasted. Through their incessant consumption, consumers provided the foodstuffs that propelled the activity on Wall Street and of high finance. Indeed by increasing their liabilities consumers raised exponentially the flow of debt and structured products that wizzed throughout high finance. And at the end of the day Wall Street could not have done what it did without the raw material needed for the process of modern alchemy - the housing and debt liabilities of consumers on Main Street. However what is it that drove consumers to take on so much credit and to spend with such manic euphoria? As was alluded to earlier, the consumer debt binge was in large part a symptom of the low interest rates which made mortgages and the like so manageable and attractive. It was also a phenomenon that manifested itself as a result of the reduced loan and credit requirements thanks to a government housing policy as well as the indifference of mortgage originators who were pushed on by huge mortgage origination fees and the hunger of Wall Street alchemists.

However a central and perhaps primary cause underlying the incessant activity of consumers was the non-rational herding mentality that was driven by nothing more the infectious market

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psychology of irrational exuberance a term first coined by Alan Greenspan in 1996 and later a central focus of academic research for Robert Shiller, an expert on consumer behaviour, asset bubbles and their causes.

Robert Shiller (2005, pp.2) who has written voluminously on the matter of consumer behaviour, market psychology and their bouts of market mania outlined that irrational exuberance is the psychological basis of a speculative bubble. I define a speculative bubble as a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increases and bringing in larger and larger class of investors, who, despite doubts about the real value of an investment, are drawn to its partly through the envy of others successes and partly through a gamblers excitement.

Indeed in the early 2000s the media, rumour and social noise prompted consumers to take on an unyielding faith in the real estate market. Reports of the doubling and tripling in value of real stirred up consumers in a bout of investor enthusiasm and believing that house prices would grow indefinitely - with few saying otherwise - countless consumers bought into the real estate market with reckless abandon.

Certainly the globally spread and manic spending binge was driven by psychological factors that (had) little to do with fundamentals (Baker, 2007) and as a result of the irrational exuberance consumer demand pushed real estate prices far away from core economic indicators.

The work of Robert Shiller which explores the non-rationality and herding behaviour of consumers is something that overlaps rather fittingly with a new field that has emerged within the wider study of economics, namely that of socionomics - a socio-economic theory that considers the social mood and how its impinges on economic activity.

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Much has been written within this nascent field of study, (cf., Nofsinger, 2001; Nofsinger, 2005; Olson, 2006; Parker and Prechter, undated A; Parker and Prechter, undated B; Prechter, 1999) however time and space constraints permit only a brief consideration of this fresh and insightful aspect of modern academia.

Nonetheless socionomic scholars hold that a social mood can be transferred through social contact which can spread confidence or lack thereof far and wide. And since the mood is collectively shared, and in a constant state of flux many simply follow the herd as individual consumers base their purchase and investment decisions on rumour and social noise, devoid for the large part of any sort of detailed knowledge of the insider dynamics of investment and trading a scenario of the free rider investor.

Indeed it was the case that most homeowners did not care why residential real estate prices rose; they assumed prices always rose, and they should simply enjoy their good fortune (Roberts, 2008, pp. xvii). And as the prices rose the social noise stirred an ever stronger public interest and indeed as the social mood reache(d) its peak, the level of optimism in society (drew) more people into investment (Redhead, 2008) thus helping to feed the asset bubble ever more.

Such a scenario highlights how emotion and perception are the core of economics (Bloom, 2010, pp.52) and in this instance the high prices were sustained only by the raw emotions, confidence and perceptions of investors as well as a primal enthusiasm as opposed to any correlation to real value. Indeed all too often humans have a chronic tendency to overconfidence (Chancellor, 2011), and it remains that errors of human judgement can infect even the smartest people, thanks to overconfidence (Shiller, 2005, pp.xv).

Certainly the psychological contagion of irrational exuberance crossed wide oceans and stirred an unbounded confidence in the solidity of the housing market even amongst the smartest and most market savvy people. However even though it should have been evident

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to housing analysts that the housing market was experiencing a bubble (Baker, 2007), only a select few took note.

It just goes to show in spite of all the advances in technology and knowledge, how something as complex as the economy can be built up so high and brought down so low by something as simple as the raw instinctive animal spirits of man and his desires. Indeed the economy is shaped by the actions or inactions and the emotions of consumers and investors in low finance and as such, if credit is the lifeblood of the economy, it goes that consumers and their emotions are the pulse that can both set the economy both racing and plummeting.

Thus, much in the same way that man and other organic entities have a mood and an emotional state, the economy - which is driven by the totality of man and the consumer can likewise reach moments of acute pleasure or distress.

The end result was that the nature and character of household debt changed fundamentally and throughout the early 2000s hyper leveraged household balance sheets became the norm. Indeed coupled with the erosion of traditional loan requirements capital spilt over the prudential banking levees and showered immense levels of credit over a wide and diverse pool of borrowers who were all to willing to take it on. The graph below highlights the increasing indebtedness of the consumer between 2003 and 2005 in particular.

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Source: (Reidy et al., 2010).

Indeed the credit tsunami fed the investor enthusiasm and with an unyielding faith in assetbased prosperity the wave of credit allowed consumers to buy their first, second, or even third house. With the belief that house prices would rise ad infinitum and with fungible mortgage debt consumers could liquidise their gains as prices rose or refinance their mortgage loans in order to purchase widescreen TVs, sportscars, holidays, boats and innumerable other luxury items. However this way of life was but a mere mirage. American consumers on Main Street were swimming in financial hubris, a financial fantasy land and an economic utopia where house prices would never fall.

Such a mentality fuelled by irrational exuberance led to significant under pricing of risk and in the end the consumer and wider finance who had so long danced with fire got severely burnt. Indeed as prices began to align to economic fundamentals consumers suddenly woke to find out that house price appreciation was not an infinite rationality.

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And as prices reverted to core fundamentals and house prices depreciated the world learnt that the same irrational exuberance that fed the real estate bubble could help to deflate the economy in a most damaging manner.

Indeed consumer, investor and market confidence or lack thereof is the central tenet of the modern economy and financial markets, and just as price hikes stir further price hikes in a rolling wave of investor confidence, so it remains that any major negative price fluctuations can cause market actors to take flight.

Indeed consumers and banks rocked the market with fire sell liquidations which drove down asset prices in a devastating downward economic spiral, bringing to an end the credit-driven super-cycle and unleashing a long and drawn out cycle of debt deflation that has continued to this day.

The above analysis of irrational exuberance lays bare the inefficiencies of man and the raw perfunctory emotion and primal instincts of the consumer that shape the mood and direction of the global economy.

Thus the goal of this section was to highlight the weakness of man and their tendency to disregard traditional sensibilities when faced with the chance to access cheap and easy credit. Indeed the greed was not limited to Wall Street but rather was manifested on Main Street and throughout society both from low and high finance.

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CHAPTER 5: SHOT 4, WALL STREET EXCESS

An Exploration of Modern Alchemy

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The science behind mortgage backed securities (MBS), collateralised debt obligations (CDOs) and credit default swaps (CDSs) is true modern day alchemy. It is a tenebrous technique that involves the financialisation and commodification of everything. Indeed modern financial alchemy has helped to transform static and illiquid assets into commodities that can be bought and sold around the world. Anything from mortgage loans, commercial real estate loans, corporate debt, credit cards, student loans, car loans and the like are converted into tradable goods in a world gripped by financialisation. For the purposes of this section we will consider in detail these esoteric tools of high finance, the magna opera of 21st Century financial engineering, and in particular this paper will focus on the financialisation of homes and homeowners as it stands that housing is a central aspect of financialisation (Aalbers, 2008, pp.148). However the financialisation of housing and the complex, opaque and baffling practices involved played a central role in the Great Credit Crash of 2008. Indeed the world found out that Wall Streets buying of credit default swaps and the trading of subprime mortgage bonds and CDOs in the end did not distribute risk as was originally intended, rather they disseminated the toxicity of subprime debt, industry malpractice and the foibles of man worldwide. Thus for the purposes of completeness it is necessary to dive into the dark world of 21st Century financial engineering.

i. Mortgage Backed Securities (MBSs)

The practice of selling and trading debt is hardly new. Indeed the trading of bonds is a practice many hundreds years old that has paid for wars and bankrolled governments the world over. It was after all securitisation that paid for the warships that allowed Britannia to rule the waves (Braithwaite, 2005). A process that was first invented in Naples, Italy in the 17th Century (ibid.), the contemporary science behind mortgage bonds has changed little. In any case the securitisation of mortgages bears witness to the liquidation of once long-term, illiquid and balance sheet clogging liabilities into tradable assets. By removing the default risk off balance sheets, remodelling loan books and tapping into the underlying value of housing loans the modern mortgage securitisation process has revolutionised modern finance.

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Indeed the development of modern mortgage securitisation, the establishment of the secondary mortgage market and the emergence of a non-exhaustive nomenclature of exotic financial innovations which have developed around the process of modern alchemy has irrefutably signalled the birth of new capitalism (Finch, 2009, p.19). However before the advent of new capitalism the mortgage business was entirely different. Indeed banks funded their housing business through lending out customer deposits at interest, retaining the original mortgages and receiving the monthly cash flow of repayments and interest. This process was known as the originate to hold model and an all together simpler business from modern mortgage lending. As a result of retaining the original mortgage loans on their books the traditional lenders also retained the risk of default and consequently they were astute arbiters and managers of risk.

However the traditional originate to hold model of mortgage lending started to be displaced by the originate to distribute model as primitive forms of mortgage securities were developed in the 1970s when banks began selling off single mortgage loans to outside investors in a product known as mortgage-pass-through securities. Much of the early business was carried out by Fannie Mae and Freddie Mac, the now infamous government sponsored enterprises (GSEs). These agencies had an implicit government guarantees and generally adhered to strict underwriting standards, and as a result their products carried high credit ratings.

Indeed they produced attractive and profitable products that allowed third parties to invest in the mortgage business without the need to engage in the time consuming process of scrutinising details and assessing default risk in order to originate loans. More importantly this new secondary mortgage market provided an invaluable source of mortgage and consumer finance and when exercised properly it provided an important tool for risk management.

But what exactly is a mortgage security/bond and how does it come into being? First of all as mentioned earlier a bond or securitised debt product can come in any form. Indeed it matters

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not the nature of the primary underlying asset. The sole concern is whether a predictable cash flow can be extrapolated from the pre-existing liability in order to back/securitize/ collateralise the original asset through the maintenance of regular repayment from the borrower to the bond holder.

Indeed a bond is a contract whereby the investor will hold that, I, the bond investor, part with my money now. You, the borrower, pledge that in return for receiving my funds now, you will make specified, scheduled payments to me in the future (Sylla, 2001).

Mortgage borrowers make regular monthly repayments and it is for that reason that mortgages are attractive and effective munition to subject to the financialisation process of modern alchemy. Indeed following the financialisation and securitisation of a mortgage loan the monthly repayments are then directed not to the mortgage originator but rather distributed (originate to distribute) to the investor who bought the securitised mortgage product.

The investors who buy debt products are thus called bond holders. They receive promissory notes that state their entitlement to receive a regular cash flow in the form of interest payments and principle amounts loaned at maturity channelled from the original mortgage borrower. The diagram below gives a competent explanation of the mortgage securitisation process.

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Source: Supreme Court of the State of New York representatives briefing in the case; Allstate Insurance Company v. Merrill Lynch (2011).

However in the late 1990s and early 2000s the mortgage securitisation business soared amongst investment and shadow banks on Wall Street who bought into the originate to distribute model with reckless abandon. Indeed the banks on Wall Street who structured and issued bonds with great efficiency ensured that mortgage securitisation quickly became a routine aspect of modern finance.

Resultantly a technique that started out in life as a rather modest cottage industry in the 1970s and 1980s, mortgage securitization was subjected to the full rigours of Wall Street as it was transformed into a multinational business carried out on an industrial scale.

Moreover the once rather simple chemistry behind mortgage securities evolved into a vastly more complicated science with techniques that involved the pooling of huge quantities of debt liabilities into packages that created a range of assorted debt products. These were the new sophisticated tools of high finance, known as collateralised debt obligations.

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ii. Collateralised Debt Obligations (CDOs)

A Collateralised Debt Obligation is simply the science of mortgage backed securities on steroids, of financialisation and modern alchemy on overdrive. It involves the pooling of an assortment of debt liabilities which are then divided into slices and tranches of debt that each carry a unique risk profile. Indeed CDOs can be made up of a rainbow selection of illiquid assets - mortgage debt of the prime and subprime variety, student loans, credit card loans, corporate and commercial loans, auto loans and even debt bonds can all be bunched together within a CDO portfolio.

Thus the principle difference between a mortgage backed security and a CDO is that a CDO is a melting pot of debt, a giant pool of illiquid assets.

The construction of a CDO contract usually requires the involvement of a special purpose vehicle (SPV) which includes assets, liabilities and a manager responsible for issuing notes to institutional investors. The notes issued by the SPV are the obligations of the CDO which entitles the note holder to regular payment from a tranche of their selection.

The financial engineering of funnelling the cash flow or income from the assorted pool of debt into a wide range of tranches provides a multifarious menu of risk which caters to the demands and diverse risk appetites of the modern sophisticated institutional investor.

The senior tranches have better credit ratings and as such the buyers of highly rated CDO tranches are entitled to the first round of the available CDO cash. Conversely the lower tranches of a CDO portfolio have a higher potential yield but are far riskier assets. Indeed it is the tiering or water falling of the cash flow that thus seeks to protect those investors who have taken on senior and more highly rated tranches.

This form of structured credit was first issued in 1987 and soon after Wall Street found out that sponsoring a CDO and selling debt assets from a broad portfolio of risk was a highly
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profitable business. Indeed debts of all kind were routinely secured in the 80s, 90s and early 2000s. However as the U.S. housing bubble inflated it became increasingly apparent that housing debt was the collateral of choice for financiers stocking up a CDO portfolio.

Indeed as the housing bubble continued its upward spiral subprime MBS, ARM (adjustable rate mortgages) and Alt-A (poorly documented loans) mortgages increasingly made up the collateral held in the CDO pool of assets. In fact the issuance of residential MBS CDOs roughly tripled over the period from 2005 to 2007 and RMBS CDO portfolios became increasingly concentrated in subprime residential MBSs (Petersen et al., 2011). Moreover statistics compiled by Bernstein Research (2011, pp.7) has shown that the annual issuance volume of CDOs rose from $33 billion in 1999 to $229 billion in 2006. The growth in the CDO issuance volume provided an estimated $361 billion in new capital to the mortgage market and more importantly gave a supposedly permanent home for the subprime and Alt-A loans being originated and packaged by financial institutions. Indeed the short-sightedness and hubris of bankers and financial engineers drove them to forge CDO contracts whose very structural foundations were assembled upon subprime loans which rested on the ability of poorly or non-documented subprime borrowers to maintain payment, a most unlikely scenario.

If the underlying debt liabilities packaged within a CDO go unpaid in large numbers the entire integrity of the structured finance vehicle can collapse. Furthermore if CDO contracts collapse en masse the very solvency of the buyers of CDOs and the integrity of the buyerseller network can be brought into question.

iii. A Boom in Modern Alchemy Pushes Subprime Lending

The originate to distribute securitisation process advanced wildly beyond its primitive roots into a complex and convoluted beast that radically altered the economic incentives of

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mortgage lenders and fundamentally warped the world wider finance. Indeed the desire of high financiers for housing debt in order to financialise pushed bankers to further loosen loan requirements.

However there were negative side effects of the most severe degree to be experienced from the financial wizardry that fused subprime mortgages with rampant financial engineering.

For centuries banks and mortgage lenders had been astute assessors and arbiters of risk, bastions of sensible money lending. However the financial engineering of mortgages had seemingly made the longstanding issue of default risk defunct, infecting mortgage originators and Wall Street with an insatiable appetite for mortgages of any kind to financialise and pass onto end-investors.

Indeed since the original lenders were no longer required to hold home loans to maturity they could quickly devoid themselves of the burdens and worries that a borrower would default. In the new process of mortgage lending the original lender would originate the loan, take a commission fee then pass on the loan and in doing so pass on the default risk. Thus the creditworthiness of the borrower soon became irrelevant as in the event of default it would be a matter for the investor.

It became standard practice that for as long as loans could be quickly dumped in the secondary mortgage market, mortgage issuers had little concern about the ability of borrowers to actually pay off their loans (Baker, 2007).

As such the high servicing fees and an incessant demand for structured debt products ignited a parallel boom in the secondary mortgage market alongside the housing boom in the real economy. Indeed the extension of mortgages simply could not keep up with investor demand which further prompted myopic bankers to extend loans to the less than creditworthy.

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It was becoming obvious that the mortgage business had developed into an assembly-line affair (Tett, 2010, pp.112). A non-stop production line as loans were extended to retail customers and quickly packaged into bundles of mortgages, labelled AAA and immediately sold to pension funds, mutual funds, insurance companies, labour unions, foreign investors and foreign banks worldwide.

The demand for both mortgages and mortgage bonds ensured that retail borrowers and real estate loans of any kind were to become feedstock (Caulkin et al., 2010, pp.7) and fertile fodder (Tett, 2009, pp.111) to mortgage lenders and the financial wizardry of investment banks. Indeed it was becoming clear that mortgage markets were no longer strictly a facilitating market for needy homeowners but rather a market that was increasingly feeding global investment (Aalbers, 2008, pp.148).

In the end it was the warped incentives of mortgage lenders and those on Wall Street combined with a federal housing policy and the widespread belief in the near economic impossibility (Stiglitz, 2010, pp.86) that house prices would interminably rise which led to the complete erosion of sensible lending practices and the normalisation of subprime loans.

Indeed with the abandonment of the customary ritual of risk assessment prior to the issuance of credit it was ensured that mortgages would be made available to anyone and everyone. And even though the underlying debtors were unlikely to make repayment Wall Street was still ready to financialise the raw material in order to feed the market demand and by 2005 there was $625 billion in subprime mortgage loans and $507 billion of which found its way into mortgage bonds (Lewis, 2008).

However Michael Lewis (ibid.) was very much right to state that such loans were built to self destruct.

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Indeed in the end it turned out that underlying the faade of a vast global network of MBS and CDO contracts was a marketplace awash with toxic subprime debt, a ticking time bomb strapped to the heart of global finances.

By February 2007 the 3 major credit rating agencies began to downgrade many MBSs and CDOs from AAA to BBB and by the summer of 2007 the financial emperor was shown to be wearing no clothes as the subprime crisis unleashed itself onto the world through a pandemic of defaults on the underlying mortgages. It truly illustrated to the world that the chemistry of financialising subprime loans was a lethal practice. But how could the subprime lending of U.S. institutions affect banks in foreign nations right across the globe? Quite simply the financial wizardry of modern alchemy (through the help of credit rating agencies, as one will see later in the paper) transformed subprime housing debt into highly rated structured finance products that foreign banks, investors, pension funds and central banks were very willing to invest in. Indeed Gillian Tett (2010, pp.116) stated that some American banks privately guessed that at least half of subprime-linked CDOs were being sold not to Americans, but into Europe (Tett, 2009, pp.116). Rather than diversifying and spreading the risk of default high finance had in the end simply exported the horrors of subprime lending to most of the worlds economies, (and) none more so than Western Europe (Datamonitor, 2008).

iv. Credit Default Swaps (CDSs)

Having probed into the contemporary world of mortgage bonds and the inextricably linked cosmos of collateralised debt obligations it is now fitting to consider the science of financial derivatives and more specifically that of credit default swaps.

Interestingly enough the science behind credit derivatives and CDSs is one that can trace its primitive roots far beyond those of debt and mortgage bonds. Indeed derivatives are as old as
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finance itself and have been employed for thousands of years in order to limit risk as rudimentary examples of futures and options contracts have been found on clay tablets from Mesopotamia dating from 1750 BC (Tett, 2009, pp.11).

So what are derivatives exactly? Most simply a derivative contract is an agreement whose value derives from an underlying variable and a tool that allows investors to shield or hedge themselves from the risk of negative prices fluctuations or even to make wagers that may pay off in the event of a future positive price swing.

Indeed derivatives have allowed financiers not only to hedge against risks but also to gamble on the turnout of any number of market events including the rise or fall of oil prices, the performance of foreign currencies as well as stocks and shares, interest rates, the solvency of a company and even weather activity. The turnout of any given bet simply depends on the behaviour of the underlying benchmark.

It is perhaps best to give a workable example. Say for instance that on a given day that the pound-to-euro exchange rate is such that one British pound buys 1.30. Well someone who is going to France for a few months in a years time is worried that by then the exchange rate (the benchmark) will have swung wildly out of his favor. However a derivative contract could hedge the buyer of the contract from an unfavorable fluctuation in the exchange rate/benchmark. Indeed that person could buy a derivative contract that would ensure that he could still buy euros at the rate of 1 to 1.30 just before his trip, thus rendering the benchmark constant and unchangeable.

The buyer simply purchases an agreement with a bank stipulating that he can make a poundto-euro exchange of 1000 with a bank in 12 months time in which the buyer is guaranteed to 1300 regardless of what the actual exchange rate is in a years time.

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A derivative agreement that stipulates that the above agreement had to happen is called a future. Such an agreement locks the buyer into a contract to purchase euros at the prespecified exchange rate. However a derivative contract could be structured in another way such that the buyer could agree to pay an extra fee of around 30 which would give him the option to either make the exchange at 1.30 or in the case that the benchmark became more favorable he would not have to exercise the exchange rate transfer at 1.30 but rather go with the more favorable one.

For a long time futures and options have been traded on agricultural commodities in which grain farmers would for example buy a future derivative contract in order to lock in at a good price to hedge against the chance that a big crop would bring in low prices. This would leave speculators to take on the losses in the event that a bumper crop drove prices down. At the same time if the crop was poor and prices were driven far beyond that of what the farmer expected, the speculators could hit a big pay day. By the 1970s derivatives jumped from the realm of commodities and into the world of finance. However credit default swaps as we know them today were not invented until the mid-1990s. It was Bill Demchak, his boss Peter Hancock, the illustrious Blythe Masters and a small group of bankers at J.P.Morgan, inspired by the chaos of the Asian financial crisis of 1997, who were responsible for the creation of a product designed to shield banking against the troubles of bad loans. Indeed the high financiers and financial wizards at J.P. Morgan had decided they could defeat the bankers oldest foe the danger that borrowers will not repay their loans (Barrett, 2009). So what exactly are credit default swaps? Well a CDS is simply a 21st Century derivative that often finds its value derived from an underlying asset such as a mortgage bond or another form of debt liability as opposed to an agricultural commodity like wheat or an exchange rate as outlined in the earlier example. Indeed not dissimilar from the exchange rate example above, a CDS contract is an agreement chartered between two parties in which one buys risk/credit protection from the other.

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Rather appropriately it has been said many times that credit default swaps are complex financial instruments whose primary purpose is to insure bond holders against the risk of default. Indeed that is why it has been uttered countless times that a CDS is a form of debt security or bond insurance. An insurance policy that covers credit risk by paying out in the event of default much like an insurance deal taken out on a house or a car will cover any losses in the event of damage or loss.

Indeed a credit default swap is a contract held between two parties in which the seller agrees to compensate the buyer if a bond issuer defaults on his or her liability. It is a form of structured finance that can be used to divert the credit risk borne by the investor (the protection buyer) to another party who is willing and ready to take on that risk (the protection seller).

Used sensibly, a derivative can provide a hedge against risk. For example, Bank A (protection buyer) who is worried about some of the bonds that it holds on its books can make a derivative deal to pay a fee to Bank B (protection seller) in exchange for Bank Bs promise to compensate Bank A if the bond issuer defaults. By buying the credit protection Bank A can rid itself of the worry and uncertainty related to the bonds that its holds and thus free itself up to take on fresh debt liabilities and to make further loans. Bank B while assuming some of the risk can immediately enjoy the fee income from the insurance premium. Banks on Wall Street and around the world saw the risk dispersion potential and it soon became a household product. Indeed hedge funds, investment banks and insurance companies all bought into the idea of bond insurance, buying and selling credit default swaps in contracts that spanned the globe. AIG however was the worlds biggest insurance company and largest issuer of CDS contracts and before the crash AIG was the go to man for CDS contracts, selling bond insurance by the lorry load to the modern alchemy factories on Wall Street who were mass producing exotic subprime structured financial products.
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However it was the fusing of bond insurance with subprime MBS and CDOs that brought the financial world ever closer together, tied together in a world wide and systemic web of credit and insurance agreements. AIGs credit default swap portfolio stood at $517 billion according to a regulatory filing, of which the giant insurance firm wrote some $79 billion in insurance on CDOs backed mainly by subprime mortgages (Goldstein, 2008). Indeed AIG had sold swap contracts and made obligations to investors across the globe and of the $441 billion in credit default swaps that AIG listed at midyear, more than three-quarters were held by European banks (Andrews et al., 2008). Moreover since the fact that CDSs are traded privately by insurance companies, hedge funds and investment banks as opposed to being orchestrated over a centralised public exchange, financial institutions were basically allowed to get up to, buy and sell and strike whatever deals they felt like. Indeed the Commodity Futures Modernization Act of 2000 had ensured that derivatives would remain unregulated and to be traded as over the counter derivatives (OTC), a term that is now largely seen as a byword for opacity and counterparty risk. The lack of oversight allowed investment banks and hedge funds to take out CDS contracts in order to take wild bets on the performance of the underlying benchmark. They were even taking out CDS contracts in order to short and distort the market. Indeed many market actors were packaging subprime debt, selling the product onto trusting investors and then betting that the very product they had just assembled would default by buying a CDS contract on the aforementioned deal. And as the subprime mortgage market unravelled it rendered subprime MBSs and CDOs worthless, ruining the banks and investors who had bought the subprime MBS and CDOs but paying off handsomely for those who had bought the bond insurance. Ultimately the collapse of the subprime mortgage market prompted investors all around the world to call on their insurer, which for all too many was AIG. The rampant demand for AIG to make good on its credit default obligations triggered the insurer to be forced to either obtain emergency liquidity support or face bankruptcy.

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In the end it turned out that credit default swaps which with the one hand can control risk, can with the other if used irresponsibly and excessively, exponentially amplify risk. Indeed Blythe Masters (2008a) who is lauded as the curator of modern CDSs stated that tools that transfer risk can also increase systemic risk if major counterparties fail to manage their exposures properly.

v. The Excesses of the Financial Wild West

The financial alchemists were modern day cowboys, pioneers, colonisers and speculators pushing the boundaries of technology and modern finance. They were crossing into unchartered plains and into a parallel world of finance riding high upon technological advances on the crest of a wave; it was a true modern day gold rush.

However as we saw in the section above, financial alchemists were helping to sell AAA rated debt all around the world. However the investment grade products was debt that was in reality worthless debt. It was subprime debt buffed up and put in a fancy dress and gobbled up by large and risk-averse institutional investors.

Indeed Wall Street was straddling a wave that was built on subprime structured finance and in the end that wave collapsed as their rampant use of chicanery brought the world to the brink of economic Armageddon.

It is appropriate in this section to consider some of the worst practices indulged in by those banks on Wall Street and the wider shadow banking network.

The band of Shadow banks were hedge funds, private equity funds, structured investment vehicles and conduits, money market funds, broker-dealers and non-bank mortgage lenders.

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But they were also the well known institutions like Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, Bear Stearns and other investment banks.

These banks had long abandoned the traditional techniques of banking, instead funding their daily activities through the practices of modern alchemy and thus the unregulated creation, servicing and trading of a plethora of exotic financial instruments that included mortgage bonds, asset-backed securities, CDOs and CDSs.

However with hindsight it has become rather clear that such practices had turned global capital markets and high finance into a great big national and not just national, global Ponzi scheme (Wolf, 2010).

The incessant competition and the unrelenting pursuit of profits and shareholder value pushed Wall Street and shadow banks to push the legal limits of finance and to wildly distort any sense of fair play on the marketplace. Goldman Sachs was perhaps the embodiment of all the worst that Wall Street excess and trickery had to offer and it is perhaps appropriate to consider some of their actions.

Indeed the questionable and immoral practices of Goldman Sachs had turned the bank into nothing more than a big hedge fund (Cohan, 2009, pp.282) and such was the readiness of Goldman Sachs to go against the interests of clients, shareholders, the market and global economic stability in order to attain year-end profits that the firm had come to be seen as the devil incarnate (Bernstein Research, 2011).

Traders in the mortgage betting rooms of Goldman Sachs went against their very own customers by wagering that the worthless securities that they had just bundled together and sold on would fail by taking large short positions on those transactions. Indeed in 2006 and 2007 Goldman churned out more than $40 billion in securities backed by at least 200,000 risky home mortgages, but never told the investors that it was secretly betting that a sharp
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drop in U.S. housing prices would corrupt the value of those very securities (Gordon, 2009). In fact in the end Goldman made even more money than they anticipated from this practice as the value of the junk mortgages fell further than they had expected.

Goldman Sachs bought into the worst that subprime lending had to offer, but then through deception and raw deceit rid itself of its toxic assets before the subprime crash, and in doing so exploited customers and clients around the world and more importantly exported their evils and systemic risk worldwide.

The extent of Goldman Sachs corruption, deviousness and criminality was exposed by the hearing held by the Senate Permanent Subcommittee on Investigations on April 27th 2010 when Senator Carl Levin pulled out document after document which demonstrated the systemic, sleazy criminality of the investment bank (Spannaus, 2010, pp.26).

Indeed Senator Carl Levin (2010) cross-examined a number of Goldman executives making reference to a number of internal emails made by Goldman traders that implicated them most seriously in this parallel underworld of criminality. Senator Levin unveiled the raw malfeasance of Goldman traders when he quoted a statement an email of a Goldman trader in relation to a CDO deal in which the trader was recorded as having said, oh boy what a shitty deal. However such devious activity was not limited solely to Goldman but rather was somewhat typical of all that Wall Street excess had to offer. Indeed the ingrained culture of excess on Wall Street coupled with almost unrestrained freedom had turned America and its network of shadow banks into the Bernie Madoff of economies (Krugman, 2009).

vi. A Summation
The use of the term alchemy is a most fitting analogy. Indeed it refers to a practice carried out in the Middle Ages when alchemists attempted to transform base metals into gold (Stiglitz, 2010,) and before the Great Crash and before the financial emperor was shown to be wearing

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no clothes, Wall Street and the rating agencies had found the formula for turning lead into synthetic gold (Sinn, 2010, pp.129).

Indeed the modern process of financial alchemy and financialisation had seemingly allowed financial alchemists to package subprime mortgages into financial gold, transforming below investment grade often worthless assets into triple-A rated liabilities as safe as secure as U.S. Treasury bonds.

Yet despite the abundance of highly educated minds on Wall Street its stands that many seemingly forgotten that lending money to people who probably wont pay it back isnt good business. If you wrap crummy loans in a clever package, theyre crummy loans (Kelly, 2008).

However as we conclude it is appropriate to note that modern financial alchemy remains a source of huge potential to the global economy. Indeed if used correctly it remains steadfast that the securitisation of debt liabilities has long been a positive development for the resilience of the financial system by enabling the dispersion of credit risk (Hyun Song Shin, 2009, pp.311).

The structuring and trading of MBS, CDOs and CDSs exercised responsibly can be a fantastic form of balance sheet management which can bring about far reaching benefits to finance and wider society. Indeed credit default swaps and derivatives are not in themselves a bad thing.properly used and understood, they can be immensely helpful (Blair, 2010, pp.668).

Alan Greenspan (2008a) who acknowledged the wealth creating and risk dispersion benefits of modern alchemy was right to recognise however that it was a financial science that was wholly abused in its subprime applications.

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Indeed the excesses by Wall Street types ensured the fulfilment of Warren Buffets (2002) premonition that credit derivatives were financial weapons of mass destruction. As a result of the crisis it has become rather clear that any ideas held that humans are altruistic by nature is a raw fallacy. The rampant deceit on Wall Street is a symptom of a game without rules or oversight and a game that pays for few and hits many hard. Certainly the treachery on Wall Street has merely confirmed that what John A. List (2004) outlined in his paper The Behaviouralist Meets the Market: Measuring Social Preferences and Reputation Effects in Actual Transactions, in which he laid out an argument to dispel a long standing theory that humans were altruistic in nature. In any case the duplicity and trickery on Wall Street unveiled a dog eat dog world in which very few people will not screw one another over in order to reach the top. Thus the purpose of this section was to outline in detail the science behind the tools of modern finance, recognizing the benefits of the science but ultimately seeking to unveil the raw deceit as high financiers and financial alchemists abused their positions in the articulation of these tools and in doing so helped to bring together one of the deadly shots that brought the global economy to the brink of collapse.

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CHAPTER 6: SHOT 5, CREDIT RATING AGENCIES

Completing the Process of Modern Alchemy

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Even though capital markets have been around for the last 300 or so years and have been global for nearly 200, credit rating agencies and the industry of rating debt securities has only existed since the early years of the 20th Century. Indeed John Moody, the founding father of Moodys Investors Service was the first to offer independent credit analysis, assigning letter grades to publicly traded securities so that investors could better understand investment opportunities as well as the strength and ability of securities to uphold steady payment. In the very first instance in 1909 John Moody assigned letter grades to railroad bonds, marking the beginning of one of the most powerful forces in modern capitalism (Kiviat, 2009). Only a few years later in 1916, Standard and Poors entered the credit rating business and in 1924 Fitch Group Inc. was set up. By the 1930s they had begun to determine the credit risk of banks holdings, as well as engaging in international financial research in order to provide credit ratings of commercial, governmental and sovereign debt. Standard and Poors downgrade of the U.S. credit rating and the stripping it of its coveted AAA rating in August 2011 only goes to show the raw impact that these institutions have on shaping the mood and direction of global finances. When they speak investors, nations and stock markets listen. Indeed they are powerful organisations that can damage countries economies and wreak havoc in the markets with the stroke of a pen (Neate, 2011). Thus credit rating agencies play a fundamental role in the modern global economy. Indeed charged with the responsibility of providing objective and independent third party analysis of the credit worthiness of issuers and a credit evaluation of their financial instruments they are central actors in modern finance. Each day the market turns to them in total faith as the ultimate arbiters of credit risk and as the measurers of good, bad and indifferent. Moving a triple-A grade by even one or two points can unleash a wave of investor fright which can have huge and unintended consequences on the wider economy. Unfortunately it is unquestionable that the big three credit rating agencies - Standard & Poors, Moodys and Fitch and their manipulation of credit ratings in the early 2000s had the most unintended and devastating consequences on the global economy. Indeed they were central cogs to the mechanics of modern financial alchemy that seemingly lauded the excess on Wall Street, helping to sustain a deadly housing bubble.

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As a result it is largely accepted that the rating agencies and their grossly inflated credit ratings were dramatis personae in the unfolding drama of the Great Crash and the financial crisis (Jestaedt and Pollard, 2010, pp.351). And even though it was the investment banks on Wall Street who underwrote and stockpiled MBS and CDO tranches with subprime debt, ultimately it was the credit rating agencies that made the stinking products marketable thanks to their grossly inflated ratings. Indeed it was a tag team and collusive process whereby the investment banks structured the junk products and then the rating agencies tarted up the bonds (Ritholtz, 2009) by labelling the garbage with AAA and other investment grade credit ratings. The credit rating agencies were the end machine at the end of the assembly-line that labelled structured finance products in the modern industry of financial alchemy. They were the ones who ultimately transformed toxic financial waste into triple-A rated products as secure as U.S. Treasury bonds. Indeed the rating agencies were the ones labelling bottles filled with putrefying sludge and produced en masse by Wall Street as pure drinkable spring water, making everything look copacetic. The effect of credit rating agencies on capital markets and wider finance cannot be over estimated. Indeed what the rating agencies said was seen as gospel, a big fat stamp of actuarial approval that ensured that investors and regulators simply looked at the fancy label, choosing not to investigate the rotten product hidden underneath. Thus ensuring that pension funds and other large scale institutional investors - who by rule are barred from purchasing low grade securities bought fancy labelled but worthless products by the shed load. By giving their seal of approval they ensured that investment banks could sell their toxic produce all around the world. Barry Ritholtz et al. (2009, pp. 246) citing Nobel Laureate Joseph Stiglitz stated that the rating agencies (are) one of the key culprits. They were the party that performed that alchemy that converted the securities from F-rated to A-rated. Indeed it is abundantly clear that the banks could not have done what they did without the complicity of the rating agencies (ibid.). They helped banks create $3.2 trillion of subprime mortgage securities and generally the agencies awarded triple-A ratings to 75 percent of those debt packages (Evans and Salas, 2009).

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It was then reported in the Coburn and Levin Report (2011) that over 90% of the AAA ratings given to subprime retail MBSs originated in 2006 and 2007 were later downgraded by the rating agencies to junk status. Most shockingly the rating agencies had awarded subprime filled MBS and CDOs securities with investment grade status well into 2006 even though the subprime mortgage market was listing heavily to one side and on the point of capsizing. Indeed the agencies only began to downgrade the status of MBS and CDOs by July of 2007, a full year after warnings first sounded from the subprime mortgage market. As a result pension funds and all sorts of entities had their books littered with junk status bonds, unsellable contagious products that collapsed the subprime securities and CDO market and crippled the wider economy. As a result the July 2007 downgrade of subprime securities and CDOs, which manifested itself in Europe with the BNP Paribas funding crisis, was perhaps more than any other, thee event that triggered the beginning of the financial crisis (ibid.) As such, since they were the ultimate judges of good and bad, it was their inaction, inaccuracy, indifference, deceit and naivety that was a central and monumental failure that went towards firstly, sustaining the bubble and secondly, precipitating the Great Crash. Had these agencies been able to give an impartial and objective rating on the merit of the underlying debt then irrefutably they could have stopped the party (Fons, 2010) and thus burst the housing bubble long before it got out of hand.

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Source: Bloomburg article by Richard Tomlinson and David Evans, (2007).

But why did the rating agencies fail so monumentally? Above all the reason lies with the massive conflict of interest that existed between the big three and their friends and loyal customers on Wall Street. Indeed the issuer pays model had ensured that the banks (issuers) paid the agencies to rate their products and as can be seen from the above model the agencies received a huge percentage of their income from the very banks whose products they rated. As a result of this the rating agencies had become dependent upon the investment and shadow banks for income which led them to fear that their revenue stream could quickly dry up if they did not provide the investment banks with the ratings they so sought. Therefore the rating agencies all too often hyped up the true worth of the structured debt products. Indeed the big three sacrificed accurate ratings in efforts to increase their business and market share which ensured the depletion of credit rating standards and a race to the bottom (Coburn, 2011). Moreover the criminality that was seen on Wall Street before the crash extended into the world of the credit rating agencies. Indeed it was reported at the hearing before the Houses Committee on Oversight and Government Reform (2008, pp.3) that a Standard & Poors employee in the structured finance division had stated that it could be constructed by cows, and we would rate it.

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Another employee stated that rating agencies continue to create an even bigger monster, the CDO market. Lets hope we are all wealthy and retired by the time this house of cards falters (ibid.). Thus the purpose of this section was to illustrate the starring role played by credit rating agencies in the run up to the Great Crash of 2008. The rating agencies occupy a special place in financial markets; however their inability to give accurate credit analysis unleashed repercussions that have extended far beyond the world of finance. They broke a bond of trust and ultimately the story of the credit rating agencies was a story of colossal failure (Waxman, 2008).

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CHAPTER 7: A SUMMATION OF THE FIVE DEADLY SHOTS Concluding Thoughts on the Causes of the Financial Crisis

Each of the 5 precipitating factors that caused the Great Credit Crash of 2008 as outlined above could not have created the housing bubble independently of one another. Rather the bubble was the coming together of five deadly shots which unleashed a self-fulfilling and deadly reaction as each ingredient fed on the other, spurring each other on in a dangerous vertical vortex of fictitious housing wealth.

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In summation this paper outlines the rise and fall of the 2000s housing bubble as follows. With hindsight we know that following the collapse of the 2000 dot-com bubble investors moved from stocks and towards real estate as a safe investment and concomitantly fear of a recession prompted the U.S. central bank to transition to low interest rates, assuring a bountiful source of liquidity to finance housing starts. Moreover the U.S. governments affordable housing policy ensured both the continuation of a lax monetary policy as well as promoting the relaxation of traditionally rigid mortgage lending standards. Thus the keen sense for real estate coupled with low interest rates and easy credit ensured that countless individuals across America and around the world bought houses. Added to the first two shots was then the third and most critical shot, that being the irrational exuberance of consumers. Indeed as the uptrend in housing began the third shot was added, stirring consumers up in a wide spread mood of irrational exuberance that crossed oceans and as a result households felt infinitely wealthier and took on ever increasing levels of debt. As consumer and commercial debt liabilities sky rocketed the fourth and fifth shots were added to the deadly mix. Certainly the reaction created from the coming together of the first three shots with modern alchemy and the troublesome credit rating agencies was deadly since the first three shots provided Wall Street and the rating agencies with the fodder and market ambiance needed in order to expand the housing bubble exponentially. Indeed the irrational exuberance created an environment that was ripe for the cowboy financing (Baker, 2008) and in that sense Wall Streets financial excesses were as much a symptom of the bubble as its cause (Stutchbury, 2010). Thats indeed why Raghuram Rajan (2010, pp.109) stated that the Feds monetary policy was having such an effect on Wall Street activity that it was turning the United States into a gigantic hedge fund, investing in risky assets around the world and financed by debt issue to the world (Rajan, 2010, pp.109). For that reason it stands that Wall Street financiers werent so much the trigger of the bubble but rather the exaggerators of a bubble and the ones who turned a big bubble into a colossal bubble. Indeed the early housing bubble triggered by low interest rates, a government
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housing policy and spurred on by irrational exuberance played into the hands of Wall Street, providing it with a wide range of debt liabilities and in particular a hugely increased selection of home loans - the feedstuff required in order to forge the most complex financial instruments.

Thus it is rather easy to conclude that the process of modern financial alchemy was not the primary cause of the financial crisis. However added to the first three shots it remains that modern alchemy and credit default swaps in particular were an accelerant (Economist, 2008) and tools that transformed a financial brush fire into a conflagration (Morgenson, 2008). In the end, once the 5 shots were mixed the world found out that they would come together in a mutually reinforcing reaction, each sustaining and pushing the other on in a selfperpetuating upward spiral. Indeed as the bubble grew it spurred on the very factors that caused its genesis in a systemic liquidity spiral that fed on itself, as a housing bubble spurs the economy directly by increasing home construction, renovation, and sales and indirectly by supporting consumption (Baker, 2006). And as the above spurred on ever more housing sales Wall Street was inundated with mortgage debt of all kinds which further fed the circular feedback effect as the securitisation of mortgages unleashed further waves of credit back onto the market. Indeed the rate of global housing appreciation was accelerated beginning in late 2003 by the heavy securitisation of American subprime and Alt-A mortgages (Greenspan, 2010). Thus the mutually reinforcing cocktail created a positive feedback loop of investor enthusiasm that amplified the precipitating factors of a speculative bubble evermore. However it was all fictitious housing wealth created by the smoke screen effect of the 5 shot deadly cocktail. In the end it was a house of cards and the highly leveraged household and bank balance sheets imploded as housing prices reverted to fundamentals. Indeed as house prices and investor enthusiasm hit a crescendo, real estate soon adjusted to core economic indicators, the edifice collapsed reverting the process into a negative feedback loop that ensured that the amplification mechanisms worked in a downward direction. And
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just as the price increases begot further prices increases, the bursting of the asset bubble ensured that price decreases begot further price decreases. This paper has not sought to absolve Wall Street of its wrongs and ingrained culture of excess; rather it has worked to paint a larger picture. Indeed the Wall activities were part of a wider culture of excess that could be seen amongst central banks, the U.S. Congress, consumers and rating agencies.

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PART 2

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IDEOLOGY CONSIDERED

CHAPTER 8: POLITICAL IDEALOGUES

The ideas of Friedrich Hayek and John Maynard Keynes (JMK) have profoundly shaped the social and economic policies of governments across the world for nearly a century. Indeed the weighty influence that these political economists wield over the governance of society and of the economy cannot be underestimated. Certainly that is why it is right to say that practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist (Keynes, 1936). However the above citation would need to be redacted in order to reflect

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historical developments since for much of the last 80 years the ordinary man has been enslaved to the ideas of at one time or another both Friedrich Hayek and JMK And yes it would appropriate to state that JMK and his ideas reigned as king of the markets from the mid-1930s until the late 1970s, in a period known as the age of embedded liberalism. Thereafter, the neoclassical or neoliberal ideas as championed by Friedrich Hayek and others reigned supreme. Indeed that is why neoliberalism has been labelled countless times as the ideology of our time.

Well that is until the Great Crash of 2008, whereupon the faith in neoliberal free markets was shattered.

Thus it is necessary to consider the philosophies of these two champion ideologues whose concepts pervade and run a rich vein through the economic policies of governments and of modern finance. Thereafter it will be appropriate to consider how economic policies should be shaped in the post-crisis world.

i. John Maynard Keynes

British economist John Maynard Keynes (1883-1946) and his celebrated manuscript The General Theory of Employment, Interest and Money (1936) was for much of the 20th Century the prevailing economic orthodoxy both in the years throughout the Great Depression and the four decades of embedded liberalism that followed WWII.

Having labelled the free and competitive market system a failed rationality, Keynes dismissed the merits of the classical economics profession, of liberated markets as well as monetary policy, and rather advocated that governments implement prescriptions of aggregate demand management as well as price and wage controls, strong social welfare protection and stiff economic regulation.
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Through the aggregate demand management model JMK laid out that depressed and bearish market conditions, triggered by a heavy drop in demand, could be countered by increased government spending. Indeed he held that increased spending could change the mood of the economy both by raising the levels cash flow and levels of unemployment.

Certainly JMK held that running a budget deficit was something that was entirely rational in recessionary periods. And likewise he maintained that a boom period and bullish market ambiance could be counteracted by a reduction in the levels of government spending, whereby JMK held that the debt accumulated in the downturn could be paid off.

Thus JMK held that governments should dictate the level of demand by taking an active role in the management of the economy. Indeed through aggregate demand planning JMK maintained that as government spending stimulates levels of demand and thus brightens the mood of the economy, full employment could be attained.

JMK also sought to use aggregate demand management to increase welfare spending through higher taxation in order to ensure the wellbeing of the poor, elderly and jobless. Indeed John Maynard Keynes who advocated heavy government incursion into the social domain was one of the key architects behind Britains cradle to the grave social welfare system.

JMK further harboured a strong suspicion towards classical economists who pushed for limited government and of a self-regulating market, and thus JMK advocated strong economic regulation.

Certainly many of the ideas expressed within The General Theory had been generated from Keynes interpretation of the causes of the Great Depression. Indeed the social democrat held

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that open trade and international financial transactions had created real and tangible economic imbalances as well as major disruptions to employment and public debt.

Appropriately it is true to say that Keynes was rather free trade-averse, and fearing what he saw as the destabilising effects of large scale trade and financial flows, Keynes ideas advocated trade restrictions, government intervention and ultimately largely closed economies.

In any case Keynes was figuratively speaking the chief economist for much of the world in the years that succeeded the war. Indeed the huge expenditures for weaponry clinched the Keynesian doctrine that government spending could underwrite prosperity (Kennedy, 1999, pp.857).

However by the late 1970s Keynesian economic thinking had been dealt a heavy blow as economies both in the U.S. and U.K stagnated. Indeed the effect was such on the AngloAmerican economies that neoclassical economists, led by Hayek, were able to take centre stage and put forward their case for the privatisation, deregulation and liberalisation of markets and in doing so they breathed life back into the credibility of the classical economics profession as epitomised by Adam Smith and his idea of the invisible hand of the market.

ii. Friedrich Hayek

The life and work of Austrian born Friedrich Hayek (1899-1992) was the direct continuation of a rich lineage of economic thinking that stretched back to the father of modern economics, Adam Smith (1723-1790), infamous for his work The Wealth of Nations as well as his notion of the invisible hand of the market.

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Indeed Friedrich Hayek who continued in the ways of Adam Smith gave classical economics a contemporary twist and as a result Hayek and his contemporaries became known as neoclassical or neoliberal economists.

And by taking advantage of the demise of the Keynesian economic thinking of government planning and of demand management in the late 1970s, Friedrich Hayek ensured that neoliberalism became embedded as the dominant economic paradigm from the late 1970s. As a result it has been said many times that neoliberalism has been the ideology of our time. In order to best understand Hayekian ideas of free markets it is necessary to consider briefly those of Adam Smith. Certainly the long road of classical and neoclassical economic thinking that has weaved across nearly three centuries finds its source with the work and ideas of Adam Smith. In any case Smith was unremitting in advocating the case for limited government, laissezfaire and the ability of the self-interested homo economicus to prosper in an environment of unfettered markets and unrestrained competition. His steadfast view of the market largely stemmed from his perception of the natural world and his preference for an environment in which individuals could act freely as opposed to being subjected to overbearing governmental coercion. He stated that the self-interest of the individual to promote his own well-being as well as capital accumulation would indirectly promote the interests of wider society. By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good (Smith, 1776, pp.572). Indeed he believed that limited government intervention was the key to market efficiency, social efficiency, strong development, affluence and growth. State interventionism for Adam Smith was to curtail the ability of the individual. Thus on so many levels the classical liberalism of Adam Smith diverges heavily from the Keynesian economic doctrine of governmental aggregate demand planning and social liberalism.

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Hayek built on the work of Smith in championing the retreat of the state and the ability of the self-interested individual. He was deeply anti-big government and central planning and believed the modern economy to be a form of spontaneous order which was vastly superior to that of any planned economies. Certainly Hayek held that unfettered forces of the market were the most efficient medium for the allocation of scarce resources. He further embraced private property rights, freedom of contract, stable monetary policy, fiscal conservatism and above all the market economy as opposed to government as the guarantor of a prosperous, free and equitable society. His belief was that knowledge in the market is a local phenomenon thus rendering any efforts of central planners defunct. Indeed the brilliance of a market economy was that it allocated resources through the decentralized decisions of a myriad of buyers and sellers who interacted on the basis of their own particular knowledge (Fukuyama, 2011). For Hayek the remit of government was simply to create and uphold the law of the land that is equally applied.

iii. A Summation
Having reviewed in Part 1 the causes of the financial crisis and then in Part 2 the ideology that underpinned financial markets pre-2008 this paper concludes that Keynes was indeed the correct immediate response in the wake of the collapse of the global finances. However whilst aggregate demand planning with increased government spending can fill a demand hole, bring about immediate and tangible results and help avert a depression, it is nevertheless clear that Keynesianism is not a long term solution. Rather a sustained economic recovery needs the restoration of normal credit flows, not the artificial ways of Keynes centralized governmental demand planning. Certainly it would be right to say that long term government spending in times of recession is what the hair of the dog is to a hangover, it merely delays the pain. Thus this paper holds that Hayekian and neoliberal prescriptions of free and liberated markets should be the future of American and Western social and economic policymaking. However at the same time this paper recognizes the major failings of excessively liberal financial
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markets pre-2008 as was experienced through the wild exorbitance of modern financial alchemy. Certainly as a result of the financial crisis Joanna Benjamin (2010) was right to state that freedom and responsibility are the woof and the weft of genuine liberalism. (However) In the years leading up to the summer of 2007, certain financial market participants took up the former, but discarded the latter. Many areas of the economy and financial markets were subjected to heavy regulation and oversight before the crisis, yet other areas, such as the over-the-counter market for CDOs and CDSs, remained hideously under regulated. As a result of the lack of oversight, the supposed self-regulation of market participants and of lending institutions did not in the end promote the interests of shareholders and of wider society, but rather devastated them. Thus the question now stands as to how far to the Left of the ideological spectrum the pendulum of financial regulation should swing or in other words to what extent private financiers should be left to roam the pastures of the global economy? There is a delicate and subtle balance to reach. Undoubtedly we need the free circulation of capital, free markets and economic liberty that is needed to ensure that the individual ingenuity, entrepreneurialism and creative forces of man can help create growth and work towards exiting the crisis. However this must be balanced against sensible economic regulation in order to protect the wider interests of society and of global economic stability. The crisis has shown that one cannot rely on the self-interest of market participants in unregulated markets to promote the interests of themselves and wider society. Indeed their deceit and rampant dishonesty has destroyed any arguments that push for unregulated financial markets. Yet the pendulum cannot swing so far as to smother the free flow of capital and the ingenuity of man. There must be a sensible and harmonious balance. Indeed it was Senator Tom Coburn (2011) who co-produced the 635 page Levin-Coburn Report following a two year investigation into the causes of the crisis stated that the free market has helped make America great, but it only functions when people deal with each other honestly and transparently.
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Thus it is unquestionable that there is a role to be played by the government in order to prevent the evils of high finance yet balanced so as to allow man to express himself free of an excessively over bearing state. Thus government intervention should reach into the economy to the extent that John Maynard Keynes so prescribes. For in many ways communism and Keynesian social democracy are merely different versions of a single malaise they called collectivism (Manne, 2010). Thus this paper holds that economic liberalism will prevail, the excesses of which must be balanced by sensible economic regulation. Indeed in the words of Dieter Pesendorfer (2010) we should expect a moderate reformulation of neoliberalism in terms of its ordoliberal conceptualisation. Certainly the ordotheorist Hans-Werner Sinn (2009) stated that America needs Walter Eucken, the father of ordoliberalism. Ordoliberalism, a distinctive strand of liberal economic thinking, is not entirely dissimilar from neoliberalism in that it cherishes the efficiency of the free market. However ordotheorists differ from neoliberals in that they do not see the market as a natural economic rationality, rather they see it as inherently unstable. As a result they espouse a market economy that is constituted by norms, thus they have long since championed the need for an wirtschaftverfassung (economic constitution). Thus this paper concludes that an economic constitution which sets out the rules of the game or the road markings could well help policymakers in the creation of a post-crisis regulatory framework. After all the Financial Crisis Enquiry Report (2011, pp.17) stated in regard to the causes of the Great Crash of 2008 that what else could one expect on a highway where there were neither speed limits nor neatly painted lines? Thus ordoliberalism with its constitutional approach could well correct the failings of neoliberal economics and help promote the institutional perspective which has for so long been absent in neoliberal writings.

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PART 3

WHY ECONOMIC LIBERALISM WILL PREVAIL

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CHAPTER 9: LESSONS FROM ROOSEVELTS NEW DEAL

The saying goes that a lesson lived is a lesson learnt and if a lesson is to be learnt from having lived through the Great Depression it is that the reactionary and authoritarian policies of President Franklin Delano Roosevelt were deeply damaging. They were social and economic policies that in fact prolonged an economic contraction. Indeed the New Deal did not end the Great Depression or restore prosperity, rather that was the doing of the incidental and ironic work of a terrible war (Kennedy, 1999, pp.xiv).

i. The Red Decade

With a near three decade long trail of economic growth and a 7 year boom, capitalism had long been in the ascent in the United States. However the 1929 stock market crash on Wall Street shattered the halcyon state of the economy, turning the fortunes of all of America
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upside down. Indeed by 1932 unemployment had approached the thirteen million mark (Fretz, 1973, pp.131) and with a prevailing Left and populous climate and the Democrats in ascendance, President Roosevelts New Deal brought about major changes to Americas economic compass.

Indeed Roosevelts inauguration in March 1933 was the start of session for a federal government that would increasingly involve itself in matters that were hitherto the business of the individual and the worry of business.

Indeed the New Deal, welcomed by trade unions and socialists, ordained government with a task to radically increase spending, to raise taxation and redistribution, to install heavy economic regulation and to establish autocratic price and wage controls.

Thus whilst the America of the 1930s was one that was suffering deeply, it was also an America that was buying into the policies of collectivism and central planning. It was a time of expanding paternalism, an era of proliferating bureaucracy and in many ways the New Deal started a decade that was to be deeply polluted by Stalinist infiltration (Lyons, 1941, pp.174).

Indeed the endemic social and economic pain gave the Soviet newspapers ample material to prove that the capitalist world was in violent dissolution (Lyons, 1941, pp.72) and as a result the government and peoples turned away from the ideological orthodoxy that had shaped earlier decades of economic policy-making; prescriptions of free markets, liberalisation and deregulation.

Robert Shiller (2008, pp.97) was right to observe that the 1929 stock market crash stirred up a populist backlash which hit banking, finance, free markets, capitalism and the American way of life very hard. Indeed Americans increasingly began to be won over to communist theories

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and as a result the 1930s and the era of the New Deal are rather appropriately referred to as the Red Decade (ibid.).

It is thus of utmost importance to consider the New Deal in more depth, to draw out the mistakes of Roosevelts calamitous policies of collectivism and wholesale government intervention and to apply them to our learning in order to right todays upturned world.

ii. Roosevelt and his Depression-Prolonging Policies

It is well established that policy blunders by the Federal Reserve, Congress, and Presidents Herbert Hoover and Roosevelt battered the economy on many fronts (Edwards, 2005). Indeed the age of the Great Depression that lasted for over a decade despite the best efforts of the federal government was a laboratory of interventionary economic policies and thus a laboratory of interventionary policies that we can learn a lot from.

Indeed the lessons of the Great Depression are the key to understanding the current crisis and an instrumental piece in the jigsaw that will help us to shape a recovery. A microcosm of economic contraction-prolonging policies, the New Deal taught a harsh lesson that tells us that an active government and wholesale intervention simply prolongs an economic downturn.

The first Depression-prolonging policy was the implementation of the Glass-Steagall Act which subjected the banking industry to more extensive oversight and in particular ensured that retail and commercial banking practices would remain separate from investment banking operations.

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Indeed the banking profession was seen almost in totality as the cause of the Great Depression and President Roosevelt (1933) was particularly vociferous in his critique of the economic royalists. The radical sentiment, anger and distrust harboured by the populous and the federal government towards the banking profession was such that Congress enacted a procession of restrictive legislation.

However the economic policies of Roosevelt put the world of banking in a straightjacket of regulation, choking off lending and any real chances of allowing business and individuals to forge a recovery. Indeed the burdensome restrictions that were placed over banking, trade and investment crippled the very mechanisms that were needed in order to engender a recovery.

A second Depression-prolonging policy of President Roosevelt was the enactments of laws that welcomed the cartelisation of industry and the extermination of competition. Indeed President Roosevelt had believed that the severity of the Depression was due to excessive business competition that reduced prices and wages, which in turn lowered demand and employment (Cole, 2003).

These ideas stemmed from a number of Roosevelts economic advisors who were artefacts of an earlier generation, economists from the World War I era who believed that wartime economic planning would bring recovery (ibid.).

In the end however it was in large part the cartelisation of industry and the extermination of competition that was a major factor that prolonged the Depression.

However these days we must live by a different mantra, one that maintains that competition is everything. After all competition it is the steady hand at our back, pushing us to be faster, better, smarter, (Wall Street Journal, 2011, pp.A14) and luckily this time round governments have stood by the idea that competition is the route towards recovery.

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Indeed the reaction to the Great Recession thus far has not been to mirror Roosevelts antitrust policy; on the contrary Neelie Kroes (2009) the former European Competition Commissioner, stated that competition is part of the solution to our economic problems.

A third Depression-prolonging policy that Roosevelt enacted was also the Smoot-Hawley Trade Act which raised tariffs and thus affected heavily the free flow of trade, capital and international commerce - the very things that were needed in order to keep credit flowing, to keep the economy ticking over and to engender a recovery. A fourth Depression-prolonging policy was that of the Federal Reserves tightfisted caution, unyielding inactivity and shortsightedness in refusing to expand the money supply. Fortunately the Feds lack of flexibility and adaptability during the 1930s was not mirrored come 2008 when the U.S. central bank ensured widespread liquidity support to ailing banks, hedge funds, mutual funds, private companies, companies, and insurers as well as placating the worst of the downturn by lowering interest rates near to zero. Indeed money supply is the lifeblood of the modern economy, banks need to be able to lend and borrow to sustain daily activities and to build a healthy recovery and the worst of the Great Depression could have been averted had the Federal Reserve been more proactive by expanding the monetary base. Another major trauma blow that prolonged the Great Depression was the huge tax increases implemented by President Roosevelt who levied 50% tax on a huge proportion of the country and the top rate marginal tax rate landed at 79%. Thus stifling innovation, entrepreneurialism and sending out a message that the country was not open for business

iii. Lesson Learnt?

The story of the Great Depression shares a similar narrative with todays Great Recession. Indeed both stories tell a classic tale of boom which shattered a longstanding faith in free markets.
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Certainly both economic collapses provided the ground for an ideological battlefield and gave centre stage to the voice on the Left. However in the wake of the 1929 crash the Left won the ideological battle. Yet this wild and reckless jolt to the left which as this paper has illustrated, prolonged the Great Depression. Whilst it is unquestionable that the Great Credit Crash illustrated the raw excesses of free markets, it is well documented that planned markets are flawed, unstable and excessive too (Carr, 2009). The Great Depression and its flawed methods of economic planification is just such an example. Indeed the main lesson we have learned from the New Deal is that wholesale government intervention can - and does - deliver the most unintended of consequences (Cole and Ohanian, 2008). Thus governments and policymakers must learn from these mistakes and avoid temptations to raise the profile of government. Rather the proper role of government is to step in during times of crisis, but ultimately it is industry and ingenuity of the individual, guaranteed through individual liberty, that will lead to recovery. Indeed Chris Edwards stated that the secret to the recovery from economic contractions is to ensure that the government generally (stands) aside and let(s) the market recover itself (Edwards, 2005). Indubitably a recovery cannot be manufactured out of government good will and spending. Thus it is in nobodys interest to pursue a planned or collectivist future as we are all to aware now that collectivism, whether it is in Germany, the former Soviet Union, Britain or the USA, makes personal liberty its victim (Williams, 2010, pp.16). Moreover we need to learn hard lessons from the federal housing program of Clinton and Bush which was in essence a continuation of Roosevelts New Deal and of Lyndon Johnsons Great Society program. And like the New Deal the federal housing initiative offers important lessons about the dangers of government efforts to manipulate or conjure outcomes in the market (Staff Report, 2009).

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In concluding it must be reiterated that it is of utmost importance that we learn from the errors of Franklin Delano Roosevelt as it was his mistakes that ultimately transformed the Hoover recession into the Great Depression (Niskanen, 2009).

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CHAPTER 10: LAND OF THE FREE

Here we will consider America and the creative forces of individualism.

i. Arnold Schwarzenegger, Individualism and Socialism

In the opening to the 1990 relaunch of Milton and Rose Friedmans famous television series Free to Choose Arnold Schwarzenegger gave an introduction extolling the unrivalled
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excellency of individual liberty. Sharing with viewers his travails of coming to the United States from a state centred Austria Schwarzenegger stated that he knew from a young age that he wanted to be the best. Yet he knew that the country of his birth could not provide him with the people, networks and inventiveness that would be needed in order to turns his muscles into money, to allow him to become a 7 times Mr. Universe, a Hollywood blockbuster and political heavyweight. Schwarzenegger instinctively knew that individualism like that (was) incompatible with socialism, so (he) felt (he) had to come to America. The story of Arnold Schwarzenegger is one that embodies the pinnacle of human achievement but it is also one that chimes mightily with the tale of America as the land of the free and America as the land of opportunity. A tale that has reverberated and been recounted around the world many times, inspiring countless to come forth. However the tale of America as the land of freedom and opportunity has important repercussions for the world today, the future of America, of other nations and of international finance. Indeed as outlined in the earlier chapters, the effect that America has on other countries around the world is instrumental, as when America sings, the world dances; however with the subprime crisis we saw that when America sneezes the rest of the world catches the cold. Thus the policy, regulatory and legislative future of America is not only its future but that of the whole world. Thus as America exits the crisis and erects a post-crisis infrastructure policy makers must remember that the story of American freedom is a very real one. It is a story that is inextricably linked to the historical foundations of the United States and the context in which early settlers left the Old World destined for a new life. Indeed early Americans fled Europe in order to escape religious persecution, intolerance and an overbearing state. Above all they wanted a new life and personal freedom. Something that America could guarantee. Years later stories would oscillate back across the Atlantic that told the story of unbounded opportunity, land and freedom. Indeed many more made the passage across the Atlantic with an eye to conquer the Great Plains and to exploit the unhampered freedom and make their

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fortune. It was the voluntary movement of waves of industrious and inventive men and women, risk-takers drawn to a free and bountiful land. This was the American Dream. The dream of unbounded liberty and riches that awaited those who sought to prove their worth; the dream of a land in which life should be better and richer and fuller for everyone, with opportunity for each according to ability or achievement (Adams, 1931). The constant quest for individual liberty and the instinctive sense of state-aversion is thus something that is derived directly from Americas ancestral forefathers; it is rooted deep in the cultural DNA and social fabric of America. Indeed that is why Thomas I. Palley (2004) was right to observe that at the cultural level, America has always celebrated radical individualism, as epitomized in the frontiersman image. Individual liberty is thus the golden thread that weaves throughout the fabric of Americas social, political and economic corpus. It is something that Americas ancestors fought for and crossed the high seas for. Indeed individual liberty has shaped a nation and defined generations of Americans. America is still that today. It is still the freest country in the world and one that offers unbounded opportunity to those of ability and perseverance. Freedom is what has made America great and unquestionably the celebration of the individual continues to allow America to create an unrivalled infrastructure of knowledge, political and economic prowess, technological advances and a nation and citizenship of unrivalled ability. Indeed it remains in the 21st Century that the real path to prosperity, political unity, and the American mainstream is self-reliance not dependence on government (Badillo, 2006). It is a philosophy that maintains that the smaller the government is, the bigger the citizen will be. Indeed this is the formula that has long been the secret to Americas great success (Prager, undated). The peoples of America just like their forebears continue to cherish selfsufficiency, self-governance, social and personal responsibility and economic freedom. Values which have shaped a citizenry, culture, politics and which have made a nation great. That is why America cannot allow government to become big in the post-crisis world, for remember, the smaller the government, the bigger, the freer and the more able the citizen shall be. The freer the individual will be to innovate, create enterprise and to orchestrate a

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recovery. Indeed Tony Blair (2010) remarked that the recovery will be led not by governments but by industry, business and the creativity ingenuity and enterprise of people. The big state has played its part, it subsidised where it did not nationalise, and by doing so it saved the global economy from financial Armageddon. But now its job is done. Now the role of the government is to move back and allow the citizen to be big once again. A big state would hamper any chance of recovery. Moreover a big state would carve out the core, distort and alter indeterminably the very character of America and its people; the very thing that makes America great.

ii. The New World of Finance

Todays financiers are the Christopher Columbus, the Thomas Cookes, and the Neil Armstrongs of the 21st Century. There is something innate in man, the force in man that drives him to be the greatest; to explore and to push the boundaries of human endeavour. Indeed the inborn trait that drove man to colonise countries around the world, to be resourceful, to be creative and to invent, is the same trait that drove man to engineer the most complex financial instruments and transactions. The passion that stoked the fires in the belly of Christopher Columbus to find the New World is the same instinctive drive that inspired the J.P. Morgan team to synthesise the loftiest of financial creations. These were not ordinary bankers; they were intellectual powerhouses, financial scientists, engineers and architects. Pushing the frontier and drawing new boundaries in the new New World for the betterment of mankind. Unquestionably however these modern day pioneers went too far. The wheel came off the wagon and they made some colossal mistakes which was the ruin of many. However finance can bring about unbounded cultural and economic riches when operated sensibly. So sensibly regulate the pioneers, give them the rules of the game and the road markings but dont squeeze out the ingenuity and the drive of man. Dont deprive modern financiers of their freedom and prevent them from doing what man has always sought to do, to explore, colonise, settle, invent, trade and advance. For these reasons explained above America must not make a post-crisis knee jerk move to the Left. America doesnt need any Rooseveltian methods; rather America needs plans by the

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many, not by the few (Fight of the Century, Round 2). Thus America must consolidate its position.

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CHAPTER 11: NATURAL RHYTHM, THE FABULOUS FRUITS AND THE FICTION OF NEOLIBERALISM

The penultimate scene of this paper is to be a short chapter that adds to chapters 9 and 10, consolidating the reasons why free markets will prevail.

i.

The Natural Rhythm of Boom and Bust

The rhythm of boom and bust has existed from time immemorial. Indeed market crashes are almost as old as the invention of money itself (Tett, 2009, pp.xvii) and ostensibly credit collapses have been global since at least 1720 (Bloom, 2010, pp.47). In a similar fashion one can say that the recent subprime financial crisis is hardly unique as it was very much one that followed a well-trodden path laid down by eight centuries of financial folly (Reinhart and Rogoff, 2008a). Certainly as one looks back over the millennia and a landscape pitted with the remnants from the dramatic rise and fall of the dinosaurs, the ascent and collapse of the Roman Empire as

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well as that of the Egyptian and Mayan Empire and numerous other sophisticated forms of life, the rhythm of boom at once appears as an entirely routine aspect of life on earth. The same rule applies to the world of finance and economics, after all the economy is organic. Indeed in recent centuries the world of finance has experienced bouts of irrational exuberance which has fuelled financial turbulence over regular intervals. The oft-cited Dutch tulip mania of 1640 is just one such example at hand and is somewhat typical of the three and a half centuries of financial turbulence that succeeded it. More recently as throughout the 20th Century there have been regular peaks and troughs of economic activity and market confidence. From the Wall Street crisis of 1907, to the great stock market collapse of 1929, the stagflation of the 1970s and the economic turbulence related to the Savings and Loan crisis of the late 1980s and the Latin American bond defaults of the 1990s. The Russian Debt crisis of 1998 triggered by the Asian financial crisis of 1997 which later spilled into the neighbouring Baltic countries and irrefutably Japans lost decade of the 1990s as well as the tech crash of 2000/2001, more recently the Great Credit Crash of 2008 and currently the sovereign debt crisis in Europe and America are all manifestations of the natural rhythm of boom and bust. Looking through the lens of history it becomes increasingly apparent that periodic bursts of chaos are normal (McRae, 2008). Certainly Gillian Tett (2009, pp.212) citing J.P. Morgan top shot Bill Winters stated that every four to five years there is a new excess in banking you had the Asian crisis, then the internet bubble. The problem this time (was) the extraordinary excess in the housing market. Thus the purpose of this section was simply to highlight that there is something in man and all organic life on earth that brings about a natural rhythm that bears witness to periods of highs and lows, periods of creation and destruction and periods of new and old. Perhaps the building up and breaking apart of sophisticated civilisations and complex economies is as natural as the process of birth and death. Indeed Howard Bloom (2010, pp.46) stated that depressions dont come from out technologies. They come from our biology. Certainly this paper proposes that nothing in life is constant, uniform or unchanging. Like the seasons, weather and the mood of man, all organic life is in a constant state of flux. Thus whilst man can strive to attain predictable and steady growth, the laws of nature will ensure periods of boom and episodes of dramatic crashes will continue well into the future.

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ii.

The Fabulous Fruits of Finance

The earlier chapters brought the reader on a tour down memory lane, a tour that has more than highlighted the deleterious failings of high finance and surreptitious high financiers. However there are fabulous fruits to be borne from finance when it is conducted properly. Indeed ever since neoliberal free markets became the economic orthodoxy over 30 years ago the world has seen unrivalled technological, social, political and economic progress. A period of time that has lifted man out of poverty and into the twenty first century. Very few in the western world cannot say that they do not have a personal computer, laptop or TV. Indeed capitalism, the free markets and the freedom and ingenuity of man created the iphone in your pocket, your car parked outside and countless other luxury items, and more importantly made them affordable and thus brought them to the masses. The level of anger expressed towards financiers and the very existence of modern finance is rather understandable in many ways. However finance is what makes the world go round, incentivises and supports the global infrastructure and if exercised properly with restraint and integrity it is immeasurably good and rather importantly it serves a public utility function (Tett, 2009, pp.28). Indeed the changes to finance and the financial landscape that have taken place over the last 30 years have made the world much better off (Rajan, 2005) and improved countless lives (Carr, 2009). Shiller (2008, p.177) rightly notes that financial technology that is properly used can be a powerful means for making everyone better off. We live in the 21st Century, an exciting age of Google, ipads and iphones, Facebook, Skype and an unlimited smorgasbord of luxuries available to one and one for all. Thus despite the dire economic situation we should not take this period of great prosperity, one that has seen the largest improvement in living standards of the greatest proportion of the world's population ever known, for granted (McRae, 2008). Certainly western liberal economic polices have been raising living standards for generations and to question free markets and 21st Century finance is to eat the hand that feeds you. Individual liberty, free markets and the capitalist system gives opportunity and hope to the
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masses, whilst big government and planification offers only one route, the diminishment of the individual and equal inequality.

iii.

Neoliberal Fiction

Neoliberalism as a theory outlined in academic journals and textbooks is not a true political rationality. Indeed the ideas that are prescribed on paper by Adam Smith and Friedrich Hayek come very far from living out in reality.

Indeed to say that we live in an age of neoliberalism has been challenged by John Braithwaite (2005) who has held that it is more appropriate to suggest that we live in an age of Regulatory Capitalism.

Certainly Braithwaite contends that the world in which we live is one in which there is ever more regulation at all levels of society. Thus he holds that neoliberalism is a fiction in that the ratio of those who hold that neoliberalism is an economic rationality is inherently flawed. Indeed Braithwaite stated that there is a reciprocal relationship between corporatisation and regulation in that it creates a situation in which there is more governance of all kinds (ibid.).

Certainly the ideas of Hayek and other neoliberals have indeed shaped policies, but they have come far from creating a neoliberal world. Indeed what is said on paper by the likes of Hayek is very much different from the world in which finance and markets live by. The asymmetry between the scholarly work of Hayek et al. versus reality has become increasingly documented and Thomas I. Palley (2004, p.4) observed that neoliberalism has departed from its theoretical rhetoric. (and) in practice, policy has not been applied as pure neoliberal theory would suggest. Indeed David Levi-Faur (2008, p.207) added to the increasing commentary on the matter when he remarked that there are wide gaps between the dominant narrative on neoliberal deregulation and the emerging realities of a regulatory explosion.

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Thus this is a major issue that must be presented to all those who denigrate the failings of the free markets and of neoliberalism who fail to observe the large schism that exists between the theory and practice of neoliberalism. Encouragingly Pesendorfer (2010) picks up on the theory versus reality divergence and exalts that it is exactly the contradictions between theory and practice that might allow neoliberalism to recover from the current situation.

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CONCLUSION

This discussion has in no way professed to have all the solutions to such a complex topic as the causes and the solutions of Great Credit Crash of 2008. It has however attempted to outline some of the key causes, considered the ideology that has shaped financial markets and presented some general insights which may go some way to help in the formulation of future economic policies. Certainly with such a complex and borderless matter as the financial crisis some sort of lateral and forward thinking is required in order approach such an issue. There were a myriad of causes to the financial crisis but ultimately through a detailed analysis of some of the major causes of the crisis as well as the ideology that underpinned the market structure ore2008, this paper has shown that free financial markets and the freedom that it gives man to explore, trade and invent is something that will go on for many years to come. This paper has sought to show that neoliberalism and individual liberty fills people with hope and aspiration, it makes people want to be inventors, entrepreneurs, business men and

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women, politicians and sports stars. It allows people to do so depending not on birth but on ability and merit and thus with a sensible reformulation the prosperity of man can be guaranteed so long as governments continue to embrace liberal economic policies. .

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