Complexity and the forgotten lesson of the financial crisis

It has been a decade since the first signs of the financial crisis hit world markets. What does it tell us about today’s politics?

by Jay Elwes / August 10, 2017 / Leave a comment

“When the crisis hit, the Royal Bank of Scotland had a balance sheet of £2.2 trillion, an amount larger than the UK’s entire GDP.” Photo: Danny Lawson/PA Archive/PA Images

In the summer of 2007, several bank-run hedge funds trading in mortgage-backed securities announced to the startled financial world that they had gone bust. It turned out that the mortgages that backed up those securities weren’t worth what people thought.

The initial result was panic, as financiers confronted the unsettling possibility that other firms might also be holding rubbish, and because nobody could tell who was in trouble, lending dried up—after all, who wants to lend money if you don’t know whether you’re going to get it back again? This shut down the channels of cash that the banks and other financial institutions needed for their daily operations.

Banks couldn’t borrow. They hadn’t gone bust, but were instead being choked by a sudden drying up of liquidity. Liquidity—that odd word was suddenly everywhere. A way of thinking about it is to imagine a cab, licensed, fuelled and ready to go. The driver has money in the bank, so is not broke. But at the last moment the cabbie realises there’s no loose change in the tin under the seat. Cabbies can’t do business without those small amounts of on-hand cash to settle up after each transaction. So the cabbie is stuck because there’s no liquidity. It was the same with the banks.

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Adam Tooze joins the Prospect team ten years after the crash to discuss his new book

Comments

Peter Bailey
August 26, 2017 at 12:01
The world is in a mess because we have lost our way. The economy should not be about GDP and exports and finance. Go to basics, it is about a community of people who have to work for a living.Governments and business need people and they need those people to wrok and earn money to live. Why - because there are only three segments to the economy, a community, a government and a business sector. There is nothing else. The government is there to provide an infrastructure of law and order. The end product of all business is the supply of goods and services to consumers. Difficult to believe but very true. Look at History, the community came along as tribes and they had leaders and later came industrialisation. Industrialisation was about making communities more efficient in their efforts, take away global considerations, and one can better appreciate that the economy is about a community of people working to improve their standard of living. Look back at history and when the American public were relatively well off the country was very strong overall economically. So were other countries and the strength of the economy comes from the standard of living of the people. GDP in fact should grow annually with the growth in population. Now we look at tax, there is only one taxpayer - the consumer. We have all sorts of taxes and income tax is one of the worst. We have all been led to believe that we pay income tax but ask - where do we get the money from to pay all of these taxes. it is really paid by the employer and adds to the cost of employment. All of the taxes end up in the business sector and are added into the price of the goods and services they supply which is why it ends up that the consumer is your main taxpayer. Governments and the business sector have to appreciate that their main task in life is to look after the community which forms the market place for business and the source of revenue for the government. With Brexit we need to change the tax systems to get many things right. It will also be found that free health and education is vital to bring down the cost of employment while putting up the spending power. The whole economy can be controlled without recessions.
Hugh R
September 4, 2017 at 08:59
To me, this article stands out as a masterpiece of clear and fair exposition.

Jay Elwes