The collapse of Lehman Brothers in September 2008 was the biggest corporate failure in American history. The US Treasury deliberately stepped aside rather than use taxpayers’ money to bail out the company. The wisdom of that decision will be debated for decades. The Western banking system came close to collapse as a credit squeeze turned to financial panic.
Andrew Ross Sorkin’s Too Big to Fail (Allen Lane, £14.99: Buy this book) is a fine narrative drawn from interviews with the leading bankers and policymakers. Sorkin punctuates his account with astute and sometimes sardonic observations of the human frailties he describes. Citing a glib memorandum sent by Dick Fuld, Lehman’s chief executive, to staff after the bank had filed for bankruptcy, Sorkin notes a parallel with Emperor Hirohito’s broadcast message in August 1945 that “the war has developed not necessarily to Japan’s advantage”.
The best place to start in understanding economic policy since the Lehman collapse is a book that scarcely mentions the crisis of 2007-08. In Lords of Finance (Heinemann, £20: Buy this book), Liaquat Ahamed brilliantly recounts the crash of 1929 and the Great Depression. That precedent has dominated the decisions of policymakers in the past 15 months.
The stock market crashed in October 1929, but losses extended through to 1931. They were caused by a catastrophic tightening of monetary policy. Central banks were determined to defend the convertibility of paper currency into gold. The Federal Reserve raised interest rates sharply when the US economy was already in deep recession. The result was misery and penury.
Ahamed tells this tale from the vantage point of the central bankers of the US, the UK, France and Germany. He gives them credit for mitigating the effects of reparations on Germany in the 1920s. But he says that they were then responsible for “the second fundamental error of economic policy in the 1920s: the decision to take the world back on to the gold standard”.
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The collective memory of the Great Depression has given urgency to the post-Lehman policies adopted by Western governments. So has a body of economic theory that developed directly from the terrible experience of the 1930s. In the past year, the Federal Reserve and the Bank of England have slashed interest rates almost to zero and expanded the money supply by buying government and corporate debt, incurring massive budget deficits.
Four books set out to make sense of the financial collapse and the remedial measures. In all of them, the name of John Maynard Keynes is prominent. Keynes’s ideas have been widely misinterpreted as a call for deficit spending and expansionary policies. They were more profound. Keynes’s central insight was that a market economy is prone to cyclical instability. Active monetary and fiscal measures are needed to stabilise the economy. Keynes explained how small shocks to an economy can lead to recession, and how recessions can feed on themselves to create a deflationary spiral.
Keynes: The Twentieth Century’s Most Influential Economist (Bloomsbury, £16.99: Buy this book), by the historian Peter Clarke, is a brisk account of his life and thinking. Clarke emphasises the importance of Keynes’s insight that confidence is a prerequisite for recovery. Businesses will invest only if they expect demand for their goods. If confidence is absent, the economy may merely stagnate, regardless of how low interest rates fall.
In Keynes: The Return of the Master (Allen Lane, £20: Buy this book), Robert Skidelsky offers a more thematic treatment of the relevance of Keynes’s work. Skidelsky is harsh on what he sees as the failure of modern economics to distinguish between risk, which can be measured and controlled, and uncertainty, which was at the heart of Keynes’s view of how economic agents behaved.
A more detailed volume on the role of ideas in the financial crisis is How Markets Fail: The Logic of Economic Calamities (Allen Lane, £25: Buy this book) by John Cassidy of The New Yorker. It is an intellectually gritty but highly readable exposition. Cassidy contrasts free-market thinking with what he calls reality-based economics. He is Keynesian in his emphasis on looking at the economy as a whole. Welfare will not necessarily result from the actions of myr-iad individual economic agents pursuing self-interest. Financial institutions posed a risk to the stability of the system yet were inadequately controlled by a Balkanised structure of regulation.
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The best book describing this malaise is Richard Posner’s A Failure of Capitalism (Harvard University Press, £17.95: Buy this book). The distinctiveness of his case is that he is a prominent conservative thinker with the intellectual acuity to argue that the crisis is not to do with the traditional enemy of conservatism, big government, but is a consequence of decisions taken by private firms. The ill-effects of those decisions were worsened by deregulation of banking.
To get a sense of the costs of the financial crisis, you need to look at the stories within it of bankruptcy and fraud. Books that consider fascinating details of the wider picture are Roger Boyes’s Meltdown Iceland (Bloomsbury, £12.99: Buy this book) and Adam LeBor’s The Believers (Weidenfeld & Nicolson, £18.99: Buy this book), who both write for The Times. Iceland is a case study of an economy whose wealth was tied to a bloated financial sector. Boyes traces the collapse of a tiny economy that had been floating on a sea of debt. The implosion of financial markets exposed ugly dealings, of which the most notorious is the scam perpetrated by Bernard Madoff. LeBor provides a cautionary tale of cupidity and crooker.
Finally, Scroogenomics (Princeton University Press, £6.95: Buy this book) by Joel Wald-fogel is a brief, witty, yet profound, argument that the business of giving presents at Christmas is economically wasteful: “As an institution for ‘allocating resources’ (getting stuff to the right people), holiday giving is a complete loser.” I’m convinced.