In his fascinating new book Lords of Finance: The Bankers Who Broke the World, Liaquat Ahamed pulls off the rare accomplishment of looking into a lost world and finding lessons for our own. Lords of Finance focuses on the central bankers who oversaw the economies of the world’s four most important powers in the days following the World War One up to the Great Depression: Montagu Norman of the Bank of England, Emile Moreau of the Banque de France; Hjalmar Schacht of Germany’s Reichsbank; and Benjamin Strong of the Federal Reserve Bank of New York. Ahamed does a splendid job of recalling the private clubs and ocean liners and elegant apartments and estates, the whole rarefied realm in which these men traveled, and of bringing each of them, with his aptitudes and idiosyncrasies, vividly to life. As importantly, Ahamed, a scholar and investment manager, lays out the descent in the Depression with horrific clarity. One sees them making the fatal mistakes, and yet one is helpless to stop them. Lords of Finance is that unusual book that opens doors, showing how impersonal forces and the human nature intermix to govern the fate of nations and peoples. Here, Liaquat Ahamed answers a few questions:
Your book is a very compelling read, no doubt more so because of our current economic predicament. Are there financial lessons that are pertinent to our situation that can be learned from the decades you write about, or are the lessons more about human nature?
The answer is both. There are eerie similarities in the lead up to the Great Depression and the lead up to the current crisis. In both cases we had a bubble–then it was in the stock market; this time it was in real estate. In both cases the bubble was caused by over-easy credit and a mistake in Fed policy. In both cases the bubble, as they always do, burst. And in both cases the ensuing collapse caused a banking crisis. The one constant element in financial crises, not only 1929 or 2008 but throughout history, is the phenomenon of bubbles. That is probably a reflection of human nature, a combination of the recurring victory of hope over experience and of the tendency towards group think.
Insistence on war reparations and adherence to the gold standard seem to have been two totems of thought to which political and financial leaders clung long after they were useful. Are there ideas that we have clung to–that we may be clinging to yet- -that we should abandon, and the sooner the better?
The closest equivalent today is the excessive confidence in unfettered markets. The one area where market failure tends to be particularly pronounced is in finance. Markets overreact on both the upside and on the downside. Some more effective system of regulation that tempers the impact of these overreactions on the wider financial and economic system is probably a good idea.
You cite Walter Bagehot’s advice in his classic Lombard Street for dealing with a financial panic–lend freely, but not to those who are actually insolvent. But a couple pages later, you say the Federal Reserve banks made a mistake in the early days of the Depression by following that advice, by withholding money from insolvent banks and letting them go under. In our current case, walking the narrow space between those two pieces of advice seems to lead to one destination–nationalization of the zombie banks, or at least something like it. Is that a fair reading?
The problem was that Walter Bagehot‘s advice did not go far enough. In a panic the central bank should lend freely and if there are insolvencies that threaten the integrity of the banking system, then the government has to step in. Basically the conclusion is that you cannot allow your banking system to collapse. There is a menu of ways to prevent a collapse. Taking over the worst banks–what you call nationalization of zombie banks–is one element in that menu. We have been doing that for years. For example in 1984 the governemnt took over Continental Illinois, the 7th largest bank in this country, and held it for 10 years before selling it.
Many people cite the success of FDR’s spending programs in the thirties as a reason to support President Obama’s stimulus package. But you credit FDR’s decision to take the US off the gold standard as the most significant step. Do you think this invalidates the reason to support Obama’s package?
There is a famous saying about fiscal stimilus in the Great Depression–that it failed to create a recovery “not because it did not work but because it was not tried.” Most people have the impression that fiscal stimulus under Roosevelt was very large. In fact it was very modest–about 1.5% of GDP at a time when the economy was 30% below potential. President Obama’s package is 3% of GDP at a time when the economy is 10% below potential, and I am sure it will work. There is still a question whether it is large enough
Toward the end of your book, you advance the opinion that the disasters of the Great Depression could have been avoided if Benjamin Strong had lived. Do you believe that? Could the leadership of one person (living or dead) have helped us avoid our current problems?
I very much believe that. Economic history is not an inexorable process. Different people would produce different policies and different policies lead to different outcomes.
You make the case that nobody had better ideas for how to handle the world economy between the wars than John Maynard Keynes. Who do you listen to today most closely?
His followers. Economists ranging from Joe Stiglitz and Paul Krugman to Larry Summers.
One of the great treats of your book is your ability to recreate the lives of these bankers in the twenties and thirties–ocean voyages, trips to world capitals to take stock, the grand apartments and hotels, the clubby atmosphere. Today, central bankers seem far less aristocratic (though I guess if you think about Alan Greenspan, not less august.) Are we any better off?
Yes I think so because we are not going to have a repeat of the Great Depression. At that time the patient was very sick and the central bankers applied precisely the wrong medicine. They allowed the banking system to collapse, they cut budget deficits and they even raised interest rates in the middle of the Great Depression. Our central bankers may not be as aristocratic but at least they are not repeating those mistakes. If there is a risk, it is that patient is somehow sicker and that while we are administering the right medicine, the doses are not large enough.
(I wasn’t smary enough to ask Ahamed this question, on The Daily Beast the other day, but Jeffrey Leeds was.) What’s your view of the market?)
I buy the idea that the market’s gone from overpricing risk to underpricing risk—and there are great values. Someone called me and said things were going to get bad, and I said, ‘The more you fear that, the better, because that means they’ve all sold.’ The bear market in the Great Depression lasted 30-something months. Profits of US corporations went from $9 billion (9 percent of GDP) to 0. I don’t think we’re going to have the same fall. Profits will probably fall by half and I would be surprised if the bear market lasted more than two or three years. We started in Oct ‘07, so we’re 16, 17 months into it. It’s got further to go, but the low is probably going to be this year, not next year.