It’s a trick question. The biggest IPO in history was on Tuesday. The credit card company Visa floated on the New York Stock Exchange at a price of $44 a share, to rake in a total of $17.9bn. That is close to double the previous record of $10.6bn, which was indeed the public flotation of AT&T, the US equivalent of BT. It’s hard to imagine a better example of capitalism’s ability to astonish than that – and it’s particularly entertaining that, at a time when markets are convulsed by anxiety about debt, the record float should be a credit card company.
Once you get interested in the way capitalism works, you notice that the stories it throws up have two features: they’re always the same; and yet they’re full of amazing details that no one would dare invent. The collapse of the US bank Bear Stearns, for instance, is on the one hand a familiar story – bank accumulates bad debt, is found out, implodes – and on the other a treasure chest of wonders and ironies. Companies, even huge financial companies like Bear Stearns, have personalities, and the personality of Bear, the fifth-largest US investment bank, was bullish, chest-out, cigar-chomping, macho, and unlovable. In 1998, the hedge fund Long-Term Capital Management – which would better have been named Short Term Crazy Betting – blew up. It had available cash of $500m but had borrowed and leveraged so extensively that it was holding contracts worth an apocalyptic $1.25tn. The president of the Federal Reserve Bank of New York, William McDonough, got together the heads of the big US banks at his offices, and essentially demanded that they rescue LTCM.
This was a moment for the fat cats and Wall Street oligarchs to demonstrate their public-spiritedness by risking their own money to rescue LTCM from its own mistakes, and in the process avert the risk of a global meltdown. The first banker to speak was James Cayne the (literally) cigar-chomping head of Bear Stearns. He was in a good position to know the gory details about LTCM’s derivative holdings, because Bear Stearns cleared LTCM’s trades. Cayne said no. He refused to help LTCM.
The other bankers went berserk. But Cayne didn’t budge, and in the process uttered a magnificently menacing line: “Don’t go alphabetically if you want this to work.” So the other banks bailed LTCM out, and did not love Bear Stearns for not doing so, and at least one person in the meeting openly vowed revenge. Last weekend, what went around came around, and one of those banks, JP Morgan Chase, bought Bear Stearns for $246m. At its peak Bear had been worth $25bn, so the price represented a discount of 91%. Bear Stearns was 85 years old and had survived eight US recessions, as well as the Great Depression; but it couldn’t survive the credit crunch.
The current financial crisis is the most serious since the second world war, and perhaps since the Great Depression; but that doesn’t mean that there isn’t money to be made. JP Morgan clearly thinks so. Its institutional personality is that of one of the old “white shoe” New York banks. (“White shoe” means snooty, posh and respectable.) The bank is good at managing other people’s hard times. Its first fortune was made in the aftermath of the American civil war, buying up and consolidating railways. It is typical of JP Morgan that is should have hired Tony Blair as an adviser – that’s its posh side – and also typical that it should already be looking at opportunities thrown up by the crunch. Before buying Bear Stearns, JP Morgan had already bought a prime chunk of Northern Rock.
Equity release is the process by which older people whose house is their main financial asset borrow money on the value of their home. People who take out equity release scheme are by definition older, better-off citizens whose home is their main capital asset – if it wasn’t, they wouldn’t be having to borrow on it. This means they are the exact opposite of the poor people who were lured into taking out mortgages by unscrupulous lenders in the US. Just because some debts are bad doesn’t mean they all are; this was a very astute buy by JP Morgan. In the Bear Stearns deal, they were able to get the US government to underwrite the dodgiest $30bn of debt. A very good deal indeed.
The credit crunch is scary, as scary as these things get. It is also business as usual, because markets always over-correct – they go too far on the way up, and too far on the way down. Depending on how you count, this is either the fourth of fifth near-disaster of my lifetime in the workforce, and each of these episodes has had a different trajectory and offered a different lesson. In order:
1987: on October 19, the stockmarket had its record one-day fall. In the US it was 22.6%; in the UK, by the end of the month, stocks had lost 26.4% of their value. To this day, no one quite knows why, but a brilliant innovation seems to be to blame – in financial disasters, brilliant innovations are often to blame. In this case, it was portfolio insurance, by which computers were programmed to sell falling stocks automatically, to prevent losses. But the computers all had more or less the same models of how to do this, so they all tried to do it at the same time. The result was that prices went off a cliff. At the time there was much speculation that this was the end of the world, but in both the US and the UK, stocks finished 1987 at a higher level than they started it.
1988: Nick Leeson destroys Barings, at a cost of £800m, by betting the wrong way on the Japanese stockmarket.
1998: The Russian government defaults on its debt payments, causing turmoil around the world. Havoc in Asia; LTCM implodes, leaving a potential $1.25tn hole in the global markets. The Fed bangs heads together, fixes it. Fun fact: in 1997, LTCM’s founding partners had forced out all outside investors, because they wanted to keep more of the profits for themselves – so they ended up owning all the losses.
2000-2001: The dotcom bubble pops. This was a classic speculative mania, like the tulips craze or the South Sea bubble, in which both professional and amateur investors ran around throwing money at anything with a .com in the title. At the height of the bubble, what is generally seen as the worst company merger in history takes place, when AOL uses its ludicrously inflated stock to buy/merge with Time Warner. This was exactly the same as if, at the end of a game of Monopoly, you were to rise from the table only to find that you had just become the real-life owner of Mayfair and Park Lane. Loss caused by merger: $99bn. Fun fact: in the dotcom implosion $5tn went down the toilet, making it the largest destruction of capital the world has ever seen.
Speaking personally, I barely noticed these events. I know people who lost jobs in the dotcom bust, but apart from that, these convulsions had no effect on my work or personal life. I couldn’t make the same claim about the Tory recession of the late 80s, which coincided with the fall in house prices – that I noticed, not least because it left my flat worth less than I paid for it for the entire next decade. It is possible to argue that recession was triggered by the 1987 mini-crash; the other market disasters had little effect on the UK. Remarkably, while the US and the EU both slipped into recession after the dotcom crash, the UK didn’t. A recession is defined as two consecutive quarters during which the economy shrinks; in the UK we’ve had 67 quarters of economic growth. That’s a record.
I don’t think it’s a record that’s likely to last much longer. Crashes are part of how markets work, but not all crashes are created equal. Unlike the four other busts I’ve lived through while in the workforce, this crash is going to impact the texture of everyday life in a much more direct way.
The reason why is linked to the causes of the credit crunch. There are two main culprits – apart from the perennial ones, greed and fear. The first was the “securitisation” of bad loans. Money was lent to people unlikely to be able to pay it back; then those debts were chopped up, and sold on, so the institution that lent the money now no longer carried the risk. As a result, the initial lender didn’t have to care about the likeliness of the borrower’s defaulting – in hindsight, a blindingly obvious recipe for trouble. Second, when these packages of debt were assessed, they were given a rating of AAA, the highest and safest available. There is a huge demand for AAA bonds, and institutions set out to create ingenious new ways of making AAA debt. I have read the keep-it-simple explanations of how this new AAA debt was produced – it features “cascades” of cash and “tiers” of debt. I’m still at a loss to understand how the giant brains involved thought poor people struggling to pay mortgages could magically produce rock-solid AAA bonds.
The big problem is that the risks are spread everywhere throughout the financial system. Banks are reluctant to lend to each other, which will make borrowing more expensive for everyone; and it is that, more than anything else, which is more or less certain to trigger a recession in the US and is likely to trigger one here. The 11.8 million of us with mortgages will pay more; our houses will (I’d have thought) significantly drop in value; spending will slow; businesses will be squeezed between fewer customers and stingier banks, and go bust; there will be, probably, an across-the-board downturn. There will be huge rows about securitisation and AAA ratings, there will be litigation and calls for new laws; there will be blood.
What there will not be is meaningful change. The credit crunch is deadly serious, but it will not change the fundamental dynamic of how international capital markets work. Markets go too far: ingenious people take bigger and bigger risks, with more and more clever strategies, some of them sound, some of them, it eventually emerges, spectacularly not. Just because this is the worst bust in decades doesn’t mean it will be the last. Somewhere out there, some bright spark is toying with an idea for a new kind of investment, a new trading strategy, which will in a few years’ time be the cause of the next crash.
By then most of us will have all got poorer for a bit, then, if we’re lucky, we’ll all have got richer again. This is how capitalism works. It is the way we live now.
