Charles Morris on Crashes

To start with, tell me about the Kindleberger book, Manias, Panics and Crashes. Is there an overall theory of crashes here?

Kindleberger’s great virtue is that he was both a respected economist and a student of human nature, and he knew that human nature could never be bottled up in an economic model. His book is a terrific narrative of a series of bubbles, going back to pre-industrial days – the Dutch tulip craze, the South Sea bubble, and so forth.

None of them is exactly the same, of course. They take place at different periods, involve different instruments and different kinds of mind-sets. But each one is about people getting caught up in one sort of enthusiasm or the other. Why would a company like Merrill Lynch think that housing prices that rose in real terms by 97 per cent between 2002 and 2005 would continue to rise?

House prices went up 97 per cent in real terms in a few years?

Yes, in the US. The same things happened in other places too, in Britain, Spain, Ireland, and the banks said: ‘Gee, this is great.’

People are enjoying the bubble so much that…

It was an obvious bubble. Even I could see it, so how come they couldn’t?

Maybe because you weren’t raking in the money. What could we do to help us foresee crashes?

I made a point in a half-joking way in a book once, but I think it was really right. We should look at the top five or ten investment banks that every year hire a bunch of top graduates from MIT and Harvard Business School. Then we should watch what those guys work on because that’s where the next crash is going to be.

It’s true! It takes about five or six years but they assign the brightest guys to whatever is new and on the cutting edge and every time it gets pushed over the brink until there’s some kind of crash. Most of the time it’s a fairly modest crash. What was so strange about this one is, I think, for the first time all the regulators helped make it happen. One of the points that the Rogoff and Reinhart book, This Time It’s Different, makes is that this happens all the time and has always happened – the whole world gets caught up in the same kind of enthusiasms.

Is there a difference between the two books?

Well, Kindleberger tells a very rich narrative of crashes, but the great thing that Rogoff and Reinhart have done is they’ve assembled this huge database. They’ve gone back 800 years and you can see roughly what’s been going on with government borrowing and lending over that time.

Eight hundred years?

Eight hundred years. We’ve been having banking crises for a long time. I did not put a book of mine on this list – Money, Greed and Risk – but it says the same kind of thing. It sort of shows the cycles and shows that all these things are essentially the same.

A point to make is that nothing gets really crazy unless at first it’s a good thing. So there’s some innovation that makes the market work better and the guys who think of that get very rich because finance is always done with other folks’ money. So when you make an innovation, the first, second and third movers make a lot of money. Then everybody else rushes in to try to do it too, and the reason banking and finance is so risky is that it’s highly leveraged. It’s playing with borrowed money. You’re not putting up your own cash, or you’re putting up a little bit and getting the bank to provide the rest. So if you can invest in an innovative way then you’re making buckets. If you’re making something real, like steel, you might overproduce it, but you can’t have such a wild kind of production that you do in banking.

What was the crisis 800 years ago?

It was something in China. But a good example is from the 14th and 15th centuries when a merchant trader would load a ship up with goods and he would sail around the world, sometimes for years, trading the goods he had for the goods he wanted. It was goods for goods and it was a slow process.

Then the Italians invented the paper bill of exchange – basically a cheque, drawn on a banking house back in Venice or Genoa. And for the first time the trader could give a piece of paper in return for goods. Trade boomed. This was a brilliant invention. So other banks came in and started issuing these pieces of paper and in 60 years there was a huge crash that brought down the Italian and Dutch banking houses.

OK, let’s talk about Skidelsky’s book on Keynes.

What’s so wonderful about Keynes was that he didn’t trust economics. He understood that this was a human study, that it was not a scientific or mathematical study. He didn’t trust economic data – he said it’s useful, but it doesn’t really tell you what’s going on. He didn’t trust mathematical models – he said they’re very helpful when you try to think through what’s going on, but don’t think it’s the truth because it’s not. What comes through that book is what a deep thinker Keynes was and that he basically understood that economics is a metaphor for complex, semi-random, not very rational human interaction. And you read it and you think: ‘Gee, if we only had Keynes.’

Isn’t this book three huge volumes?

Skidelsky does a one-volume version as well as the three-volume version. I’ve read them both and the one-volume version is really fine. It’s 900 pages, a wonderful read, with lots of beautiful luscious history in it – Cambridge in 1912 when there was that brief period prior to World War I when Cambridge may have been the very best place in the world that you could be if you were smart and had taste.