Abstract
If hindsight is 20/20, then a postscript review of hindsight should provide additional clarity. Of the dozens of serious books that examined the determinants of the 2008 financial crisis, Herbert M. Schwartz’s Subprime Nation: American Power, Global Capital and the Housing Bubble stands out for its sharp take on the large macro flows that ultimately led to the collapse of financial markets and real economies around the world. Now, four years after the collapse of Lehman Brothers and three years after Schwartz’s work was first published, it is worth a second look. On the whole, the treatise stands up well to the prolonged U.S. housing slump and Great Recession; its weaknesses in explaining the present day’s economic and political shifts are the same weaknesses that readers discerned in 2009.
Subprime Nation rests on the argument that large-scale capital flows into the United States allowed America to borrow money cheaply and invest abroad, creating a financial arbitrage that fueled the domestic housing market. In addition to creating a supply imbalance, U.S. policy that encouraged homeownership caused a growth differential between the U.S. and other developed nations—which, in turn, led to low(er) interest rates and the continued growth of U.S. economic power abroad. Feedback loops intercept, and are especially true for China–U.S. trade imbalances, with Chinese investment in Mortgage Backed Securities (MBS) and real U.S. growth between 1991 and 2005. The subtext of the outline, made explicitly in the book, is that no one thing is to blame. Policy makers did not plan for U.S. housing-led growth, rather, institutional structures put in place decades earlier.
The macroeconomic trends that Schwartz describes not only contributed to the housing bubble, but also precipitated the collapse. Rising inflationary pressures, caused by Chinese demand for energy and an exhaustion of U.S. homebuyers, led to rising interest rates and the housing market implosion. The mathematical models that underlied the MBSs were similarly affected, and financial institutions were summarily on life support. The intricate dealings of the days and weeks immediately surrounding the financial markets’ near-collapse have been thoroughly dealt with in other books authored by the actors themselves and onlooking journalists. Subprime Nation distinguishes itself by packing apart the macroeconomic details of the “long 1990s” in great detail, sidestepping the dramatic details of the financial collapse and initial bailout.
Not all of Schwartz’s arguments are novel. Indeed, the trade imbalances between East Asia and the United States, and the political and economic forces that enable and perpetuate them, were well established before the collapse. In addition, the focus on differential—rather than level—growth is important but rather well trodden. The idea that growth is “graded on a curve” is one of the premises behind a reserve currency, and Schwartz does not bring new information there. His contribution in this area comes mainly in the form of focusing on the role of differential housing policy.
Focusing on the broad macroeconomic trends of capital flows and monetary policy also implies a less intense breakdown of the micro determinants of the bubble and collapse. Surely, behavioral economics and agency theory have much to add as well. The structure of bankers’ compensation packages favored creating MBSs to sell and keep as equity, which in turn fueled speculative mortgage origination. Herd mentalities and myopia further allowed the mispricing of the MBSs and insurance contracts written against them. Schwartz mentions these issues in the latter half of the book, but they are not part of his looping schematic. Likewise, while housing policy drives much of the explanation in the book, there is comparatively little discussion about how financial regulatory policy factored in the financial crisis. Especially considering the subsequent federal legislation that focuses on relation reforms (again, hindsight is 20/20), there is little doubt that the lack of consumer protections, regulatory scrutiny, and accounting rigor played a prominent role in the 2008 crisis.
Despite these flaws, Schwartz’s book remains a valuable read today. Consider the elements of his causal analysis: trade imbalances lead to U.S. financial arbitrage, which leads to a housing bubble, which leads to differential growth, etc. Much of these pieces are still in play; most of Subprime Nation’s chapters could be written about the present, three years after the book’s publication. Because Schwartz focuses on large-scale economic and political movements, reforming or reversing the trends he describes will be a long-term event that occurs in multiple stages. In contrast, the Consumer Financial Protection Agency should be well up and running before the U.S. and China meaningfully approach a solution to their co-dependence. Few books or articles written in the immediate aftermath of the 2008 crisis could hold up as well.
Of course, Schwartz could not foresee everything, and he predicted the end of the recession to start at the end of 2009 or beginning in 2010. The housing bubble burst by 2008, but it has maintained a slow but steady slump or anemic recovery ever since. It is thus worth asking: have reforms and the changed housing scene altered the economic landscape sufficiently to render Schwartz’s “long 1990s” theory obsolete? Perhaps the housing bubble is replaceable with other economic trends, like the growth in student debt or the volatility in the European sovereign debt market. This is a sobering thought; both examples lead to differentially higher U.S. growth and are propelled by a glut of foreign lending—and suggest another house of cards waiting to fall—albeit much less spectacularly since the U.S. consumer is still chastened after the Great Recession. But the possibility that major elements of Schwartz’s treatise can be replaced suggests that it is rather too robust: what good is a theory if major causal elements are easily supplanted by unconnected and unforeseeable replacements?
It is a tall order for any book to successfully highlight all the macro and micro determinants of the financial crisis and remain applicable years later, so the thought experiment above is just that. Congress has somewhat reluctantly focused its energies on financial regulation, without having to address the macro imbalances. The global recession, and the country/region-specific nuances that have spanned the last three years may be addressing part of the trade imbalances, with U.S. manufacturing experiencing its first year of growth since the “long 1990s” ended. But political pressure in developed countries is tilting to the side of growth, rather than austerity, policy. This would exacerbate and not reverse the trend. The takeaway is that the macro determinants of the 2008 financial crisis, so adeptly described by Schwartz, are going to be incredibly difficult to untangle. The globalized nature of financial institutions and markets makes hiccups in one country dangerous to the entire system. Schwartz’s book may be relevant for years to come.