The attraction in reading the book titled Firefighting is that it is like hearing things straight from the horse’s mouth, as the three authors had worked with relevant authorities during this phase and got the system back on its feet.
The global financial crisis is probably the event that has engendered the maximum number of books and papers, throwing up a lot of facts and interpretations. Therefore, one may ask the question whether we really require another one after almost 11 years. The attraction in reading the book titled Firefighting is that it is like hearing things straight from the horse’s mouth, as the three authors had worked with relevant authorities during this phase and got the system back on its feet. That probably is a novelty when one picks up the book.
However, for those who have read other books on the subject, this one may not have anything very different to add, as most facts, which include the genesis of the crisis and the rescue missions, are well known now. In short, the crisis was all about too much of risk leverage, coupled with excessive short-term financing used for long-term lending, and the migration of risk from the formal banking sector to the shadow banking system, where there was too little regulation.
More importantly, there was no access to the Federal Reserve’s emergency safety net, which made the difference at the end of the day. To top it all, there were too many large firms that were too big to fail and were interconnected. This magnified the problem when it spread fast across the sector. Add to this the opaque mortgage-backed securities, which added to the puzzle, and it was a recipe for disaster if things went wrong. The authors also admit that the regulatory bureaucracy was outdated and fragmented, with no one being responsible for monitoring or even addressing systemic risks.
The authors have pointed out that the main cause of the crisis was ‘maturity transformation’, which meant borrowing short-term and lending long-term. This will ring a bell in our minds in India, as the present NBFC crisis, though not quite widespread but localised, had its genesis in a similar model. Therefore, when the crisis erupted and institutions had been blocked out of the CP market, the crisis just escalated. The CDOs and ABS were the second part of the story. In fact, the other point made about the crisis is that institutions that went down under were technically not regulated by the Federal Reserve, just as is the case with the NBFCs, where there are various regulations followed but no specific regulator. In fact, even capital standards were weak at that time with backward-looking regimes instead of forward ones.
A warning sent out here is that every time there is a boom in any financial segment, regulators need to be extra cautious as it could mean the sowing of the seeds of a bubble that can burst. This is what capitalism is all about and the Schumpeterian concept of creative destruction is a natural process that has to play out periodically, which, in turn, will lead to the transformation where the weak are sieved out and the system emerges stronger. The authors describe in a very incisive manner the meltdown that happened as the virus spread from one institution to the other. In such situations, there is general distrust that is built, and every institution is apprehensive of the other and not willing to deal with them. This is what made life difficult, which finally led to the quantitative easing programme that had the Fed directly buy bonds in the market to provide liquidity as market players were loath to lend to one another.
The authors are upfront in taking on the criticisms that have been levelled on them in terms of using public money to save the capitalists who were the ‘bad men’. Their view is that this was required to save the rest of the system, or the consequences would have been catastrophic. The act of saving the system and using all that was required to ensure it happened has actually helped the economy reach where it is today. The funding provided to institutions like AIG actually paid off, as they returned the money with a premium. Therefore, in retrospect, too, the action taken was judicious.
There is a first-person account of the deliberations and reactions to various institutions going down, including Bear Stearns, Lehman, JP Morgan, Merrill Lynch, Morgan Stanley, etc. But it is presented in a more official manner, unlike some of the first books on the crisis, for instance Too Big to Fail by Andrew Ross Sorkin, which was more exhaustive in documenting the parleys in various meetings. The authors also clear doubts on why Bear Stearns was rescued but not Lehman — it was more because they were not able to get a buyer given the time constraints. So, it was not a case of partiality being shown or a late reaction.
The book does not really get too much into the QE solution and has focused more on the crisis and the reaction of the Fed and the government to the problem. The authors are also clear that the next crisis can never be known from a regulatory perspective but there should be more safeguards built, especially when money is borrowed in the market and hence should be dynamic in nature.
From a regulatory standpoint, they argue that it would be necessary to have a policy on what can be done in such situations so that the playbook is in place. This book is surely a very good refresher with useful insights. The sequencing of the events has been narrated in a succinct manner, which makes the book extremely readable. There are almost 70 pages of graphs in a book of 230 pages, which may not be of much interest to the average reader.
(Madan Sabnavis is chief economist, Care Ratings.)