How a local squall might become a global tempest

By Niall Ferguson

The phrase “perfect storm” has been trotted out once too often to characterise the past year’s financial crisis. Yet the real perfect storm may still lie ahead.

Fans of the George Clooney film will recall that the perfect storm was caused by the convergence of a hurricane off the Atlantic seaboard, an area of low pressure south of Nova Scotia and a cold front swooping down from Canada. Result: howling winds, vast waves and the loss of at least one boatload of Gloucester fishermen.

One year after the onset of the financial crisis we are still calling the “credit crunch”, could we be witnessing a similar catastrophic convergence, as the slow-moving hurricane of a US banking crisis hits first a commodity price rise and then a global slowdown?

Until now this crisis has been primarily a US affair, albeit with collateral damage (literally) on the balance sheets of many European banks. The crisis had its origins in a US real estate bubble fuelled by easy money and lax lending standards. Ordinary Americans gave up saving, pinning their hopes for the financial future on a leveraged play on the real estate market. In barely a decade, household sector indebtedness surged from 90 per cent to 133 per cent of disposable personal income. At its peak in August 2004, annual house price inflation exceeded 20 per cent.

With the inevitable bursting of that bubble, the process has gone into reverse. House prices are falling at an annual rate of 15 per cent. The catalyst for the bust were defaults by subprime borrowers but, as prices continue to fall, less marginal homeowners are coming under pressure. Credit Suisse recently forecast that by the time the crisis is over as many as 6.5m loans will have fallen into foreclosure – more than one in 10 of all US mortgages.

A property crash like this has not been seen since the Great Depression. The difference is that the monetary and fiscal authorities have done everything in their power to prevent a repeat of what Milton Friedman and Anna Schwartz dubbed “the great contraction” between 1929 and 1933. What happened then was that falling asset prices caused thousands of banks to fail, while the Federal Reserve did almost nothing to mitigate (and a good deal to accentuate) the consequent monetary implosion. Under Ben Bernanke’s historically informed leadership, the Fed has done the exact opposite, slashing interest rates and, more importantly, targeting liquidity at banks through the discount window and new term auction facilities.

This has so far averted a full-scale banking crisis but it is important not to overstate the achievement. Most kinds of mortgage-backed securities have not significantly recovered from the initial crisis, while the market for collateralised debt obligations is all but dead. After writedowns in excess of $400bn (€260bn, £205bn) and capital injections of about $300bn, many banks still look fragile. Shares in at least 40 US banks are down 70 per cent or more. We know the US Treasury will intervene to avert the collapse of inst- itutions it deems too big (or important) to fail: witness the brokered sale of Bear Stearns and the hasty bail-out of Fannie Mae and Freddie Mac. But many second-rank banks seem certain to follow Indymac into oblivion.

Call it a partially contained banking crisis, then. The impact on the rest of the economy is still bound to be serious. Before the crunch, credit extension in the US was growing at 4 per cent a year; now the figure is minus 7 per cent. The evidence is mounting that the US economy is on the brink of recession. Business bankruptcies are up, payrolls are down and corporate earnings have slumped. And, of course, as things get tough on Main Street there will be a second wave of financial problems, beginning with corporate defaults and commercial real estate blow-ups.

The question is whether or not this American hurricane is about to run into two other macroeconomic weather systems. Up until now the global impact of the crisis has been limited. Indeed, strong global growth has been the main reason the US recession did not start sooner. With the dollar weakened as an indirect consequence of the Fed’s open-handed lending policy, US exports have surged. According to Morgan Stanley, net exports accounted for all but 30 basis points of the 1.8 per cent growth in US output over the past year.

The downside of this, however, was a rise in commodity prices as strong Asian demand coincided with a depreciating dollar. For a time, this coincidence of a US slowdown and soaring oil prices revived unhappy memories of 1970s stagflation. But now a new and colder front is crossing the macroeconomic weather map: the prospect of a global slowdown.

Admittedly the forecasts do not sound too alarming. A reduction in global growth from 4.1 per cent this year to 3.6 per cent next year could positively help damp inflationary pressures. Optimists such as Jim O’Neill at Goldman Sachs celebrate the “decoupling” of China from the US, pointing out that nearly all China’s growth is accounted for by domestic demand, not exports.

Yet there are four reasons to be less cheerful. First, Europe has clearly not decoupled from America. Indeed, partly because of the strength of the euro, the eurozone is now growing more slowly than the US. And remember: the European Union’s economy is still more than five times larger than China’s. It also matters a great deal more to US exporters.

Second, the commodity price rise has generated inflationary pressures in many emerging markets that will not recede overnight. According to Joachim Fels of Morgan Stanley, 50 of the 190 countries in the world currently have double-digit inflation. The World Bank has identified 33 countries where high food prices have already generated civil unrest.

Third, decoupling is not a cause for celebration if, on closer inspection, it is a synonym for deglobalisation. The growth of the world economy since 1980 has owed much to lower trade barriers. Unfortunately, the recent breakdown of the Doha round of global trade talks sent a worrying signal that commitment to free trade is weakening. It was troubling, too, how many governments responded to the jump in rice prices by imposing export restrictions.

One year on, what began as a US crisis is fast becoming a world crisis. Small wonder only a handful of global equity markets are in positive territory relative to August 2007, while more than half have declined by between 10 and 40 per cent. The US slowdown will also affect many emerging markets less reliant on exports than China. At the same time, the global slowdown is about to kick away the last prop keeping the US recession at bay. No, this is not the Great Depression 2.0; the Fed and the Treasury are seeing to that. But, as in the 1930s, the critical phase is not the US phase. It is when the crisis goes global that the term “credit crunch” will no longer suffice.

Bookshelf
Shocked by the New

By MICHAEL DIRDA

The Same Man
By David Lebedoff

George Orwell and Evelyn Waugh were both born in 1903 to middle-class families and both destined to become masters of English prose. Yet given that the authors of "1984" and "Brideshead Revisited" are among the most honored English writers of the mid-20th century, as well as the subjects of multiple biographies and critical studies, it is hard not to wonder, at first, whether David Lebedoff's "The Same Man" is really necessary.

And indeed, Mr. Lebedoff spends most of his book giving a succinct, if unremarkable, summary of Orwell's and Waugh's lives and careers. But then, in a startling last chapter, he makes it clear that "The Same Man" has not only a biographical purpose but also a polemical one. Yes, he notes, Orwell chose to become the Outsider, rejecting the blandishments of class, status and privilege, deliberately living at the poverty line or just below it. Yes, Waugh hungered for the trappings of the aristocracy, partied with the golden lads and lasses of Oxford's "Brideshead generation," and ultimately made himself into a blimpish country squire. Nonetheless, Mr. Lebedoff says, the leftist anti-Stalinist and the reactionary Catholic apologist both arrived at the same fundamental -- and, in Mr. Lebedoff's view, sound -- critique of the modern world and all its hedonistic, shallow falsity.

"What they had most in common was a hatred of moral relativism," Mr. Lebedoff writes of his subjects. "They both believed that morality is absolute, though they defined and applied it differently. But each believed with all his heart, brain, and soul that there were such things as moral right and moral wrong, and that these were not subject to changes in fashion. Moral relativism was, in fact, the gravest of sins. Everything else they believed in common flowed from this basic perception. . . . They fought the dictators, of course, but both knew that the larger battles were yet to come, and that victory over the advance scouting parties of soulless uniformity was only a first step. . . . What both believed -- their core, who they were -- was that individual freedom mattered more than anything else on earth and reliance on tradition was the best way to maintain it."

Mr. Lebedoff argues that, even taking into account the increase in material comfort and medical knowledge in the 21st century, Orwell and Waugh "would dread and abhor much about our time, and might even see it as worse than their own." After all, he continues, "their fundamental concern was that the Modern Age would strip humans of their humanity." This, Mr. Lebedoff asserts, is clearly happening, and with a vengeance.

In fact, the long final chapter of "The Same Man" offers both a summary of Waugh and Orwell's worldview and Mr. Lebedoff's own diatribe against the abuses of political correctness, the rise of a test-score meritocracy, "the growing displacement of majority rule by the rulings of experts," the retreat from true religious faith, our age's frenzied pursuit of vacuous pleasure and the increasing triumph of "abstract, lifeless, and maddeningly generalized prose," as well as the further debasement of English by the Internet, the control of our political parties by "extremists" and the overall "coarsening of our general culture."

In particular, Mr. Lebedoff insists that we have lost touch with tradition and natural instinct, having exchanged faith in character, decency and common sense for a sheeplike reliance on the superficially but impressively educated -- those same smug valedictorians and CEOs who once led us into a disastrous land war in Asia and who more recently made "the precipitous effort to transplant democracy to sandy soil that had never sustained such roots." In Mr. Lebedoff's view, our leaders repeatedly ignore our actual needs and concerns to pursue their own hobbyhorses, no matter what the cost.

Little wonder, then, that Mr. Lebedoff emphasizes the ways in which Waugh's anarchic comedies and Orwell's political fables portray worlds governed by fantasy and delusion. He notes that Waugh's early masterpiece "Vile Bodies" and Orwell's chilling "1984" are both visions of dystopia, revealing "the aimlessness of life without faith, the impossibility of living without tradition, the absence of fairness, the triumph of might."

It is true, Mr. Lebedoff concedes, that Orwell identified with the working man and Waugh with the aristocracy. But both men, he says, loathed the rise of narrow specialists, middle managers, conformist salarymen and ruthless overachievers. In their eyes such experts and functionaries were creating a society hardly worth living in, a robotic world that encouraged people to act and think alike, a world divorced from the land, tradition and history. What, finally, did it matter that Evelyn Waugh would write with a fountain pen and dress in black tie for dinner at his country estate while Orwell would clatter away on his manual typewriter in a tiny cottage without electricity? Their fundamental beliefs made them "the same man."

What is one to make of all this? Mr. Lebedoff tends to simplify both Orwell and Waugh to support his thesis. He sweeps too many disparate elements of modern life into a single and overharsh verdict upon it. And his compact account of his two heroes' lives serves mainly as the groundwork for that final jeremiad on the sins of our plastic, feel-good world. Still, it's hard not to be caught up by the force of Mr. Lebedoff's passion and to feel at least some agreement with his social critique, however extreme it may be at times. "The Same Man" is consequently just the kind of book that both Waugh and Orwell, full of passion and conviction themselves, might have enjoyed -- or enjoyed arguing with.

Mr. Dirda is a Pulitzer Prize-winning critic and the author of the memoir "An Open Book" and of four collections of essays, including the recent "Classics for Pleasure."

The McCain Veepstakes

The Beijing Olympics are about to begin, but in Washington the real games of August involve vetting the potential Presidential running mates. As a young, rookie candidate running on "change," Barack Obama can help himself by choosing a safe, seasoned politician like Evan Bayh or Joe Biden. As the trailing candidate from an unpopular party, John McCain has the harder decision because there really is no obvious candidate.

Our view is that vice presidential nominees rarely matter much to election prospects because voters focus on the top of the ticket. A bad selection can hurt, of course, and veep nominees can be very important both to governing and especially to the future of the party. We'd advise Mr. McCain to make his choice based mainly on the latter two criteria, especially because at his age he could be a one-termer.

This means choosing someone who voters think has the stature to be President from the outset, and also doesn't give up Mr. McCain's clear experience edge over Mr. Obama. That probably rules out a pair of young, attractive Governors, Bobby Jindal of Louisiana and Alaska's Sarah Palin, despite their potential and appeal as GOP reformers.

Experience also argues against tapping nonpoliticians like eBay's Meg Whitman or FedEx's Fred Smith. Both have undeniable appeal as successful entrepreneurs who could help Mr. McCain's economic bona fides. But the magnitude of press scrutiny that any nominee must endure today is a lot to ask of someone who's never sought elective office. Even Presidential nominees get to spend months auditioning off-Broadway in the primaries, while Dan Quayle knows all about the way the press corps treats unknown GOP veeps.

A successful choice would also be someone who doesn't offend the currently listless conservative base. Independent Democratic Senator Joe Lieberman of Connecticut would be a splendid VP in our book, and is solid on foreign policy and taxes, but he'd probably alienate too many social conservatives. The best choice on the merits, former Florida Governor Jeb Bush, has the wrong last name. Florida Governor Charlie Crist could help the nominee in a big state with 27 electoral votes. But like Iowa caucus winner Mike Huckabee, Mr. Crist has a record of too-frequent political opportunism that would disappoint much of the party.

A name often mentioned is Mitt Romney, who looks and speaks the part and as an entrepreneur himself could help on the economy. The former Massachusetts Governor failed to catch fire in the primaries, though, and, however unfairly, his Mormonism seems to be an issue with many evangelicals. Our own concern is that he continues to defend his state health-care reform even as it looks increasingly like a fiscal disaster.

By now you might be wondering if there's anyone we do like. Well, Fred Thompson would bring governing judgment and policy heft, and because he isn't much younger than Mr. McCain might make sense as a duo promising to serve one term, clean up the mess, and go home. On the other hand, he might be better suited for Attorney General if Mr. McCain prevails.

Tim Pawlenty of Minnesota is a conservative on most issues who has twice won the governorship of a liberal swing state. He's as confused as Mr. McCain on global warming, but he seems to have more principles than Mr. Crist. Rob Portman, former White House budget chief and once a rising star in Congress, brings candle power and might help in his home state of Ohio. Some McCain advisers will say his Bush experience rules him out, but he has depth as a policy wonk.

South Carolina's Mark Sanford, now in his second term as Governor, is unknown to most voters but is well liked among GOP activists for his reform credentials. Elected to Congress in 1994, he kept his promise to serve only three terms. As Governor, he's pushed for lower taxes, less spending and more school choice for disadvantaged kids. Mr. Sanford did stumble recently during a CNN interview, going blank when asked to name policy differences between Mr. McCain and President Bush. Still, it was a minor misstep, and Mr. McCain could do worse.

A darkhorse pick would be John Kasich, another Buckeye-state politician and former Congressman who left Washington before Tom DeLay and other Republican leaders forgot why the voters elected them. Mr. Kasich is still well known in Ohio and is widely thought to be aiming at a run for Governor in 2010. He's an energetic campaigner, the son of a mailman who can talk about taxes and spending in ways that voters can understand.

If there were a miracle choice for Mr. McCain, that person would be obvious by now. There isn't, and an attempt to find one can easily backfire (Spiro Agnew, Geraldine Ferraro). Mr. McCain's age and moderate political profile suggest he needs a younger but still experienced conservative who can help him unite the party and govern if he happens to win.