Between Debt and the Devil

Adair Turner was a scholar of Gonville and Caius College and President of the Union when I was at Cambridge 40 years ago. Now in the House of Lords, he has held many distinguished positions and became chairman of the UK Financial Services Authority only a week before the crash in 2008. In this brilliant and penetrating analysis he discusses the factors leading up to the 2008 crisis, citing an incident when the Queen visited the Economics Department at the London School of Economics in the spring of 2009 and asked why no one saw the crisis coming. Turner admits frankly that he was one of these, and would have made the same errors if he had had a policy role before the crisis. Subsequently, he played a major role in global financial reform, and this book sets out his radical assessment and proposals.

One of his central and most interesting ideas is that 'modern financial systems left to themselves inevitably create debt in excessive quantities, and in particular debt that does not fund capital investment but rather the purchase of already existing assets, above all real estate.' (p. 4) He observes that 50% of total wealth is held in mostly urban real estate. The aftermath of the crisis is what he calls the debt overhang trap, explaining why much of the private debt has been shifted to public debt and why the recovery has been so slow as overleveraged individuals try to cut their levels of debt with a consequent dampening effect on aggregate consumer demand. An underlying problem is that the creation of credit (by banks) has hitherto been correlated with continuing economic growth demanded by the system. Turner sees the need to regulate this creation of credit, and devotes a section to this, also observing that markets – especially financial ones – can never be perfect.

This leads to his fundamental analysis of the shortcomings of current economics in terms of its assumptions. Just as socialist planned economies mistakenly assumed rational consumers and predictable expectations on a linear mechanistic basis, so modern economists with their sophisticated mathematical models make the same error – literally a fatal conceit in the light of inherent reducible uncertainty. He shows how economic ideas influence practical policy choices and exposes their methodological and philosophical bias: 'a preference for mathematical precision and elegance at the expense of realism' - i.e. the complexities of the real world. (p. 242) He wryly observes that 'you cannot see the crisis coming if you have theories and models that assume that the crisis is impossible.' In the real world, 'optimal policy inevitably involves a choice between alternative imperfections and alternative dangers' - hence the title of the book. In the afterword for the paperback edition, Turner discusses failed orthodoxy and the populist reaction: rising prosperity has not been evenly distributed - indeed, inequality has been exacerbated, and he sees action on this front as politically imperative, especially in the light of 'jobless growth' and disproportionate rewards going to the few. He also advocates a role for governments in terms of limited central bank money creation as one way of remedying a chronic deficiency of aggregate demand. The book is brimming with new ideas, and space enables me to mention only a few. If you only read one book on the 2008 financial crisis and its aftermath, this should be it.