His vision of history

Are we doomed to repeat the past? That is the question Liaquat Ahamed's acclaimed new book, Lords of Finance, raises. Lee Bailey reports from New York.

Crowds in Wall Street in New York following news of the stockmarket crash.
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With nervous nods to George Santayana, policymakers and individual consumers alike have been busy searching history for lessons to aid in recovery from the current financial downturn. It takes a great mind and years of experience to explain such complex and far-reaching events, and Liaquat Ahamed possesses both. The Washington, DC-based author of the recently published Lords of Finance: The Bankers Who Broke the World is a veteran hedge fund manager, sits on the board of the influential Brookings Institution and headed the World Bank's investment division. And in his book, which explores the decisions made by central bankers before and during the crash of 1929, he has reached some useful conclusions about that global financial crisis that may shed light on today's turmoil.

Much intellectual firepower has been aimed at fixing the immediate problems with the global economy, an understandable focus given how much havoc the downturn has played with our jobs and property values. But history does repeat itself, and it still behoves us to listen when thinkers of Ahamed's calibre mine the past for lessons. "I started life as an economist," says Ahamed when asked for a thumbnail biography. The statement, delivered matter-of-factly, conjures a Benjamin Button-esque infant sprung from the womb a fully formed Keynesian, savaging the gold standard as he cries for his milk. Ahamed chuckles, realising the comedy of his oversimplified claim, and clarifies:

"I was born in Kenya, went to graduate school at Harvard and then joined the World Bank as an economist in the late Seventies." While he makes gross elisions in his own history ? he fails to mention his undergraduate work at Cambridge, for example - Ahamed's approach to global financial history in Lords of Finance is much more meticulous. In conversation he maintains wide-ranging opinions about matters from monetary policy to aid to banks in the Gulf states, and seated in the plush comfort of his Manhattan pied-à-terre, overlooking Park Avenue, it's clear that Ahamed knows a thing or two about personal finance, too.

For those despairing over the swooning markets, he makes the case for a silver lining by citing the example of John Maynard Keynes, the paradigm-shattering economist and "hero" of his book. Keynes had amassed a small fortune in the Twenties, but lost most of it in currency trades during the 1929 crash. In 1932 he took what was left, Ahamed explains, and invested it carefully, for the long term, in stocks. "When Keynes died, he was worth about $2 million, or about $24 million in today's terms," Ahamed notes. "Not too bad for a Cambridge don." The lesson? That "great fortunes have been built up by people taking advantage of panics."

Ahamed, who is 56, adds to this a dose of common sense. "Beware of bubbles," he warns. "They always burst. Don't invest in five properties with borrowed money and assume that you'll be able to get out faster than the next person." Like some other observers, Ahamed sees Islamic banking as something of a safe harbour from churning seas of speculation. "In Islamic banking you can't employ leverage to the same extent," since lenders hold equity and "are sharing in and are conscious of the risk." Overleveraged investments were one cause of the current downturn, Ahamed says, and sharia-compliant banking is nearly void of highly leverage arrangements.

Looking again to history, Ahamed questions the future role of Gulf cities in finance. "[In the Twenties and Thirties], there were some financial centres that completely disappeared as such," he says. "Paris was the second financial capital of the world before 1914, and it never reclaimed that status. Amsterdam, because the Dutch were neutral during the first world war, became a financial centre sort of like Dubai has been recently." But Amsterdam soon went the way of Paris.

In the future, Ahamed says, the action will unfold farther east, in China. "The question is, can the Shanghai-Hong Kong complex represent a sort of new financial centre?" he wonders. "Is Shanghai now to New York what New York was to London [after the first world war]? Of course, the US was the largest economic power even before it was a financial power. China is still not yet the largest economic power, so I personally don't think we're anywhere near that transition."

As for the challenges currently faced by the emirates, Ahamed says protection of the banking system should be the highest priority, taking precedence over ongoing stimulus efforts. Abu Dhabi recently spent Dh16bn recapitalising its local banks, and the UAE's central bank has made roughly Dh120bn available to local financial institutions to reinvigorate lending. Whereas the US needs stimulus because consumer spending has tanked and "monetary policy has lost all traction," Ahamed doesn't believe that a decrease in spending is a potentially fatal problem in the Gulf. "The danger in the Middle East is that you have asset prices collapsing," he says. "You're going to have a series of bankruptcies. And that's fine ? I don't think they should be stopped. The big risk is that it poisons the banking system. That's the lesson we've learnt here ? you have to protect your banks. You're going to need government intervention."

Ahamed also weighs in on the recent $800 billion US stimulus package: "I would have preferred the stimulus to have been larger ... although to a degree it was probably neither politically nor institutionally feasible to pass anything more. I would suspect it's not the last stimulus package we will have because I don't think in and of itself it will act as enough of a locomotive to turn the economy around."

Ahamed has observed the flight of expatriate workers from the UAE with interest, noting that mobile labour is a relatively new phenomenon in the history of crises. Whether they're fleeing debt or simply leaving due to absence of opportunity, foreign workers can act as vectors for financial weakness. "The world was global in the Twenties, in the sense that capital was mobile, and goods were mobile." Workers, however, were not. "Foreign workers are going to be one of the biggest transmission mechanisms for the current crisis, especially on the lower end of the pay scale. I would bet that remittances to South Asia from the Gulf are being hit badly."

In certain respects, Ahamed views the present crisis as more pervasive than that which precipitated the Depression. "That crisis was primarily in the stock market," he says. "But, only about 10 per cent of the population was involved in the stock market at the time." By contrast, in the "ownership society" of the modern day, the real estate bubble touched everyone. "You couldn't go to a dinner party recently and not hear people talking about how much money they were making flipping condos. It was pervasive."

As the private sector frets over consumer debt and a stalled real estate market, governments should be standing arm-in-arm, Ahamed asserts. He seems to regard the so-called "Gulf internationalism" practised by the Emirates as the appropriate stance, even if it has opened to country up to some turbulence in recent months. "You need countries to act as leaders. Each country acting on its own is likely to produce 'beggar thy neighbour' policies. Important countries need to say that they will act not only in their own narrow self-interest but in a sort of wider global interest," he adds. As is his wont, he refers again to the history books: "Protectionism in the US [in the Twenties] was an example. It didn't cause the Great Depression, but it was a way for the US to export its unemployment problem abroad. Then its trading partners tried to kick the ball back with protectionist policies of their own and so you had a system of passing the parcel around without solving the problem."

As most epochal events tend to do, the current economic meltdown has produced an outpouring of books attempting to explain the still unfolding crisis. Some of the better ones include The Subprime Solution by economist Robert Shiller, portfolio manager George Cooper's The Origin of Financial Crises, The Return of Depression Economics by Paul Krugman, a Nobel laureate, and The New Paradigm for Financial Markets, by George Soros, the famous financier.

These gentlemen are far from slouches when it comes to understanding and explaining economics and finance, but Ahamed's tome stands out for vividly bringing to life the heroes and villains of the financial world, those who brought about the crash of 1929 and those who attempted to prevent it. The reader becomes familiar with these historical figures, as opposed to merely reading of their actions. Writing in The New York Times, Joe Nocera, a business journalist and author, lauds Mr Ahamed's storytelling: "From a literary point of view ? and let me pause to note that this is a beautifully written book; Ahamed has a gift for phrase-making and storytelling that most full-time writers would envy ? the decision to build Lords of Finance around these four men is a brilliant conceit." Most other reviews - including those in Forbes, The Financial Times and The Economist - have been as favourable.

In his book, Mr Ahamed quotes a 19th-century British periodical that called the US "a nation of the most degenerate gamesters in the world." While he personally doesn't employ such vituperative description, he is comfortable placing blame on the US for the current state of affairs, if only by oblique reference. "It's clear to me that some countries are more prone to speculation than others," he says, citing Germans and Swiss as financially conservative populations. But even the cautious have suffered at the hands of the reckless, he says. "One of the ironies of this whole situation is that even prudent countries are being hammered in this economic downturn," Ahamed notes. "Europe has been hit worse than the US, and Japan, which is a nation of savers and has been very prudent for the last 10 years, just saw its GDP go down by 3 per cent in one quarter."

But more precisely, where does the discredit for the crunch lay? In his book Ahamed pins much of the blame for the Depression on the loose policies of central bankers like the American Benjamin Strong, Montagu Norman of Britain, Germany's Hjalmar Schacht and Émile Moreau of France. He detects a pattern of irresponsible monetary policy in more recent crises as well. (A natural sceptic, he started research for his book in 1999 after seeing a Time story hailing Robert Rubin, Lawrence Summers, and Alan Greenspan "the committee to save the world" from the Asian crisis that was then roiling markets.)

"[The current crisis] was not inevitable, nor was the Great Depression," Ahamed claims. "They were caused by a sequence of blunders made by individuals. As they say in Washington, policy is people. There is no question in my mind that there has been mismanagement by certain key people before and during this crisis." One difference Ahamed sees between the meltdowns of today and the Thirties is in public perception. "The bank crisis back then was very obvious, with people queued up outside of banks to take money out," he explains. "The current crisis has been much more subtle, in part because of the growth of what is now called the shadow banking system ? money market funds, investment banks, special purpose vehicles ? all of which look like banks but are operating sort of below the radar and out of the spotlight."

What unfolded in 2008, he says, was essentially a run on the shadow banking industry. "We have had massive shifts of money out of these banks, all through clicks of a mouse instead of queues in the street." Even criminal acts of finance have analogues in the past. "With a bubble comes financial skulduggery of all sorts," Ahamed says. "The equivalent of Bernie Madoff [in the Twenties] was Ivar Kreuger, a Swedish manufacturer of matches who ripped a whole bunch of people off. There were also bankers paying themselves too much and walking a fine legal line. We have it now and we had it then."

Although the present-day global financial crisis is not as severe as the Great Depression, Ahamed views it as just as much of a node in economic history. "I think we will come to view 2008 as the end of an era," he says. "It represents a sea change in the public view of what banks can do, how individuals should behave, what kind of money can be made, the role of government, and the way the financial sector operates. 1929 changed everything for the next 50 years, and I think we're at a similar juncture now."