We of Little Faith

Contributed photo

Niall Fergusan, author of The Ascent of Money: "We were already looking at a shift from West (America) to East (China). But the crisis has speeded that up."

Niall Ferguson
Mon., Nov. 9. Quick Center for the Arts, Fairfield University, 1073 N. Benson Rd., Fairfield. 8 p.m. $45. 203-254-4010, www.quickcenter.com

It's said there are no atheists in foxholes. Especially when the ammunition's run out.

Certainly all of us taxpayers, thrust as bailout cannon fodder into the battle to save global finance, may sometimes brood over America's four word article of faith — "In God We Trust" — the entreaty that clings to the back of every dollar bill. Yet we are daily reminded that economic recovery depends on consumers' willingness to heave ourselves up from the foxholes and brave incoming fire.

We put the question of this dicey balance between faith and reason to Niall Ferguson, Laurence A. Tisch Professor of History at Harvard University and author, most recently, of The Ascent of Money: A Financial History of the World (which was adapted into a recently broadcast series on PBS). He also gave us a glimpse of the road ahead.

Weekly: You've said money is about trust. We have to believe it's worth something. Given what we now know about investment banks and the ruinous consequences of their practices, should we still trust?

Niall Ferguson: I think it's very hard to feel enormous amounts of confidence in a great many institutions. The banks, including big commercial banks, have indeed conducted themselves with great recklessness in the last 10 years. The only reason we have trust in them is, in fact, that we trust the FDIC (Federal Deposit Insurance Corporation) to cover our deposits if these banks should fail. Which is a funny kind of trust to have. The question then becomes — are we right to trust the FDIC? If people stopped trusting it, then there would be really very serious trouble. It's amazing they do trust it, since its resources are clearly far too limited for it to cope with the escalating number of bank failures.

In any case, behind the FDIC stands the Federal government. Do we trust that? Clearly most people do. At least, they trust it enough to pay their taxes. Foreign investors trust it enough to lend money although its debts are exploding in scale. If you look closely at the system, it really does hinge on our continuing trust above all in government and in governmental institutions. The nightmare scenario is that we might start to lose trust in them, too, at which point, the system would break down.

You've written that financial history is essentially the result of natural selection and you've called some banks dinosaurs. What makes them dinosaurs?

Look at Citigroup or Bank of America. They became excessively large. They were trying to do too many things and were only able to generate profits satisfactory to their shareholders by becoming dangerously leveraged. I've been discussing this for a while, arguing that the idea of a one-stop shop financial institution that does absolutely everything is misconceived. The crisis blew apart their business model. The only reason they're still alive is that the costs to society of their failure appeared to be too high. So we stepped in. Here the parallel with natural selection breaks down, because it stops being a Darwinian world. It becomes a world in which there is intelligent design. There is some kind of divine entity that can intervene when the going gets tough and save institutions from extinction. And that's exactly what happened. The Federal government kept the dinosaurs on life support.

These subsidies continue to distort the system?

Yes. Of course, it's highly unfair. The excessively large institutions are now effectively government guaranteed. They were able to borrow on the bond market with a government guarantee. They received capital injections from the U.S. taxpayer to help recapitalize them. None of that was done for small banks. Small banks, the overwhelming majority of financial institutions in the U.S., are left to sink or swim and many are sinking. It would be surprising if hundreds more banks didn't fail in the next 12 months. Some people say as many as 1,000 are on the critical list. So it's a huge distortion. It means that there are essentially government sponsored entities at the heart of our financial system. The big survivors of the crisis are basically government sponsored entities.

In a playing field like that, it's very difficult to know the worth of anything.

Yes. I don't know how you'd value a bank stock right now. In the end, these are essentially plays on government guarantee. The Fed will lend through the discount window and through many other different channels at next to zero percent. The bank in the happy position of being able to get free money only has to invest it in government bonds to make a profit. The spread between what it pays the Fed and what it gets from buying government debt is enough to make a bank profitable.

As it is, the more aggressive and successful firms — Goldman Sachs, J.P. Morgan — are, interestingly, behaving in ways more reminiscent of hedge funds than of banks at the moment. It's not that they're making new loans to consumers or corporations. The volume of bank credit is contracting. What they're doing instead is essentially engaging in hedge fund-like trading. That's how much of the Goldman profit over the last quarter was generated. They're [behaving like] government guaranteed hedge funds. These are institutions that are quote "too big to fail" so they can engage in really quite risky behavior knowing that if all goes horribly wrong, as it did last year, they're too systemically significant to go down. Like a classic case of "heads they win, tails we lose."

You write we may be "living through one of the most astonishing shifts there has ever been in the global balance of financial power" with respect to China. Is this the beginning of the Chinese century?

We were already looking at a shift from West to East. But the crisis has clearly speeded it up. If things continue in the present way, China will catch up with the U.S. in terms of gross domestic product within 20 years. That's a pretty remarkable thing considering the U.S. economy has been the biggest in the world for the past century. Does this mean it'll be a Chinese century? Maybe not. Things could go wrong. China can have 10 or 20 years of sustained growth, but there are major social, environmental, and demographic problems that are ultimately going to be very serious. People used to do this about Japan. Of course that didn't happen. I think what we can say is that the days of American primacy look numbered. At the very least, the U.S. is going to have to get used to sharing economic power with a major Asian rival in the form of China.