Easy Money, Book 3

Easy Money Trilogy #3

by Vivek Kaul, Kaushik Ramachandran (Reading)

This is the third book in the Easy Money trilogy which discusses how what the world now calls the global financial crisis evolved in the aftermath of the real estate bubble bursting in the United States and other parts of the world. In this book, we will try to understand the various reasons behind the financial crisis, and also identify the different villains behind it.

Genres: Economics, Nonfiction, Finance

MP3 CD

First published March 15, 2015

About the author

Vivek Kaul is a writer who has worked at senior positions with the Daily News and Analysis(DNA) and The Economic Times, in the past.

Currently he works as an economic commentator. Other than Equitymaster, his writing has appeared across various other publications in India. These include The Times of India, India Today, Business Standard, Business Today, Business World, The Hindu, The Hindu Business Line, Indian Management, The Asian Age, Deccan Chronicle, Forbes India, Mutual Fund Insight, The Free Press Journal, BBC.com, Quartz.com, DailyO.in, Business World, Huffington Post India and Wealth Insight.

In the past he has also been a regular columnist for Rediff as well as Firstpost. He has lectured at IIM Bangalore, IIM Indore, IIM Kozhikode, TA PAI Institute of Management and the Alliance University (Bangalore).

Reviews

[Praveen · Rating 5 out of 5]

There is a situation in Michael Moore's famous documentary "Capitalism: A Love Story' which was released just one year after the 2008 financial crisis , where Michael Moore stands in front of Walls Street and asks everyone who comes out "Can you explain what is derivatives / CDO's and how it works ?" he struggles to understand and quotes that they are purposely complicated so as to avoid proper regulation.

Not only Michael Moore, all the world finds it same way.

In the preface of "Easy Money" Series Vivek Kaul mentions , he wonders whether people writing this stuffs actually understood or not ?

I started off with "Fault Lines: How Hidden Fractures Still Threaten the World Economy' by Raghuram G. Rajan in 2010 and went forward with neumerous books on this subject but Vivek Kaul's "Easy Money" Series provides with highlights of all the important books on this topic along with his own analysis and examples in more layman terms , which provids more clarity than others.

I recommend this series of books to all those people who jumps into any publication which discuss about money and the crisis which it created in our world, Vivek has put forward massive effort to bring all the details and different point of views in one single source.

This is must to have in your booksshelf.

[Parth Agrawal · Rating 4 out of 5]

Vivek Kaul is a name which caught my eye when I read his articles in The Mint. He himself admitted in that article that he does not consider himself a conventional expert in the field of finance and economics but just a self-taught enthusiast. His articles are lucid and very palatable for a layman to understand the concepts of finance and economics and their practical implication

I must admit that it was a bit unconventional on my part to start the Easy money trilogy with the last book. However, I definitely don’t regret it because this particular volume is a riveting cocktail of economics and history with its prime focus on the behavior of global financial institutions in the aftermath of global financial crisis and where is that behavior leading us as a specie

If one would ask me to define the theme of this book, it answers the following questions:
1) What went wrong with the global financial crisis in 2008?
2) Who all were involved in it?
3) When and how were the seeds sown for this destruction?
4) How did it affect the whole world?
5) Did we learn anything from our previous mistakes or not?

As I went through the initial few chapters, I did question the utility of reading American financial and economic history. However, I must admit that as I kept on reading, I realized that whether we like to admit it or not, American financial and economic history is the current and ongoing reality of many other countries in the world including India. You may agree or disagree with a lot of what has happened in the American past but you cannot avoid what has happened as provides us with a roadmap to figure out where it is headed

I want to apologize in advance as this review is going to be long but I am positive that you will agree with the content which I am putting out using the ideas of the author. Let us begin our story:

1) At the time when great depression hit America in 1929, housing loans were given out to people in the form of balloon loans in which only interest was paid for the first 3-5 years and the whole principal became due after this period. In the aftermath of the depression, people started defaulting on these loans. Hence, government came up with an organization called Home Owners’ Loan Corporation (HOLC) which bought all these loans from the banks and turned them into 15 year fixed interest loans which were self-amortizing (it means that in these 15 years, both principal and interest shall be repaid). So now, the loans shifted from the books of banks to this new organization’s books and the borrowers were repaying money to HOLC

2) In 1934, federal housing agency (FHA) was setup which started insuring mortgaged offered by banks. Only condition for this was that the loans have to be of fixed interest rate and self-amortizing). It is important to note here that the government came up with an organization which took away the default risk that banks used to face and now they only had to take care of the interest rate risk

3) What was the interest rate risk? 15 year long home loans were being financed by short term deposits which caused asset-liability mismatch for the banks. Furthermore, rate of interest in home loans were fixed while the deposit rates were floating which caused them losses at times

4) American government wanted to encourage home ownership and in 1938, they created Federal National Mortgage Association (FNMA) which got its nick name as Fannie Mae. It had access to long term deposits from the government which was designed to take away the interest rates of the banks and FIs. Thus, they bought all the mortgages loans sanctioned by these banks and FIs. Default risk of the banks was already taken out as FHA insured the mortgages and now, even the interest rate risks were taken out by Fannie Mae

5) It bore fruits as home ownership increased in USA from 46.5%in 1900 to 64.2% in 1990. Meanwhile, Fannie Mae was split and gave rise to Ginnie Mae (Government National Mortgage Association). This was done because Fannie Mae got listed in the stock exchange so it ceased to be a government organization but it still commanded a quasi-government status which allowed it to raise long term money from the government and market at cheaper interest rates

6) In 1970, government came up with Federal Home Loan Mortgage Association (FHLMC) or Freddie mac. This was created to ensure that Fannie Mae doesn’t turn into a private monopoly now that it has been listed on the market

7) Now Ginnie Mae consolidated all the residential mortgages that it had inherited from Fannie Mae and converted into a bond which was called Mortgage Backed Security (MBS). These bonds were sold to investors which allowed Ginnie Mae to raise more money and buy non-residential mortgages left with the banks and FIs. Ginnie Mae’s income is now = EMI from the non-residential mortgages – the interest that they have to pay the investors of MBS. Since Ginnie Mae only securitized those securities which have been guaranteed by FHA, MBS became a very secure instrument and turned into an alternative of Treasury Bonds

8) Furthermore, Fannie Mae, Freddie Mac and Ginnie Mae guaranteed their investors that their interest will be paid even if the mortgages were defaulted through foreclosure of loans and sale of properties, through the aforementioned government agencies and through the insurance provided by FHA

9) Slowly, mutual funds and pension funds started investing into MBS and it created a safe and large ecosystem which was closed ended and risk was minimal. However, it all started to change when the success of MBS goaded the government into allowing the Fannie Mae to buy private mortgages as well which were not insured by FHA in 1970. From this point onwards, risk started to creep into the system. The underlying element which was common throughout this nexus was the transfer of loans from one organization’s balance sheet to another. It meant that the organization which sanctioned the loans were not the ones who were saddled with the consequences of their deeds. It gave rise to depletion in quality control and incentivized risky behavior as banks, backed by the government agenda to encourage home ownership, started to give loans to those who didn’t have the capacity to repay them. These loans later turned out to be sub-prime mortgages and this is how greed of banks and FIs enabled the introduction of risk into the system and created the global financial crisis

It has been highlighted by the author that more than once, American government has tried to quell the popular uprising and perception that wages in real terms are falling which has reduced the consumption which in turn caused the economy to slow down. So what did they do? They over-focused on one aspect of an individual’s life which could make them feel rich about themselves and that is ownership of house and in the process, created a real-estate bubble. When the bubble burst in 2008, the government bent over backwards to bail the firms out which were “too big to fail” while hardly any individual home owner was given any government assistance to save his/her actual house. Once the crisis passed away, easy money policy through quantitative easing became the norm as the interest rates were dropped as low as possible to ensure that the consumption in the economy remains intact. However, they failed to realize that consumption is not decreasing because people don’t have access to cheap credit but because they have very low income and savings rate which fell below 1% in USA in 2005. By promoting a culture that venerates consumption at all costs, American society squeezed whatever little savings it had managed to save during the dot com bubble burst. Furthermore, the QE policy of the US Federal reserve expected that access to high liquidity and credit will goad the firms to borrow and use the funds to expand their business but most of the money got invested into stock markets of the emerging markets and the rest of it was used by the firms to buy-back the shares of their own company. Buying back of shares was done to boost the EPS (Earning per share) which in turn boosted the share price of their company. Since the contingent part of the remuneration of top brass of these companies was linked to the stock prices through stock options and bonuses, they solely focused on filling their own pockets. 72% of the EPS growth in S&P 500 between 2012 and 2017 has been attributed to buy backs. Even the corporate tax reduction by President Donald trump in 2018 from 35% to 21% caused the same result

Before I wrap up, there is one more aspect of the US economy that I want to highlight and it is about its currency USD. Dollar is uniquely positioned as compared to the other currencies of the world. For example: If Pakistan defaults on its sovereign bonds, they will go to IMF to bail them out, trade in some austerity measures in exchange and then they will have to earn $ to repay the loans that they have taken in $. However, USA is a country for which $ is not only an international reserve currency but a local currency. They can print as much as they want and repay their old loans using it while reducing the local purchasing power of their currency. A big reason that USD continues to be an international reserve currency is that more than 67% of world trade is done in USD, oil supplies from the OPEC countries are also sold in USD etc. It is important to understand that the international stature of USD is the reason why in 2008 financial crisis, despite being the epicenter of the crisis, people around the world started bringing their money back to USA because it represented a sturdy and fail proof economic system. Standard and Poor degraded the US treasury bonds from AAA to AA+ still there was a rush to buy US treasury bonds which increased the price and reduced the yields. Law of economics suggest that down gradation of bond ratings is supposed to reduce the price and increase the yield but exact opposite happened

I can go on and on about this book and the beautiful concepts that have been explained in it but I would be robbing you of the opportunity to read this beautiful book and enjoy it yourself.

[Vikash Anand · Rating 5 out of 5]

The third book in the series of Easy Money by Vivek Kaul i.e. The Greatest Ponzi Scheme ever and how it threatens to destroy the global financial system is an insightful book about various causes behind the global financial crisis of 2008. The easy money policy of the United States, over-promotion of homeownership and resulting risks associated with various financial innovations resulted in the financial crisis of 2008.

Easy Money can spoil the entire system
The US government set-up Federal National Mortgage Association & Federal Home Loan Mortgage Corporation nicknamed as Fannie Mae & Fannie Mae respectively to incentivize homeownership by expanding the market of mortgages. Fannie Mae & Fannie Mae bought mortgages from banks and financial institutions and held them on its books. Fannie Mae & Fannie Mae incentivized the homeownership in the US.

The American economy was in a minor recession for a period of seven months before September 2001. In the aftermath of the September 2001 attacks the reports and statistics streaming in painted a very worrying picture regarding the economy of America. Americans had stopped spending on everything other than the items they would need in case there were more attacks. With spending collapsing, there was a danger of the minor recession turning into a major one. To prevent this, Alan Greenspan, the then chairman of the Federal Reserve, as he had in the past, decided to cut interest rates aggressively. Central banks cut interest rates in the hope that consumers borrow money to spend and businesses borrow money to expand, and so the economy grows. People did borrow and spend, but they went overboard with it.

The low-interest-rate regime created conditions for a bubble; the only difference this time around in comparison to the dot-com-bubble was that real estate replaced stocks as the medium of speculation. America’s new bubble after dot-com was real estate and it was built on the belief that ‘anyone can make money in real estate’.

Boom in sub-prime lending
Loans were easy to get, as the entire banking system concentrated on simply giving out loans rather than finding out the credibility of the borrower. Banks could securitize their loan. Banks pooled together similar kinds of loans, such as home loans or mortgages. Against these loans, they sold bonds to investors. These bonds paid a rate of interest, which was slightly lower than the interest that the borrower was paying on the loan. By selling bonds, the banks got back the money immediately, unlike earlier, when the money was stuck for the period of the loan. This money could be used to give out more loans. The fundamental way in which banks had operated had changed. Earlier, when a bank gave out a loan, the loan remained on its books, till the borrower completely repaid it. Hence, the risk associated with the borrower not repaying the loan was taken on by the bank.

When the borrower of the loan repaid it through an equated monthly installment (EMI), the banks passed on a major portion of this to the investors who had bought the bonds. The difference between what the borrower paid as interest and what the bond investor got as interest was money the bank made. It also got a commission on selling these bonds. Since the loans no longer remained on the bank’s books, it wasn’t interested in checking out the repayment capacity of the borrower any more. In fact, the more loans the bank gave out, the more bonds it could securitize, and hence, the more money it could make.

Due to historical low default rate (around 0.08-0.15%) on home mortgages the senior tranche was considered very safe, and Mezzanine and equity tranches i.e. lower tranches were considered a bit risky. The senior tranche was given a AAA rating. The Mezzanine and equity tranches got lower ratings. Pension funds, insurance companies liked to invest in these mortgage based securities as they were getting slightly higher returns as compared to treasury bonds at almost the same level of risk. The lower tranches of securities were a bit risky. Hedge funds and aggressive debt mutual funds were investing in the lower tranches chasing higher return.

Financial Innovation or Miss innovation
To give out more loans, banks came up with several creative products like option adjustable-rate mortgage (ARM). An option ARM was a thirty-year home mortgage in which the borrower had the option of paying a lower EMI initially. The lower EMI in the initial years made the interest-only option ARM an appealing product to borrowers. Banks came up with even more creative option ARMs to appeal to almost anyone even to those who couldn’t afford to pay EMRs. Most of the sub-prime borrowers had taken option ARMs, and these mortgages had limited documentation. By 2005, the lending terms had become so easy that loans could be made to someone with no income, no job or assets nicknamed as Ninja loans. Also the long-standing myth that real estate prices would keep going up due to economic and population growth was at work.

The easy money floating around led to an increase in homeownership in the United States. By 2005, 69% of US households owned their homes. Around half of this increase could be attributed to the sub-prime lending boom.

Low-interest regime supported by US dollar as global currency reserve
The United States is the biggest economy in the world. Export-led countries China, Japan, South Korea, Taiwan export their goods to US, and earn dollars in the process. These dollars were then invested in treasury bonds as well as financial securities. With so much money chasing US financial securities, the issuers of these securities could in turn offer low rates of interest on them. The low-interest rate scenario despite US government running into a high budget deficit also allowed people to borrow money at low rates and buy homes.

The low-interest regime also incentivized people to use the equity in their homes and spend it on consuming other goods like electronics, cars etc. Home equity loans formed a major part of consumer spending before the financial crisis broke out. The US economy

The gaint Ponzi cycle worked as described in the book

“The United States shopped, China earned, China invested back in the United States, the United States borrowed, the United States spent, China earned again and China lent money again. The same was true with Japan, although to a lesser extent.
The entire US-China-Japan arrangement was like that. The Chinese invested money in various kinds of American financial securities, which helped keep interest rates low in the United States. This helped Americans to consume more. The more money found its way back into China (like a return on a Ponzi scheme) and was invested again in various kinds of American financial securities, helping keep interest rate low. It also kept the consumption going. Like in a Ponzi scheme, the dollars earned by China and other countries kept coming back to the United States."

Bursting of the sub-prime bubble
Nevertheless, as is the case with such bubbles, things started to unravel after a point of time due to over promotion of homeownership. Housing prices stopped going up and borrowers started defaulting on their mortgages. The defaults were also strategic as also people with high credit score until now were also defaulting. People who continued paying all other debts like car loans, credit cards also defaulted on EMI payment towards the house.

By 2007, the default rate on sub-prime loans had already gone into double digits and was at 12.6%. With homes being repossessed and foreclosed, the house prices started to fall. This meant the investors who had bought bonds issued against mortgages were also in trouble. Losses were huge on the sub-prime bonds that had been issued against sub-prime mortgages. The investment bank Lehman Brothers, which was a big investor in sub-prime bonds, went bust in mid-2008, and the US government had to come to the rescue of various financial firms such as Fannie Mae, Freddie Mac, AIG and Citigroup. This was done to ensure that the financial system did not come to a standstill.

Ironically, the solution central banks and governments the world over have found to counter the global financial crisis was what caused the problem in the first place. An era of easy money has been unleashed again in the case of global financial crisis of 2008. The Federal Reserve has been dousing small fires constantly by trying to dose all fires by keeping interest rate low, it has resulted in bug financial fire of 2008. Trying to incentivizing the housing market and not allowing the housing prices to fall as fast as they would have been a strategy that merely postpones the big fire or crisis.

The Greatest Ponzi Scheme ever and how it threatens to destroy the global financial system by Vivek Kaul is an insightful book and very much recommended for anyone interested in understanding the global financial crisis of 2008, and implications of easy money policy adopted by various government. The implications of easy money policy followed by governments are also very much applicable to individuals, it merely results in dosing of small fires and postponement of big fires. It’s important to be conscious of distractions due to the availability of easy money in life, it can result in big fire later on.

[Shineson Anarky · Rating 5 out of 5]

Review of all 3 volumes

(Book Review)
Book : Easy Money (3 Vols)
Author: Vivek Kaul
Publishers: HarperCollins
“We are born into a government 60 years in debt
That soon will be unable to even pay the interest on that debt
And the banks will burn
Money will be useless”
- Charles Bukowski (Dinosauria We)

In monetary parlance, easy money refers to a monetary policy which aims to increase the money supply in the economy. The book “Easy Money” in three volumes chronicles the rise of money, its mutation into various forms, with focus on easy money policy and the resulting booms and busts.

The first volume focuses on the period upto World War I, the second volume ends at dot-com bubble and the third volume focuses on the Global Financial Crisis of 2007–08 and its aftermath.

The book is eminently readable, given that it is written by a financial journalist rather than an academic economist. The jargon used in the books are explained with easily graspable examples.

The author explains how debasement, (i.e., addition of base metals to precious metals in the coinage) the easy money policy of ancient times mutated into easy money policy of printing more money with no gold reserve to back it up and ended up as fiat money.

What is this fiat money? I am reproducing a paragraph here from my previous article on bitcoin.

“Modern paper currency had severed its links with Gold. Now the paper we hold on to is only backed by guarantee of the issuing Central Bank and the sovereign authority.”

In reality, the end of gold standard in 1971 has paved the way for dollar standard, with dollar being the global reserve currency. This transition from gold standard to gold exchange standard to modern dollar standard is provided in detail. This unique position is referred in the book as exorbitant privilege of dollar.

So, after the advent of this modern fiat money backed by dollars, how does a government manage its easy money policy?

Conventionally, a Central Bank uses the following methods to achieve the easy money objective.

a) Reduction in Interest rates
Reduction of benchmark interest rates by the Central Bank is a common Monetary policy tool. In India, this rate is the repo rate i.e., rate at which the commercial banks borrow money from RBI. Currently this rate is at 4.40%.

The conventional economic wisdom is that the reduction in interest rates will spur up lending, thereby boosting economic activity both in supply side and demand side, resulting in economic growth.

While in India, space is still left to manoeuvre in the repo rate route, most of the central banks in developed nations have shifted the central bank rates to near zero or negative levels.

This easy money policy in Europe and US has lead to capital outflows to emerging market economies as oft-repeated in the book, money chases the point of highest return. Further, this negative rate has also lead to peculiar situations whereas banks such as Jyske Bank offered negative interest rates on its mortgages and few other banks offered negative interest rate on deposits.

b) Reducing Capital and Reserve requirements:

Banks in India are required to keep a portion of their deposits with RBI and as investment in highly liquid assets like G-Secs, approved securities etc. This is not much discussed in the book.

However, capital requirements are discussed in detail. Banks must hold an amount of capital as determined by their Risk Weighted assets according to Basel norms. By shifting the assets i.e., loans from banks’ books by securitization (e.g., creation of mortgage backed securities), banks were able to free up their capital and lend more. This has also lead to a market for derivatives based on MBS culminating in GFC 2007–08

c) Open Market Operations:

RBI/ Central Banks conduct purchase of G-Secs to improve liquidity in the economy
Beyond this there are also other unconventional monetary policy tools to achieve the easy money objective. This usually occurs in a Zero Lower Bound situation occurs. i.e., the interest rate is at zero or near zero.

One of such widely known tools is Quantitative Easing. Usually as mentioned above Central Banks Purchase G-Secs from open market to improve liquidity. QE refers to a policy by which Central Banks buy bonds/ other financial assets from open market from private institutions. In some cases, Central Banks were also involved in equity markets.

In Indian context, recent Targeted Long Term Repo Operations (TLTRO) which mandates banks to invest in securities from primary/ secondary market could be termed as indirect QE. However, as banks have to hold these assets in their investment books subject to capital norms, RBI’s direct involvement is minimal.

There are also other unconventional monetary policy tools like Operation Twist, Helicopter Drop, Forward guidance etc., which were not discussed / discussed only briefly in the book.

The author argues that easy money policy is the major reason behind asset price bubbles such as dot-com bubble and GFC 2007–08. The author also warns that this unfettered easy money policy may lead to runaway inflations at an unexpected point in time. In short, the author mildly warns that the situation mentioned in the poem quoted at the beginning of the essay may come true if current global economic order is disturbed and unfettered easy money policy is implemented.

[Dmitry Mikhaylov · Rating 5 out of 5]

This book is about a modern history of the global financial system. The author has done a great deal of research on the topic and is sharing a lot of interesting facts backed by credible resources.
One of the highlights of the book is the real estate crisis of 2008, which Mr. Kaul explains in fine detail.
The other interesting topic is the US dominance on the global market. The US has an exhobitant privilege to "print" new money, and inject it in the economy. This allows the US to maintain a trade deficit with other countries, i.e. to import more than it exports. The author is explaining the prerequisites for this condition, its supporting factors, and what can potentially threaten the status quo.
The language of the book is good for an unprepared reader, the conplex concepts are explained based on simplified examples.

[Vishnu Boorla · Rating 4 out of 5]

Reading this series is must for anyone wanting to understand the genesis, evolution and intricacies of money. Vivek's writing is lucid and simple to understand, even for anyone without degree in economics or understanding of stock market and/or central banks. I for one cannot wait for the 4th book, especially with covid pandemic bringing the world to it's knees. Thank you Vivek Kaul - the Master !!!

[Irene · Rating 3 out of 5]

The information in this book is outstanding. But the presentation needs work. It's obvious that the author's first language is not English, which leads to some awkward phrasing. It's not terrible--just enough to cause me to reread and rephrase things in my head. I hesitate to give examples here, because it will just seem nitpicky and hypercritical. To sum up, the book contains good information but could have benefited from some modest editing.

[Bhuvanesh Kandasamy · Rating 4 out of 5]

The book gives you an idea of how the United States benefitted by keeping interest rates low for a long period due to countries like China and Saudi Arabia investing their surplus money in US treasury bonds. This might be the greatest Ponzi scheme ever. The book also captures the events after the Y2K boom. However, with the latest Trump tariff era, status quo might be challenged

[Ayush Anand · Rating 4 out of 5]

Overall an excellent trilogy. By the end of third book, you might feel it’s repetitive, hence not 5 star. The research put into the book and how Vivek has simplified the complex stuff, are truly marks of a great author.

[Anubhav Jalan · Rating 4 out of 5]

Recommended book for students of commerce and economics to get a good overview of concepts as well as history of crisis in a succinct way.

[Palani · Rating 5 out of 5]

Vivek Kaul does a great job of explaining finance jargon in simple terms. Great book to read.

[Sparsh · Rating 4 out of 5]

A quick , easy & effective read

[Chaitanya · Rating 4 out of 5]

Although a lot had been said,written and documented about 2008 financial crisis, this trilogy not only explains it in a great detail, also gives comprehensive outlook of current global financial system since it's inception . It sufficiently answers how and why related to '08 crisis,world debt, Dollar as world currency in engaging way.
As you reach to the conclusion, you will have more questions than the answers.
But questions will be new,far scary and difficult to answer !

[Virat Sharma · Rating 5 out of 5]

An unputdownable book for those who would like to know about the Sub-prime crises and its aftermath effects, Moral Hazard created by the U.S govt after continuous bailouts, Why some big financial institutions are too big to fail and the missed opportunity to break them off and why banks are reluctant to raise fresh capital (because it affects its return on Equity and thus, profitability). There is much much more in this book to be learnt ! A page turner and I can vouch for this book . Buy it. Read it. Read it again.

[Sujoy · Rating 5 out of 5]

Really nice book. In the same lines as the previous one, it gives a very good insight on what happened and why. The reader friendly explanation is really what makes this book enjoyable, otherwise there is a lot of financial and economic mumbo-jumbo to make the head spin a bit.
This book made me curious to know more. So, am reading Satyajit Das's Extreme Money now, as Vivek cited him quite a lot in the book and also one of the first in the acknowledgements.

Extreme Money is definitely recommended to those who don't want to remain ignorant to global matters.

[Dr. Rajnish Dubey]

Ft