Mr. Galbraith notes that the speculative bubble in America in the late 1920's did not go unnoticed around the world. In fact, the demand to borrow for stock purchases was so great that the whole world got into the act. Galbraith writes:
This cost was being assumed, in the first instance, by the New York banks, but they, in turn, were rapidly becoming agents for lenders the country over and even the world around. There is no mystery as to why so many wished to lend so much in New York. One of the paradoxes of speculation in securities is that the loans that underwrite it are among the safest of all investments... At the beginning of 1928 this admirably liquid and exceptionally secure outlet for non-risk capital was paying around 5 per cent. While 5 per cent is an excellent gilt-edged return, the rate rose steadily through 1928, and during the last week of the year it reached 12 per cent. This was still with complete safety.
In Montreal, London, Shanghai, and Hong Kong there was talk of these rates.... A great river of gold began to converge on Wall Street, all of it to help Americans hold common stocks on margin. Corporations also found these rates attractive. At 12 per cent Wall Street might even provide a more profitable use for the working capital of a firm than additional production. A few firms made this decision: instead of trying to produce goods with its manifold headaches and inconveniences, they confined themselves to financing speculation. Many more companies started lending their surplus funds on Wall Street.
There were still better ways of making money. In principle, New York banks could borrow money from the Federal Reserve bank for 5 per cent and re-lend it in the call market for 12 per cent. In practice they did. This was, possibly, the most profitable arbitrage operation of all time.
Heh, the rhymes are almost drowning out my laughter at Mr. Galbraith's uber-cool writing! Complete safety...
For one, it seems to be accepted in the popular press that our global economy is a new phenomenon. It is not. Our great-grandparents lived in a global economy. They use telegraph instead of email, and steamship and railroad instead of planes and cars, and they read newspapers instead of blogs, but as Mr. Galbraith points out the speculative party in New York in the 1920's was an open one --- just as the wild securitization of crappy US home loans, and then of everything else that could be securitized, drew in partygoers from around the globe.
Secondly, the presumed bullet-proof quality of the collateral underlying our stew of CDOs, CLOs, CDSs, etc parallels the assumptions back then about the money-good nature of stock-margin loans. The Joe Cassano's of the world --- he being the magnificently remunerated mastermind of AIG Financial Products, the biggest pigeon at the poker table if ever there was one --- were not mindless idiots. They really felt they were dealing based on solid collateral, just as Mr. Cassano must have been certain the CDS insurance he sold would never face claims. (Or was he?)
Thirdly, finance in the late 20's became so attractive that companies dropped production to engage in it. Why does that sound familiar? GE, anyone? In general the premium for clever finance operations grew rapidly in their era and ours --- why be a loser and operate a low-margin manufacturing business when you could hit a home-run on Wall Street, especially if you can develop a reputation riding the tide inside a respected franchise, say Goldman or Merrill, and then cash in with a 2-and-20 deal?
Thinking of global, here comes a random comment. The current generation of Chinese government leadership is largely composed of people who were trained as engineers. It is widely presumed that the next generation will be lawyers and MBAs, as this is understood to be a self-evident and natural evolutionary progression for a successful modern society. Might they want to investigate that self-evident truth?
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