The Ascent of Money_ A Financial History Part 5

The process was called securitization and it was an innovation that fundamentally transformed Wall Street, blowing the dust off a previously sleepy bond market and ushering in a new era in which anonymous transactions would count for more than personal relations.h.i.+ps. Once again, however, it was the federal government that stood ready to pick up the tab in a crisis. For the majority of mortgages continued to enjoy an implicit guarantee from the government-sponsored trio of Fannie, Freddie or Ginnie, meaning that bonds which used those mortgages as collateral could be represented as virtually government bonds, and hence 'investment grade'. Between 1980 and 2007 the volume of such GSE-backed mortgage-backed securities grew from $200 million to $4 trillion. With the advent of private bond insurers, firms like Salomon could also offer to securitize so-called non-conforming loans not eligible for GSE guarantees. By 2007 private pools of capital sufficed to securitize $2 trillion in residential mortgage debt.52 In 1980 only 10 per cent of the home mortgage market had been securitized; by 2007 it had risen to 56 per cent. In 1980 only 10 per cent of the home mortgage market had been securitized; by 2007 it had risen to 56 per cent.ar It was not only human vanities that ended up on the bonfire that was 1980s Wall Street. It was also the last vestiges of the business model depicted in It's a Wonderful Life It's a Wonderful Life. Once there had been meaningful social ties between mortgage lenders and borrowers. Jimmy Stewart knew both the depositors and the debtors. By contrast, in a securitized market (just like in s.p.a.ce) no one can hear you scream - because the interest you pay on your mortgage is ultimately going to someone who has no idea you exist. The full implications of this transition for ordinary homeowners would become apparent only twenty years later.

We tend to a.s.sume in the English-speaking world that property is a one-way bet. The way to get rich is to play the property market. In fact, you're a mug to invest in anything else. The remarkable thing about this supposed truth is how often reality gives it the lie. Suppose you had put $100,000 into the US property market back in the first quarter of 1987. According to either the Office of Federal Housing Enterprise Oversight index or the Case-s.h.i.+ller national home price index, you would have roughly trebled your money by the first quarter of 2007, to between $275,000 and $299,000. But if you had put the same money into the S&P 500 (the benchmark US stock market index), and had continued to reinvest the dividend income in that index, you would have ended up with $772,000 to play with, more than double what you would have made on bricks and mortar. In the UK the differential is similar. If you had put 100,000 into property in 1987, according to the Nationwide house price index, you would have more than quadrupled your money after twenty years. But if you had put it in the FTSE All Share index you would be nearly seven times richer. There is, of course, an important difference between a house and a stock market index: you cannot live inside a stock market index. (On the other hand, local property taxes usually fall on real estate not financial a.s.sets.) For the sake of a fair comparison, allowance must therefore be made for the rent you save by owning your house (or the rent you can collect if you own two properties and let the other out). A simple way to proceed is simply to strip out both dividends and rents. In that case the difference is somewhat reduced. In the two decades after 1987 the S&P 500, excluding dividends, rose by a factor of just over five, still comfortably beating housing. The differential is also narrowed, but again not eliminated, if you add rental income to the property portfolio and include dividends on the stock portfolio, since average rental yields in the period declined from around 5 per cent to just 3.5 per cent at the peak of the real estate boom (in other words, a typical $100,000 property would have brought in an average monthly rent of less than $416).53 In the British case, by contrast, stock market capitalization has grown less slowly than in the US, while dividends have been a more important source of income to investors. At the same time, restrictions on the supply of new housing (such as laws protecting 'greenbelt' areas) have bolstered rents. To omit dividends and rents is therefore to remove the advantage of stocks over property. In terms of pure capital appreciation between 1987 and 2007, bricks and mortar (up by a factor of 4.5) out-performed shares (up by a factor of just 3.3). Only if one takes the story back to 1979 do British stocks beat British bricks. In the British case, by contrast, stock market capitalization has grown less slowly than in the US, while dividends have been a more important source of income to investors. At the same time, restrictions on the supply of new housing (such as laws protecting 'greenbelt' areas) have bolstered rents. To omit dividends and rents is therefore to remove the advantage of stocks over property. In terms of pure capital appreciation between 1987 and 2007, bricks and mortar (up by a factor of 4.5) out-performed shares (up by a factor of just 3.3). Only if one takes the story back to 1979 do British stocks beat British bricks.as There are, however, three other considerations to bear in mind when trying to compare housing with other forms of capital a.s.set. The first is depreciation. Stocks do not wear out and require new roofs; houses do. The second is liquidity. As a.s.sets, houses are a great deal more expensive to convert into cash than stocks. The third is volatility. Housing markets since the Second World War have been far less volatile than stock markets (not least because of the transactions costs a.s.sociated with the real estate market). Yet that is not to say that house prices have never deviated from a steady upward path. In Britain between 1989 and 1995, for example, the average house price fell by 18 per cent or in real, inflation-adjusted terms by more than a third (37 per cent). In London the real decline was closer to 47 per cent.54 In j.a.pan between 1990 and 2000, property prices fell by over 60 per cent. And, of course, in the time that I have been writing this book, property prices in the United States - for the first time in a generation - have been going down. And down. From its peak in July 2006, the Case-s.h.i.+ller 'composite 20' index of home prices in twenty big American cities had declined 15 per cent by February 2008. In that month the annualized rate of decline reached 13 per cent, a figure not seen since the early 1930s. In some cities - Phoenix, San Diego, Los Angeles and Miami - the total decline was as much as a fifth or a quarter. Moreover, at the time of writing (May 2008), a majority of experts still antic.i.p.ated further falls. In j.a.pan between 1990 and 2000, property prices fell by over 60 per cent. And, of course, in the time that I have been writing this book, property prices in the United States - for the first time in a generation - have been going down. And down. From its peak in July 2006, the Case-s.h.i.+ller 'composite 20' index of home prices in twenty big American cities had declined 15 per cent by February 2008. In that month the annualized rate of decline reached 13 per cent, a figure not seen since the early 1930s. In some cities - Phoenix, San Diego, Los Angeles and Miami - the total decline was as much as a fifth or a quarter. Moreover, at the time of writing (May 2008), a majority of experts still antic.i.p.ated further falls.

US stocks versus real estate, 1987-2007

In depressed Detroit, the housing slide started earlier, in December 2005, and had already dragged house prices down by more than ten per cent when I visited the city in July 2007. I went to Detroit because I had the feeling that what was happening there was the shape of things to come in the United States as a whole and perhaps throughout the English-speaking world. In the s.p.a.ce of ten years, house prices in Detroit - which probably possesses the worst housing stock of any American city other than New Orleans - had risen by nearly 50 per cent; not much compared with the nationwide bubble (which saw average house prices rise 180 per cent), but still hard to explain given the city's chronically depressed economic state. As I discovered, the explanation lay in fundamental changes in the rules of the housing game, changes exemplified by the experience of Detroit's West Outer Drive, a busy but respectable middle-cla.s.s thoroughfare of substantial detached houses with large lawns and garages. Once the home of Motown's finest, today it is just another street in a huge sprawling country within a country: the developing economy within within the United States, the United States,55 otherwise known as Subprimia. otherwise known as Subprimia.

'Subprime' mortgage loans are aimed by local brokers at families or neighbourhoods with poor or patchy credit histories. Just as jumbo mortgages are too big to qualify for Fannie Mae's seal of approval (and implicit government guarantee), subprime mortgages are too risky. Yet it was precisely their riskiness that made them seem potentially lucrative to lenders. These were not the old thirty-year fixed-rate mortgages invented in the New Deal. On the contrary, a high proportion were adjustable-rate mortgages (ARMs) - in other words, the interest rate could vary according to changes in short-term lending rates. Many were also interest-only mortgages, without amortization (repayment of princ.i.p.al), even when the princ.i.p.al represented 100 per cent of the a.s.sessed value of the mortgaged property. And most had introductory 'teaser' periods, whereby the initial interest payments - usually for the first two years - were kept artificially low, back-loading the cost of the loan. All of these devices were intended to allow an immediate reduction in the debt-servicing costs of the borrower. But the small print of subprime contracts implied major gains for the lender. One particularly egregious subprime loan in Detroit carried an interest rate of 9.75 per cent for the first two years, but after that a margin of 9.125 percentage points over the benchmark short-term rate at which banks lend each other money: conventionally the London interbank offered rate (Libor). Even before the subprime crisis struck, that already stood above 5 per cent, implying a huge upward leap in interest payments in the third year of the loan.

Subprime lending hit Detroit like an avalanche of Monopoly money. The city was bombarded with radio, television, direct-mail advertis.e.m.e.nts and armies of agents and brokers, all offering what sounded like attractive deals. In 2006 alone, subprime lenders injected more than a billion dollars into twenty-two Detroit ZIP codes. In the 48235 ZIP code, which includes the 5100 block of West Outer Drive, subprime mortgages accounted for more than half of all loans made between 2002 and 2006. Seven of the twenty-six households on the 5100 block took out sub-prime loans.56 Note that only a minority of these loans were going to first-time buyers. They were nearly all refinancing deals, which allowed borrowers to treat their homes as cash machines, converting their existing equity into cash. Most used the proceeds to pay off credit card debts, carry out renovations or buy new consumer durables. Note that only a minority of these loans were going to first-time buyers. They were nearly all refinancing deals, which allowed borrowers to treat their homes as cash machines, converting their existing equity into cash. Most used the proceeds to pay off credit card debts, carry out renovations or buy new consumer durables.at Elsewhere, however, the combination of declining long-term interest rates and ever more alluring mortgage deals did attract new buyers into the housing market. By 2005, 69 per cent of all US households were home-owners, compared with 64 per cent ten years before. Around half of that increase can be attributed to the subprime lending boom. Significantly, a disproportionate number of subprime borrowers belonged to ethnic minorities. Indeed, I found myself wondering as I drove around Detroit if subprime was in fact a new financial euphemism for black. This was no idle supposition. According to a study by the Ma.s.sachusetts Affordable Housing Alliance, 55 per cent of black and Latino borrowers in metropolitan Boston who had obtained loans for single-family homes in 2005 had been given subprime mortgages, compared with just 13 per cent of white borrowers. More than three quarters of black and Latino borrowers from Was.h.i.+ngton Mutual were cla.s.sed as subprime, compared with just 17 per cent of white borrowers. Elsewhere, however, the combination of declining long-term interest rates and ever more alluring mortgage deals did attract new buyers into the housing market. By 2005, 69 per cent of all US households were home-owners, compared with 64 per cent ten years before. Around half of that increase can be attributed to the subprime lending boom. Significantly, a disproportionate number of subprime borrowers belonged to ethnic minorities. Indeed, I found myself wondering as I drove around Detroit if subprime was in fact a new financial euphemism for black. This was no idle supposition. According to a study by the Ma.s.sachusetts Affordable Housing Alliance, 55 per cent of black and Latino borrowers in metropolitan Boston who had obtained loans for single-family homes in 2005 had been given subprime mortgages, compared with just 13 per cent of white borrowers. More than three quarters of black and Latino borrowers from Was.h.i.+ngton Mutual were cla.s.sed as subprime, compared with just 17 per cent of white borrowers.57 According to the Department of Housing and Urban Development (HUD), minority owners.h.i.+p increased by 3.1 million between 2002 and 2007. According to the Department of Housing and Urban Development (HUD), minority owners.h.i.+p increased by 3.1 million between 2002 and 2007.

Here, surely, was the zenith of the property-owning democracy. The new mortgage market seemed to be making the American dream of home owners.h.i.+p a reality for hundreds of thousands of people who had once been excluded from mainstream finance by credit-rating agencies and thinly veiled racial prejudice.

Criticism would subsequently be levelled at Alan Greenspan for failing adequately to regulate mortgage lending in his last years as Federal Reserve chairman. Yet, despite his notorious (and subsequently retracted) endors.e.m.e.nt of adjustable-rate mortgages in a 2004 speech, Greenspan was not the princ.i.p.al proponent of wider home owners.h.i.+p. Nor is it credible to blame all the excesses of recent years on monetary policy.

'We want everybody in America to own their own home,' President George W. Bush had said in October 2002. Having challenged lenders to create 5.5 million new minority homeowners by the end of the decade, Bush signed the American Dream Downpayment Act in 2003, a measure designed to subsidize first-time house purchases among lower income groups. Lenders were encouraged by the administration not to press sub-prime borrowers for full doc.u.mentation. Fannie Mae and Freddie Mac also came under pressure from HUD to support the sub-prime market. As Bush put it in December 2003: 'It is in our national interest that more people own their home.'58 Few dissented. Writing in the Few dissented. Writing in the New York Times New York Times in November 2007, Henry Louis ('Skip') Gates Jr., Alphonse Fletcher University Professor at Harvard and Director of the W. E. B. Du Bois Inst.i.tute for African and African-American Research, appeared to welcome the trend, pointing out that fifteen out of twenty successful African-Americans he had studied (among them Oprah Winfrey and Whoopi Goldberg) were the descendants of 'at least one line of former slaves who managed to obtain property by 1920'. Heedless of the bursting of the property bubble months before, Gates suggested a surprising solution to the problem of 'black poverty and dysfunction' - namely 'to give property to the people who had once been defined as property': in November 2007, Henry Louis ('Skip') Gates Jr., Alphonse Fletcher University Professor at Harvard and Director of the W. E. B. Du Bois Inst.i.tute for African and African-American Research, appeared to welcome the trend, pointing out that fifteen out of twenty successful African-Americans he had studied (among them Oprah Winfrey and Whoopi Goldberg) were the descendants of 'at least one line of former slaves who managed to obtain property by 1920'. Heedless of the bursting of the property bubble months before, Gates suggested a surprising solution to the problem of 'black poverty and dysfunction' - namely 'to give property to the people who had once been defined as property':

Perhaps Margaret Thatcher, of all people, suggested a program that might help. In the 1980s, she turned 1.5 million residents of public housing projects in Britain into homeowners. It was certainly the most liberal thing Mrs Thatcher did, and perhaps progressives should borrow a leaf from her playbook . . . A bold and innovative approach to the problem of black poverty . . . would be to look at ways to turn tenants into homeowners . . . For the black poor, real progress may come only once they have an owners.h.i.+p stake in American society. People who own property feel a sense of owners.h.i.+p in their future and their society. They study, save, work, strive and vote. And people trapped in a culture of tenancy do not . . .59

Beanie Self, a black community leader in the Frayser area of Memphis, identified the fatal flaw in Gates's argument: 'The American Dream is home owners.h.i.+p, and one of the things that concerns me is - while the dream is wonderful - we are not really prepared for it. People don't realize you have a real estate industry, an appraisal industry, a mortgage industry now that can really push to put people into houses that a lot of times they really can't afford.'60

As a business model subprime lending worked beautifully - as long as interest rates stayed low, as long as people kept their jobs and as long as real estate prices continued to rise. Of course, such conditions could not be relied upon to last, least of all in a city like Detroit. But that did not worry the subprime lenders. They simply followed the trail blazed by mainstream mortgage lenders in the 1980s. Instead of putting their own money at risk, they pocketed fat commissions on signature of the original loan contracts and then resold their loans in bulk to Wall Street banks. The banks, in turn, bundled the loans into high-yielding residential mortgage-backed securities (RMBS) and sold them on to investors around the world, all eager for a few hundredths of a percentage point more return on their capital. Repackaged as collateralized debt obligations (CDOs), these subprime securities could be transformed from risky loans to flaky borrowers into triple-A rated investment-grade securities. All that was required was certification from one of the two dominant rating agencies, Moody's or Standard & Poor's, that at least the top tier of these securities was unlikely to go into default. The lower 'mezzanine' and 'equity' tiers were admittedly more risky; then again, they paid higher interest rates.

The key to this financial alchemy was that there could be thousands of miles between the mortgage borrowers in Detroit and the people who ended up receiving their interest payments. The risk was spread across the globe from American state pension funds to public health networks in Australia and even to town councils beyond the Arctic Circle. In Norway, for example, the munic.i.p.alities of Rana, Hemnes, Hattjelldal and Narvik invested some $120 million of their taxpayers' money in CDOs secured on American subprime mortgages. At the time, the sellers of these 'structured products' boasted that securitization was having the effect of allocating risk 'to those best able to bear it'. Only later did it turn out that risk was being allocated to those least able to understand it. Those who knew best the flakiness of subprime loans - the people who dealt directly with the borrowers and knew their economic circ.u.mstances - bore the least risk. They could make a 100 per cent loan-to-value 'NINJA' loan (to someone with No Income No Job or a.s.sets) and sell it on the same day to one of the big banks in the CDO business. In no time at all, the risk was floating up a fjord.

In Detroit the rise of subprime mortgages had in fact coincided with a new slump in the inexorably declining automobile industry that cost the city 20,000 jobs. This antic.i.p.ated a wider American slowdown, an almost inevitable consequence of a tightening of monetary policy as the Federal Reserve raised short-term interest rates from 1 per cent to 5 per cent; this had a modest but nevertheless significant impact on average mortgage rates, which went up by roughly a quarter (from 5.34 to 6.66 per cent). The effect on the subprime market of this seemingly innocuous change in credit conditions was devastating. As soon as the teaser rates expired and the mortgages reset at new and much higher interest rates, hundreds of Detroit households swiftly fell behind with their mortgage payments. As early as March 2007, about one in three subprime mortgages in the 48235 ZIP code were more than sixty days in arrears, effectively on the verge of foreclosure. The effect was to burst the real estate bubble, causing house prices to start falling for the first time since the early 1990s. As soon as this began to happen, those who had taken out 100 per cent mortgages found their debts worth more than their homes. The further house prices fell, the more homeowners found themselves with negative equity, a term familiar in Britain since the early 1990s. In this respect, West Outer Drive was a harbinger of a wider crisis of the American real estate market, the ramifications of which would rock the financial system of the Western world to its foundations.

On a sultry Friday afternoon, shortly after arriving in Memphis from Detroit, I watched more than fifty homes being sold off on the steps of the Memphis courthouse. In each case it was because mortgage lenders had foreclosed on the owners for failing to keep up with their interest payments.au Not only is Memphis the bankruptcy capital of America (as we saw in Chapter 1). By the summer of 2007 it was also fast becoming the foreclosure capital. Over the last five years, I was told, one in four households in the city had received a notice threatening foreclosure. And once again subprime mortgages were the root of the problem. In 2006 alone subprime finance companies had lent $460 million to fourteen Memphis ZIP codes. What I was witnessing was just the beginning of a flood of foreclosures. In March 2007 the Center for Responsible Lending predicted that the number of foreclosures could reach 2.4 million. Not only is Memphis the bankruptcy capital of America (as we saw in Chapter 1). By the summer of 2007 it was also fast becoming the foreclosure capital. Over the last five years, I was told, one in four households in the city had received a notice threatening foreclosure. And once again subprime mortgages were the root of the problem. In 2006 alone subprime finance companies had lent $460 million to fourteen Memphis ZIP codes. What I was witnessing was just the beginning of a flood of foreclosures. In March 2007 the Center for Responsible Lending predicted that the number of foreclosures could reach 2.4 million.61 This may turn out to have been an underestimate. At the time of writing (May 2008), around 1.8 million mortgages are in default, but an estimated 9 million American households, or the occupants of one in every ten single-family homes, have already fallen into negative equity. About 11 per cent of subprime ARMs are already in foreclosure. According to Credit Suisse, the total number of foreclosures on all types of mortgages could end up being 6.5 million over the next five years. That could put 8.4 per cent of all American homeowners, or 12.7 per cent of those with mortgages, out of their homes. This may turn out to have been an underestimate. At the time of writing (May 2008), around 1.8 million mortgages are in default, but an estimated 9 million American households, or the occupants of one in every ten single-family homes, have already fallen into negative equity. About 11 per cent of subprime ARMs are already in foreclosure. According to Credit Suisse, the total number of foreclosures on all types of mortgages could end up being 6.5 million over the next five years. That could put 8.4 per cent of all American homeowners, or 12.7 per cent of those with mortgages, out of their homes.62 Since the subprime mortgage market began to turn sour in the early summer of 2007, shockwaves have been spreading through all the world's credit markets, wiping out some hedge funds and costing hundreds of billions of dollars to banks and other financial companies. The main problem lay with CDOs, over half a trillion dollars of which had been sold in 2006, of which around half contained subprime exposure. It turned out that many of these CDOs had been seriously over-priced, as a result of erroneous estimates of likely subprime default rates. As even triple-A-rated securities began going into default, hedge funds that had specialized in buying the highest-risk CDO tranches were the first to suffer. Although there had been signs of trouble since February 2007, when HSBC admitted to heavy losses on US mortgages, most a.n.a.lysts would date the beginning of the subprime crisis from June of that year, when two hedge funds owned by Bear Stearnsav were asked to post additional collateral by Merrill Lynch, another investment bank that had lent them money but was now concerned about their excessive exposure to subprime-backed a.s.sets. Bear bailed out one fund, but let the other collapse. The following month the ratings agencies began to downgrade scores of RMBS CDOs (short for 'residential mortgage-backed security collateralized debt obligations', the very term testifying to the over-complex nature of these products). As they did so, all kinds of financial inst.i.tutions holding such a.s.sets found themselves staring huge losses in the face. The problem was greatly magnified by the amount of leverage (debt) in the system. Hedge funds in particular had borrowed vast sums from their prime brokers - banks - in order to magnify the returns they could generate. The banks, meanwhile, had been disguising their own exposure by parking subprime-related a.s.sets in off-balance-sheet ent.i.ties known as conduits and strategic investment vehicles (SIVs, surely the most apt of all the acronyms of the crisis), which relied for funding on short-term borrowings on the markets for commercial paper and overnight interbank loans. As fears rose about counterparty risk (the danger that the other party in a financial transaction may go bust), those credit markets seized up. The liquidity crisis that some commentators had been warning about for at least a year struck in August 2007, when American Home Mortgage filed for bankruptcy, BNP Paribas suspended three mortgage investment funds and Countrywide Financial drew down its entire $11 billion credit line. What scarcely anyone had antic.i.p.ated was that defaults on subprime mortgages by low-income households in cities like Detroit and Memphis could unleash so much financial havoc: were asked to post additional collateral by Merrill Lynch, another investment bank that had lent them money but was now concerned about their excessive exposure to subprime-backed a.s.sets. Bear bailed out one fund, but let the other collapse. The following month the ratings agencies began to downgrade scores of RMBS CDOs (short for 'residential mortgage-backed security collateralized debt obligations', the very term testifying to the over-complex nature of these products). As they did so, all kinds of financial inst.i.tutions holding such a.s.sets found themselves staring huge losses in the face. The problem was greatly magnified by the amount of leverage (debt) in the system. Hedge funds in particular had borrowed vast sums from their prime brokers - banks - in order to magnify the returns they could generate. The banks, meanwhile, had been disguising their own exposure by parking subprime-related a.s.sets in off-balance-sheet ent.i.ties known as conduits and strategic investment vehicles (SIVs, surely the most apt of all the acronyms of the crisis), which relied for funding on short-term borrowings on the markets for commercial paper and overnight interbank loans. As fears rose about counterparty risk (the danger that the other party in a financial transaction may go bust), those credit markets seized up. The liquidity crisis that some commentators had been warning about for at least a year struck in August 2007, when American Home Mortgage filed for bankruptcy, BNP Paribas suspended three mortgage investment funds and Countrywide Financial drew down its entire $11 billion credit line. What scarcely anyone had antic.i.p.ated was that defaults on subprime mortgages by low-income households in cities like Detroit and Memphis could unleash so much financial havoc:aw one bank (Northern Rock) nationalized; another (Bear Stearns) sold off cheaply to a compet.i.tor in a deal underwritten by the Fed; numerous hedge funds wound up; 'write-downs' by banks amounting to at least $318 billion; total antic.i.p.ated losses in excess of one trillion dollars. The subprime b.u.t.terfly had flapped its wings and triggered a global hurricane. one bank (Northern Rock) nationalized; another (Bear Stearns) sold off cheaply to a compet.i.tor in a deal underwritten by the Fed; numerous hedge funds wound up; 'write-downs' by banks amounting to at least $318 billion; total antic.i.p.ated losses in excess of one trillion dollars. The subprime b.u.t.terfly had flapped its wings and triggered a global hurricane.

Among the many ironies of the crisis is that it could ultimately deal a fatal blow to the government-sponsored mother of the property-owning democracy: Fannie Mae.63 One consequence of government policy has been to increase the proportion of mortgages held by Fannie Mae and her younger siblings Freddie and Ginnie, while at the same time reducing the importance of the original government guarantees that were once a key component of the system. Between the 1955 and 2006 the proportion of non-farm mortgages underwritten by the government fell from 35 to 5 per cent. But over the same period the share of mortgages held by these government-sponsored enterprises rose from 4 per cent to a peak of 43 per cent in 2003. One consequence of government policy has been to increase the proportion of mortgages held by Fannie Mae and her younger siblings Freddie and Ginnie, while at the same time reducing the importance of the original government guarantees that were once a key component of the system. Between the 1955 and 2006 the proportion of non-farm mortgages underwritten by the government fell from 35 to 5 per cent. But over the same period the share of mortgages held by these government-sponsored enterprises rose from 4 per cent to a peak of 43 per cent in 2003.64 The Office of Federal Housing Enterprise Oversight has been egging on Fannie and Freddie to acquire even more RMBS (including subprime-backed securities) by relaxing the rules that regulate their capital/a.s.sets ratio. But the two inst.i.tutions have only $84 billion of capital between them, a mere 5 per cent of the $1.7 trillion of a.s.sets on their balance sheets, to say nothing of the further $2.8 trillion of RMBS that they have guaranteed. The Office of Federal Housing Enterprise Oversight has been egging on Fannie and Freddie to acquire even more RMBS (including subprime-backed securities) by relaxing the rules that regulate their capital/a.s.sets ratio. But the two inst.i.tutions have only $84 billion of capital between them, a mere 5 per cent of the $1.7 trillion of a.s.sets on their balance sheets, to say nothing of the further $2.8 trillion of RMBS that they have guaranteed.65 Should these inst.i.tutions get into difficulties, it seems a reasonable a.s.sumption that government sponsors.h.i.+p could turn into government owners.h.i.+p, with major implications for the federal budget. Should these inst.i.tutions get into difficulties, it seems a reasonable a.s.sumption that government sponsors.h.i.+p could turn into government owners.h.i.+p, with major implications for the federal budget.ax So no, it turns out that houses are not a uniquely safe investment. Their prices can go down as well as up. And, as we have seen, houses are pretty illiquid a.s.sets - which means they are hard to sell quickly when you are in a financial jam. House prices are 'sticky' on the way down because sellers hate to cut the asking price in a downturn; the result is a glut of unsold properties and people who would otherwise move stuck looking at their For Sale signs. That in turn means that home owners.h.i.+p can tend to reduce labour mobility, thereby slowing down recovery. These turn out to be the disadvantages of the idea of property-owning democracy, appealing though it once seemed to turn all tenants into homeowners. The question that remains to be answered is whether or not we have any business exporting this high-risk model to the rest of the world.

As Safe as Housewives Quilmes, a sprawling slum on the southern outskirts of Buenos Aires, seems a million miles from the elegant boulevards of the Argentine capital's centre. But are the people who live there really as poor as they look? As Peruvian economist Hernando de Soto sees it, shanty towns like Quilmes, despite their ramshackle appearance, represent literally trillions of dollars of unrealized wealth. De Soto has calculated that the total value of the real estate occupied by the world's poor amounts to $9.3 trillion. That, he points out, is very nearly the total market capitalization of all the listed companies in the world's top twenty economies - and roughly ninety times all the foreign aid paid to developing countries over between 1970 and 2000. The problem is that the people in Quilmes, and in countless shanty towns the world over, do not have secure legal t.i.tle to their homes. And without some kind of legal t.i.tle, property cannot be used as collateral for a loan. The result is a fundamental constraint on economic growth, de Soto reasons, because if you can't borrow, you can't raise the capital to start a business. Potential entrepreneurs are thwarted. Capitalist energies are smothered.66 A large part of the trouble is that it is so bureaucratically difficult to establish legal t.i.tle to property in places like South America. In Argentina today, according to the World Bank, it takes around thirty days to register a property, but it used to be much longer. In some countries - Bangladesh and Haiti are the worst - it can take closer to three hundred days. When de Soto and his researchers tried to secure legal authorization to build a house on state-owned land in Peru, it took six years and eleven months, during which they had to deal with fifty-two different government offices. In the Philippines, formalizing home owners.h.i.+p was until recently a 168-step process involving fifty-three public and private agencies and taking between thirteen and twenty-five years. In the English-speaking world, by contrast, it can take as little as two days and seldom more than three weeks. In de Soto's eyes, bureaucratic obstacles to securing legal owners.h.i.+p make the a.s.sets of the poor so much 'dead capital . . . like water in a lake high up in the Andes - an untapped stock of potential energy'. Breathing life into this capital, he argues, is the key to providing countries like Peru with a more prosperous future. Only with a working system of property rights can the value of a house be properly established by the market; can it easily be bought and sold; can it legally be used as collateral for loans; can its owner be held to account in other transactions he may enter into. Moreover, excluding the poor from the pale of legitimate property owners.h.i.+p ensures that they operate at least partially in a grey or black economic zone, beyond the reach of the state's dead hand. This is doubly damaging. It prevents effective taxation. And it reduces the legitimacy of the state in the eyes of the populace. Poor countries are poor, in other words, because they lack secure property rights, the 'hidden architecture' of a successful economy. 'Property law is not a silver bullet,' de Soto admits, 'but it is the missing link . . . Without property law, you will never be able to accomplish other reforms in a sustainable manner.' And poor countries are also more likely to fail as democracies because they lack an electorate of stakeholders. 'Property rights will eventually lead to democracy,' de Soto has argued, 'because you can't sustain a market-oriented property system unless you provide a democratic system. That's the only way investors can feel secure.'67 To some - like the Maoist terrorist group s.h.i.+ning Path, who tried to a.s.sa.s.sinate him in 1992 in a bomb attack that killed three people - de Soto is a villain.68 Other critics denounced him as the Rasputin behind the now disgraced Peruvian President Alberto Fujimori. To others, de Soto's efforts to globalize the property-owning democracy have made him a hero. Former President Bill Clinton has called him 'probably the greatest living economist', while his Russian counterpart, Vladimir Putin, has called de Soto's achievements 'extraordinary'. In 2004 the American libertarian think-tank the Cato Inst.i.tute awarded him the biennial Milton Friedman Prize for work that 'exemplifies the spirit and practice of liberty'. De Soto and his Inst.i.tute for Liberty and Democracy have advised governments in Egypt, El Salvador, Ghana, Haiti, Honduras, Kazakhstan, Mexico, the Philippines and Tanzania. The critical question is, of course, does his theory work in practice? Other critics denounced him as the Rasputin behind the now disgraced Peruvian President Alberto Fujimori. To others, de Soto's efforts to globalize the property-owning democracy have made him a hero. Former President Bill Clinton has called him 'probably the greatest living economist', while his Russian counterpart, Vladimir Putin, has called de Soto's achievements 'extraordinary'. In 2004 the American libertarian think-tank the Cato Inst.i.tute awarded him the biennial Milton Friedman Prize for work that 'exemplifies the spirit and practice of liberty'. De Soto and his Inst.i.tute for Liberty and Democracy have advised governments in Egypt, El Salvador, Ghana, Haiti, Honduras, Kazakhstan, Mexico, the Philippines and Tanzania. The critical question is, of course, does his theory work in practice?

Quilmes provides a natural experiment to find out if de Soto really has unravelled the 'mystery of capital'. It was here in 1981 that a group of 1,800 families defied the military junta then ruling Argentina by occupying a stretch of wasteland. After the restoration of democracy the provincial government expropriated the original owners of the land to give the squatters legal t.i.tle to their homes. However, only eight of the thirteen landowners accepted the compensation they were offered; the others (one of whom settled in 1998) fought a protracted legal battle. The result was that some of the Quilmes squatters became property owners by paying a nominal sum for leases, which, after ten years, became full deeds of owners.h.i.+p; while others remained as squatters. Today you can tell the owner-occupied houses from the rest by their better fences and painted walls. The houses whose owners.h.i.+p remains contested are, by contrast, seedy shacks. As everyone (including 'Skip' Gates) knows, owners generally take better care of properties than tenants do.

There is no doubt that home owners.h.i.+p has changed people's att.i.tudes in Quilmes. According to one recent study, those who have acquired property t.i.tles have become significantly more individualist and materialist in their att.i.tudes than those who are still squatting. For example, when asked 'Do you think money is important for happiness?', the property owners were 34 per cent more likely than the squatters to say that it was.69 Yet there seems to be a flaw in the theory, for owning their homes has not made it significantly easier for people in Quilmes to borrow money. Only 4 per cent have managed to secure a mortgage. Yet there seems to be a flaw in the theory, for owning their homes has not made it significantly easier for people in Quilmes to borrow money. Only 4 per cent have managed to secure a mortgage.70 In de Soto's native Peru, too, owners.h.i.+p alone doesn't seem to be enough to resuscitate dead capital. True, after his initial recommendations were accepted by the Peruvian government in 1988, there was a drastic reduction in the time it took to register a property (to just one month) and an even steeper 99 per cent cut in the costs of the transaction. Further efforts were made after the creation of the Commission for the Formalization of Informal Property in 1996 so that, within four years, 1.2 million buildings on urban land had been brought into the legal system. Yet economic progress of the sort de Soto promised has been disappointingly slow. Out of more than 200,000 Lima households awarded land t.i.tles in 1998 and 1999, only around a quarter had secured any kind of loans by 2002. In other places where de Soto's approach has been tried, notably Cambodia, granting legal t.i.tle to urban properties simply encouraged unscrupulous developers and speculators to buy out - or turf out - poor residents. In de Soto's native Peru, too, owners.h.i.+p alone doesn't seem to be enough to resuscitate dead capital. True, after his initial recommendations were accepted by the Peruvian government in 1988, there was a drastic reduction in the time it took to register a property (to just one month) and an even steeper 99 per cent cut in the costs of the transaction. Further efforts were made after the creation of the Commission for the Formalization of Informal Property in 1996 so that, within four years, 1.2 million buildings on urban land had been brought into the legal system. Yet economic progress of the sort de Soto promised has been disappointingly slow. Out of more than 200,000 Lima households awarded land t.i.tles in 1998 and 1999, only around a quarter had secured any kind of loans by 2002. In other places where de Soto's approach has been tried, notably Cambodia, granting legal t.i.tle to urban properties simply encouraged unscrupulous developers and speculators to buy out - or turf out - poor residents.71 Remember: it's not owning property that gives you security; it just gives your creditors security. Real security comes from having a steady income, as the Duke of Buckingham found out in the 1840s, and as Detroit homeowners are finding out today. For that reason, it may not be necessary for every entrepreneur in the developing world to raise money by mortgaging his house. Or her house. In fact, home owners.h.i.+p may not be the key to wealth generation at all.

I met Betty Flores on a rainy Monday morning in a street market in El Alto, the Bolivian town next to (or rather above) the capital La Paz. I was on my way to the El Alto offices of the microfinance organization Pro Mujer, but I was feeling tired because of the high alt.i.tude and suggested we stop for some coffee. And there she was, busily brewing up and distributing pots and cups of thick, strong Bolivian coffee for shoppers and other stall-keepers throughout the market. I was immediately struck by her energy and vivacity. In marked contrast to the majority of indigenous Bolivian women, she seemed quite uninhibited about talking to an obvious foreigner. It turned out that she was in fact one of Pro Mujer's clients, having taken out a loan to enlarge her coffee stall - something her husband, a mechanic, had not been able to do. And it had worked; I only had to look at Betty's perpetual motion to see that. Did she plan any further expansion? Yes indeed. The business was helping her put their daughters through school.

Betty Flores is not what would conventionally be thought of as a good credit risk. She has modest savings and does not own her own home. Yet she and thousands of women like her in poor countries around the world are being lent money by inst.i.tutions like Pro Mujer as part of a revolutionary effort to unleash female enterpreneurial energies. The great revelation of the microfinance movement in countries like Bolivia is that women are actually a better credit risk than men, with or without a house as security for their loans. That certainly flies in the face of the conventional image of the spendthrift female shopper. Indeed, it goes against the grain of centuries of prejudice which, until as recently as the 1970s, systematically rated women as less creditworthy than men. In the United States, for example, married women used to be denied credit, even when they were themselves employed, if their husbands were not in work. Deserted and divorced women fared even worse. When I was growing up, credit was still emphatically male. Microfinance, however, suggests that creditworthiness may in fact be a female trait.

The founder of the microfinance movement, the n.o.bel prize winner Muhammad Yunus, came to understand the potential of making small loans to women when studying rural poverty in his native Bangladesh. His mutually owned Grameen ('Village') Bank, founded in the village of Jobra in 1983, has made microloans to nearly seven and a half million borrowers, nearly all of them women who have no collateral. Virtually all the borrowers take out their loans as members of a five-member group (koota), which meets on a weekly basis and informally shares responsibility for loan repayments. Since its inception, Grameen Bank has made microloans worth more than $3 billion, initially financing its operations with money from aid agencies, but now attracting sufficient deposits (nearly $650 billion by January 2007) to be entirely self-reliant and, indeed, profitable.72 Pro Mujer, founded in 1990 by Lynne Patterson and Carmen Velasco, is among the most successful of Grameen Bank's South American imitators. Pro Mujer, founded in 1990 by Lynne Patterson and Carmen Velasco, is among the most successful of Grameen Bank's South American imitators.ay Loans start at around $200 for three months. Most women use the money to buy livestock for their farms or, like Betty, to fund their own micro-businesses, selling anything from tortillas to Tupperware. Loans start at around $200 for three months. Most women use the money to buy livestock for their farms or, like Betty, to fund their own micro-businesses, selling anything from tortillas to Tupperware.

By the time I tore myself away from Betty's coffee stall, the Pro Mujer offices in El Alto were already a hive of activity. I found it hard not to be impressed by the sight of dozens of Bolivian women, nearly all in traditional costume (each with a miniature bowler hat, pinned at a jaunty angle), lining up to make their regular loan payments. As they told stories about their experiences, I began wondering if it might just be time to change an age-old catchphrase from 'As safe as houses' to 'As safe as housewives'. For what I saw in Bolivia has its equivalents in poor countries all over the world, from the slums of Nairobi to the villages of Andhra Pradesh in India. And not only in the developing world. Microfinance can also work in enclaves of poverty in the developed world - like Castlemilk, in Glasgow, where a whole network of lending agencies called credit unions has been set up as an antidote to predatory lending by loan sharks (of the sort we encountered in Chapter 1). In Castlemilk, too, the recipients of loans are local women. In both El Alto and Castlemilk I heard how men were much more likely to spend their wages in the pub or the betting shop than to worry about making interest payments. Women, I was told repeatedly, were better at managing money than their husbands.

Of course, it would be a mistake to a.s.sume that microfinance is the holy grail solution to the problem of global poverty, any more than is Hernando de Soto's property rights prescription. Roughly two fifths of the world's population is effectively outside the financial system, without access to bank accounts, much less credit. But just giving them loans won't necessarily consign poverty to the museum, in Yunus's phrase, whether or not you ask for collateral. Nor should we forget that some people in the microfinance business are in it to make money, not to end poverty. 73 73 It comes as something of a shock to discover that some microfinance firms are charging interest rates as high as 80 or even 125 per cent a year on their loans - rates worthy of loan sharks. The justification is that this is the only way to make money, given the cost of administering so many tiny loans. It comes as something of a shock to discover that some microfinance firms are charging interest rates as high as 80 or even 125 per cent a year on their loans - rates worthy of loan sharks. The justification is that this is the only way to make money, given the cost of administering so many tiny loans.

Glasgow has come a long way since my fellow Scotsman Adam Smith wrote the seminal case for the free market, The Wealth of Nations The Wealth of Nations, in 1776. Like Detroit, it rose on the upswing of the industrial age. The age of finance has been less kind to it. But in Glasgow, as in North and South America, and as in South Asia, people are learning the same lesson. Financial illiteracy may be ubiquitous, but somehow we were all experts on one branch of economics: the property market. We all knew that property was a one-way bet. Except that it wasn't. (In the last quarter of 2007, Glasgow house prices fell by 2.1 per cent. The only consolation was that in Edinburgh they fell by 5.8 per cent.) In cities all over the world, house prices soared far above what was justified in terms of rental income or construction costs. There was, as the economist Robert s.h.i.+ller has said, simply a 'widespread perception that houses are a great investment', which generated a 'cla.s.sic speculative bubble' via the same feedback mechanism which has more commonly affected stock markets since the days of John Law. In short, there was irrational exuberance about bricks and mortar and the capital gains they could yield.74 This perception, as we have seen, was partly political in origin. But while encouraging home owners.h.i.+p may help build a political const.i.tuency for capitalism, it also distorts the capital market by forcing people to bet the house on, well, the house. When financial theorists warn against 'home bias', they mean the tendency for investors to keep their money in a.s.sets produced by their own country. But the real home bias is the tendency to invest nearly all our wealth in our own homes. Housing, after all, represents two thirds of the typical US household's portfolio, and a higher proportion in other countries.75 From Buckinghams.h.i.+re to Bolivia, the key to financial security should be a properly diversified portfolio of a.s.sets. From Buckinghams.h.i.+re to Bolivia, the key to financial security should be a properly diversified portfolio of a.s.sets. 76 76 To acquire that we are well advised to borrow in antic.i.p.ation of future earnings. But we should not be lured into staking everything on a highly leveraged play on the far from risk-free property market. There has to be a sustainable spread between borrowing costs and returns on investment, and a sustainable balance between debt and income. To acquire that we are well advised to borrow in antic.i.p.ation of future earnings. But we should not be lured into staking everything on a highly leveraged play on the far from risk-free property market. There has to be a sustainable spread between borrowing costs and returns on investment, and a sustainable balance between debt and income.

These rules, needless to say, do not apply exclusively to households. They also apply to national economies. The final question that remains to be answered is how far - as a result of the process we have come to call globalization - the biggest economy in the world has been tempted to ignore them. What price, in short, a subprime superpower?

6.

From Empire to Chimerica Just ten years ago, during the Asian Crisis of 1997-8, it was conventional wisdom that financial crises were more likely to happen on the periphery of the world economy - in the so-called emerging markets (formerly known as less developed countries) of East Asia or Latin America. Yet the biggest threats to the global financial system in this new century have come not from the periphery but from the core. In the two years after Silicon Valley's dot-com bubble peaked in August 2000, the US stock market fell by almost half. It was not until May 2007 that investors in the Standard & Poor's 500 had recouped their losses. Then, just three months later, a new financial storm blew up, this time in the credit market rather than the stock market. As we have seen, this crisis also originated in the United States as millions of American households discovered they could not afford to service billions of dollars' worth of subprime mortgages. There was a time when American crises like these would have plunged the rest of the global financial system into recession, if not depression. Yet at the time of writing Asia seems scarcely affected by the credit crunch in the US. Indeed, some a.n.a.lysts like Jim O'Neill, Head of Global Research at Goldman Sachs, say the rest of the world, led by booming China, is 'decoupling' itself from the American economy.

If O'Neill is correct, we are living through one of the most astonis.h.i.+ng s.h.i.+fts there has ever been in the global balance of financial power; the end of an era, stretching back more than a century, when the financial tempo of the world economy was set by English-speakers, first in Britain, then in America. The Chinese economy has achieved extraordinary feats of growth in the past thirty years, with per capita GDP increasing at a compound annual growth rate of 8.4 per cent. But in recent times the pace has, if anything, intensified. When O'Neill and his team first calculated projections of gross domestic product for the so-called BRICs (Brazil, Russia, India and China, or Big Rapidly Industrializing Countries), they envisaged that China could overtake the United States in around 2040.1 Their most recent estimates, however, have brought the date forward to 2027. Their most recent estimates, however, have brought the date forward to 2027.2 The Goldman Sachs economists do not ignore the challenges that China undoubtedly faces, not least the demographic time bomb planted by the Communist regime's draconian one-child policy and the environmental consequences of East Asia's supercharged industrial revolution. The Goldman Sachs economists do not ignore the challenges that China undoubtedly faces, not least the demographic time bomb planted by the Communist regime's draconian one-child policy and the environmental consequences of East Asia's supercharged industrial revolution.3 They are aware, too, of the inflationary pressures in China, exemplified by soaring stock prices in 2007 and surging food prices in 2008. Yet the overall a.s.sessment is still strikingly positive. And it implies, quite simply, that history has changed direction in our lifetimes. They are aware, too, of the inflationary pressures in China, exemplified by soaring stock prices in 2007 and surging food prices in 2008. Yet the overall a.s.sessment is still strikingly positive. And it implies, quite simply, that history has changed direction in our lifetimes.

Three or four hundred years ago there was little to choose between per capita incomes in the West and in the East. The average North American colonist, it has been claimed, had a standard of living not significantly superior to that of the average Chinese peasant cultivator. Indeed, in many ways the Chinese civilization of the Ming era was more sophisticated than that of early Ma.s.sachusetts. Beijing, for centuries the world's largest city, dwarfed Boston, just as Admiral Zheng He's early-fifteenth-century treasure s.h.i.+p had dwarfed Christopher Columbus's Santa Maria Santa Maria. The Yangtze delta seemed as likely a place as the Thames Valley to produce major productivity-enhancing technological innovations.4 Yet between 1700 and 1950 there was a 'great divergence' of living standards between East and West. While China may have suffered an absolute decline in per capita income in that period, the societies of the North West - in particular Britain and its colonial offshoots - experienced unprecedented growth thanks, in large part, to the impact of the industrial revolution. By 1820 per capita income in the United States was roughly twice that of China; by 1870, nearly five times higher; by 1913 nearly ten times; by 1950 nearly twenty-two times. The average annual growth rate of per capita GDP in the United States was 1.57 per cent between 1820 and 1950. The equivalent figure for China was -0.24 per cent. Yet between 1700 and 1950 there was a 'great divergence' of living standards between East and West. While China may have suffered an absolute decline in per capita income in that period, the societies of the North West - in particular Britain and its colonial offshoots - experienced unprecedented growth thanks, in large part, to the impact of the industrial revolution. By 1820 per capita income in the United States was roughly twice that of China; by 1870, nearly five times higher; by 1913 nearly ten times; by 1950 nearly twenty-two times. The average annual growth rate of per capita GDP in the United States was 1.57 per cent between 1820 and 1950. The equivalent figure for China was -0.24 per cent.5 In 1973 the average Chinese income was at best one twentieth of the average American. Calculated in terms of international dollars at market exchange rates, the differential was even wider. As recently as 2006, the ratio of US to Chinese per capita income by this measure was still 22.9 to 1. In 1973 the average Chinese income was at best one twentieth of the average American. Calculated in terms of international dollars at market exchange rates, the differential was even wider. As recently as 2006, the ratio of US to Chinese per capita income by this measure was still 22.9 to 1.

What went wrong in China between the 1700s and the 1970s? One argument is that China missed out on two major macroeconomic strokes of good luck that were indispensable to the North-West's eighteenth-century take-off. The first was the conquest of the Americas and particularly the conversion of the islands of the Caribbean into sugar-producing colonies, 'ghost acres' which relieved the pressure on a European agricultural system that might otherwise have suffered from Chinese-style diminis.h.i.+ng returns. The second was the proximity of coalfields to locations otherwise well suited for industrial development. Besides cheaper calories, cheaper wood and cheaper wool and cotton, imperial expansion brought other unintended economic benefits, too. It encouraged the development of militarily useful technologies - clocks, guns, lenses and navigational instruments - that turned out to have big spin-offs for the development of industrial machinery.6 Many other explanations have, needless to say, been offered for the great East-West divergence: differences in topography, resource endowments, culture, att.i.tudes towards science and technology, even differences in human evolution. Many other explanations have, needless to say, been offered for the great East-West divergence: differences in topography, resource endowments, culture, att.i.tudes towards science and technology, even differences in human evolution.7 Yet there remains a credible hypothesis that China's problems were as much financial as they were resource-based. For one thing, the unitary character of the Empire precluded that fiscal compet.i.tion which proved such a driver of financial innovation in Renaissance Europe and subsequently. For another, the ease with which the Empire could finance its deficits by printing money discouraged the emergence of European-style capital markets. Yet there remains a credible hypothesis that China's problems were as much financial as they were resource-based. For one thing, the unitary character of the Empire precluded that fiscal compet.i.tion which proved such a driver of financial innovation in Renaissance Europe and subsequently. For another, the ease with which the Empire could finance its deficits by printing money discouraged the emergence of European-style capital markets.8 Coinage, too, was more readily available than in Europe because of China's trade surplus with the West. In short, the Middle Kingdom had far fewer incentives to develop commercial bills, bonds and equities. When modern financial inst.i.tutions finally came to China in the late nineteenth century, they came as part of the package of Western imperialism and, as we shall see, were always vulnerable to patriotic backlashes against foreign influence. Coinage, too, was more readily available than in Europe because of China's trade surplus with the West. In short, the Middle Kingdom had far fewer incentives to develop commercial bills, bonds and equities. When modern financial inst.i.tutions finally came to China in the late nineteenth century, they came as part of the package of Western imperialism and, as we shall see, were always vulnerable to patriotic backlashes against foreign influence.9 Globalization, in the sense of a rapid integration of international markets for commodities, manufactures, labour and capital, is not a new phenomenon. In the three decades before 1914, trade in goods reached almost as large a proportion of global output as in the past thirty years.10 In a world of less regulated borders, international migration was almost certainly larger relative to world population; more than 14 per cent of the US population was foreign born in 1910 compared with less than 12 per cent in 2003. In a world of less regulated borders, international migration was almost certainly larger relative to world population; more than 14 per cent of the US population was foreign born in 1910 compared with less than 12 per cent in 2003.11 Although, in gross terms, stocks of international capital were larger in relation to global GDP during the 1990s than they were a century ago, in net terms the amounts invested abroad - particularly by rich countries in poor countries - were much larger in the earlier period. Although, in gross terms, stocks of international capital were larger in relation to global GDP during the 1990s than they were a century ago, in net terms the amounts invested abroad - particularly by rich countries in poor countries - were much larger in the earlier period.12 Over a century ago, enterprising businessmen in Europe and North America could see that there were enticing opportunities throughout Asia. By the middle of the nineteenth century, the key technologies of the industrial revolution could be transferred anywhere. Communication lags had been dramatically reduced thanks to the laying of an international undersea cable network. Capital was abundantly available and, as we shall see, British investors were more than ready to risk their money in remote countries. Equipment was affordable, energy available and labour so abundant that manufacturing textiles in China or India ought to have been a hugely profitable line of business. Over a century ago, enterprising businessmen in Europe and North America could see that there were enticing opportunities throughout Asia. By the middle of the nineteenth century, the key technologies of the industrial revolution could be transferred anywhere. Communication lags had been dramatically reduced thanks to the laying of an international undersea cable network. Capital was abundantly available and, as we shall see, British investors were more than ready to risk their money in remote countries. Equipment was affordable, energy available and labour so abundant that manufacturing textiles in C