The boys in the bubble
Blaming selfish bankers, bridge-playing CEOs and greedy consumers for the financial crisis might provide economic commentators with a fix of moralistic self-satisfaction. But it means overlooking the larger systemic forces at work.
At the start of 2009, many people are still reflecting on the past year and imagining what this new year will bring. One of the biggest concerns, at both a societal and personal level, is the state of the economy. After the severity of the financial crisis hit home in 2008, many are no doubt wondering how bad it might become in 2009.
Cover illustration by
In the US, all eyes are on the new Obama administration, which seeks a monumental stimulus package, for $800 billion or more. A lot more has happened over the past three months: we’ve seen the temporary rescue of the American automakers, and the exposure of Bernard Madoff’s ‘Ponzi scheme’, both of which run in the billions (and actually Madoff’s scam, at $50 billion, was three times larger than the auto bailout).
To many, the big drops in the stock market and the disappearance of long-standing financial institutions, such as the investment bank Lehman Brothers, came all of a sudden in September 2008, and mark the start of the current crisis. But some think of the Bear Stearns bailout in March 2008 as the key turning point, while others begin with the collapse of two Bear Stearns hedge funds in June 2007.
Yet a new anthology usefully reminds us that today’s financial unravelling has a history that extends further back in time. Panic: The Story of Modern Financial Insanity is a collection of essays and articles on the financial bubbles and panics that have emerged since the ‘Black Monday’ stock market crash in October 1987. As the book’s editor, Michael Lewis, points out: ‘At the time , to a lot of people, it felt like the end of something. In retrospect it appears more of a beginning.’ Indeed, it was the start of a substantial increase in credit and speculative activity, which has culminated in today’s financial crisis.
As editor, Lewis is on familiar ground: he is best known for Liar’s Poker, his 1989 insider memoir of life as a young Wall Street trader, as well as other bestsellers, such as The New New Thing (on the internet boom) and Moneyball (on baseball). He is a consistently smart and entertaining writer, and this shines through in Panic: in addition to writing an introduction, he has included seven of his own articles, which are among the best in the collection. The other contributions vary in quality, but the essays by John Cassidy, Roger Lowenstein and Paul Krugman are particularly useful.
Given the centrality of the financial crisis to political discussions today, the book’s publication is well timed and almost prescient. But the timing also means that it is not the most up-to-date journalism – the latest article was penned in April 2008, and we know much has developed since then. But this is not really a problem, given that the main purpose of the book is to explore the antecedents to the current economic predicament, and how these events were perceived at the time. (And as it happens, one of the better pieces of journalism about the Wall Street bust to emerge recently is Lewis’ own article, ‘The End’, in the December issue of Portfolio magazine.) (1)
The book is organised into four sections, each centred around a financial panic: the 1987 crash; the 1997-98 Asia financial crisis and the bailout of the hedge fund Long-Term Capital Management; the internet boom; and the current subprime mortgage crisis. Each section contains articles that follow a similar rise-and-fall pattern: euphoria and cheerleading on the way up; inklings of problems; outright panic and crash; and a post-mortem reassessment and laying of blame.
On the whole, the financial journalism profession, or at least a large section of it, does not come out well. Lewis writes of the journalists’ ‘Olympian detachment’ after bubbles burst, how they argue in an all-knowing way how obvious it was all along that the boom was superficial and unsustainable. The only problem is, they never said it while it was happening.
The book provides a good summary of the key events since 1987, and the main arguments put forward to explain them. Most of the articles generally avoid economic jargon, thus making it an accessible introduction. And following Lewis’ style, it contains nuggets of humour – both fictional (Dave Barry’s hilarious ‘Get Rich by Becoming Wealthy Making Big Money in Real Estate’ infomercial) and non-fictional (dot coms spending millions on Super Bowl advertising, including Computer.com, which pissed away $3.5million, or 60 per cent of its funding, in a 90-second commercial). The book will bring those relatively new to financial matters up to speed, and provides a refresher to those who are more familiar with this history.
But even more important than knowing what has happened before is making sense of the events of the past two decades, leading up to today’s crisis. And in this regard, the book is, unfortunately, not much help.
Lewis clearly appreciates that how events are interpreted and explained matters, because it impacts on how we will respond. As he notes, prior crises have been reduced to simplistic, shorthand answers: ‘The 1987 stock market crash was blamed on program trading; the Asian currency crisis was blamed on some combination of hedge funds and IMF-induced policies; the internet bubble was blamed on Wall Street analysts.’ And Lewis’ article ‘In Defence of the Boom’ provides a refreshingly contrarian view of the backlash against entrepreneurship after the popping of the internet bubble. He criticises the anti-corruption crusade of New York state’s then attorney general, Eliot Sptizer, for his after-the-fact political opportunism (‘where in the stock market of five years ago was Eliot Spitzer?’), which criminalised risk-taking and recast speculators who lost on their bets as hard-done victims.
Today, there is much blame to go around for the housing market crisis and its after-effects. In particular, many want to put a face to the ‘crime’ of the crisis: for instance, one of the articles in the anthology blames Bear Stearns’ CEO, Jimmy Cayne, for, among other things, continuing to play in a bridge contest while his firm was in turmoil. Other common responses name some combination of irresponsible borrowers, predatory lenders, greedy investment bankers and asleep-at-the-switch regulators. But identifying certain individuals or groups as selfish culprits is not very helpful; doing so might provide the finger-pointer with some moralistic self-satisfaction but this pose fails to understand the larger, systemic forces at work.
The problem is that even the more sophisticated analyses typically remain trapped in the world of finance, and do not relate developments in that sphere to the broader economy. This is true of the articles in Panic, including Lewis’ introduction. He refers to the ‘seemingly causeless panic’, meaning that it appears that the financial crises from 1987 onwards did not seem to be linked to any deterioration in underlying economic conditions. At the time of the 1987 crash, many, including historian and economist John Kenneth Galbraith, wondered if it would lead to another Great Depression. Of course it didn’t, and Lewis concludes that this crash was ‘the world’s first seemingly traumatic financial event without obvious economic causes or consequences’.
Similarly, Lewis argues that the fact that later panics, such as the collapse of the Long-Term Capital Management (LTCM) hedge fund, did not result immediately in an economic downturn must mean that they were unrelated to the real economy. (And in fact, LTCM’s fall was followed by, counter-intuitively, a huge growth in the number of hedge funds.) The subprime mortgage-related crisis is now recognised to have wide-ranging effects on the economy generally, but Lewis’s understanding of this latest calamity remains limited to the financial realm. He recognises that the latest crisis is different from those preceding it, but only in that ‘the sheer numbers of people involved’ in financial problems are greater, as ‘the man on the street, for the first time, acted on the same foolish principles that have guided the behaviour of sophisticated Wall Street traders for the past few decades’. In other words, what’s different today is that both Main Street and Wall Street underestimated financial risk and acted irresponsibly.
In fact, as Frank Furedi has argued on spiked, the financial crisis is related to the real economy (2). The issue is that the mediations between the financial and non-financial sectors are not readily apparent, because they are complex and dynamic. But, generally speaking, the increasing role of finance in the economy since the 1980s is an expression of the stagnation in productive industry. Credit has expanded and facilitated economic growth, but it has not been allied with greater investment in productive capacity or a restructuring of operations to restore underlying profitability. Instead, capital has tended to flow from one speculative wager to the next – from internet stock prices to property prices and unproductive consumption.
According to Lewis, financial booms and busts since 1987 are due to the ‘new complexity of financial markets’, including new investment strategies such as portfolio insurance, rather than real or perceived economic problems. It is remarkable how someone like Robert Rubin, the former US treasury secretary and a top director of Citigroup, can admit that he never heard of ‘liquidity puts’ before they blew up at Citigroup to the tune of $25 billion, costing CEO Chuck Prince his job.
But, even the byzantine forms that finance can take today can be related to an un-dynamic economic environment. As the financial commentator Daniel Ben-Ami argues, modern financial techniques reflect a risk-avoidance tendency that is evident in the economy generally. Yet as we can see in the current crisis, this flight to safety, while lucrative in the short term, has ultimately backfired: ‘Many key financial instruments that have played a large role in the crisis – including credit derivatives and securitised mortgage products – are essentially mechanisms for transferring risk. Yet, contrary to what their creators intended, they have created the basis for ‘contagion’ as financial problems have spread.’ (3)
I wouldn’t say that if you had to read one book on the financial crisis, Panic is it – because it’s a tired cliché, and you should read more than one book. For those wanting to get to grips with today’s financial crisis and understand what had led up to it, this anthology is a reasonable place to start. But to break out of the finance bubble, you’ll need to look elsewhere.
Sean Collins is a writer based in New York.
Panic! The Story of Modern Financial Insanity, by Michael Lewis is published by Penguin. (Buy this book from Amazon(UK).)
(1) The End, Portfolio, December 2008
(2) See The Crisis with No Name, by Frank Furedi, 16 December 2008