openEconomy

Travels amongst the financial ruins

A review of the financial disaster-tourism from the master chronicler of the foibles of finance (Boomerang: Travels in the New Third World, Michael Lewis). Think of banks as belonging to the public sector, argues Lewis, and don't think that the US is immune from great reckoning ahead
Ethan Wagner
14 November 2011

Emblazoned on the cover of Boomerang, Michael Lewis’ new economic analysis-cum-travelogue exploring the effects of the collapse of large swaths of the international financial system over the past few years, is the dollar-bill portrait of a proud and serene George Washington that has come to represent economic confidence and stability. Only this image differs slightly from the one in your wallet—our first president has a shiny, swollen black eye. The author’s message seems clear: if the financial storm began in the United States and is now busy wreaking havoc across Europe, it is worth remembering that its route is likely to be circuitous. The final reckoning will happen right where it began.

One of our ablest chroniclers of the greed and overreaching that led to the Lesser Depression (as Paul Krugman has taken to calling the implosion), Lewis has a unique talent for finding insiders who can offer authoritative insight and then distilling even the most abstruse subjects into interesting, easily understood terms. This is an especially valuable skill at this moment. When The Telegraph can cap an article on the possible collapse of the European currency and economy with the headline “Euro Armageddon is approaching, but it’s too boring and complicated to explain,” as it did with a tongue-in-cheek but honest piece it ran this week, Lewis’ ability to focus public attention on the potentially calamitous consequences still ahead of us is much needed.

Embarking on “financial disaster tourism,” the author begins his globetrotting in Iceland, scene of one of the last decade’s most meteoric rises, followed—naturally and painfully—by a crash just as swift. “From 2003 to 2007, while the value of the U.S. stock market was doubling, the value of the Icelandic stock market multiplied nine times,” Lewis recounts. “Reykjavik real estate prices tripled. In 2006 the average Icelandic family was three times as wealthy as the average Icelandic family had been in 2003, and virtually all of this new wealth was, in one way or another, tied to the new investment banking industry.”

Flush with their new found wealth, Iceland’s nouveau riche spent lavishly, snapping up Beverly Hills mansions, British football clubs, Danish airlines, and Indian power plants; one banker went so far as to fly Elton John in for a two-song set at his birthday. A London hedge funder told Lewis that he was so dumbfounded by some of the investments Icelandic banks were making that he’d hired a private investigator. Another banker summed up Iceland’s growth model with an analogy: “You have a dog, and I have a cat. We agree that each is worth a billion dollars. You sell me the dog for a billion, and I sell you the cat for a billion. Now we are no longer pet owners but Icelandic banks, with a billion dollars in new assets.”

Stopping next in Greece, the author surveys one of the most desolate economic landscapes in post-crash Europe. Unlike Iceland, where bankers conjured wealth out of thin air, Greece’s woes stem primarily from the simple fact that, for the better part of the last decade, Greeks weren’t terribly interested in paying taxes and their government didn’t try very hard to collect them. A Greek newspaper editor tells Lewis that tax fraud was so commonplace as to not merit any column space. Two-thirds of Greek doctors report earning less than 12,000 euros a year, rendering their incomes non-taxable. There is, of course, a law on the books punishing tax fraud with jail time. “If the law was enforced,” one tax collector tells the author, “every doctor in Greece would be in jail.”

The Minister of Finance, George Papaconstantinou, tells Lewis about an off-the-books program that the previous administration had created at the Ministry of Agriculture. The program employed 270 people and was supposedly created to digitize the photographs of public lands in Greece. He explains the problem: “The trouble was that none of the 270 people had any experience with digital photography. The actual professions of these people were, like, hairdressers.”

If the banks were to blame in Reykjavik, Lewis believes culpability lies with the masses in Athens. In May 2010, Greeks called a general strike; as crowds marched through the capital, they passed a bank where employees had the audacity to be working despite the stoppage. Enraged, the crowd hurled Molotov cocktails through the bank’s windows and set the building on fire. Three workers were killed, including a young woman four months pregnant. “That they burned a bank is, under the circumstances, incredible,” Lewis writes. “If there were any justice in the world the Greek bankers would be in the streets marching to protest the morals of the ordinary Greek citizen.”

The author performs a similar post-mortem in Ireland, where a housing-fueled inflation bubble, which at its peak employed 25% of the country’s workforce (it is unusual for the construction sector to account for more than 10% in most developed countries), burst catastrophically and eventually led to a run on the nation’s banks. On 2 October 2008, the Irish government’s bank regulator went on national television and gave a shaky, confidence-crushing performance. Colm McCarthy, an economist at Ireland’s University College, explained its effect to Lewis: “What happened was that everyone in Ireland had the idea that somewhere in Ireland there was a little wise old man who was in charge of the money, and this was the first time they’d ever seen this little man. And then they saw him and said, ‘Who the fuck was that??? Is that the fucking guy who is in charge of the money???’ That’s when everyone panicked.”

Though there is a fleeting moment of comfort that, for once, the United States may not be the source of the next disaster to befall the global economy, Lewis reminds the reader that any schadenfreude-inspired celebrations would be short-lived. Whereas the American economy might have been immune from the ripples of a Greek default or European currency collapse a generation ago, there is no safe remove in the modern era. Alighting in California, Lewis turns his sights toward his own country, where the laws of economic physics seem at the moment to be dangling dangerously (and probably temporarily) in suspension. In August 2011, for the first time in history, the U.S. credit rating was lowered by Standard & Poors. Against logic, the market responded with a voracious increase in demand for U.S. treasury bonds, pushing interest rates down even further. Contrast this with Europe, where the prospect of a downgrade to a major continental economy inspires dread in Berlin, Paris, and Brussels. Greek sovereign debt, for example, is now rated by the S&P as a greater default risk than bonds issued by Angola, Belarus, Burkina Faso, and the Cook Islands.

Lewis believes that default on municipal date could be the next banana peel tossed in the road to recovery in the United States. But rather than sounding the alarm about a particularly risky financial instrument or sinister actor, Lewis seeks to direct our attention to a far larger systemic problem. “It isn’t a problem with the government; it’s a problem with the entire society,” he writes. “It’s what happened on Wall Street in the run-up to the subprime crisis. It’s a problem of people taking what can, just because they can, without regard to the larger social consequences. Alone in a dark room with a pile of money, Americans knew exactly what they wanted to do, from the top of the society to the bottom. They’d been conditioned to grab as much as they could, without thinking about the long-term consequences. Afterward, the people on Wall Street would privately bemoan the low morals of the American people who walked away from their sub-prime loans, and the American people would express outrage at the Wall Street people who paid themselves a fortune to design the bad loans.” Later, he reiterates the warning: “The financial problems were the symptom. The disease was the culture.”

While the author’s argument is compelling, the book is not without its faults. Though its effect is tempered by his light-hearted portrayal of life outside America, Lewis is guilty of regularly drawing sweeping conclusions of entire peoples and societies based on little more than a quip from a banker, an aside from a disgruntled tax collector, a comment from a rightfully suspicious monk.He writes, seemingly without irony, about what Neil Armstrong, while training in Iceland for the lunar landing, might have thought during a brief visit to the country: “But then, he was a tourist, and a tourist can’t help but have a distorted opinion of place: he meets unrepresentative people, has unrepresentative experience, and runs around imposing upon the place the fantastic mental pictures he had in his head when he got there.” Lewis contends that “the credit wasn’t just money; it was temptation. It offered entire societies the chance to reveal aspects of their characters they could not normally afford to indulge.” That may be so, but the writer might approach his subjects with a little more humility and acknowledge that he may not possess the power to deduce just what those attributes are after three nights in a hotel.

If Boomerang reads a bit like a collection of leftovers from the author’s 2009 bestseller The Big Short, one of the definitive accounts of the collapse, that’s because it is—Lewis acknowledges in the book’s introduction that many of the anecdotes that fill the following pages were gathered in the course of compiling the earlier volume, yet didn’t quite fit with the theme of American financial hubris as the singular cause of the global collapse. In this collection, Lewis occasionally strays into bizarre territory, including a strange digression linking the German response to the financial bubble with its culture’s supposed fascination with excrement, an argument which seems neither especially convincing nor relevant.

So where does that leave us? One of the book’s most vital observations is offered by Kyle Bass, a Texas investor who noticed that worldwide debts, both public and private, had more than doubled between 2002 and 2007 from $84 trillion to $195 trillion; he then bet against the market after concluding that much of what appeared to be genuine economic growth was little more than transactions enabled by people borrowing money they probably couldn’t afford to repay. Bass tells Lewis that our prior conception of banks as private enterprises must be reevaluated in the face of evidence from the last four years. Large banks are, in effect, extensions of their governments, sure to be bailed out in a crisis (the disastrous consequences of letting Lehman Brothers fail virtually ensures that no government would, in a similar situation, again consider such inaction). In other words, the public debt of a given country should no longer be thought of as the officially cited figure, but rather that number plus the debt within each country’s banking system, which, should another crisis arise, would be transferred to the government.

This may be of critical importance to remember during the next scare; New York University economist Nouriel Roubini believes that there is a 50% chance that the United States and Europe will enter a new recession in the next year. Several years ago, Bass presciently predicted to Lewis that Greece, Spain, Ireland, Portugal, and Italy—often referred to in shorthand as the PIIGS countries, or Club Med—were all at risk of defaulting on their sovereign debt (surprisingly, Bass also included Switzerland—not typically viewed as vulnerable—in this group). Sure enough, Greece today is insolvent and most of the other countries are teetering on the brink, threatening to bring down much the continent’s economy and imperil the Euro as a meaningful currency (unlike Iceland, which was not part of the Euro zone and was therefore able to devalue the krona, Greece cannot simply let the Euro fall).

In response, Europe has surged into inaction, moving fitfully over the past several months to barely pass rescue packages that are orders of magnitude short of the size most economists agree is necessary to halt the crisis. Matt Yglesias at the Center for American Progress recently supplied an offbeat but apt metaphor for understanding the paralysis with which Europe has greeted this threat:

Imagine a situation where something’s gone wrong and there’s more than one way to fix it. Like a bunch of friends are driving down to a vacation in three different cars, and one car runs out of gas while the other suffers a flat tire. You could all pack into one car. Or you could siphon gas out of one of the cars that has gas, and fill the empty car’s tank. Or you could remove the tire from the gas-less car and use it to replace the flat. Or you could call AAA and wait for a tow truck. Or someone could walk to the local gas station. There are lots of ways you could resolve the problem, some of them better than others and all of them impacting the interests of different people in different ways. The issue you’re going to have isn’t that the problem is “too hard to solve,” it’s that getting everyone to agree on one particular solution is difficult.

The Euro Zone, as it’s currently configured, lacks a single figure who can resolve the question in one way or another by deciding upon a course of action. Most of the plausible scenarios being bandied about boil down to Germans forking over money to their less responsible neighbors. Understandably, these solutions have generated little enthusiasm in Germany (and other nations not kindly disposed to handing over their cash, including Slovakia and Finland); hence, the EU’s plodding response thus far.

Last week, however, the countries of the Euro Zone announced a deal in which the European Financial Stability Fund (EFSF, essentially German funds, with some French money thrown in for good measure), will pay fifty percent of Greece’s debt (creditors will have to write off the rest), guarantee new Greek bonds, and re-capitalize banks in vulnerable countries. Currently, the EFSF has only about €240 billion available, so it’s not entirely clear where the rest of the necessary funds will come from (the private sector? China?). Nevertheless, the markets rallied, with European and American exchanges witnessing some of their highest gains this year. The following day they crashed once more—the Greeks, whom everyone assumed would jump at just such a country-saving deal, would have the opportunity to reject the plan in a referendum, announced Greek Prime Minister George Papandreou. The future of the European economies, after a brief moment of hope, looks very much in doubt once again. Then the referendum was called off and the markets rose again. ...

And if the volatility in the European market can’t be contained, where will the financial fire spread next? Most likely it will make detours to Asia, Latin America, and elsewhere around the globe, but remember that black eye on George Washington—odds are that, eventually, it’ll end up right back where it began.

 

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