Whoops! is very good indeed. It explains the recent financial crash in clear and entertaining terms, and puts the size of the problem in perspective. An easy but very interesting read. Recommended. The bits below are mostly tangential to the details of the crash itself, but are the bits that I’d have turned page corners down for if I wasn’t unduly precious about my books.
1. The Cashpoint Moment
But I’ve always felt that both schools of thought [criticising communist regimes or criticising capitalism] miss a critical point. The socialist-bloc countries had grave, irredeemable flaws; the western liberal democracies are the most admirable societies that have ever existed. There is no “moral equivalence”, as it used to be called, between them. However — and this is the uncomfortable move in the argument, the one which outrages both the old right and the old left — the population of the west benefited from the existence, the policies and the example of the socialist bloc. For decades there was the equivalent of an ideological beauty contest between the capitalist west and the communist east, both of them vying to look as if they offered their citizens the better, fairer way of life. The result in the east was oppression; the result in the west was free schooling, universal healthcare, weeks of paid holiday and a consistent, across-the-board rise in opportunities and rights. In western Europe, the existence of local parties with a strong and explicit admiration for the socialist model created a powerful impetus to show that ordinary people’s lives were better under capitalist democracy. In America, the equivalent pressures were far fainter — which is why American workers have, to Europeans, grotesquely limited holiday time (two weeks a year), no free healthcare and a level of life expectancy lower than that of Europe.
And then the good guys won, the beauty contest came to an end and so did the decades of western progress in relation to equality and individual rights. In the USA, the median income — the number bang in the middle of the earnings curve — has for workers stayed effectively unchanged since the 1970s, while inequality of income between the top and the bottom has risen sharply. Since 1970, the highest paid fifth of US earners have grown 60 per cent better paid. Everyone else is paid 10 per cent less. In the 1970s, Americans and Europeans worked about the same amount of hours per year; now Americans work almost twice as much. That’s the case for the people in the middle: for the people at the top, and especially for the people at the very top, it’s different: between 1980 and 2007, the richest 0.1 per cent of Americans saw their income grow 700 per cent.
RBS was in 2008, by the size of its assets, not just a big bank, and not just one of the biggest companies in Europe. The Royal Bank of Scotland, by asset size, was the biggest company in the world. If I had to pick a single fact which summed up the cultural gap between the City of London and the rest of the country, it would be that one. I have yet to meet a single person not employed in financial services who was aware of it; I wasn’t aware of it myself.
2. Rocket Science
Finance, like other forms of human behaviour, underwent a change in the twentieth century, a shift equivalent to the emergence of modernism in the arts — a break with common sense, a turn towards self-referentiality and abstraction and notions that couldn’t be explained in workaday English. In poetry, this movement took place with the publication of The Waste Land. In classical music, it was, perhaps, the premiere of The Rite of Spring. Dance, architecture, painting — all had comparable moments. (One of my favourites is in jazz: the moment in A Night in Tunisia where Charlie Parker plays a saxophone break which is like the arrival of modernism, right there, in real time. It’s said that the first time he went off on his solo, the other musicians simply put down their instruments and stared.) The moment in finance came in 1973, with the publication of a paper in the Journal of Political Economy entitled ‘The Pricing of Options and Corporate Liabilities’, by Fischer Black and Myron Scholes.
A friend of mine who did an MBA at Stanford told me that on his course students had to identify themselves as either “quants” or “poets”.
3. Boom and Bust
This is the single biggest reason why the UK has not joined the euro — because the British economy has cycles which aren’t exactly in phase with Europe, and because the interest rate has such a directly personal effect on people’s finances here. If we had joined the euro and our mortgages were tied to those groovily low euro interest rates, money would have been even cheaper, and credit even more easily available, so the housing bubble would have been even bigger, and the crash correspondingly crashier. (Two examples of countries where that happened: Ireland and Spain.)
Some areas are still harder and/or more expensive for writers, and one of them is car insurance. Writers’ premiums are significantly higher than for regular citizens. I asked a mortgage broker why this is: is it because novelists are supposed to be drunk all the time and prone to crashing into things? His reply: “Yeah, partly, but it’s more that you’ll write a book, and it’ll be a big success, like Bridge Jones or something, and then they’ll bake it into a film and you’ll meet Renée Zellweger and then you’ll be driving around with her and have an accident and she’ll go through the windscreen of your car and the insurance company will have to compensate her for loss of earnings. That’s what they’re really worried about.”
if you try to ask why these factors arose — why it is that our mortgages and hence our market are different — you end up with this answer: nobody knows. The investment products which allow people to own homes in Britain are different than elsewhere because they grew up to answer a need that is different: our obsessive need to own our own homes. Our risky, long-term, innovative (sometimes recklessly so) mortgages came into existence because the market set out to find ways to let us fulfil our heart’s deepest desire, to own our own property. The appetite created the products, not the other way around.
90 Oil is the world’s most traded commodity. Coffee is next.
5. The Mistake
If stairs were invented today, and a full analysis of their dangers was made, along with the gory statistics — the literally gory statistics — then there would be an impassioned, sustained and I’m pretty sure eventually successful campaign to have them banned on health and safety grounds. It’s happened to much safer things than stairs. Stairs are absolutely lethal.
132 Nassim Taleb:
“You’re worse off relying on misleading information than on not having any information at all. If you give a pilot an altimeter that is sometimes defective he will crash the plane. Give him nothing and he will look out the window. Technology is only safe if it is flawless.”
The last decades have seen numerous five-, six- and seven-sigma events. Those are supposed to happen, respectively, one day in every 13,932 years, one day in every 4,039,906 years, and one day in every 3,105,395,365 years. And yet no one concluded from this that the statistical models in use were wrong.
But by the time the market had finished with its packaging and securitisation and CDOs and CDSs and VaR and Gaussian copula formulas, that turned into events which the CEO of Goldman Sachs, David Viniar, described like this: “We were seeing things that were 25-standard deviation moves, several days in a row.” It is almost impossible to put into words how big a number twenty-five sigma is, expressed as odds-to-one. Twenty sigma is ten times the number of all the particles in the known universe; twenty-five sigma is the same but with the decimal point moved fifty-two places to the right. It’s equivalent to winning the UK national lottery twenty-one times in a row. That’s the probability of a single twenty-five-sigma event. Goldman was claiming to experience them several days in a row. That is so wrong you can’t put it into words. It shouldn’t be humanly possible to be that wrong.
6. Funny Smells
There is a profound anthropological and cultural difference between an industry and a business. An industry is an entity which as its primary purpose makes or does something, and makes money as a byproduct. The car industry makes cars, the television industry makes TV programmes, the publishing industry makes books, and with a bit of luck they all make money too, but for the most part the people engaged in them don’t regard money as the ultimate purpose and justification of what they do. Money is a byproduct of the business, rather than its fundamental raison d’être. Who goes to work in the morning thinking that the most important thing they’re going to do that day is to maximise shareholder value? Ideologists of capital sometimes seem to think that that’s what we should be doing — which only goes to show how out of touch they are. Most human enterprises, especially the most worthwhile and meaningful ones, are in the that sense industries, focused primarily on doing what they do: healthcare and education are both, from this anthropological perspective, industries.
Or at least that’s what they are from the point of view of the people who work in them. But many of these enterprises are increasingly owned by people who view them not as industries but as businesses: and the purpose of a business is, purely and simply to make money. The attitudes of a business owner are different from those of people who work in an industry, and from the point of view of business an industry’s ways of doing things are often in love with practices inherited from the past, wilfully inefficient, wilfully indifferent to fundamental realities of how the world works. Money doesn’t care what industry it is involved in, it just wants to make more money, and the specifics of how it does so are, if not exactly a source of unconcern, then very much a means to an end: the return on capital is the most important fact, and the human or cultural details involved are just that, no more than details. To workers in an industry, the attitudes and thinking of business are often summed up in the shorthand term “accountants”, as in We want to do such-and-such but the accountants won’t let us, or Such-and-such used to work well but then the accountants got hold of it. Hollywood, for instance, used to be an industry, primarily involved in making films, in the days when it made many more of them; now it is a business, whose primary preoccupation is to make money. The films are bigger and stupider and there are fewer of them, but when they do succeed, they make so much money that, in the words of Julia Phillips, the producer of Jaws, “there is no bottom line.”
There are four sectors in which Britain is world-class: finance, arms manufacturing, the creative arts and higher education. Of these, the first receives strong government support, the second lavish investment and strong support, the third is largely left to mind its own business and the fourth has been gradually run down, with three decades of consistent discouragement and underfunding. What would Britain look like today if instead of the arms industry or the City it had been our Russell Group universities which had been the subject of attempts to achieve world supremacy?
[The Economist] is an excellent newspaper (a term they prefer to “magazine”), in particular full of good first-hand fact-finding. The first 80 per cent of almost every article is full of fresh things. But every single piece, on every single subject, reaches the same conclusion. Whatever you’re reading about, it turns out that the solution is the same: more liberalisation, more competition, more free markets. However nuanced and original the detail in the bulk of the piece, the answer is always the same; it makes The Economist seem full of algebraic formulas in which the answer is always x.
Artists, sportsmen, surgeons, plumbers and the rest of us have secret voices of doubt, inner reservations about ourselves, but if you go to work with money, and make money, you can be proved right in the most inhumanly pure way. This is why people who have succeeded in the world of money tend to have such a high opinion of themselves. And this is why they seem to regard themselves as paragons of rationality, while others often regard them as slightly nuts.
7. The Bill
Keynes, entertainingly, pinpointed the initial cause of British prosperity as Sir Francis Drake’s theft of gold from the Spanish in 1580. From her piece of that action, Queen Elizabeth was able to pay off all the country’s foreign debts, balance the budget and end up with about £40,000 left over: an amount which, at 3 per cent compounded, added up in 1930 to the £4 billion which was Britain’s foreign reserves. In terms of GDP per capita, Britain was four times richer than it had been when Drake stole the gold. In a century’s time, by 2030, Keynes estimated that the country would be between four and eight times richer again, and that this would mean that, in effect, mankind’s greatest problem, the struggle for bare economic survival, had been solved.
The “hedonic treadmill” is what this is called: as you have more and more, your idea of what it would be to be happy keeps receding just out of reach. It’s always the next pay rise, the next purchase, the next place you move to or where you go on holiday, which will make you happy.
As for the [US] bailouts, there are various ways of calculating their cost so far, with Neil Barofsky, the inspector general in charge of administering the programme, putting the cost so far on 31 March 2009 at $2.98 trillion. By adding to that the imminent bailout of the gigantic financial corporation Citigroup, the market commentator Barry Ritholtz came up with a total cost of the bailout as $4.6165 trillion. (He also makes the point that some estimates of the cost are even higher, and quotes a Bloomberg News Service figure of $7.76 trillion.) He then put the figure in historical perspective. That number is bigger than the cost of the Marshall Plan, the Louisiana Purchase, the 1980s Savings and Loan crisis, the Korean war, the New Deal, the invasion of Iraq, the Vietnam War and the total cost of Nasa including the moon landings, all added together — repeat, added together (and, yes, the old figures are adjusted upwards for inflation).
In April 2008, at the time of the [UK] Budget, the projected deficit for 2009-10 was £38 billion. By 24 November, the projected deficit was £118 billion. At the budget on 22 April 2009, Alistair Darling admitted that the real figure is going to be £175 billion. The total projected borrowing for the next four years is £606 billion. National debt will hit 79 per cent of GDP — the highest peacetime figure ever. The economy is going to have its worst year since 1945. The debt is going to cost from £35 to £47 billion a year to service — that’s just the debt alone. We’ll be spending more on debt than we are on the entire transport budget.
An even stronger counter-example [to banking’s culture of risk] is aviation. I am terrified of flying, but I have to admit that airlines have been extraordinarily effective at generating a culture of safety, in which that value is unquestionedly paramount. This is allied to an impressive degree of transparency … That is partly because the industry has learnt, in the words of Easyjet’s founder Stelios Haji-Ioannou (who learnt this lesson in the oil-tanker business): “If you think safety is expensive, try having an accident.” But the culture of modern banking is not like that; in fact it’s close to the opposite of that. The bankers’ slogan is something closer to “We’re not that fussed about safety, because if we have an accident, it’s you who pays.”
Epilogue (August 2010)
206-7 [Mainly for the turn of phrase:]
Thanks to the special measures currently in place the banks can borrow from their governments at, effectively, zero per cent rates of interest. They can then invest the money at higher rates of interest, 5 to 7 per cent say. This is a direct transfer of wealth from the taxpayer to the banks, and the only difference between it and an actual, physical licence to print money is that the banks don’t have a piece of paper with the words “Official Licence To Print Money” written across the top.
…there have since 1950 been only two periods during which public spending was cut for two years in a row. The coalition is proposing to cut it for six consecutive years.
Since 1923, there have been only two bank failures in Canada. In the US, there have been 17,000.
The risks posed by the financial sector remain intact, and in my view are likely to lead to another systemic crisis at some point within the next few years. … ( … three possible [causes]: a panic in the Eurozone, caused by defaults and/or a country dropping out of the currency; a meltdown caused by automated stock trading, which now accounts for over 60 per cent of all activity on the markets; a bubble bursting in China.) When that happens, there will be a period of extraordinary danger, greatly exceeding the crash of 2008, because next time it will be close to impossible for the politicians to help the banks stay solvent.