Wednesday, July 28, 2010

More Summer Reading on the Global Financial Meltdown

After surviving the World Cup (too late to blog about) and a couple of weeks at Calvin College in a seminar on "Faith and Globalization," I've gone back to my summer reading on the causes of the global financial crisis.

This time, I turned to British novelist John Lanchester's I.O.U.: Why Everyone Owes Everyone and No One Can Pay. It's the clearest, funniest, and most helpful examination of the crisis yet. Not only does he do a good job bringing the whole crisis down to earth, explaining it well, but he also thinks clearly about the larger context in which the crisis took place. And he makes the reader laugh along the way.

He correctly observes that one of the biggest gaps of cultures today is between those who understand global finance (very few) and those who don't (most of us). By trying to bridge this gap, he serves both cultures: the culture of global finance experts and the culture of the rest of us.

As I did in my last post, I'm going to focus on the overlapping points in his analysis and my own in chapter three of the book. At several points, he makes observations paralleling those in The Fullness of Time.
  • The collapse of the Communist bloc (pp. 12-24) as the opening for the triumph of global finance (i.e., "the end of history"means that there are no ideological competitors to challenge capitalism).
  • ATMs and "frictionless" money: He starts out his first chapter (not unlike my third chapter), with a story of going to an ATM in Hong Kong with his father in the 1970s and being bothered. "The sheer frictionlessness with which money moves around the world is frightening; it can induce a kind of vertigo" (p. 8).
  • Money as an abstraction: He points out that we have a hard time grasping what money is, until realities intrude on us (pp. 8-9). He even points out that the way that money began to operate was like postmodern theories about the "play of signifers," and so on.
  • The role of arrogance and quantitative abstraction in underestimating risks: In chapter 4 of I.O.U., Lanchester observes how the quantitative "geniuses" were building a system that depended on subprime borrowers:
By 2006, "more than half of all applications for mortgages were either 'piggback' loans, meaning that they were double loans taken out to buy the same property, or 'liar loans,' in which applicants were invited to state their own income, or 'no doc' loans, in which the borrower produced no paperwork. Gee, what could possibly go wrong" (p. 132)?
  • Mathematical abstractions replacing common sense and a concrete sense of what's going on: 
"Consider the case of Lawshawn Wilson in Baltimore, with no job and no income, supposedly making mortgage payments to the trustee who was the ultimate owner of her mortgage, Citigroup Mortgage Loan Trust Inc., 2007-WFHE2. How likely is a problem with that and similar mortgages? Not too unlikely, one would have thought. But by the time the market had finished with its packaging and securitization and CDOs [collateralized debt obligations] and CDSs [credit default swaps, or insurance against failures]  . . . the CFO of Goldman Sachs, David Viniar, described  [it] like this: 'We were seeing things [subprime defaults and collapsing real estate prices] that were 25-standard deviation moves, several days in a row.' It is almost impossible to put into words how big a number 25 sigma is, expressed as odds to one . . . . It's equivalent to winning the U.K. national lottery twenty-one times in a row. That's the probability of a single 25-sigma event. Goldman were claiming to experience them several days in a row" (p. 164) . . . . They weren't just wrong in practice, the way you are wrong if you call heads and a coin lands tails; they were philosophically wrong. They [global financial firms] were exposed as doing something which was contrary to the nature of reality" (p. 167).
  • The failure of regulators to ask simple questions of global financial firms like "I don't understand, please explain"(p. 181)--something that humility and a sense of groundedness in concrete realities might have promoted. Instead regulators in the UK and US trusted firms to police themselves with "market discipline" and instead used "light touch regulation."
  • The difference between the pursuit of money and the practice of industry (similar to the central theme in a recent article of mine):
"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 by-product. The car industry makes cars, the television industry makes TV programs, 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 by-product of the business, rather than its fundamental raison d'etre. Who goes to work in the morning thinking that the most important thing he's going to do that day is maximize 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 that sense industries, focused primarily on doing what they do; health care and education are both, from this anthropological perspective, both industries . . . . Money doesn't care what industry it is involved in, i just wants to make more money, and the specifics of how it does are, if not exactly a source of unconcern, 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" (pp. 197-98). 
  • Summing up his thesis
"The credit crunch was based on a climate (the post-Cold War victory party of free-market capitalism), a problem (the subprime mortgages), a mistake (the mathematical models of risk), and a failure (that of the regulators) . . . . But that failure wasn't due so much to the absence of attention to details as it was to an entire culture of the primacy of business, of money, of deregulation, of putting the interests of the financial sector first. This brought us to a point in which a belief in the free market became a kind of secular religion" (p. 202).
When he gets to his final chapter, on where to go from here, he doesn't have a lot to say, but I think we can be hopeful that the god of Mammon failed to deliver on all of his promises, opening us up to hopeful alternatives. The Christmas story provides one such alternative, as it re-enacts (among other things) the paradoxical triumph of humility, concreteness, and embodied relationships.

Friday, July 2, 2010

Summer Reading on the Financial Meltdown

On my summer reading list were a couple of books on Wall Street's subprime mortgage meltdown: Michael Lewis' The Big Short, which is a readable, personality-driven narrative; and Roger Lowenstein's The End of Wall Street, which is a more detailed, less entertaining, journalistic analysis of the major Wall Street firms' mistakes. Neither would make great beach reading, but if you are interested in understanding recent history both would be worthwhile reads.

Given that chapter 3 of The Fullness of Time touches on the roots of this crisis (at least in my view), I was curious to see how these authors interpreted the mess, and to see how well I understood it. 

Lewis really doesn't offer much of an analysis, preferring instead to let his sources spin a story of greed, excess, and blindness. And these sources are the heroes who didn't succumb to the blindness -- analysts and traders who saw the crisis coming and bet against collateralized debt obligations (CDOs) backed by subprime mortgages. By selling these bonds "short" -- borrowing to sell them first and buying them back later at a low price, while pocketing the difference -- these characters made astronomical profits. It's an interesting story but it doesn't help most of us understand the crisis a whole lot better. Greed still wins out, just on the other side of the trade.

By contrast, Lowenstein tries to analyze deeper roots of the crisis and offer more general lessons along the way. While his narrative is confusing at times, he makes telling comments about what was happening. Two passages in particular struck me.

The first was a passage where he talked about the use of quantitative methods within Wall Street firms, based on inadequate historical data. They thought they had quantified and mastered the risks of mortgages defaulting:
Historical data, such as stock prices and mortgage default statistics, were seen as evidence of immutable truths: the stock market is relatively stable; the housing market doesn't crash; home mortgages default at a rate of 1 percent per annum. Wall Street adopted quantitative strategies because they afforded more precision than old-fashioned judgment--they seemed to convert financial gambles into hard science . . . . The problem was that homeowners weren't molecules, and finance wasn't physics (p. 45).
I argue in chapter 3 (and also in a 2008 Christian Scholar's Review article that I adapted into part of that chapter) that arrogance and abstraction (cutting oneself off from concrete reality) were two key roots of the crisis. Both of these are evident in this passage. Lowenstein goes on to describe the precision with which Merrill Lynch estimated its potential lossses from subprime CDOs at "$71.3 million." As he puts it, "This was absurd--not because the number was high or low, but because of the arrogance and self-delusion embedded in such fine, decimal-point precision" (p. 46).

Abstraction was evident throughout the process, as traders forgot that the entire system was based on loaning ever-increasing amounts of money to borrowers who were likely to default. They forgot what their money was actually doing on the ground. Michael Lewis notes that a Mexican grape picker who made less than $20,000 a year was approved for a loan to buy a house worth more than $500,000. Loans were given to NINA (no income, no assets) borrowers and then packaged into these CDOs. Thus, the very foundation of these CDOs was shaky from the start, and anyone who could have thought concretely about where their money was actually going could have seen this (as Lewis' heroes did).

The other interesting passage in The End of Wall Street strikes again at the problem of thinking that one can control risk:
The new finance was flawed because its conception of risk was flawed.  The banks modeled future default rates (and everything else) as though history could provide the odds with scientific certainty--as precisely the odds in dice or cards. But markets .  .  . are different from games of chance. The cards in history's deck keep changing. Prior to 2007 and'08, the odds of a nationwide mortgage collapse would have been seen as very low, because during the previous seventy years it had never happened. What the bust proved, or reaffirmed, was that Wall Street is (at unpredictable moments) irregular; it is subject to uncertainty (p. 288)
As I argue, the practice of humility would have recognized this uncertainty and moderated the excessive risk taking that destroyed financial markets in 2007 and 2008. I also argue in chapter 3 that a healthy appreciation of concreteness--thinking in detail about what money is actually doing--would have prompted traders to stop what they were doing. And the practice of relationality--understanding what investment money was doing to human relationships and embedding money within those relationships--would have helped us all to recognize what was happening.

Are these utopian hopes? Or everyday virtues modeled by Christians? I think we are already practicing all three of these all the time. We just need to let them inform what we do with our money.