Pleasant & Unpleasant “Truths”
Mark T. Williams (2010) Uncontrolled Risk: The Lessons of Lehman Brothers and How Systemic Risk Can Still Bring Down the World Financial System; McGraw-Hill
David Harvey (2010) The Enigma of Capital and the Crisis of Capitalism; Oxford University Press
Gary B. Gorton (2010) Slapped by the Invisible Hand: The Panic of 2007; Oxford University Press
Kevin Dowd and Martin Hutchinson (2010) Alchemists of Loss: How Modern Finance and Government Intervention Crashed the Financial System; John Wiley
William Isaac (2010) Senseless Panic: How Washington Failed America; John Wiley
Maria Bartiromo with Catherine Whitney (2010) The Weekend that Changed Wall Street: An Eyewitness Account; Portfolio/ Penguin
Randall Lane (2010) The Zeroes: My Misadventures in the Decade Wall Street went Insane; Scribe Publications
In Japanese Director Akira Kurosawa’s film Rashomon, the rape of a woman and the murder of her Samurai husband is seen through the accounts of four witnesses. The bandit/rapist, the wife, the dead man (speaking through a medium) and narrator outline different accounts of events. Unfolding in a series of flashbacks, the descriptions are shared by the characters with a commoner waiting out a fierce thunderstorm in a decrepit gatehouse only identified by a sign as Rash?mon.
Only the final account from the only witness (although he did not admit this at the trial) appears objective, unbiased and unmotivated by other factors. In so far as the viewer accepts the “truth” of the final version, it allows each different version to be examined in terms of its motivations.
The bandit/ rapist accepts responsibility but claims it was a duel, imbuing the event with honour and heroism. The wife casts herself as a victim, although she may have incited the duel, allowing her to appear modest and innocent. Given that all parties were present at the incident and know the factual sequence of events, it is the motivations behind the various versions that remain intriguing.
A Rashomon like character now imbues books on the global financial crisis. Multiple versions of the events are emerging. As the old saying goes there is “my truth, your truth and the truth.”
One approach is the “chronology”. In “Capital Offense”, veteran journalist (formerly at Newsweek and now at the National Journal) Michael Hirsh provides a history of “the Age of Capital”.
Mr. Hirsh’s thesis is that the foundations for the global financial crisis can be traced to an extended period of history where political ideology rather than sound economics and policy dominated. A supercilious belief that “free markets” would lead to prosperity did not quite tally with a succession of economic crises: the Asian crisis, LTCM, the collapse of the Internet bubble and finally the sub-prime mortgage debacle that morphed into a global credit crunch.
The author’s critique is not really of “free markets” but of the “financial-government complex” and “crony capitalism”- – the later term being coined ironically by Larry Summers to chastise the business-government links in Asia that he argued needed reformation! “Capital Offense” provides an insightful history of the failure of successive US Administrations and regulatory regimes to understand the Frankenstein monster they were creating. The portraits of the “wise men” is particularly unflattering.
Well written, Mr. Hirsh’s status as a Washington insider enables him to give a vivid portrait of the history of the deregulation of the financial system and the implementation of rules to assist financiers with ultimately disastrous consequences. Just as Andrew Ross Sorkin’s book “Too Big Too Fail” provided a portrait about the process and players attempting to salvage a failing financial system in September 2008, “Capital Offense” provides a equally interesting view of how over 30+ years a sequence of decisions created the conditions for the crisis.
“Uncontrolled Risk” attempts a similar but more focused chronology of the failure of Lehman Brothers. Mark William, an academic and former risk management professional, provides a solid history of the rise and collapse of the firm.
Factually correct, the text draws heavily on a plethora of works covering Lehman’s history (Greed and Glory and Wall Street” and “Last of the Imperious Rich”) and the events leading up to the Chapter 11 filing (“Colossal Failure of Common Sense” and “Too Big to Fail” and “In Fed We Trust”). In this sense, “Uncontrolled Risk” is a “meta” book (a book about other books), providing a summary for the reader unwilling to read the primary sources. One reviewer on amazon.com found this feature of the book particularly compelling. Short on time and needing to prepare a final term paper, the reviewer found Mr. William’s book ideal as the title of the review states: “Great book, especially when under a deadline.”
The narrative suffers from the fact that it appears to have been written prior to the release of the exquisitely detailed Valukas Report, which provides a fuller picture of the rise and fall of Lehmans especially of some of the firm’s practices. The evidence from the Report, at times, is at odd with the more conventional narrative of “Uncontrolled Risk”.
The Epilogue offers ten suggestions for avoiding future problems, including a call to adopt policies in place in Canada, where banks avoided the worst of problems. The author appears to have confused good fortune and path dependency with competence.
The suggestions are similar to that already being debated including “motherhood” and “apple pie” proposals for higher capital, reduction of moral hazard and greater accountability. The faith in politicians, regulators and policymakers is touching but at odds with their repeated failures over the last 30 years. As Scottish philosopher David Hume observed: “All plans of government, which suppose great reformation in the manners of mankind, are plainly imaginary.”
An alternative to the “chronology” is the “analytical study”. This generally means the author’s prejudices can be given full scope.
David Harvey, an academic, provides a Marxist perspective on the crisis. “The Enigma of Capital” views the current problems as merely the latest manifestation of capitalism’s recurrent crises. The author also sees this crisis as different, signalling limits to growth have been reached. In Professor Harvey’s view, the credibility of the financial growth model has been undermined. At the same time, the continuance of US global dominance has been weakened because of the rise of India and China.
Professor Harvey accepts that its resilience and inventiveness means that capitalism is capable of reinventing itself. But the author believes the cost that must be paid by the weak and poor is simply too great to allow a return to the status quo.
“The Enigma of Capital” is at its most lucid in the early chapters where Professor Harvey describes how capital moves and shapes the world, always creating the conditions for the next crisis. In later Chapters, the author’s attempts to fit the present crisis into neat frameworks consistent with the work of Marx and Engels seem formulaic and forced.
The argument at the core of “The Enigma of Capital” is unconvincing at several levels. The labour movements throughout the world have not moved beyond a desire to improve the existing “system” for most of a century. Declining union membership and diminished bargaining power means any response is fragmented. In fairness, Professor Harvey recognises these problems in his thesis. He also accepts that, at least in the US, being labelled a “communist" is hardly the recipe for success.
Marx, himself, wrote that capitalism would not perish before all its options and strategies for renewal were exhausted. There is still some way to go before that occurs, if ever. There is also little sign, at least as yet, that the population is willing to abandon capitalism. After all as John Kenneth Galbraith observed: “Under capitalism, man exploits man. Under communism, it’s just the opposite.”
“Slapped by the Invisible Hand” is an extended version of Yale Professor Gary Gorton’s academic papers, including those presented at the Fed’s Jackson Hole Conference in August 2008 and at a further conference in May 2009.
Professor Gorton writes for his admiring academic clan, known to include Fed Chairman Ben Bernanke. This is reflected in a certain loquacious if circumlocutory exposition style: “This agent cares about the intertemporal marginal rate of substitution, so the pricing kernel weights the expected returns on the demand deposits in determining the currency-deposit ratio.” As Steely Dan’s Donald Fagen once sang: “What passes for knowledge, I can’t understand.”
Professor Gorton’s analysis of the causes and development of the crisis is entirely conventional. The inclusion of curious cartoons, illustrations and a photo of e. coli bacterium (undoubtedly a form of academic “daring” treated in academic seminars with gasps!) is not. The book focuses on the Panic of 2007, finding that it wasn’t significantly different in general terms from the Panics of 1893 or 1907. In fact, “Slapped by the Invisible Hand” portrays much of what went wrong as obvious, although the author appears to be surprised by events as they played out.
For example, on the topic of the shadow banking system, Professor Gorton reaches the “startling” conclusion that the network of hedge funds, structured investment vehicles and securitisation operated like an alternative banking system. This resulted in a “wholesale bank run” when funding for these vehicles dried up. There is limited discussion of the factors, including bank capital rules and accounting standards, which encouraged the development of these factors.
Professor Gorton displays considerable naivete in describing valuation models and the collateralisation of derivative transactions. As an adviser and consultant to AIG, Professor Gorton could reasonably be expected to have a deeper understanding of the issues.
In August 2008, AIG estimated CDS losses at $8.5 billion but the firm remained confident that no actual loss would eventuate as its risk models showed that there was a 99.85% chance that there would be no actual losses. But as required under derivative contracts, collateral calls began to flow in. Counterparty’s models showed larger losses than AIG’s internal models. There was suspicion that AIG’s trading partners were manipulating prices to increase losses and the collateral demanded. Commenting on the battles over collateral, Gary Gorton observes only that: “It is difficult to convey, the ferocity of the fights over collateral.”
AIG proprietary risk models used historical data on defaults to estimate the likelihood of losses on the insured portfolios of corporate debt and mortgages. The chance of losses on the super senior tranches that FP insured, based on the modelling, was assessed as remote. It wasn’t a one-in-ten-thousand year event, it was a one-in-a-million year event. The risk was priced on the assumption that no losses would ever occur. The models do not appear to have taken into account the risk of mark-to-market losses and also the need to potentially post collateral. Both failures proved fatal. AIG seems to have ignored German historian Ernst Junger’s warning: “a half witted mathematician could cause more damage in a second than Frederick the Great in three Silesian campaigns.”
In “Alchemists of Loss”, Kevin Dowd, a former academic and author of financial risk management books, and Martin Hutchinson, a former banker and now a journalist, take aim at the financial and economic theories which lie at the heart of the global financial crisis.
The alchemists of the title are several Nobel Prize winners, investment bankers, the political class, economists, and regulators. “Alchemists of Loss” argues that the financial economy has become one massive rent extraction machine where gains are privatised and the losses are socialised. The authors conclude that bails outs funded by deficit spending will not “solve” the problem leading instead to problems of government debt, which in turn will require monetisation by inflation or default.
Entertainingly written and well argued, “Alchemists of Loss” is sharpest in its criticism of poorly conceived and even more poorly enforced financial regulation and flawed risk models. The book is less successful in some of its prescriptions. Puzzlingly, the book embraces “extreme value theory” as a superior although imperfect risk management methodology.
The reader may not be convinced that hydrologists, practised at predicting the likelihood of catastrophic floods, will prove superior to physicists in modelling financial risk. As Richard Feynman observed about the Challenger disaster: “If some guy tells me that the probability of failure is 1 in 105, I know he’s full of crap.”
In the absence of everything else, there is always the “personal” perspective. This allows pervasive “name dropping”, extensive use of gossip and avoids, sometime entirely, the need for detailed research or the horrors of accurate referencing.
In “Senseless Panic” William Isaac, a former Chairman of the Federal Deposit Insurance Corporation (“FDIC”), outlines a selective history of the author’s tenure during the banking and S&L crises of the 1980s. The connection to the present is somewhat tenuous, seeking undoubtedly to cash in on the current interest in the current global financial crisis.
Short and concise, “Senseless Panic” is at its most interesting when it explores the savings and loans problem when the FDIC closed 534 banks in 1989. Mr. Isaac provides insights into the problems of the “too big too fail”, pointing to his refusal to allow the failure of Continental Illinios, then the country’s seventh-largest bank. The author argues that maintaining public confidence is more important than reducing market discipline or creating moral hazard. Mr. Isaac, naturally, believes that Lehman Brothers should have been rescued and argues for a more interventionist regulator who forces banks to increase capital and reserves in good times to cover losses through bad times.
Mr. Isaac seems to be unaware of the observation of English Philosopher Herbert Spencer that: ““the ultimate result of shielding men from the effects of folly is to fill the world with fools.”
In “The Weekend that Changed Wall Street” CNBC “star” Maria Bartiromo aka “Money Honey” provides a “celebrity” take on the crisis. Some readers may be reminded of Groucho Marx’s famous comment: “From the moment I picked your book up until I laid it down, I convulsed with laughter. Someday I intend on reading it.”
There was a time, long past, when reporters merely reported on the facts and only occasionally passed opinions. Ms Bartiromo seems to have cast herself as a central and sometime the sole character in the drama. “Weekend” self consciously on each page focuses on the “I”.
The author seeks to share what happened “in a way that ordinary people can understand”. In order to do this, “Weekend” takes us into the author’s boudoir – “my world – behind the curtain of capitalism” (a hitherto unknown financial metaphor) to provide “ an intimate look at the personal stories of those involved…from the richest and most powerful to the average workers.” From the airbrushed “come hither” look on the dusk jacket to highly derivative and, at times, corny text, “Weekend” exceeds the sum of your worst fears. Certainly, as Faulkner noted about Hemingway, there will be no need for the reader to rush for a dictionary in perusing this offering.
There are problems of “time space” as the weekend seems to stretch out for a number of years, emerging through a wormhole into the European debt crisis (imaginatively entitled “A Greek Tragedy”) and the Goldman Sachs indictment over a CDO transaction. There are problems of judgement – Ken Lewis is “a quiet man who masked his masterful business sense…” (page 85) and Goldman Sachs’ “reputation was solid”. (page 183) There are problems of classification – Nassim Taleb’s “Black Swan” is apparently “a critical view of the deception inherent in financial instruments” (Page 177).
There is “in depth” analysis – “Greece was in over its head and didn’t show it.” (Page 179). There is poetry – “Each afternoon, when I alight from my car on Broad Street in front of the New York Stock Exchange, I pause for a moment to look up. I have been doing this for sixteen years; it's an automatic response. There is majesty to the edifice, and its architectural grace is breathtaking.” (page 208) There is hope, although some readers by this stage may be in despair – “…we must restore fundamental principles. We must, once again, allow integrity to guide and protect us.” (Page 208)
The real insight provided by “Weekend” is unintended. The surreal power of the vapid medium of financial TV and its frequently shallow coverage of events is striking. The “names” that curry favour with the networks for coverage and airtime is astonishing. What they say is perhaps even more astonishing, as is the author’s readiness to share “off air” and presumably private remarks. The book also reveals some interesting things about modern publishing, especially its focus on celebrity rather than content, argument or writing skill.
If the future of democracy and capitalism requires a free, knowledgeable and fearless press then this book does not augur well.
In December 1998, the Economist, reviewed Soros’ The Crisis of Global Capitalism (a fellow “celebrity”, albeit with considerably more market savvy and a habit of making money) as follows: “Because of who he is there will always be buyers for his books, publishers for his books and cash-strapped academics to say flattering things about his books. None of this alters the fact that his books are no good… A remarkable thing happens to money when it passes through Mr. Soros; it emerges multiplied, but otherwise unchanged. With other inputs the results are more disappointing – to be blunt, more in line with biology. Mr. Soros gorged on chopped philosophy, mashed economics and fact and figures swimming in grease. It was too much. Before he knew what was happening out rushed this book.” It is not known whether The Economist plans to review “Weekend”.
In the “Zeroes”, Randall Lane, a journalist and founder of a number of ill-fated publications like including Trader Monthly, Dealmaker, and Private Air, provides undoubtedly one of the most entertaining and ultimately the most insightful views of the crisis.
Mr. Lane sought to capitalise on the “conspicuous consumption” of the trading and banking classes. His magazines were targeted at this demographic with features like the Trader’s Monthly roll call of salaries/ bonuses. The game was to attract advertising dollars from luxury goods manufacturers who wanted to sell their over-priced and over-hyped products to people with a lot of money and not a lot of taste.
As the title suggests, the book traces the author’s adventures in this world. Descriptions of previously well-documented excesses of traders and bankers are enlivened by the author’s own dealings with traders and private equity investors who bankroll his empire. The book paints a realistic picture of the culture and milieus of the trading classes that were at the heart of the crisis. It accurately renders the attitudes, especially the ignorance and avaricious self-interest of bankers.
Entirely autobiographical, beautifully written with a lively, self deprecating humour, Lane observes from the peripheries, setting down a highly readable record of the times. The account is deeply personal as Mr. Lane has “skin in the game” losing his own, his family and friend’s money in the ultimate failure of the business.
In the same way as “Liar’s Poker” and “Wall Street” came to represent the financial world of the 1980s, “Zeroes” tales of trading fortunes made and lost and excessive life styles provides an entertaining record of the period.
In Rashomon, Akira Kurosawa presents a meditation on the subjectivity of truth and the uncertainty of factual accuracy. Like the film, the growing literature on the financial crisis is increasingly a meditation on the nature of financial reality. The truth remains unknowable and illusive but the purveyors of the different versions of the facts reveal a lot about their own motivations and agendas.
© 2010 Satyajit Das All Rights reserved. Satyajit Das is author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives – Revised Edition (2010, FT-Prentice Hall).
