August 2011

Arts & Letters

Air traffic out of control

By Lindsay Tanner
'Extreme Money' by Satyajit Das

Did you know that the Japanese Ministry of Finance advertises Japanese government bonds by claiming that men who own them are more popular with women? Or that Black Sea waterfront properties in Bulgaria were the hottest real estate in the world before the global financial crisis? Or that cacao, corn, dried fish, almonds, tea and rice have all been used as money in different human societies? Or that Enron is short for enteron, the Greek word for ‘intestine’?

I didn’t know any of these things, so I’m mightily impressed if you do. My miscellaneous knowledge has been expanded by Satyajit Das’s Extreme Money: The Masters of the Universe and the Cult of Risk (Penguin, 496pp; $32.95), which explores the origins of the GFC. Written for the educated layperson, it’s littered with pithy sayings by everyone from Groucho Marx to Shakespeare.

Das, an experienced derivatives trader and Sydney-based author of the bestselling Traders, Guns and Money has put together a powerful book, almost a case for the prosecution against his own sector. Das works his way methodically through most aspects of the crisis, especially the misbehaviour of those at its epicentre, Wall Street bankers. Das is brutal about his subject, and he’s a good storyteller. His book is a morality tale about the evils of allowing financial dealers to take over the world. It has a very emotionally satisfying flavour: if you’d like a few prejudices emphatically confirmed, get hold of a copy.

The trouble is, though, it’s not quite as rigorous as it appears. The book’s strengths are undermined by Das’s slightly slipshod use of information, shallow analysis and an erratic style.

The obscure facts can be interesting. I had not heard the theory that the original The Wonderful Wizard of Oz story was a satire on the American populist campaign for a combined gold and silver standard, known as bi-metallism. It was sobering to discover that the assets of the Icelandic banking system (the total amount of their loans) ballooned from a few billion dollars in 2003 to around $140 billion in 2007. The brief history of the hedge fund, beginning with Alfred Winslow Jones in 1949, is instructive.

The primary accusation at the heart of the book is absolutely spot-on. Das outlines the appallingly reckless behaviour of financiers in graphic, shocking detail. Every now and then, he really nails it:

Specialised products, combined with information and skill asymmetries between banks and customers, created profit opportunities. Investors hired advisors, who hired consultants, who hired fund managers, who bought products from banks, who laid off the risk with other banks or investors. Everybody along the chain earned a share of the action.

That’s the crucial point. Ultra-smart investment bankers didn’t create an array of absurdly complex, artificial financial products for the fun of it. They did so to extract obscenely large fees and commissions from the endless churn of vast sums of money their ‘products’ generated. As Das notes, the most stark illustration of this is the fact that in 2007 about 41% of all corporate profits in the US were earned by financial sector businesses, which employed only about 5% of the workforce. Is it any wonder that so many of the key players made outrageous amounts of money from this vast game of paper-shuffling?

Das also highlights the way the sector latched onto the worthy objective of improving retirement incomes as a means of enriching its clientele: “The single idea of providing for retirement expanded into a vast industry of consultants, actuaries, financial planners and investment managers. In the feeding frenzy, after deduction of all fees and expenses, there was less and less left for the golden years.” He lampoons some of the self-serving myths that emerged before and during the crisis, such as Ben Bernanke’s claim that the core problem was a glut of savings in the developing world, and the notion that the subprime crisis was caused by misguided attempts to help poor people. “It was not lending money to poor people that was the problem,” writes Das. “The problem was lending money poorly.”

Former American Labor Secretary Robert Reich once described financial intermediaries as “the air traffic controllers of capitalism”. They channel capital into the most efficient investments and thus improve economic outcomes and living standards. Yet when the controllers start trying to fly the planes, disaster ensues. Instead of fulfilling its role of serving the needs of the real economy, the financial sector milked it ruthlessly.

 Das overstates the importance of financial sector misbehaviour in precipitating the financial crisis, and underplays vital structural and contextual factors.

The origins of the financial crisis are complex. The rapid rise of China generated emerging imbalances in the global economy. The profligate, adventurist approach of the Bush administration ensured that the US not only failed to adjust to these pressures, it exacerbated them. Huge budget deficits financing expensive wars and regressive tax cuts helped create a bubble in the American economy, with the aid of extremely lax monetary policy under Federal Reserve chairman Alan Greenspan. 

The Basel II agreement governing global regulation of capital backing for bank lending greatly increased incentives to invest in residential mortgages. American regulators loosened their supervision of the financial sector. Increasingly complex, obscure financial instruments meant that the number of points of intermediation between original investor and ultimate borrower increased significantly. At each point, the prospect of inadequate information and mispricing of risk arises, so the more steps in the chain, the greater the likelihood that risks will be obscured. Changes in computer technology played an important role: the main reason this endless slicing and dicing of financial products didn’t occur in the 1980s is that the cost and complexity of doing it was prohibitive. 

Das does make passing reference to some of these issues, but that’s about it. He lets politicians and regulators off the hook, so keen is he to demonstrate the iniquities of his own class. That leads to slightly misleading conclusions. If you give matches to children there’s a fair chance you’ll end up with your house on fire. Das is rightly critical of the people who lit the fire but doesn’t say enough about those who let them get their hands on the matches.

The threadbare nature of his wider economic analysis can be irritating. He talks of manufacturing being wound back, as if this were a deliberate policy objective rather than the result of technological change, productivity improvements and developments overseas. He notes the surprising growth of the public sector under Thatcher and Reagan, without acknowledging that much of this was driven by strong growth in sectors usually dominated by government such as education, health, aged care and defence. He repeats the popular claim that speculators are responsible for big increases in oil and grain prices without adducing serious evidence in support of this proposition, which is highly debatable. He pays little attention to the role of saturation instantaneous media during the crisis; the magnification of panic that ensued was clearly a key factor in spreading the contagion from Wall Street into the real economy around the world.

There are plenty of unsettling errors in Extreme Money. Das calls Boston Consulting Group the “Boston Consultant Group”. He refers to W Edwards Deming, who transformed postwar Japanese manufacturing, as “Edward Deming”. He describes the fourteenth largest economy in the world as “tiny Australia”, and says former Macquarie Bank boss Alan Moss “annually earned A$33.5 million”, when this occurred in one year only. And he calls the Sarbanes–Oxley Act 2002 the “Sarbane-Oxley Act”. These slips may seem trivial, but they undermine the reader’s confidence in the rest of the book.

Das’s style is also erratic. Entertaining and shocking stories dominate the narrative, often distracting from the central argument. At times Das descends to undergraduate sneering, such as in his decidedly unflattering portrait of Greenspan. Extreme Money would be much better had an economic historian co-authored or edited it.

Nevertheless, the book is highly readable and informative, and Das’s prosecutorial style is completely justified. Anyone who decodes the ratings of the three major agencies so amusingly – CCC means “Russian roulette with five bullets in the chamber” and D means “scrape your brains off the wall and place in a plastic bag” – demands to be read.

Lindsay Tanner
Lindsay Tanner retired from his position as the federal minister for finance in 2010 after a long career with the ALP. He is the author of several books, including Sideshow: Dumbing Down Democracy.

Japanese government ad proclaiming that what women really want is a man who owns government bonds. © Ministry of Finance Japan/Dentsu
Cover: August 2011

August 2011

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