Panic: The Story of Modern

Financial Insanity
Michael Lewis (Ed.), W.W. Norton & Company, 2009, 391 pp.

Ethan Porter
I.
Bad times can clarify things. Take today’s economic crisis. So far, it’s put millions
of people into unemployment lines, forced almost as many out of their homes, and,
before all is said and done, might leave several destabilised nations in its wake. But it’s
also underscored a truth that was widely unacknowledged beforehand: for at least
the past two decades, the centre of global power has resided not in Washington or
with any government, but in the corporate boardrooms of Wall Street (as well as its
hip, slick cousin, Silicon Valley). The truly momentous decisions, with immediate
consequences affecting countless people, have largely been made in the private
sector. Government, meanwhile, has endured as mostly a passerby, occasionally a
first responder.

Panic: The Story of Modern Financial Insanity tells this tale by clipping together
financial news accounts from four recent moments of peril – the crash of the late
eighties, the Asian/Russian crisis of the late nineties, the Internet bubble’s deflation
a few years after, and the ravaged landscape we find ourselves in today. The book is
edited by Michael Lewis, the popular financier-turned-writer, who dashes in and out
to provide interstitial commentaries on each successive crisis (while also including
some of his own articles in the collection). But this isn’t merely a scrapbook of
horrors; Lewis uses the articles he selects to advance a specific argument. These
crises, it turns out, have followed a predictable pattern. First comes the Shiny New
Thing. This Shiny New Thing is said to permanently change the rules; henceforth,
history will be split in two – when we were aware of the Thing, and when we were
not. This is followed by a rush to profit, which occurs without anyone bothering
to check under the hood, let alone recognise inherent flaws. Eventually, everything
collapses, and ‘How could we have been so foolish?’ becomes an international
rallying cry.

Often, though, the ‘we’ is altered, and the question is turned to: how could they
have been so foolish? The ‘they,’ of course, depends on who you are. There are the
masses, the ignorant hordes that storm the financial beaches at the mere whiff

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of buried treasure. Then there are the financier-alchemists, who really do believe
that they have invented a way of turning water into money. And then there are
the experts, the economists, who pontificate and propagate conceptual financial
models while setting aside the less easily quantifiable question of human emotion.

Our current troubles are owed, certainly somewhat, to the handiwork of such
experts. Although Enron collapsed seven years ago, it seems reasonably clear that
the Enron model has survived since, in which the ostensibly smartest guys in the
room conspire to create profit schemes so complicated no one else can unravel them
and figure out that, contrary to rumour, they are worth practically nothing. Some
of the financial tools now bedevilling the market are so complicated, so intent on
their own obscurity that even titans of the financial world weren’t aware of them.
Something called a ‘liquidity put,’ for instance, helped bring Citigroup to its knees.
But Bob Rubin, the boss of Citigroup and the legendary former Treasury Secretary,
‘had never heard of liquidity puts’ (p. 343). And it’s understandable why: a liquidity
put was an option that ‘allowed buyers of complex and presumably safe mortgage
securities to hand them back to Citigroup at par if they became hard to finance’ (p.
343). Anyone with a modicum of common sense would oppose such a thing.

But liquidity puts, not to mention Collateralised Debt Obligations (CDOs) and
‘kilos’ – don’t ask – are merely the contemporary inheritors of a long tradition of
complex financial tools gone awry. The crash of the 1980s was in part owed to the
popularity of the Black-Scholes pricing option. Formulated by two economists,
one of whom later won a Nobel Prize; Black-Scholes is basically a form of portfolio
insurance. ‘The model is based on the assumption that a trader can suck all the risk
out of the market by taking short a position and increasing that position as the
market falls, thus protecting against losses, no matter how steep’ (p. 4). What Black-
Scholes doesn’t account for is the way in which emotion can intrude upon sterile
theory. In a panic, no one is looking to buy, and short-selling becomes impossible.

Those most attuned to the winds of emotion, and thus most prone to irrational
decision-making, are those who know the least: the small to mid-sized investors
outside of the Wall Street/Silicon Valley world. In each boom, they, the people
went in blindly – without anyone telling them to slow down – and quickly got in
too deep, in financial shenanigans they didn’t understand. In our ongoing tragedy,
there are people like Joe Carey, a small real estate agent from Ohio, who, in 2002,
moved to Florida and bet everything on a series of housing deals. By late 2007,
after a few years of wild profits, the housing market was so bad that he had to

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close up shop altogether. In the mid-nineties, as the Asian economy was in rapid
ascent, a Thai citizen, Sirivat Voravetvuthikun ‘borrowed $8 million … to build
two condominium towers outside Bangkok, but he went broke and started a small
business selling sandwiches on the streets’ (p. 149). These regular investors seemed
to have imbibed the optimism of one LA screenwriter and part time investor, who
told Time Magazine right before the 1980s crash that, ‘It’s so simple, it’s insane. If
you do this carefully, it’s like picking money off trees’ (p. 17).

But nothing is ever that easy; money does not grow on trees. Such spoonfuls of
conventional wisdom would have benefited not just our screenwriter friend, but
also the financiers who fall into fevers of irrational exuberance in every bull market.
A Lewis piece written for The New York Times Magazine during the Internet-fuelled
boom of the nineties is downright hilarious in retrospect. ‘New New Money’
showcases the efforts of Jim Clark, a famous Internet entrepreneur overflowing
with hubris, to start up a company called Healtheon. Although it was bleeding cash
and its business plan seemed to depend more on PR than anything else, Wall Street
took Healtheon very seriously. Healtheon’s mission: ‘to slide in and eliminate $250
billion in waste [in the health care industry] without causing the people who made
their living wastefully to raise hell, and it would do this by forming partnerships
with the stronger companies (p. 180).’ The intention, in other words: take a few
PR gurus and a negative balance sheet, and conquer the notoriously dysfunctional
American health care system. Healtheon has since mutated into WebMD, an
adequate supplier of online medical advice. But it’s no world-beater.

II.
It may impolite to say it, but it must be said: what all these people have in common
is the vast gulf that separates them from reality. The best-trained economists, the
most enthusiastic entrepreneurs, and the wizards of Wall Street have all, at various
times over the last twenty years, been revealed as tragic know-nothings. Sometimes,
it is comforting to laugh at the way in which their arrogance masked their ignorance.
James Cayne, the CEO who rode Bear Sterns into the ground, is shown five days
before the collapse of Bear’s hedge funds, ‘chatting with visitors over lunch … less
interested in discussing the markets then in talking about a breakfast-cereal allergy
and his stash of unlabeled Cuban cigars’ (p. 337). After his company was set aflame
by the imploding market, he kept his regular appointments at the golf course, as if
nothing had happened.

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But their ignorance is also tragic. While James Cayne is fortunate enough to find
refuge on a golf course, many small- and mid-sized investors have no such luxury.
Nor, for that matter, do those who never even considered themselves investors, but
are caught in the maelstrom of global economics nonetheless, and who are now
out of a job or worse. Unpredictability is the mother’s milk of capitalism. But
inexplicability is something else. When markets become inexplicable – that is,
beyond the reach of even financial executives and esteemed economists – there is a
grave danger to both the market and the democratic society that exists in tandem
with it.

This holds true especially today, when the power of the market seems to trump
government. Recall Bill Clinton’s furious questioning of top aides in 1993: ‘You
mean to tell me that the success of my program and my re-election hinges on the
Federal Reserve and a bunch of fucking bond traders?’ [1] Well, yes, it did. Already,
financial commentators, most notably Martin Wolf in The Financial Times, are
warning that Obama’s Administration is on the rocks due to the gyrations of the
market. [2]

Political science 101 says that a democratic society depends on the consent of the
governed, and the existence of clearly demarcated lines of accountability between
citizens and their government. But if the most influential actor is not the government,
but the private sector, what then? It seems to me that, at the very least, the private
sector’s behaviour must meet a threshold of accessibility and accountability. Judging
by the contents of Panic, as well as the tumult of the past eighteen months, the
private sector has clearly failed to meet that threshold. What’s occurring now is, in
a sense, a problem of delayed understanding: before the recession, too few people
understood what was going on in major financial institutions.

The only man in Panic who intuited our current crisis before it happened is the one
who profited off of it the most. The story of John Paulson, who turned a fortune
of about $100 million into several billions by ‘shorting’ – betting against – the
housing market at precisely the right time, seems distressingly emblematic of pre-
crash America. ‘Where is the bubble we can short?’ he asked the employees at his
investment firm (p. 361). Surely he was not alone in forecasting around 2005 that
the bubble would burst. And no one ought to begrudge a Wall Street man his profit;
after all, making money is why Wall Street exists. But where was the government’s
John Paulson? In each crisis profiled in Panic, government regulation and oversight

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function like an absentee parent – vaguely desired, but not really missed until after
disaster has already struck.

It’s time to reverse the order of things. Government must assert itself, as it has
not done for decades. Equally comforting and distressing about Panic is the way
it makes the current crisis seem all too familiar. To some extent, we’ve been here
before. Even the protestations that we’ve never been here before – yes, we’ve been
there, too. If the Herculean efforts now underway to reverse the economic collapse
succeed, let’s be sure that this is the last time we go through a downturn marked by
such uncertainty, defined less by what we know about it than what we don’t.

Easier said than done, of course. Moreover, it’s a task made doubly hard by
acknowledging what we must avoid: the temptation to head back into the
mountains, throw away our computers, and abandon everything about the global
economy. As liberals, we must not shirk modernity. You simply can’t walk back
technology. The advancements made in computer science over the past few decades,
from the creation and promulgation of the PC to the inescapability of the Internet,
are here to stay. These are the tools that gave us the global economy, and they will
not evaporate. And they’ve done a great deal of good. But the global economy
must now be matched by a global regulatory regime that prizes accessibility and
accountability.

These twin principles of democracy, in other words, must become the twin
principles of global regulation. Such a regime, however, must not merely content
itself to restrain markets in the name of accessibility and accountability – although
there will be times when restraint is clearly in order. What it also must do is promote
investor education, and make the financial world explicable. Restoring trust in the
market will not be easy, but for the sake of our commitment to democracy, it is
essential. One hedge fund trader whose firm has stayed successful even in this down
market recently explained their secret to me: ‘We only invest in products we can
understand.’ Let us hope that such a sentiment becomes the guiding light of the
next economy.

Ethan Porter is the associate editor of Democracy: A Journal of Ideas.

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References
Harris, John (2005) The Survivor, New York: Random House.
Wolf, Martin (2009) ‘Why Obama’s New Tarp Will Fail to Rescue the Banks.’ The Financial Times,
February 10.

Notes
[1] See Harris 2005, p. 5.
[2] See Wolf 2008.

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