The author of Liar’s Poker, Michael Lewis, on America’s crash history.
Question: Why have Americans been unable to learn from their mistakes?
Michael Lewis: If you look at what’s happened since I walked into the financial markets in the mid-80s, it’s been a series of convulsions, each of which would have sunk an earlier generation. The crash of ‘87, the internet boom and bust, the long-term capital management hedge fund in Greenwich going bust with a trillion dollars of obligation, and the Fed coming in and saying that capitalism as we know it are threatened. It is threatened.
In a funny way, up until this point, up until the subprime crisis, there were no consequences. I mean, yes, things happen in the financial markets, but very broadly, the economy didn’t experience anything but a long boom. I mean with little dips in it.
And so there was never any real pain. And I think there’s a kind of a general sense in the markets that these things have become kind of trivial, normal events. I think that if you connect the dots, we have arrived now at a terminus; we have arrived at a point; he lessons are being learned right now, that people now figured out that you engage in unsustainable financial activity, and if it gets to be big enough, it can actually be a real disaster, not just a newspaper disaster.
Question: Are Americans more reckless with their behavior in markets?
Michael Lewis: I’d say this, that we’ve made a fetish of markets in this country. And markets are a great tool. It’s a kind of a nonsensical, “I believe in free markets,” whatever the hell that means, and, which is undermined. And that, combined with 30 years of bashing government and undermining the status of government, inability of government to do its job, has resulted in a very corrupt regulatory regime.
You’ve got people working at the FCC who make $50,000 trying to monitor people who are making $10 million. And if they don’t annoy those people, in a couple of years, they can get a job where they too can make millions of dollars working at the people they’re supposed to regulate.
A lack of conviction about serious regulation of things, like Wall Street risk, the FCC has been very good at hounding people who are up to kind of trivial things; Martha Stewart or Mark Cuban.
I wrote a piece about a 16-year-old kid who they accused of manipulating the markets.
But they’ve been very bad at doing things like asking what risks are you running. Now, partly, that’s not their responsibility; but whose responsibility is it? And why wasn’t the risk run by Wall Street firms better monitored?
Having said that, we take the lead, I think, in making financially free markets, but we exported that belief, too.
It’s very funny, as we sit here, it isn’t just the United States that’s in trouble, even though the big sin was the subprime mortgage lending debacle, that was here; others emulated our style of finance. You’d be worse off being in Iceland today than being in America. Actually, everybody in Iceland, I think, is bankrupt. And what they did was essentially mimic what a hedge fund does.
So, this is a long and rambling answer to a very specific question, but why us? A combination of ideas and circumstance, but the result is that we actually were deluded into thinking that nothing really could go wrong in the financial markets; I was, too.
I really did think that people at Goldman Sachs and Merrill Lynch and UBS and Deutsche Bank, that they basically knew what they were doing. The CEO basically had a grip on what the risks were the firms were running, and wouldn’t do suicidal things. But they all did.
And as I dug into the problem, and I started to really pay attention to it at the beginning of this year , I was shocked. I couldn’t believe how idiotic it had become. And it was just a system run out of control. It was a system that managed to mis-align the incentives of the people who took risks with the larger culture, so that all sorts of risks got taken that shouldn’t have gotten taken.
Question: Can we ever assimilate the complex financial instruments that, in part, led to this crisis?
Michael Lewis: Probably not. I don’t know.
I have a different answer for this now than I would have had when I walked out of Salomon Brothers. When I walked out of Salomon Brothers, I really did feel like a lot of this financial innovation was a very good thing, that it was bringing, for example, mortgage financing to people at a much lower price than they would have had before the mortgage bond market was created. A lot of the tools are very valuable tools.
It is true that when you hit a level of complexity, where essentially smart people still can’t understand it, unless they devote their lives to it, at some point it becomes not a useful tool. Because maybe in theory it’s a useful tool, but in practice, what ends up happening is it’s used for evil ends. It’s used for the wrong purposes. It’s used to mask risks. It’s used to disguise what people are doing.
And then when you create a climate in the financial markets where it’s basically where people have no choice but to have faith in the really smart people who know what they’re doing, because you can’t understand what they’re doing, you create a climate that’s just ripe for disaster, because the money that’s being invested has no capacity to understand what it’s investing in.
Look at the problem we have at the subprime crisis. One of the things that’s really striking about it as the [US] Treasury and the Fed tries to fix the problem, which they won’t be able to do because it’s too big a problem; but even they didn’t understand it. That even when the Fed had people inside Wall Street firms, after Bear Stearns went down, to report back on what the risks were these firms were running, even then they didn’t understand.
So how can an investor understand it? Why would any investor invest in Goldman Sachs or in Morgan Stanley when the Federal Reserve and the Treasury combined can’t figure out what the hell they’re up to? It is not an investment at that point. It’s just a wild speculation.
So what happens is when complexity reaches a certain point, it becomes opacity, and the markets do not really function well with opacity, so they need transparency. So I do think that there is a kind of a natural limit to the amount of complexity that the markets can assimilate.
Recorded Nov 21, 2008.