What a carve up – Book review


If you want to understand how the City came to play such a central role in British economic and political life, why a crash was inevitable, and why the crisis is being resolved on terms which give so much and ask so little of the financial sector, this is the most important thing you need to understand: the influence of investment banks on modern politics and policy.

Over the past 10 months, publishers have issued books about the credit crunch with almost the enthusiasm and frequency with which banks once issued structured products. As with structured products, however, many of them are the same material in new packages.

The background to the major financial crisis of our age involves anthropology, economics and politics. Anthropologists routinely study tribes in remote parts of the world, but few turn their attention to the tribes that today inhabit lower Manhattan and Canary Wharf. It is no accident that the FT’s own commentator on the dysfunctionality of wholesale capital markets, Gillian Tett, has a PhD in anthropology; her account of the origins of the crisis in Fool’s Gold begins with a bonding ritual at Boca Raton.

Until there are more field studies, we will have to rely on participants’ own accounts of their activities. Beginning with Michael Lewis’s Liar’s Poker, a stream of books now describes the group behaviour associated with trading, behaviour very different from the norms of either everyday business or traditional finance.

Two such accounts are provided by Seth Freedman and Tetsuya Ishikawa, young men who, at the turn of the century, joined esteemed and thinly disguised City institutions. Like Lewis, they found extraordinary wealth followed by extreme disillusionment. The unifying theme is one of boys behaving badly. These various accounts vie with each other in their extravagant descriptions of the vulgarity and avarice of the inhabitants of the trading floor.

Chapter 10 of Freedman’s Binge Trading, in which some of these individuals muse on their role in society, is beyond parody. One hedge fund manager explains how the non-financial economy benefits from his activities through his firm’s contract for in-house massage; a trader boasts of the earnings of the Africans who clean the toilets. Several express the belief that anyone capable of doing their jobs will certainly already be doing so.

This ludicrous though fragile arrogance is well captured in Tetsuya Ishikawa’s How I Caused the Credit Crunch – not the best book on the crisis, but certainly the best title. There is more than enough in Ishikawa’s loosely autobiographical account to repel the ordinary taxpayers who are today picking up his bills. Bills run up at brothels and at fine restaurants where participants ate the meals of celebrity chefs and drank fine wines until they vomited; bills incurred by young men who were clever, articulate and who understood little more about the complex structured products they were selling than the people buying them.

Ishikawa gives insight into one of the questions that underlines the crisis – how could the people who sold these products have been so short-sightedly greedy? Edmund Andrews offers insight into another – how could the people who bought them have been so foolish? Andrews is a New York Times financial journalist who himself became a victim of predatory sub-prime lenders.

The power of both these accounts is that they make it easy to think “there but for the grace of God go I”. Any impressionable new graduate catapulted from university into the unreal world of bond sales, any struggling reporter seeking to build a new life after a costly divorce, might have been involved as participant rather than as bystander. The injustice is that Andrews, but not Ishikawa, will have to pay the money back.

Although the everyday experiences of Ishikawa and Andrews were very different, the underlying economics at work is the same. Financial engineering would, for a time, create illusory wealth. That illusion would enable bankers to dine at restaurants otherwise beyond their means and enable reporters to buy houses which were truly beyond their means.

Richard Posner is a phenomenon. A US federal appeal court judge and legal academic, he is also a prolific author on an astonishing range of subjects. Posner has no particular relevant knowledge or experience of the credit crunch, and no new ideas on how the policy issues raised by the events he describes might be resolved. But his book The Failure of Capitalism originated as a blog. And the lively blogger, waking every day with fresh ideas, feels a pressing urge to communicate his or her observations on world affairs to a wide audience. Few have the perseverance and discipline to turn their daily blogs into annual or biannual books. Posner does, and he provides a very competent account of the events which led to the current crisis, with an emphasis on the political and ideological context.

But this is a very particular political and ideological context. Posner is more in love with economics than most economists. He shares his blog with Gary Becker – together they are leaders of the Chicago School, whose members attempt to offer economic explanations for every kind of human behaviour and efficiency justifications for every arrangement of human institutions.

Nevertheless, for Posner the crisis was A Failure of Capitalism. A failure of capitalism, though not of capitalists. Posner emphasises that the capitalist behaviour that caused the credit crunch was neither irrational nor inappropriate. “The aggregate self-interested decisions of these institutions produced the economic crisis by a kind of domino effect that only government can prevent – which it failed to do. That was a grave government failure”.

Widely expressed among financial market participants is the view that we would never have trashed the house if our parents had supervised us properly. But it won’t do. If self-interested behaviour, inadequately restrained by state actions, leads to social and economic disaster it does not follow that the individuals and businesses which engage in the self-interested behaviour escape culpability. We don’t apply that standard to lorry drivers. We expect them to drive safely and professionally and hold them responsible when their failure to do so causes accidents. “I would have had to slow down” is not an excuse. It is not apparent that we should lower our expectations when it comes to the senior executives of banks.

Equally importantly, the events leading up to the credit crunch did not represent rational self-interested behaviour on the part of the institutions – as distinct from the individuals – involved. After all, most of these institutions are now effectively bust. Philip Augar, a former Schroders MD turned author, sees the important issue here. In Chasing Alpha, he puts (hypothetical) words into the mouth of Andy Hornby, chief executive of HBOS, who might have said to shareholders: “‘Wait a minute. This money market funding could disappear and the housing market could slump. I am going to shrink market share, build up deposits, and earnings per share will halve. Is that OK?’ But if he had, he would probably have got a pretty rude answer.” He would have got that rude answer – but what he proposed would certainly have been the right thing to do, and would perhaps have been the right thing to do even within the fleeting timescale of so-called long term incentive schemes.

It isn’t important – though it is relevant to Posner’s ideological stance – to discuss whether recurrent patterns of problematic behaviour are rational. The autobiographical accounts reveal, as if we needed reminding, that behaviour is adaptive – people conform to the culture of the environment in which they find themselves. That was true for Ishikawa, for Andrews and for Hornby. As the credit boom was about to implode in 2007, Chuck Prince, still chief executive of Citigroup, described the dilemma in his own memorable words in the FT: “So long as the music is playing, you have to get up and dance”.

The best and most comprehensive account so far of the economic origins of the crisis is to be found, perhaps unexpectedly, in the FSA’s own “Review of Financial Regulation”. Lord Turner’s own polished pen shows through in many paragraphs – he is himself the author of a book, Just Capital (2001), which, at the beginning of the credit expansion, offered muted cheers for regulated market capitalism. Unfortunately the review’s analysis of where we should go from here is inadequate relative to its analysis of how we got to be here. But that brings us directly to the most important perspective: the political.

As a Federal Reserve chairman in more stable times, the late William McChesney Martin observed, “it is the job of the regulator to take away the punch bowl when the party gets going” – and to turn down the music to which Chuck Prince felt obliged to dance. Today’s regulators not only did not, but could not. The economics and anthropology of markets and their regulation take place only within a political context.

The best appreciation of the political dimensions of the crisis is not to be found, as you might expect, in The Spectre at the Feast, a book by a professional political scientist – Andrew Gamble is professor of politics at Cambridge. Or in The Storm, by a practising politician – Vince Cable is the parliamentarian who has been consistently the most prescient and thoughtful in his analysis of the credit crunch. These books contain interesting material on the ideological background and on Westminster. For real insight into the political dimension, however, you should turn to Augar, the former investment banker, and to BBC reporter Paul Mason’s Meltdown.

Both writers devote chapters to the key influence in the anthropology, economics and politics of the last two decades of financial markets: the rise of the investment bank. The thesis is developed most extensively in Augar’s previous book, The Greed Merchants. When Anthony Sampson wrote his magisterial Anatomy of Britain half a century ago, describing the power structure of British society, his chapter on merchant banks portrayed them as a gentlemanly relic of a bygone commercial age. A newcomer in London, SG Warburg, was then ruffling feathers by defying the sedate conventions of the panelled offices.

No knowledgeable observer writing such a book today would give more space to the Church of England – or, for that matter, Parliament – than to the institutions we now call investment banks. The brass plates on the doors have been replaced by the names of American and European banks; the titled grandees who once occupied the dining rooms have been replaced by clever corporate financiers and aggressive traders drawn from around the world. These institutions are the most powerful political force in the land.

As FT columnist John Gapper said in his review last year of Charles Ellis’ history of that company – “a lot of people used to think that Goldman Sachs ran the US economy. Now we know it does”.

If you want to understand how the City came to play such a central role in British economic and political life, why a crash was inevitable, and why the crisis is being resolved on terms which give so much and ask so little of the financial sector, this is the most important thing you need to understand: the influence of investment banks on modern politics and policy.

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