I.O.U.: why everyone owes everyone and no one can pay

by John Lanchester

Well, this book wasn't exactly what I was expecting, but it was okay. I almost gave up early on, because I was annoyed at the mix of &3163; and $, but the specific amounts turn out not to be all that relevant, and their sheer size in the trillions and very high billions is impressive in either currency. Also, the author is a Brit, and he does look at the 2007-08 financial crisis from a specifically Anglo-American perspective, and he does highlight some crucial difference in how things played out on both sides of the Atlantic.

The author has an interesting theory, but it only comes up at the beginning and end of the book. He believes that the fall of Communism left the capitalist democracies, and especially the "Anglo-Saxon" model of capitalism as practiced in the US and UK, without an enemy or a credible alternative or basis for comparison, creating a climate in which extreme deregulation of banking and financial services set the stage for the worldwide financial crisis and massive bailouts and credit crunch of the late 2000s. Most of the book is then a look at the steps leading up to the sub-prime mortgage/collateralized debt obligation/credit default swap debacle, and some of its aftermath.

A much longer book could be made from this story, so the amount of information packed into this relatively small volume is actually pretty amazing. In lieu of attempting to summarize, here are a few of the things that grabbed my attention:

• Investment banks did (and no doubt still do) create subsidiary entities called SPVs "special purpose vehicles" and SIVs "structured investment vehicles" to keep assets (such as securitized debt) and the associated risk of those assets off the banks' balance sheets, and to avoid or circumvent rules, such as those requiring a certain amount of capital reserves to cover said risky assets. SIVs and SPVs can be set up for 364 days or fewer, as a workaround for rules that would apply to a company that existed for a year or more. Even where regulations exist, skirting the rules and brazenly violating the spirit of the rules is widespread.
• "It shouldn't be possible to be that wrong" is what the author says about the risk modeling and statistical analysis that convinced bankers and regulators that they had magically made all the risk disappear (or at least passed it on to someone else). For example, the 1998 Russian bond default should have happened once in 3 billion years, but it wasn't the only supposedly highly unlikely event to have happened in recent decades; still, bankers believed the math that said problems with packaged and securitized sub-prime mortgages were absurdly unlikely, equivalent to winning the UK national lottery 21 times in a row.
• Further criticizing the risk-taking and bonus-accumulating culture of financial services, the author makes a distinction between "business" (which celebrates economic thinking, where money just makes more money and profit is the only product) and "industry" (which makes or does something, with money as means and byproduct). Beyond the immediate effects of the worldwide crash and bailouts, the turning of entire national economies (US and UK) away from industry to unregulated financial services, and the triumph of capitalism over communism, has the secondary result that business and economic thinking have spread to areas it doesn't belong, such as education, health care, government services. The free market and capitalist ethos is not a good model for social welfare projects, which should begin with a discussion of values, principles and desired outcomes, then proceed with decisions about what is affordable and feasible. The alternative is economic thinking, in which the idea of value is replaced by the idea of price, and which seeks to maximize "profit" by privatizing, downsizing, and monetizing the common good.

Long story short, we still need more balance between capitalism and communalism. Meanwhile, I'm going to try to position myself to buy a house when the next "asset correction" causes prices to bottom out again, which I predict will happen in about three or four years.