Opening our eyes to how we got where we are... and where we may be heading

Every now and then one reads a book that opens your eyes to what’s going on around us.

It was the case for me with Thomas Piketty’s book Capital in the Twenty-First Century. He shows how the era of reduced inequality between the First World War and the 1980s was historically exceptional, and that since that time the process has gone into reverse, with inequality growing rapidly and reaching dangerous levels.

It was the case again with Michael Lewis’s The Big Short. This is a far shorter book, which has its appeal, and it’s also a great deal more entertaining – I found myself repeatedly irritating my wife as I chuckled over certain passages and insisted on reading them out to her. But it was also an extraordinary eye-opener.

Lewis, whose Liar’s Poker did an excellent job exposing the seamy and ultimately worthless work that was being done on Wall Street in the 1980s, generating huge fortunes without creating any value, has an extraordinary talent for describing the underbelly of finance and doing it with clear, compelling writing.

What he shows in The Big Short is that the entire market that grew out of dealings in sub-prime mortgage bonds in the first decade of this century was based on essentially a lie. An increasing proportion of the financial instruments traded were based on worthless loans, far too many of which never had the slightest chance of being repaid. But while huge, and inadequately regulated, Wall Street firms could continue to be astronomical paper sums of money from them, the incentives were on to keep making the loans, issuing the instruments, and trading them.

This was part of the trend towards inequality so well analysed by Piketty. It was also a direct consequence of the Reagan-Thatcher years of active deregulation of the finance world in particular, and of industry more generally. As Michael Lewis points out, it wasn’t so much the greed of the firms that was to blame – the greed was always there. It’s that they were allowed to engage in business that they simply didn’t understand: not the people who were producing the instruments, not the traders trading them, not the executives who were paid eye-watering salaries to keep them in control.

The firms they led also put pressure on the ratings agencies to keep rating the bonds highly – triple-A, the top value – even though they were based on junk loans. The ratings agencies, the last line of regulation, proved completely inadequate to the task. But then they too are private companies, and subject to the blackmail that if they failed to provide a top rating, they’d lose the client to someone who would. Though it’s unlikely they had any understanding of the instruments they were rating.

No one understood.

Well, that’s not quite true. A handful of people did, and that’s the core of Lewis’s story. He tells the story of that handful and of the way they bet against the sub-prime mortgage market. When people claim today to have known what was happening then, check that they were part of that tiny group – if they weren’t, they’re lying.

Michael Burry: perhaps the first to have foreseen the 2007 Crash
And he made a packet by betting against it...

The book’s well worth reading, if you want a pacy, exciting, amusing and clear description of how the biggest financial crash the world has seen since 1929 took place. They got it right, and they made a packet out of betting they were right – betting, in fact, that the sub-prime mortgage market would fail. That's the ‘Big Short’ of Lewis’s title: this handful of clear-sighted individuals made a lot of money by shorting, betting against, the certainties that dominated Wall Street and banking around the world. 

In passing, the charge made by many British Conservatives that the 2007 crash was in any way attributable to the Labour government, in power at the time, is of course self-serving rubbish. If any political force is to blame, it’s the conservatives on both sides of the Atlantic, who so enthusiastically pursued deregulation all those years ago. As Piketty points out, they’re creating a world in which the  top 0.1% or 0.01% endlessly enrich themselves at the cost of all the others, and 2008 was merely a pothole on that road.

At most, one can accuse Labour and others on the Centre-Left of having done too little to roll back Conservative laxness towards the finance sector.

The saddest lesson from the experience? The journey on that road continues. Trump is an enthusiastic driver in that direction; it’s not clear that Clinton would do little more than moderate the speed of travel. In Britain, we have a new leadership of the Labour Party that might be able to force a change in course, but while the Conservatives cling on to power, we too will go that way. And the picture around Europe, or in Russia, China or India, is hardly more encouraging.

So read The Big Short for its qualities as a book and for the lessons it teaches. Then, once you’ve learned what it tells you about the recent past, ask yourself whether you’re prepared to see us heading for something similar in the future.

Because there’s only ourselves who can stop that happening…