Boomerang: Travels in the New Third World, by Michael Lewis

Courtesy of www.guardian.co.uk

Michael Lewis is a writer for Vanity Fair, and alongside the fellows at NPR's Planet Money, he has made the financial crises of the past five years more comprehensible for people without London School of Economics degrees. And for people with them, actually -- as it turns out, not all the financial "geniuses" who gave us vehicles like credit default swaps completely grasped the implications of their work. Lewis finds an exquisite balance: He doesn't simplify to the level of money for dummies; he presents the often Byzantine fiscal finagling in very human terms, both for the finagler and the finagled.

When he was investigating the American credit crisis, Lewis noticed that American economists had gotten into the habit of consoling themselves by looking to Iceland and muttering, "Well, at least we haven't done that."  One of them opined, "You have to understand. Iceland is no longer a country. It is a hedge fund." Lewis trundled off to Reykjavik to investigate. The trail of financial ruin led thence to Ireland, Greece, Germany, and finally to California, the boomerang ultimately returning to its source. We often speak of the global financial crisis as if it's one syndrome, a wide-spread pandemic caused by the same pathogen, exhibiting the same symptoms, but Lewis shows us that this is not so. The Icelandic flu is quite a different from the Greek plague. All the nations Lewis visits played a part in each others' fiscal demise, but each had its own distinctive mode of self-destruction.

Lewis characterises Iceland as "a nation of extremely well-to-do (No. 1 in the United Nations’ 2008 Human Development Index), well-educated, historically rational human beings who had organized themselves to commit one of the single greatest acts of madness in financial history."  One factor is the country's isolation. The Icelanders are a famously small, in-bred clan of people who suddenly felt that after 1100 years, the world might be ready to recognise their inherent greatness. They left their fishing boats in droves and entered international banking.

This in a country the size of Kentucky, but with fewer citizens than greater Peoria, Illinois. Peoria, Illinois, doesn’t have global financial institutions, or a university devoting itself to training many hundreds of financiers, or its own currency. And yet the world was taking Iceland seriously.

The Icelanders bought assets in a foolhardy fashion, and sold them to each other at madly inflated prices. When foreign economists questioned the numbers, the Icelanders dismissed them as envious busy-bodies. The economic boom was deafening. So was the collapse.

From 2003 to 2007, while the value of the U.S. stock market was doubling, the value of the Icelandic stock market multiplied nine times. ...

When their three brand-new global-size banks collapsed, Iceland’s 300,000 citizens found that they bore some kind of responsibility for $100 billion in banking losses—which works out to roughly $330,000 for every Icelandic man, woman, and child.

Trying to grasp how any of this could have happened, Lewis, to his own amazement, simply arranged an appointment with the Prime Minister. Even this told him something about the country.

There is a policeman sitting behind a reception desk, feet up on the table, reading a newspaper. He glances up, bored. “I’m here to see the prime minister,” I say for the first time in my life. He’s unimpressed. Anyone here can see the prime minister...
Half a dozen people will tell me that one of the reasons Icelanders thought they would be taken seriously as global financiers is that all Icelanders feel important. One reason they all feel important is that they all can go see the prime minister anytime they like.

This sense of self-importance, however, is not always bolstered by a corresponding competence.

There’s a charming lack of financial experience in Icelandic financial-policymaking circles. The minister for business affairs is a philosopher. The finance minister is a veterinarian. The Central Bank governor is a poet. Haarde, though, is a trained economist—just not a very good one.

As Lewis noted, Icelanders are well-educated, and most PhDs are not content with fishing careers. Lewis interviews Stefan, a former fishing boat captain turned failed currency trader.

“I think it is easier to take someone in the fishing industry and teach him about currency trading,” he says, “than to take someone from the banking industry and teach them how to fish.” ...

“You spent seven years learning every little nuance of the fishing trade before you were granted the gift of learning from this great captain?” I ask. “Yes.” “And even then you had to sit at the feet of this great master for many months before you felt as if you knew what you were doing?” “Yes.” “Then why did you think you could become a banker and speculate in financial markets without a day of training?” “That’s a very good question,” he says. He thinks for a minute. “For the first time this evening I lack a word.” ...

In retrospect, there are some obvious questions an Icelander living through the past five years might have asked himself. For example: Why should Iceland suddenly be so seemingly essential to global finance? Or: Why do giant countries that invented modern banking suddenly need Icelandic banks to stand between their depositors and their borrowers—to decide who gets capital and who does not? And: If Icelanders have this incredible natural gift for finance, how did they keep it so well hidden for 1,100 years? At the very least, in a place where everyone knows everyone else or his sister, you might have thought that the moment Stefan Alfsson walked into Landsbanki ten people would have said, “Stefan, you’re a fisherman!” But they didn’t. To a shocking degree, they still don’t.

 In Greece, Lewis discovered that the banks were not really at the root of the problem:  "The biggest problem the banks had was that they had lent roughly 30 billion euros to the Greek government—where it was stolen or squandered. In Greece the banks didn’t sink the country. The country sank the banks."

A newly appointed Greek finance minister held meetings to determine the scale of the country's financial disaster. For days, people timidly raised their hands and mentioned this deficit, or that debt, all of which had somehow managed to stay off the official books. "By the final day of discovery, after the last little hand had gone up in the back of the room, a projected deficit of roughly 7 billion euros was actually more than 30 billion. The natural question—How is this possible?—is easily answered: until that moment, no one had bothered to count it all up."

Part of the problem, he patiently explained to Lewis, is the absence of revenue. The Greeks seem to consider it a point of honour to avoid paying taxes. Lewis interviews two former tax-collectors. At first he thinks they're having a bit of fun with him.

“If the law was enforced,” the tax collector said, “every doctor in Greece would be in jail.” I laughed, and he gave me a stare. “I am completely serious.” ...
“This wasn’t all due to misreporting,” he says. “In 2009, tax collection disintegrated, because it was an election year.” “What?” He smiles. “The first thing a government does in an election year is to pull the tax collectors off the streets.” “You’re kidding.” Now he’s laughing at me.  I’m clearly naïve.

That official corruption is endemic in Greece is now indisputable, but Lewis points out that the officials were not unwilling to share their ill-gotten wealth. In fact, they handed it out in gobs.

As it turned out, what the Greeks wanted to do, once the lights went out and they were alone in the dark with a pile of borrowed money, was turn their government into a piñata stuffed with fantastic sums and give as many citizens as possible a whack at it. ...

A businessman turned minister of finance named Stefanos Manos pointed out that it would be cheaper to put all Greece’s rail passengers into taxicabs: it’s still true. “We have a railroad company which is bankrupt beyond comprehension,” Manos put it to me. “And yet there isn’t a single private company in Greece with that kind of average pay.” The Greek public-school system is the site of breathtaking inefficiency: one of the lowest-ranked systems in Europe, it nonetheless employs four times as many teachers per pupil as the highest-ranked, Finland’s. Greeks who send their children to public schools simply assume that they will need to hire private tutors to make sure they actually learn something.

When EU membership put limits on the amount of budget deficits and inflation, the Greeks resorted to stunts like removing high-priced tomatoes from the consumer price index. This tomfoolery simply never occurred to the more stolid EU member nations who looked at the numbers and didn't question them.

Lewis moves on to formerly jolly Ireland.

Ireland's financial  disaster shared some things in common with Iceland’s. It was created by the sort of men who ignore their wives’ suggestions that maybe they should stop and ask for directions, for instance. But while the Icelandic male used foreign money to conquer foreign places — trophy companies in Britain, chunks of Scandinavia — the Irish male used foreign money to conquer Ireland...  Left alone in a dark room with a pile of money, the Irish decided what they really wanted to do with it was buy Ireland. From each other.

Ireland has battled a stubborn inferiority complex born of centuries of relative poverty. The Irish themselves seemed a bit startled by their sudden prosperity.

As recently as the 1980s 1 million Irish people, in a nation of a mere 3.2 million, lived below the poverty line, yet by the start of the new millennium the Irish poverty rate was under 6 percent, and Ireland was the second richest country in the world, according to the Bank of Ireland. 

Lewis mentions one economic growth factor, unlikely to bring a smile to the Pope's face.

This in turn had been mainly driven by Ireland’s decision, in 1979, to legalize birth control. That is, there was an inverse correlation between a nation’s fidelity to the Vatican’s edicts and its ability to climb out of poverty: out of the slow death of the Irish Catholic Church arose an economic miracle. 

Ireland's boom was largely one of real estate. Development soared, as did property prices. It ended with a great number of empty buildings. And abandoned cars.

A few months after the spell was broken, the short-term parking lot attendants at Dublin Airport noticed that their daily take had fallen. The lot appeared full; they couldn’t understand it; then they noticed the cars never changed. They phoned the Dublin police, who in turn traced the cars to Polish construction workers, who had bought them with money borrowed from the big Irish banks. The migrant workers had ditched the cars and gone home.

And where was the Irish government during this great boom? Going about its usual business, it seemed, perhaps as puzzled as all the other Irish folk. When panic seemed imminent, the ineffectual Finance Minister made a television speech. He did not exert a calming influence.

Now the Irish people finally caught a glimpse of the guy meant to be safeguarding them: the crazy uncle had been sprung from the family cellar. Here he was, on their televisions, insisting that the Irish banks’ problems had nothing whatsoever to do with the loans they’d made . . .

The finance minister might as well be standing in front of Pompeii and saying that the volcano wasn’t really worth mentioning. Just a little lava! “THIS ISN’T ICELAND,” is what he actually says. “We’re not a hedge fund that’s populated by 300,000 farmers and fishermen."

“What happened was that everyone in Ireland had the idea that somewhere in Ireland there was a little wise old man who was in charge of the money, and this was the first time they’d ever seen this little man,” says McCarthy. “And then they saw him and said, Who the fuck was that??? Is that the fucking guy who is in charge of the money??? That’s when everyone panicked.”

Ireland's financial demise differed in another way from that in the US: While the American bankers who wrought much of the havoc walked away with full pockets, the Irish bankers were ruined when their banks collapsed.

Germany is, of course, at the centre of the custodial company charged with cleaning up this whole mess. It too played a role in the mess-making, but a more indirect one. Germany financed other countries' messes.

The curious thing about the eruption of cheap and indiscriminate lending of money between 2002 and 2008 was the different effects it had from country to country. Every developed country was subjected to more or less the same temptation, but no two countries responded in precisely the same way. Much of Europe had borrowed money cheaply to buy stuff it couldn’t honestly afford. In effect, lots of non-Germans had used Germany’s credit rating to indulge their material desires. The Germans were the exception. Given the chance to take something for nothing, the German people simply ignored the offer...

They lent money to American subprime borrowers, to Irish real estate barons, to Icelandic banking tycoons, to do things that no German ever would do. The German losses are still being toted up, but at last count they stand at $21 billion in the Icelandic banks, $100 billion in Irish banks, $60 billion in various U.S. subprime-backed bonds, and some yet to be determined amount in Greek bonds. The only financial disaster in the last decade German bankers appear to have missed was investing with Bernie Madoff (perhaps the only advantage to the German financial system of having no Jews). In their own country, however, these seemingly crazed bankers behaved with restraint. The German people did not allow them to behave otherwise. It was another case of clean on the outside, dirty on the inside. The German banks that wanted to get a little dirty needed to go abroad to do it.

Many older, traditional German bankers marvel at the fiasco. They never accorded young banking whippersnappers the towering, egomaniac status that America, Iceland and Ireland did, yet the risky loans took place.One statesmanlike bank officer reflects on his profession's more grounded past.

Banking, done in the proper German fashion, is less a free enterprise than a utility. “Why should you pay twenty million to a thirty-two-year-old trader?” Müller asks himself. “He uses the office space, the IT, the business card with a first-class name on it. If I take the business card away from that guy he would probably sell hot dogs.”

Lewis focuses upon Germans' love of rules. They adore them and adopt whole systems of them covering every aspect of life. The problem, he discovers, is that people who live by rules too often assume that others do likewise. One German financier mourns his lost faith in the United States' financial system.

"I did not have the idea that your market would completely collapse.” He pauses. “It has told something to me. I was in the belief that the best supervised of all banking systems was in New York. To me the Fed and the SEC were second to none. I did not believe that there would be e-mail traffic between investment bankers saying that they were selling . . .” He pauses again, and decides he shouldn’t say “shit.” “Dirt,” he says. “This is by far my biggest professional disappointment. I was in a much too positive way U.S.-biased. I had a set of beliefs about U.S. values.”

The German disappointment in the Greeks is even more pronounced. The only way to avoid the collapse of the Euro zone, some opine, is for the Greeks to, well... stop being so Greek.

At the bottom of this unholy mess, from the point of view of the German Finance Ministry, is the unwillingness, or inability, of the Greeks to change their behavior. That was what the currency union always implied: entire peoples had to change their way of life. Conceived as a tool for integrating Germany with Europe, and preventing the Germans from dominating others, the euro had become the opposite. For better or worse, the Germans now control the financial fate of Europe. If the rest of Europe was to continue to enjoy the benefits of what was essentially a German currency they’d need to become more German. And so, once again, all sorts of people who would rather not think about what it means to be “German” are compelled to do so.

At last, Lewis' boomerang loops back to its source, the United States. As he speaks with economists about the disaster that is the Federal budget, someone mentions to him that the government will just parcel the problem out to the states by cutting federal funds for this and that. Like all the international finance ministers who congratulate themselves for not being Icelandic, most state governments breathe sighs of relief that they're not California. Lewis goes out for an early morning bike ride with former California governor, Arnold Schwarzenegger. He quickly realises why the state's government cannot solve the problems. The people, in effect, won't let it.

California had organized itself, not accidentally, into highly partisan legislative districts. It elected highly partisan people to office and then required these people to reach a two-thirds majority to enact any new tax or meddle with big spending decisions. On the off chance that they found some common ground, it could be pulled out from under them by voters through the initiative process. Throw in term limits—no elected official now serves in California government long enough to fully understand it—and you have a recipe for generating maximum contempt for elected officials. Politicians are elected to get things done and are prevented by the system from doing it, leading the people to grow even more disgusted with them. “The vicious cycle of contempt,” as Mark Paul calls it. California state government was designed mainly to maximize the likelihood that voters will continue to despise the people they elect.

The people are accustomed to living beyond their means: "The average Californian, in 2011, had debts of $78,000 against an income of $43,000."  When Schwarzenegger began to grasp the scale of the red ink, he did not panic. He seems at least to have experienced a mild sense of alarm.

“We were all of a sudden short three hundred million dollars in revenue for the month,” says Schwarzenegger. “I somehow felt, Uh-oh."

So when a state is bankrupt, what does it do? Cut funding to the cities. After Lewis' bike ride, the former governor's associates quipped, "Hey, it could be worse. We could be living in Vallejo!" Lewis of course headed to Vallejo.

WELCOME TO VALLEJO, CITY OF OPPORTUNITY, reads the sign on the way in, but the shops that remain open display signs that say, WE ACCEPT FOOD STAMPS. Weeds surround abandoned businesses, and all traffic lights are set to permanently blink, which is a formality as there are no longer any cops to police the streets. Vallejo is the one city in the Bay Area where you can park anywhere and not worry about getting a ticket, because there are no meter maids, either.

Vallejo now has one civil servant -- a mayor who took the job under duress.

Since the bankruptcy, the police and fire departments had been cut in half; some number of the citizens who came to Phil Batchelor’s office did so to say they no longer felt safe in their own homes. All other city services had been reduced effectively to zero. “Do you know that some cities actually pave their streets?” says Batchelor.

Vallejo's funds are now struggling simply to meet the retirement pay of retired civil servants; the city cannot afford to hire any new ones. Lewis consults a social psychologist who says the whole issue is the American lust for immediate gratification. 

The problem with police officers and firefighters isn’t a public-sector problem; it isn’t a problem with government; it’s a problem with the entire society. It’s what happened on Wall Street in the run-up to the subprime crisis. It’s a problem of people taking what they can, just because they can, without regard to the larger social consequences...

A color-coded map of American personal indebtedness could be laid on top of the Centers for Disease Control’s color-coded map that illustrates the fantastic rise in rates of obesity across the United States since 1985 without disturbing the general pattern. The boom in trading activity in individual stock portfolios; the spread of legalized gambling; the rise of drug and alcohol addiction; it is all of a piece. Everywhere you turn you see Americans sacrifice their long-term interests for a short-term reward.

The pain of need may be the only way to get Americans to change their ways, he says. Heaven knows the Icelanders, Irish and Greeks are feeling the pain now. Boomerang gives us the clear picture of our global financial relationships, but each country has experienced its own, distinctive boom and bust. Each can look at the others and think, Phew! We haven't mucked it up as badly as they did, but eventually the shrapnel from our own time-bombs wakes us up. Or will, shortly.