Are bankers the new magicians, pulling gilt-edged rabbits out of empty hats? Or are they the new dentists, the most depressed of professionals because the public associates them with pain and suffering? John Lanchester suggests a combination of both, and he achieves it with an approach that ricochets between horror and humour in a slim book covering everything you need to know about the international financial crisis.
An award-winning novelist ( The Debt to Pleasure, Fragrant Harbour), Lanchester brings two desperately needed qualities to the subject: an outsider's viewpoint and an engaging writing style. With lines such as, "The jet engine of capitalism was harnessed to the ox cart of social justice," Lanchester injects an element of delight on a topic not normally associated with lively phraseology. He is also surely the first writer to employ a Charlie Parker saxophone solo as an analogy for a momentous event in financial philosophy.
His overall message, however, is serious and alarming, as the title suggests: Leave Wall Street financiers and their international confreres unsupervised, and they'll make themselves enormously wealthy while pulling down around them the very edifice that made it possible.
They did this, Lanchester explains, by creating money out of nothing. He is remarkably precise on the date and incident that launched this debacle. It began, he points out, with a disaster of a very different kind: the oil spill of the Exxon Valdez in 1989, forcing Exxon to ask its bank, J.P. Morgan, for a $5-billion line of credit to cover potential damages. Unwilling to tie up that many greenbacks, which would eat into the bank's capital reserves and reduce its lending power, the bright lights at Morgan created a new animal for the financial menagerie, a voracious little beast called a credit default swap, or CDS, essentially an insurance agreement passed to anyone who cared to assume the risk.
Morgan persuaded the European Bank for Reconstruction and Development to adopt the CDS, paying the EBRD to take the beast off its hands. If Exxon needed the $5-billion, the EBRD would provide the cash. If Exxon didn't need it, the EBRD pocketed a fee from Morgan, whose capital reserves remained untapped. Everybody wins! Light bulbs went on in bank boardrooms around the world with the realization that CDSs were derivatives, which can be bought and sold like bonds or common shares.
Financiers, remember, produce nothing of value. They merely facilitate the transfer of cash between parties, pocketing a portion of each transaction. CDSs represented a new, immensely profitable form of transaction that eventually spawned asset-backed commercial paper (ABCP) and similar vermin.
By 2009, Wall Street, whose earnings had previously never exceeded 16 per cent of the U.S. gross domestic product, represented 41 per cent of that GDP, most of it from the exchange of CDSs and their offspring. That great slurping noise through the early 1990s was the sound of salivating bankers. There was more. If the repayment of loans can be guaranteed, then loans become risk-free. And if the risk is removed from a bank's loan portfolios, the banks needn't keep all those pesky reserves to cover potential loan defaults, leaving more money for new loans, and ad infinitum.
Bankers were magicians, and soon their top hats began spewing out rabbits by the millions. No one stopped to question the source of those rabbits or who would feed and clean up after them. The answer, of course, was you and me. Lanchester blames Ronald Reagan and Margaret Thatcher for banishing regulatory oversight of the financial industry, and former Federal Reserve chairman Alan Greenspan for maintaining the folly.
Lanchester spends a good deal of time, however, praising Canada for its banking oversight and applauding our banks, those grey eminences whose fees are as numerous and ravenous as black flies on steroids. Forget the fees, Lanchester suggests, and admire the acumen.
He's not alone. The Organization for Economic Co-operation and Development (OECD) calls our banks the safest in the world. U.S. banks are rated 40th, behind Botswana's; Britain's are 44th. What's more, Canada has registered just two bank failures since 1923; the United States has recorded 17,000.
Before you stand up to sing O Canada, note that Lanchester identifies two Canadians as villains.
One is David X. Li, a Chinese national educated at Laval University and the University of Waterloo, who crafted a mathematical formula that measures risk, enabling credit default swaps to be priced with (supposed) accuracy.
The other is Myron Scholes, whose nationality Lanchester assumes is American. In 1973, Scholes co-wrote a paper in the Journal of Political Economy that determined how to price derivatives, opening the door to their trading on a broad scale. Scholes is a Canadian. I know, because he and I graduated in the same class from Westdale Secondary School in Hamilton. Myron went on to launch a multibillion-dollar hedge fund, earn untold millions of dollars in personal wealth and win a Nobel Prize in Economics. I didn't.
Nobel Prize or no, Scholes and his buddies are responsible for creating a banking crisis that will suck assets out of almost every household in the developed world for the next decade, at least. This is the sober message lurking among Lanchester's delightful wordplay, and it deserves attention by everyone who cares to understand where we are, how we got here and who is responsible.
John Lawrence Reynolds is the author of Bubbles, Bankers & Bailouts: The Global Financial Crisis and How You Can Survive It. His most recent book, The Skeptical Investor, was published this month.