Reviews for Chaos or Community?: Seeking Solutions, Not Scapegoats for Bad Economics

The average rating for Chaos or Community?: Seeking Solutions, Not Scapegoats for Bad Economics based on 2 reviews is 4.5 stars.

Review # 1 was written on 2007-07-23 00:00:00 Kelly Toole This brilliant, scary little book is the first account I've seen of the credit crunch which truly made sense. I read it in a day, and, if you're at all interested in politics, economics or current affairs, I can't recommend it too highly. Lanchester is an acclaimed novelist, which shows in the witty and stylish writing; here, he also proves that he's a great investigative journalist. The credit crunch was a first-magnitude disaster, and at several points I found myself comparing Whoops! to the magisterial report written after the Columbia Shuttle crash in 2003. The Columbia Investigation Board looked at the accident from three perspectives. First, they had to determine the proximate cause of the accident, in engineering terms: what specific mechanical failure made the Shuttle break up over Texas and crash? Second, they wanted to know what went wrong at the managerial level: how did this problem slip through the elaborate net of safety checks that preceded the launch? Third, and most far-reachingly, they tried to understand the problem at the level of the whole NASA organizational ethos. Why was management focussing on the wrong targets, to the point where safety standards could erode and allow a catastrophe like this to happen? As everyone now knows, their answers were as follows. The proximate cause of the accident was a piece of falling foam, which cracked the front edge of the Shuttle's wing, allowing incandescent gas to get into it on reentry and melt everything inside. The managerial problem was, in a now-famous phrase, NASA's "broken culture of safety". Even when things had previously been considered dangerous, a tendency developed to assume that they were in fact safe if they had been seen to occur before without an accident having happened. Finally, the Board concluded that NASA had lost its way. No one knew any more what they were trying to achieve, and the artificial nature of their main goal, to keep building the probably useless Space Station, meant that senior managers were unable to prioritise sensibly. So, back to the credit crunch. The Western World's banks filled up with toxic debt and very nearly fell from the skies. Why? And how? I'd heard many of the pieces before: subprime mortgages, CDOs, deregulation, excessive leveraging. But I couldn't put it all together. Some American and British banks had lent money to people who, rather too often, weren't capable of paying it back. Was that such a bad mistake that it had the potential to break the whole world's financial systems? And, if it was, how could they have been so stupid as to allow it to happen? Here's a précis of Lanchester's explanation; I'll start, as he does, with the broken culture of safety. You deposit your money in the bank, and they lend it out at interest. As long as they do this carefully, and are sure enough of getting the money back, they make money for you and money for themselves. The bank's business is to manage the associated risk of not getting back the money that it's loaned out. A crucial issue is leverage. The bank would ideally like to lend out as much money as possible, so that it can make as much profit as possible. At the same time, caution dictates that the bank shouldn't make bets that are too large, because that increases the probability of something going wrong. If too many people default on their loans, the bank will run out of money. The leverage is, roughly, the ratio between how much money the bank loans out, and how much it's keeping to cover loans that default. By 2008, British and US banks had a leverage of about 50. So, they had to be very careful, because if even a small proportion of their loans went sour they would be bankrupt. Evidently, they weren't sufficiently careful. Why? Well, some very smart people had recently invented these complex financial instruments called Collateralized Debt Obligations (CDOs). They let a bank package up a bunch of debt, pull it apart into various pieces with different associated levels of risk, and sell those pieces on to other banks. The CDO was basically insurance on the debt. The banks loved this idea, because, once they'd turned their debts into CDOs and sold them to other people, those debts weren't formally counted as debts any more. They could still pick up interest on them, but they were free to loan out more money, and make larger profits. Unfortunately, the mathematics of CDOs is incredibly complex. Even if you have a PhD in statistics, you won't necessarily understand it very well. I'm pretty sure that the CEOs of these big banks, who were making the key decisions, didn't all have PhDs in statistics. The banks loaned money to every home-owner they could find who might be considered a reasonable risk, but they still wanted more profits. They started to wonder about the other people, the ones who normally wouldn't be considered reasonable risks; people with bad credit histories, or unsafe jobs, or no jobs at all. I had not previously come across the phrase "ninja mortgage": no income, no job or assets. Bankers, astonishingly, decided that they could sell ninja mortgages. It was all a question of managing risk. Suppose there was some mathematical way to combine a lot of risky propositions, and turn them into a safe bet? It's not as far-fetched as it seems. You'd be insane to bet your life on the toss of a coin. But suppose someone said that they'd flip a coin 100 times. If it came up heads at least five times, you'd collect a million dollars, but if there were 96 or more tails you'd die. I'd definitely consider this offer. So there were all these uncertain subprime mortgages, and what the bankers wanted was some way to use the magic of CDOs to turn them into safe bets. And now we come to the piece of falling foam, a part of the story that I previously hadn't heard at all. Another very smart mathematician thought he'd found a solution, using the so-called Gaussian copula function. Here it is, the formula which nearly destroyed Western civilization: The Gaussian copula function, it was claimed, did the magic trick, and let bankers combine all those risky bets into sure-fire propositions. The credit-rating agencies were so convinced that they gave the resulting CDOs triple-A ratings: they thought that they were as secure as US Government debt. Alas, it turned out that the mathematics wasn't as clear-cut as the bankers had believed. (Well, hardly anyone understood it, and it had never been seriously tested...) Worse, the CDOs had hidden the original debts so thoroughly that people buying them didn't actually know what they were based on. And worst of all, the bankers had somehow persuaded the US and British governments to deregulate the market in CDOs, which by now was worth tens of trillions of dollars, an amount comparable to the whole world's GNP. Unrestricted trade in CDOs was legal, but it obeyed the letter of the law while completely flouting its spirit. As Lanchester said, it was rather like discovering that, if you drove at more than 70 in an area where the speed limit was 30, the speed cameras couldn't see you. That's roughly what the bankers were doing. When the US housing market went into a downturn, the subprime loans started defaulting. The Gaussian copula functions didn't model this situation correctly, because the statistics used to make the estimates were all very recent, and came from a rising market. The sure-fire bets weren't sure-fire at all, and unrestricted trade in CDOs had spread these bad bets everywhere. For a few days, it seemed possible that the entire world banking system would collapse. And what was it that made this whole absurd adventure possible in the first place? How could the CEOs of the large banks risk the futures of their corporations, and indeed their countries, on a piece of untested mathematics that they didn't even understand? Lanchester has two answers. One is plain, old-fashioned greed. They had a lot, and they wanted more, and they didn't think that they, personally, were risking very much. Indeed, these people are still mostly in their jobs, and the ones whose banks have collapsed have retired with fat pensions. They called it right. The second answer was the faith many people had that markets were the correct answer to everything. Markets were smarter than people, and people shouldn't presume to try and control them. But, with the answers now in, it seems that Adam Smith, Milton Friedman and the rest of that crowd were wrong. Markets aren't always smarter than people. My personal feeling is that the credit crunch concluded the story of the 20th century, which was largely a demonstration of what happens when people believe in things without adequate grounds to support those beliefs. An absolute belief in the excellence of the free market turned out to be not very much more sensible than an absolute belief in the superiority of the Aryan race or an absolute belief in the dictatorship of the proletariat. I'm completely with Kurt Vonnegut:Say what you will about the sweet miracle of unquestioning faith, I consider a capacity for it terrifying and absolutely vile.Having seen the above examples, it would be nice to hope that people will be more sceptical in future. But I wouldn't count on it.

Review # 2 was written on 2021-01-30 00:00:00 Jonathan Blakeman One of the few times George W. Bush ever rose to quotability came during the 2008 credit crunch, when he was heard to mutter darkly: "This sucker could go down." He wasn't talking about the US banking system; he was talking about civilization as we know it. That's how close we were to the abyss. Another few days and you'd have seen armed mobs looting 7-Eleven's and Viggo Mortensen trudging down the Road. Some day, decades from now, someone's going to write the definitive history of the financial crisis. Until then, John Lanchester's I.O.U. will probably stand as the go-to book. Written by an intelligent layman'or "civilian", as he sometimes prefers' it bristles with a kind of wtf, dude? incredulity. Which is only fitting. I mean, the world very nearly ended because a Chinese math geek published an equation in some obscure journal. That's just stupefying. The whole story is just stupefying. At the end of the day, I'd still like to believe in capitalism, which, say what you will, has always picked up the tab for liberal democracy (a point made by Lanchester himself). It's just that, once a century or so, capitalism goes on a wild binge, maxes out the credit cards and wraps the Porsche around a utility pole. It's the Lindsay Lohan of economic systems, and we're married to it. Maybe we just need to accept that, in this relationship, the sexy fun times will always end in insolvency and despair, and that longish stretches of semi-normalcy are about all we can hope for.