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What (and Who) Got Us Into This Mess?—A Q&A With Michael Lewis, Editor of Panic: The Story of Modern Financial Insanity

If there’s one lesson to be learned from Panic, it’s that investors should be terrified by combinations of the words “fundamentals,” “economy” and “strong.”

Q. Meaning?

A. Let me give you an analogy: Say you are an insurance company and you sell lots of very cheap hurricane insurance to people who live on Miami Beach. You don’t get paid as much as you really should for this insurance, but you might make [out] like a bandit if no hurricane hits. If a hurricane comes, everyone’s doomed because you don’t have enough money to pay for everyone’s losses. But either way, the mere fact that you sold that insurance doesn’t make a hurricane more likely.

On the other hand, if those in the financial markets create lots of crash insurance, and lots of banks that had crash insurance begin selling it off because they don’t think they need it, people know that you’re going to lose a fortune if the crash happens. So in a way, it creates pressures for the crash to happen because investors become concerned that financial institutions aren’t going to be viable. This leads to runs on banks. So, yes, there has been a systematic underestimation of the likelihood of disaster, but I also think that this underestimation has actually led to some of the disasters.

Q. What holds the financial market together?

A. At its core, it’s a productive enterprise. In the end, capital is basically rational, and you hope it finds its way to the people who can put it to the most use—and that they then turn it into more capital. For example, you invest in a business, the business makes profits and you get your little slice of those profits. If you want to get right down to it, economic growth comes from innovation—from people finding better ways to do the same things.

Q. What can be done to protect against panics?

A. The government could do a much better job of regulating and preventing big firms from taking catastrophic risks—risks that will cause the stock market to go down 50 percent, for example.

Q. For starters. What else?

A. The government could also regulate the agencies that assign credit ratings to governments, companies and individual piles of securities. Those ratings agencies have become totally unreliable. Moody’s and S&P are the two agencies that put gold seals of approval on big piles of subprime mortgages because they were paid to do so. They were completely unregulated by the government. It’s outrageous that they did what they did. We need an objective ratings agency that people know they can trust.

Q. What surprised you while compiling this anthology?

A. It surprised me how clearly some people were able to express and predict what was going to happen. John Cassidy wrote a piece in the New Yorker in 2002 saying that we’re in the beginning of a housing bubble that’s going to be much, much worse than the Internet bubble and that it was going to create financial catastrophe. But it didn’t matter. Nobody paid any attention.

Q. What are your thoughts on the bailout plan?

A. I think they’ve attacked the problem from the wrong end—they see it as a top-down problem. They seem to think that if they feed huge sums of money into these giant failed institutions, somehow these institutions will turn around, stop failing and be engines of economic growth. But they failed for a reason. They were run badly by people who didn’t know what they were doing and who shouldn’t be given an opportunity to prove they don’t know what they’re doing all over again.

Q. Strong words.

Those institutions are at the mercy of events that they have no control over, namely what’s going on in the larger economy. If markets continue to collapse, if people lose jobs, lose their homes and renege on credit card debt, it doesn’t matter how much money is pumped into Citigroup at the top—it’s still going to be a mess.

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