If there’s one lesson to be learned from Panic: The Story of Modern Financial Insanity, it’s that investors should be terrified by combinations of the words “fundamentals,” “economy” and “strong.”
One phrase should sound familiar: Republican presidential candidate John McCain essentially doomed his bid for the White House with the famous assessment that “the fundamentals of our economy are strong.” His pronouncement has deep historical roots. In 2000, then-Treasury Secretary Lawrence Summers—on the heels of the dot-com bubble and the stock market meltdown on April’s Black Friday—announced that he was “confident the economy will continue to grow … our fundamentals are strong.” But the great originator of the phrase, portentously, was Herbert Hoover, who declared on Oct. 25, 1929: “The fundamental business of the country … is on a very sound and prosperous basis.”
Financial crises have much more than phrases in common. That this is especially true for contemporary finance is the gist of Panic, edited by author Michael Lewis. For this insightful, entertaining anthology, Lewis chose newspaper and magazine articles, book excerpts and other writings from immediately before, during and after four recent financial meltdowns: the crash of ’87, the foreign market collapse in the late ’90s, the burst of the dot-com bubble and the current subprime mortgage crisis. Panic, then, serves as a condensed history of contemporary finance, amplifying the echoes of financial irresponsibility from our recent past.
Lewis, author of Moneyball, The Blind Side and the New York Times bestseller Liar’s Poker (based in part on his experience as an investment banker), spoke with AARP Bulletin Today about where we went wrong, who’s to blame and what to expect next.
Q. You write that the recent financial panics have been cyclical. How are they all connected?
A. The period since the early ’80s has been characterized by people behaving in ways that are financially unsustainable.
Most of your readers are probably bewildered by the subprime mortgage crisis because what happened is so bizarre. How did trillions of dollars get lent to people who had no creditworthiness? It took incredible financial complexity to generate this idiocy. That complexity is what marks this period, and what marks all these crises. At the bottom of each is some new, complicated instrument that has been invented by really smart people—and it’s a tool that gets misused. The complexity of these tools essentially allows people to disguise the risks they’re running. The risks become bad risks, the situation becomes unsustainable, and panic ensues. This thing we’re going through now, though, is a different beast, for all sorts of reasons.
Q. How so?
A. For one thing, this crisis is on a much greater scale than the previous ones. I mean so much bigger. Instead of billions, or even tens of billions, we’re talking trillions of dollars of mistakes.
Q. So why haven’t we learned more from the past?
A. Well, what’s weird about the panics and crashes that led up to this one is that they didn’t have any serious consequences for most ordinary people. They were these self-contained financial events that only had consequences in little pockets of the financial world, largely because the Federal Reserve got really clever in responding to them. So people just ignored them and assumed that Wall Street knew what it was doing.
Q. In each of these crises, people were counting on unlikely events not to occur, and when they did, they caused a panic. It seems that “unlikely” events aren’t that unlikely at all.
A. Yes. The risk models they used on Wall Street were pretty good in estimating the risk of stocks and bonds and derivatives in normal times, but dramatically underestimated the risks of rare events.