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Sunday, October 9, 2011

Michael Lewis on the financial crisis: Boomerang: Travels in the New Third World

To paraphrase Leo Tolstoy, financially stable countries are all alike, every bankrupt country is bankrupt in its own way. Listen to this interesting podcast on NPR's Fresh Air How The Financial Crisis Created A 'New Third World' (audio, 39 min) by Michael Lewis, the author of Boomerang: Travels in the New Third World, and learn how Greece, Ireland and Iceland recently got bankrupt (or nearly so), with a bonus chapter on fiscal mismanagement of his home state of California.
I always listen with great interest to podcasts by Michael Lewis, a fascinating, knowledgeable and funny speaker and author, who worked for many years at the investment bank Salomon Brothers, and since then has become the best selling author of books such as The Big Short: Inside the Doomsday Machine, Liar's Poker, Moneyball and many others.

Lewis starts talking about Boomerang by telling the story of the hedge fund manager Kyle Bass, who earned huge returns betting against the subprime mortgage loans during the financial crisis of 2008. Bass predicted at about the same time that the next crisis would be the debt crisis of sovereign countries, many of which bailed out the banks, and put the banks' bad debts on their own books. Bass is now poised to make a lot of money on the bets he made since 2008 - bets against countries like Greece being able to repay their debt.
The story of the Greek crisis starts when the investment bank Goldman Sachs helped Greece rig their books with off market currency trades to help them get admitted to the eurozone - without telling explicitly that they in effect were lending money to Greece. This kind of trick would have landing people in jail, if performed in the corporate land in America. After the books were successfully rigged and Greece was admitted to the eurozone, it went on a spending spree, doubling the size of its public sector. Greece has a highly inefficient public work sector, where you would sometimes get fired if you work well. The Greek public sector is a corrupt enterprise, a patronage where the ruling party is rewarding its political supporters with jobs. Greek banks got in the current poor financial state by buying Greek government bonds, which eventually dropped in price as a result of huge debts and dysfunctional public sector.

Ireland got bankrupt in a different way. Its middle class used to be doing okay until the Irish embarked on a speculative bubble, in which they inflated the prices of Irish land and real estate. This was fueled by easy credit and by a certain historical fondness of Irish for their own land. For example, an upper middle class house in Dublin could sell for tens of millions of dollars. Note that the bankruptcies of Greece and Ireland were not caused by the American financial crisis.

In the bonus chapter on California, Lewis tells the story of voters consistently selecting, using referendum or elections, the policy of having nice public services without wanting to pay for them. As a result, the state is in poor financial health, and the problems are being pushed downstream to the city level. For example, an hour north of Berkeley, there is an actual bankrupt city of Vallejo.
So Greece can happen right here - if we are not careful...

2 comments:

  1. I was puzzled by the ending remark in the post. Who are "we" and why/how "we" should be careful?

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  2. I meant that poor financial state can spread systemically across the federal, state and municipal levels, unless we (the majority of people, as voters or consumers) do not become more careful (fiscally conservative), using methods of our choice. "Greece" that can "happen here" is just a metaphor (perhaps too imprecise) for modern bankruptcy at state level. We should be more careful because the alternative, as you can see from examples in the post, plus many others, has unpleasant consequences not always of our choice. How to be more careful is a great question! Thanks for raising it. That would be a topic more future posts.

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