Panic: The Story of Modern Financial Insanity
Michael Lewis (ed.)
When is a story not a story? And when should an author, like children of yore, be seen and not heard? And when is modern insanity not terribly different from historical insanity?
I might answer those questions and I might not because I’m not entirely certain what to think about this book, which I selected to distract myself from this year’s electoral shenanigans. If ever there was a year for politics and markets, it was 2020.
This is a different sort of book from an author I’ve encountered before. Michael Lewis is a near-contemporary who first came to notice in the 1980s with a fly-on-the-wall account of the goings-on at one of Wall Street‘s then most successful firms, Salomon Brothers. Since then he’s expanded his remit to include sports (he wrote Moneyball, the book that inspired the film), politics and even academia. Yet I continue to think he’s strongest when the subject is money.
That may be because despite his semi-insider status he seems as skeptical of the whole enterprise as I. If you want to identify the one sector of the economy that most closely resembles economics textbooks, it’s arguably high finance. There you’ll find it all: naked self-interest, the value of transparency–and also of inside scoop, innovation (often pointless innovation), creation and destruction.
You might also find a rigged game in which the employees and managers of the largest firms are working for the house. But that’s a mere detail and for all I know, Lewis takes that as a given.
What he isn’t taking for granted is the seeming increase in financial crises. Starting with 1987’s Black Monday crash (which still holds the record for the largest single-day decline in the DJIA on a percentage basis) and working through the back-to-back Asian and Russian debt crises and on to the ugly demise of the sub-prime housing market in 2008, the book is a more or less real-time (it was published in 2009) attempt to understand why every ten years the world financial system, ar a least a major part of it, appears to be on the verge of collapse.
Lewis’ method is to collect contemporaneous writing from across the period to explain what people were saying at the time, what they were saying soon afterward and what they said the next time trouble arose. If you were a reader of the financial press at any time during the 20-year span he covers, you’re sure to come across at least a couple of familiar names.
Perhaps unsurprisingly, the writer who appears most often, and in the wake of each crisis, is named Michael Lewis. I’ll be fair: he issues a warning about that at the outset and we learn in the afterword that this is a non-profit venture, any profits were donated to the Greater New Orleans Foundation.
You might think that answers the second of my three questions, but it doesn’t. Because the issue isn’t his presence–he is one of the writers of his generation best equipped to write about such matters–it’s his intrusive presence. The transgression of which I speak comes in his own piece on the LTCM meltdown. In it, we meet Hans Hufschmid, a colleague who started as a trainee with Lewis at Salomon back in the mid-80s and ended up at the infamous hedge fund.
Hans is now our author’s one-man reference set. He’s who Lewis might have been if he’d stayed in the game. That a significant chunk of his net worth disappeared overnight provides only some small solace to our scribe who now gets ‘paid by the word.’ I can’t help thinking that many a writer would kill to be in Lewis’ shoes, with his first book a bestseller, several more thereafter, three film deals and, presumably, a phone that rings whenever an editor thinks about covering some aspect of the financial industry. Many writers, I hope, find a way to live in middle-class comfort; Lewis lives in the Berkeley Hills.
I’ve said before that I enjoy Lewis as a writer, even when he makes missteps. Here the misstep, oddly enough, is a narrative one. In his best work, starting with the first book, Lewis identified the one or two larger-than-life/hard-to-believe characters who carried the tale forward. The action, good and bad, could be hung on their backs. Here, though, across the two-decade span, such a strategy falls apart. Salomon Brothers was part of Travelers by the time LTCM quaked. By the time Lehman Brothers failed, Lew Rainieri and John Meriwether were wrapping their careers up.
To the extent that there is a story here, it’s a simple one: things have become too complex for any one man or group of executives to understand let alone manage effectively. So they manage what they do understand–people and profits. Trouble arises when what’s inside the heads of people is the source of your profits. At such a point, understanding what your staff means when they say “a significant amount of the aggregate options position $Gamma may lead to a wider distribution of returns” might be useful. Even I know that the last part of that sentence is just a fancy way of saying risks are rising. What might be life-threatening is Gamma, whatever that may be1.
As stories go that’s not really a page-turner. Worse, it’s not terribly original, either. Lewis would have us believe otherwise. ” Financial panics have become almost commonplace; events that are meant to occur once in a millennium now seem to occur every few years.” (p. 8)
Let’s leave aside the dubious proposition that financial meltdowns are intended. (What else can ‘meant to occur’ mean?) The history of the US in the 19th century can be taught in a number of ways. Focus on the Missouri Compromise, the Wilmot Proviso and the Dred Scott decision and you’ve chosen one path. Tell a tale of panics starting with the one in 1819 and making stops in 1837, 1857, 1873 and 1893 and you’re looking at a familiar series. There’s a reason you can find a list of financial crises organized by century.
Must we conclude that capital markets find themselves doomed to boom-bust cycles? That’s a tale for another book. Several, actually. I’d be remiss not to note that Karl Marx was perturbed, and perhaps motivated, by the consequences of such collapses. Or that Hyman Minsky suggested stability brought about instability.
Both of those examples offer fascinating stories. By comparison, this book offered me a drive through an old neighborhood narrated by old friends. An escape from the present, perhaps, but in the end not terribly much more.
Have a happy Thanksgiving.
The intrusion of a footnote in the style of David Foster Wallace seems necessary here. Gamma is defined as the rate of change in an option’s delta per 1-point move in the underlying asset’s price. Absolutely clear once we ascertain what delta is. Luckily, delta is simply the ratio of the change in the price of an asset to the change in the price of its derivative. This mathematical intermarriage becomes important in constructing delta-gamma hedges, which can reduce risk, but might also reduce alpha, or outsized performance. That means additional factors need to be considered. One such factor is convexity, which describes the relationship between a bond’s price and its yield and indicates what change in duration can be expected from a given change in interest rates (which are, of course, a function of price). Then there’s gamma’s color, which measures gamma’s change over time and which is sometimes called gamma decay. It’s defined as the third-order derivative of an option’s value, once to time and twice to the option’s price. About now, you should be wondering what sized bottle of Advil the managers of Wall Street firms keep in their top desk drawer and if their bookshelves include an English-Greek dictionary and The Complete Idiot’s Guide to Calculus. You need not believe any of the above. But if you’re curious or care to see if I’m making this stuff up–and I wouldn’t blame you at all if you thought that–then I suggest you spend some time exploring the high-finance briar patch. A good starting point is the Investopedia definition of gamma.