Sunday, December 07, 2008

Middle Class Lewis

Michael Lewis published Liar's Poker about the 1980s Salomon Bros where he worked. His book exposed the fact that Wall Street does not actually allocate capital rationally towards productive investments. In fact, Lewis was attractively candid that he couldn't tell how his bank allocated capital at all.

He was blushingly modest, putting the incompetence on his own shoulders rather than on the investment industry as a whole. People loved the book, and kept buying the Wall Street products he had supposedly exposed.

He wrote a retrospective last month, where he says,
I thought I was writing a period piece about the 1980s in America. Not for a moment did I suspect that the financial 1980s would last two full decades longer or that the difference in degree between Wall Street and ordinary life would swell into a difference in kind. I expected readers of the future to be outraged that back in
1986, the C.E.O. of Salomon Brothers, John Gutfreund, was paid $3.1 million; I expected them to gape in horror when I reported that one of our traders, Howie Rubin, had moved to Merrill Lynch, where he lost $250 million; I assumed theyʼd be shocked to learn that a Wall Street C.E.O. had only the vaguest idea of the risks his traders were running. What I didnʼt expect was that any future reader would look on my experience and say, “How quaint.”
Very true. But keep reading. Overall, Lewis is a classic example of the great middle-class enabler of the world of finance.

For example, he remarks to Mac Greer that
I think it is true that the models that have been used on Wall Street since the early 1980s to price financial risk -- to essentially price financial insurance, which takes different forms, but the most common form is an option -- work reasonably well in normal financial environments, when things aren't too volatile. When there are really extreme moves, they fall apart. And over and over in the past 25 years, we have seen really extreme moves in which they fall apart.
This is like an engineer praising a new material by saying, "our alloy holds up well on all aircraft control surfaces, except when those surfaces are needed to maintain stability during a storm, in which case they collapse."

Pretty dumb, Michael. How about the cultural analysis?
If the Wall Street firms had been partnerships instead of corporations, if the people in them had had total long-term engagement with the risks they were taking, they never would have done what they did. If American culture had not evolved to inure people to the risks of leverage, then I don't think nearly so many people would have borrowed money they couldn't repay.
Uh huh. If America were socialist and pigs could fly, and companies cared about workers instead of throwing them over the side at the first roll of the hull, then finance workers wouldn't have maxed out leverage to make a million bucks today knowing their rich firm was going to fire them tomorrow.

Then he says Detroit should be allowed to fail.

With middle-class financial intellectuals like Lewis, no wonder we're screwed. I like his writing and his characters, but twenty years later, couldn't we find a better analyst?

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