The Current Financial Crisis

It was last week that I stumbled across this article and analysis from Michael Lewis, the famous author of books such as Liar's Poker, Moneyball, Coach, and The Blind Side. I have read all (or a significant portion; in the case of Coach, it was about a 20-page excerpt from the NY Times Magazine, their Sunday paper insert) of those books, and Lewis has to be one of my favorite writers these days. Lest one think Lewis solely writes about sports, he also authored Next in 2001, The New New Thing in 2000, and Trail Fever (AKA Losers) in 1997.

Lewis' most recent book, Panic, just hit the shelves in late 2008, which means he didn't waste any time turning around a new manuscript after publishing The Real Price of Everything in January of 2008. It makes me wonder just a little how well each book is researched and written, although if his previous works are any indication, I will probably enjoy delving into his more serious economic tomes.

Getting back to the original article, which was published in the December 2008 issue of the magazine Conde Nast Portfolio, I was impressed with how Lewis tied everything related to the collapse of Wall Street in 2008 back to one event. One event that happened way back in the early 1980s. According to Lewis, Wall Street was destined to collapse ever since John Gutfreund sold the trading partnership of Salomon Brothers to the Phibro Corporation, thereby divorcing the element of risk from the persons making the trades.

Now, I clearly understand that Lewis had insider experience working for Gutfreund at Salomon Brothers in the '80s. It was his experience pushing complex options and derivatives on the trading floor that formed the basis of his first book and cemented his status as a writer. Naturally, his experience formed a prism through which he seeks to explain later events. And there could very well be an awful lot of truth in that one simple premise: once risk was transferred to shareholders, Wall Street was freed to take ever-increasing (and ever-more-idiotic) gambles with vast sums of money.

However, I'd like to think it was just a little more complex than that. Historians are well aware that significant events often transpire through unexpected coincidences, producing unforeseen results. Never rule out dumb luck when it comes to making history.

The thing that always amazes me is just how fluid history really is. Events we were so completely sure of when our high school textbook declared, "This is how it happened!" often merit further review and differing opinions. Even without going nutso on the concept of Political Correctness, there are no shortage of revisionists who challenge and deny the most basic factual understandings. For as many people who saw airplanes crash into the World Trade Center twin towers on 9/11/2001, there are an almost equal number of people who believe the U.S. government or Israel was responsible. Perhaps more than equal. Scary thought.

Regarding the current economic and financial crisis we seem to find ourselves in, I have to think that there were other circumstances, other events that contributed to the crisis. The entire mess can't all be tied back just to taking Salomon Brothers public, can it?

Despite all the talk of how hard it is to find and raise capital, my own perspective is that there was too much capital sloshing around the system ever since the mid-'90s. So much money was flowing through the system, the hedge fund managers, the financiers, and the investment bankers all felt compelled to take ever larger risks with their clients' money to find a "suitable" return on the investment. Even here in east-central Illinois, I knew of at least three or four Venture Capital firms, all looking for the next Mosaic (Netscape) Internet technology firm to spring from UIUC.

Speaking of the hedge fund managers, more and more people NOT worth millions of dollars felt compelled to get into these investment clubs, hoping to find a decent rate of return while hedging their bets. Sadly, the mathematical models based on quantitative statistical analysis favored by hedge fund managers all seemed to follow the same patterns, so very little hedging was actually accomplished. Certainly, no one had a broad, general market melt-down built into the statistical models.

I often wondered what would happen if (or when) the Baby Boomers decided they would pull their retirement savings out of stocks and move it into more conservative investments. If the constant inflows of new money helped to drive stock prices up, thereby driving Price to Earnings (P/E) Ratios higher during the '90s and mid-'00s (a simple result of supply being outpaced by demand), then the reverse would be true if outflows exceeded inflows on all those 401(k) and IRA mutual funds, right?

At any rate, I think this financial crisis is probably larger than any one factor, any one explanation. Exploring the byzantine world of financial derivatives, including Collateralized Debt Obligations (CDOs), is enough to make any one's head spin, including Lewis and Gutfreund. If those guys couldn't understand how all that money was being invested, what hope do any of the rest of us have? We might as well be giving our money to the Bernie Madoffs of the world.

And yet, perhaps Lewis is right. Perhaps, in this case, the principle of Occam's Razor applies. All of these other issues could be just compounding factors based upon Lewis' rather simple premise. It's certainly food for thought.