Review by Michael Smith

The stats quoted by John Lanchester in Whoops!, his excoriating book about the financial crash of 2008, are simply staggering. By June that year, the size of the market in derivates, the complex financial instruments devised by the banks to spread the risk of lending in the mortgage market, was estimated at $54 trillion, ‘close to the total GDP of the planet and many more times more valuable than the total number of all the stocks and shares traded in the world’. Later in the book he reports that the market in Credit Default Swaps was, by the end of 2007, worth $62 trillion. And in London, the global HQ of the derivatives market, the average turnover of over-the-counter derivates ‘peaked in 2007 at a value of £2,105,000,000,000 (that’s $2.105 trillion) every day. That’s right: every day.’

Yet, staggeringly, ‘there is no central register of CDSs, and no body capable of assessing and managing market wide-risks.’ So when mortgage borrowers, some with no income, no jobs and no assets--the so- called ‘ninja’ borrowers in the sub-prime mortgage market--began to default on repaying their loans, it was no wonder that the whole edifice unravelled so dramatically, with such painful consequences for governments and tax payers who had to bail out the banks.

The banks simply froze their lending to one another. ‘It’s like a game of pass-the-parcel, in which nobody knows who’s actually holding the parcel, much less what’s going to be found inside it when it is unwrapped,’ comments Lanchester laconically. Banks simply stopped passing the parcel. ‘Many individuals thought that debt and leverage were running at dangerously high levels. But the trouble was that nobody felt a need to own the problem.’

Deregulation, pushed by the banks, had been the mantra since the Ronald Regan era and the end of the Cold War, so much so that regulating agencies such as the USA’s Securities and Exchange Commission and London’s Financial Services Authority simply failed in their duty. ‘The current crisis was caused by the banking sector’s excessive influence on US government policy,’ writes Lanchester, including the abolition in 1999 of the 1933 Glass-Steagall Act, which had separated the investment (or ‘casino’) banking from commercial, or retail, banking. Yet, ‘legislators had next to no idea what derivates were or how they worked.’ In the post-Cold War world, Lanchester comments, ‘the free market became a kind of secular religion’.

The bankers became the high priests of a disastrous ideology, based on money, profit and excessive greed. ‘Banking,’ comments Lanchester, ‘is all about the management of risk; and in this central respect the bankers massively failed. They did so by relying on mathematical models that they themselves didn’t fully understand.’

The title of Lanchester’s book is of course classic British tongue-in-cheek understatement. The book might have been called OMG (Oh My God, for the uninitiated). It is subtitled ‘Why everyone owes everyone and no one can pay’. His book is by far the best and wittiest introduction to the financial crash and the world of banks and financial markets, for those who want to understand how close the world came to a global catastrophe and why.

Lanchester, a London-based journalist, tells with dry and barbed humour about those who invented the complex mathematical instruments called derivates (they were pioneered by a team of mathematical whiz kids and financial analysts, known in the trade as quants, at J P Morgan), and he catalogues how the whole disaster came about: ‘The credit crunch was based on a climate (the post-Cold War victory party of free-market capitalism), a problem (the sub-prime mortgage market), a mistake (the mathematical models of risk) and a failure, that of the regulators.’

As he points out, ‘a 20 per cent drop in US house prices, not on the face of it an extraordinarily unlikely thing, was enough to cause a global banking crisis that nearly destroyed the entire system followed by a global recession, verging on depression. So why didn’t more economists seem aware of that possibility?’ The mathematical models of probability were simply wrong.

Lanchester is very good on the psychology of banking and bankers who live in a bubble of their own: ‘Artists, sportsmen, surgeons, plumbers and the rest of us have secret voices of doubt, inner reservations about ourselves, but if you go to work with money, and make money, you can be proved right in the most inhumanly pure way. This is why people who have succeeded in the world of money tend to have a high opinion of themselves. And this is why they seem to regard themselves as paragons of rationality, when others often regard them as slightly nuts.’

Moreover, ‘bankers’ pay structures rewarded them when things went up, but did not punish them when things went down. That, added to the fact that so much pay came in the form of bonuses, encouraged a culture of gambling on big returns in good years. The good years were total bonanzas. As for the bad years, they didn’t have to pay any money back: the bankers were so well paid that there was in effect no downside.’ The levels of recent bank bonuses, he says, are ‘unconscionable’.

In the end, Lanchester concludes that ‘in fields such as education, equality of opportunity, health, employees’ rights, the social contract and culture, the first conversation to happen should be about values and principles; then you have the conversation about costs, and what you as a society can afford. In Britain in the last twenty to thirty years that has all been the wrong way round. There was a kind of reverse takeover, in which City values came to dominate the whole of British life.’

He continues: ‘The credit crunch could have been a moment to reflect on that. We in the West can do something that no people in history have done; we can show the world that we know when we have enough. As the planet runs out of resources, due mainly to the fact that everyone on it wants to live an equivalent lifestyle to those of us in the west, this lesson would have the potential to save the world.’ In a world running out of resources, he says, ‘the most important ethical and political and ecological idea can be summed up in one word: “enough”.’

Sadly, it’s a lesson we simply haven’t learnt. Indeed, the great danger is that we’ve learnt nothing. Without legislation against the excesses of casino banking, or indeed prosecutions for wrong-doing, a further financial crash could happen all over again.

‘Whoops!’ by John Lanchester, Penguin Books, 240 pages, paperback, ISBN 978-0-141-04571-9