Individual Responsibility and Financial Meltdowns

By now, most people in the blagosphere have read Matt Taibbi’s roller coaster piece in Rolling Stone on the financial crisis. It’s a fantastic read, macho and bombastic. I want to quibble with the article’s narrative, which starts and ends with greedy financiers and shameless Republicans taking over the government for the benefit of reckless robber barons, but it’s a standard narrative in the Left, and other people are more qualified than me to address that.

What really unsettled me was a recurring populist (and Lord knows I’m no enemy of populism in certain contexts), us-vs-them theme in the story, the subtext of which is, basically, that if you’re financially literate, you’re one of them. This makes the article actually impossible to argue with, since it states that if you disagree with Taibbi, you’re part of the problem because you’re, basically, contaminated by financial literacy:

Because all of this shit is complicated, because most of us mortals don’t know what the hell LIBOR is or how a REIT works or how to use the word “zero coupon bond” in a sentence without sounding stupid — well, then, the people who do speak this idiotic language cannot under any circumstances be bothered to explain it to us and instead spend a lot of time rolling their eyes and asking us to trust them.

Well guess what, I know how to use the word “zero coupon bond” in a sentence without sounding stupid (e.g. “It takes about thirty seconds to understand the difference between a regular bond and a zero coupon bond.”), and it doesn’t make me the enemy. And since I happen to think the world would be much better off if more people were financially literate, I’m concerned about people who argue that the more qualified you are about an issue, the less your opinion matters.

Imagine an article on some constitutional issue that declared that anyone who went to law school (guilty!) is unqualified to comment on the Constitution because lawyers speak this “idiotic language” and the rest of us can’t use the word “eminent domain” in a sentence without sounding stupid.

And the thing is: this shit really ain’t that complicated, Matt. I believe it takes many years of experience and a tremendous amount of knowledge and intelligence to run a bank or a trading desk, qualities that I don’t remotely possess, but I also honestly think that it isn’t that hard to understand broadly (a) how the financial system normally functions and (b) the outlines of the current crisis. People complain about the alphabet soup of CDSs and CDOs but it’s just not very hard to understand, in broad strokes, what these things are. In fact, Matt does a great job of explaining them, even though Wikipedia informs me that he has no educational or professional background in finance.

The reason I care about financial literacy is that with financial illiteracy comes a very serious disease: free lunch mentality.

This brings me to the second article I wanted to mention, by Michael Lewis in Vanity Fair, about Iceland’s meltdown (pun intended). Unlike Taibbi’s article, this one is almost flawless. It’s truly a beauty. Go read it now if you haven’t, and then come back.

…

All done?

As it relates to the point I’m trying to make, the story does a great job of showing how Iceland’s catastrophe is the byproduct of not just reckless bankers (although there certainly were those) but the entire population taking part in the carry trade, borrowing in one currency to buy another, to buy houses, cars, and basically anything else. But the thing is that it is the same people who are now rioting and protesting the government and lobbing death threats at bankers who, a year before, were taking on massive amounts of unsustainable debt. “Ah, but we were told it was safe! We got ripped off!” these people would doubtlessly respond. Well, if you were told… I have a very nice tower in Paris to sell you, beautiful iron latticework, it’s a bit old but it’s the tallest building in the city.

There’s a case to be made that sellers of subprime mortgages to at-risk people with low incomes and low education are mostly to blame when these people end up not being able to pay, but the Icelandic PhDs who took out euro-denominated loans to buy Range Rovers and the Viking equivalents of McMansions aren’t in the same category and, in my view, should have known better.

Some people have already made this point, which is that financial crises such as the one we’re in aren’t merely the fault of reckless bankers and asleep-at-the-wheel regulators (although to be sure there was no lack of those) but, in fact, the entire society. And this is because most of us are blinded by the human impulse to pursue a free lunch. House prices can only go up! There’s gold all over California! Or is it East India? It’s the reason we fall for scams and create financial bubbles. It’s hard-wired into our nature. But so is violence and humping anything that moves, and yet society has come up with mechanisms that keep these impulses in check most of the time.

But the thing is these bubbles create a backlash against finance. This is certainly bad for economic reasons, as stifling finance stifles the entire society. But I want to make the point that it also has a more subtle, but in the longer run perhaps even more damaging effect: to create a backlash against knowledge of finance. Which in turn sows the seeds of the next bubble, as we all lunge for the next free lunch.

Of course you could respond that the most qualified wizards at the best institutions also suffered from free lunch mentality, and that’s true. History is full of extremely intelligent, qualified people thinking and doing incredibly stupid things, from scientists in the early 20th century supporting crackpot racist “theories” to New Coke to Isaac Newton losing his shirt in the biggest financial bubble of his day. Yet you wouldn’t use that as an argument against education.

Most people often view finance, especially in the aftermath of crises such as this one, as some dark magic art, this realm of animal spirits that “most of us mortals” can’t and shouldn’t hope to understand. This is deeply unhealthy. Anyone who saves for retirement, takes out a loan to buy something, or has a bank account, or cares about his country (and his own balance sheet) not imploding a la Iceland, really ought to know a little bit about concepts like the time value of money and portfolio diversification.

It’s staggering to read the arguments Aristotle made against finance 2,500 years ago and read the rants today about these people who “make money out of money,” as if there was any other way, and trade “pieces of paper,” as if the cash in our pockets wasn’t pieces of paper with even less intrinsic value than a stock or a bond. It’s time to realize that finance is one of the greatest inventions of mankind, right there with fire and writing, that yes it blows up in our faces sometimes, but just as we didn’t round up all the physicists and shot them after we split the atom, we should realize that more knowledge and appreciation of finance, not less, is what is going to get us out of this hole (and the next one).