Panic! The Story of Modern Financial Insanity

Thomas Carlyle famously dubbed economics “the dismal science,” and the name has stuck. But nothing can be dismal in Michael Lewis’s hands. With his books on money and finance, which include the fabulously entertaining bestsellers Liar’s Poker, The Money Culture, and The New New Thing, he made even readers whose eyes normally glaze over at the mention of credit default swaps or collateralized debt obligations sit up and enjoy themselves.

The idea for Panic! The Story of Modern Financial Insanity was conceived by novelist and McSweeney’s editor Dave Eggers, who suggested to Lewis that he put together a collection of newspaper and magazine articles on the subject of modern market crashes, beginning with Black Monday, 1987. The resulting book covers four panics: that of 1987; the Asian crisis of the late 1990s; the explosion of the Internet bubble; and the current subprime mortgage collapse — at least so far, for the story is hardly over. “Each section,” as Lewis says, “opens with a piece or two that captures the feeling in the air immediately before things went wrong. It then moves on to the many attempts to come to grips with the strange and unexpected seeming disaster that just occurred.” Writers in the collection include, along with Lewis himself, experts like Joseph Stiglitz, Paul Krugman, John Cassidy of The New Yorker, Franklin Edwards of Columbia University, Robert J. Shiller of Yale, and the humorist Dave Barry. All the writers have been chosen not only for their erudition and intelligence but for their readability and the easy accessibility of their language as well. Even econo-dolts will understand what they’re talking about.

“Financial panics have become almost commonplace,” Lewis notes in his introduction; “events that are meant to occur once in a millennium now seem to occur every few years. Could this be because the financial system was built on an idea that badly underestimates the risk of catastrophes — and so conspires with human nature to create them?” He dates this syndrome to the crash of 1987, which he calls the beginning of the Age of Financial Unreason, and suggests that that event did not mark the end of something but the beginning of something else, something we are still groping to come to terms with.

What caused the crash of ’87? Steven Koepp of Time remarked nervously, two months prior to the event, on “the seemingly relentless bullishness of the market”; financier Leo Melamed, after it was over, recalled “a mixture of fear, greed, and concern that was combustible.” Lester C. Thurow’s analysis of the meltdown as “the product of herd panic, not so different from the sudden panic that occurs among herds of antelope on the plains of Africa,” is rather surprisingly borne out by a fascinating article by Robert J. Shiller in The Washington Post in April 1988. A survey that he presented to a representative group of investors clearly indicated “that the market does have a certain ‘life of its own,’ and that in explaining October 19, the dynamics of investor thinking and behavior were more important than economic fundamentals.” The single biggest factor in the crash, in fact, appeared to be a reaction to price declines themselves, creating a vicious circle in which price declines fed on previous price declines, with respondents all too often citing ‘gut feeling’ as their primary forecasting method. Michael Lewis, who at that time was a young trader at Salomon Brothers, remembers the widespread feeling of helplessness that day as he and his colleagues sat there watching the numbers fall. “It was striking how little control we had of events,” he remembered, “particularly in view of how assiduously we cultivated the appearance of being in charge by smoking big cigars and saying fuck all the time.”

There was more than enough pain to go around, but there was also a certain Schadenfreude over the troubles predicted for the widely disliked Yuppies. Trend prognosticator Faith Popcorn voiced the general idea: “One house, one car, one raincoat — that’s what it’s going to be.” How could she — and we — be so wrong? Black Monday turned out to have had no serious consequences at all, and the greed that was considered a marker of the 1980s was only just beginning the huge acceleration that went on for another 20 years. Nineteen eighty-seven, and the Asian crisis of a decade later, marked “the rise of the ever more highly mobile financier, running ever more highly mobile money?. Obviously the poor guy in Thailand who lost his company doesn’t think of his crisis as a Wall Street subplot. But on Wall Street, that’s what it was.”

The Internet bubble introduced a new phenomenon to Wall Street. “The Internet formula for success,” Lewis writes, “turned traditional capitalism on its head. Traditionally a company persuaded people to invest in it by making profits. Now it persuaded people to invest in it first, and hoped the profits would follow?. In this new world skepticism was not a sign of intelligence. It was a sin.”

And what did we learn from it all? Not much; each crisis, different in itself, seems to fit a certain psychological pattern. There is chaos, upheaval, loss, radical changes in status and fortune. “The guy out in the wilderness who had been saying for the past four years that the good times were an illusion and a sham is wheeled in to take a bow and then hustled off stage, so that everyone else can regroup, and the whole process can start over again.”

Our current crash is just different enough from those that have preceded it to make it difficult to draw comparisons. It could have been foretold, and a few people did so: John Cassidy’s “The Next Crash,” for example, published in The New Yorker in November 2002 and included here, is extraordinarily prescient. Yet economists, politicians, and pundits are now floundering. Perhaps the problem is that economics is not really a science — or if it is a science, it is one whose laws are still largely mysterious to us, and one adulterated by human behaviorthat, in spite of what Adam Smith wrote about rationalism and enlightened self-interest, does not seem to be either rational or enlightened. Lewis is correct to stress “the limits of reason in human affairs,” remarking (of the Asian crisis) that financial analysts’ “attachment to higher reason was a great advantage only as long as there was a limit to the market’s unreason. Suddenly, there was no limit.”

But it seems that even irrationality cannot be counted on, for as Paul Krugman points out, the current panic is quite a rational one: there is a lot of bad debt out there. So how do we learn from the past? How can we apply a knowledge of previous booms and busts to the precarious present? Lewis’s collection does not propose any answers, alas; but it does explain many murky points, and in a most entertaining fashion.