Liquidity, Default, Risk
Roy Edroso Looks into the Abyss of Stupidity

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Review of 'Panic!,' edited by Michael Lewis:

Review of 'Panic!,' edited by Michael Lewis: The Story of Modern Financial Insanity: W.W. Norton; 391 pages; $27.95:

Over the past 16 months, the financial crisis of 2007-9 has gone from a potential worry to a cold to the flu to galloping pneumonia. And now W.W. Norton publishes a book with Michael Lewis' name on the cover that tells us that we should PANIC! Don't think that this is a book written by the smart, thoughtful, lively and witty Michael Lewis, who made his reputation with "Liar's Poker," his memoir of working as a bond salesman on Wall Street in the 1980s. Only eight of the 50-odd short-form pieces collected in the near-400 pages of this book are by Lewis. Do think of this as Lewis' answer to the question: What good, short and comprehensible things should I read if I want to understand our modern financial crisis? And Lewis' answer is a very good one: He has an excellent eye, and what he likes, we readers will like as well - at least if we like to read him, and I do.

Over the past quarter century we have seen some half-blown (Mexico, saving and loans) and four full-blown financial panics: the portfolio-insurance U.S. stock market panic of October 1987, the East Asian financial crisis of 1997-8, the 2000-2001 collapse of the dot-com bubble and the current real-estate-triggered mess. Lewis collects the newspaper and short magazine pieces on each of these four that he thinks offer the most insight and interest, and packages them in a book. It's very handy, very readable - and you can learn a huge amount.

My one serious complaint is that it is a book. That means that only one-tenth of the material comes from 2008 - the last-written piece was first published on April 27. A lot has happened since then. Right now I have the book at my left hand and my laptop at my right, with one window open to one of Lewis' Bloomberg columns about the crisis ( and another open to his excellent piece of reportage "The End of Wall Street's Boom" for the December issue of Portfolio ( As a person interested in the panic now and in the future, I find my computer more interesting. On the other hand, I can take the book into the bathtub - so it still has one key edge, even though its production process sacrifices timeliness.

What is Lewis' take on the current crisis? His first arresting point is that this is something that we have done to ourselves rather than something that shadowy villains have done to us. "The striking thing ..." he writes, "is how egalitarian it has been. ... Stan O'Neal, the former CEO of Merrill Lynch, was fired for the same reason the lower-middle-class family in the suburban wasteland between Los Angeles and San Diego may have lost its surprisingly nice home. Both underestimated the likelihood of an unlikely event: a financial panic. ... The small army of Wall Street traders ... look as naive and foolish as the man on the street. ... The man on the street ... acted on the same foolish principles that have guided ... Wall Street traders."

His second arresting point is that all of the attempts to manage risk have done so by applying a mathematical theory of finance that is guaranteed to break down when a panic actually comes and when real risk is there to be managed. Lewis quotes John Seo of Fremont Capital saying: "It's hard to believe that anyone - yes, even me - ever believed it [the theory]. It's like trying to [replace] a fire-insurance policy by dynamically increasing or decreasing your coverage [bet that there will be a fire] as fire conditions wax and wane. One day, bam, your house is on fire, and you call for [someone to sell you] more coverage?"

His third arresting point is that it was the confidence that the models could manage risk that has in fact created the kinds and sizes of risk that the models certainly cannot manage.

The hope is that the fallout will be relatively small. A few million homeowners who thought they were building equity and find instead that they were running risks that they had no business running and have really been renting - some cheaply and some expensively - for the past few years. Rather more investors nearing retirement who find that the S&P index funds in their 401(k) accounts are worth only half what they expected 18 months ago. Some princes of Wall Street with still-outsize fortunes that are much smaller than they had gotten used to looking forward to. Some tens of thousands of yuppies expecting high-paying finance jobs who find that they are not there. And a few million more workers unemployed for a year or two than if we had regulated our financial markets properly and so headed off the possibility of this crisis before it came to pass.

The hope is that the government has the tools and the energy and the smarts to keep this a garden-variety recession - and not let it turn into a semi-great or even a small depression.

That's the hope.

J. Bradford DeLong is a professor of economics at UC Berkeley, a research associate of the National Bureau of Economic Research and a former deputy assistant secretary of the Treasury. E-mail him at

This article appeared on page M - 1 of the San Francisco Chronicle