Banks Are Not Eternal

15. 3. 2017

Michael Lewis, Boomerang: Travels in the New Third World. W.W. Norton & Co., 2011

In 2008 Kyle Bass, an investor who had made a fortune having predicted the crash on the subprime mortgages market, was looking for new opportunities. The first shock came when he tried to get a grip on the situation: for example, no one was able to assess for him the ratio between revenues of a given country and the size of its banking sector. No one was interested in that. Gathering absolutely basic data took him four months. The second shock was brought by the final calculations: Irish debt was to the tune of 25 years of fiscal revenues while for Spain and France it was more than 10 years. It was difficult or rather impossible to believe that. So Bass showed his data to Keneth Rogoff, a great economist and the best expert in the world on sovereign bankruptcy. Rogoff also did not believe in what he saw. Today we have no trouble believing.

The American philosopher John Searle once presented a brilliant theory saying that facts may be divided into two fundamental categories: brutal facts and institutional facts. Brutal facts are facts the existence of which is imposed on us by reality itself—no sane person would claim that a wall standing in front of him or her did not exist. Social facts are facts the existence of which requires consent—if we do not subscribe to the opinion that given words form a marital vow, which in its turn is a kind of contract, the marriage has not been concluded. And here we turn to Boomerang. As Michael Lewis reminds us, the existence of a bank or the whole banking system is based above all on an act of faith—if we stop believing in the system, we condemn it to failure (people withdraw their deposits and the run makes the bank fall). In other words, in Searle’s classification a bank is an institutional fact.

The current financial crisis is explained in an infinite number of ways. Lewis’s book suggest one more—quite new interpretation—of which he is perhaps not aware. Under this interpretation the crisis would be the result of a cognitive blunder: we had been treating an institutional fact as a brutal fact. We had mistakenly assumed that the banking system or government finances are more remindful of a stone wall than a marital vow.

Boomerang speaks about countries which due to their colossal debt in many respects slipped from the category of “very rich” (before the crisis Iceland was the leader in the Human Development Report, in the early 21st century Ireland was the second richest country in the world according to the Bank of Ireland) to the category “Third World country” (business risk in Ireland was higher than in Iraq in 2011). But Boomerang also has its invisible protagonists: investors who made very small investments guaranteeing huge profits if a state went bankrupt. For example, 1,100 dollars paid for insurance of Greek bonds worth one million dollars could bring some 700 thousand dollars if Greece would have problems with paying up. In short, the architects of the market designed it in such a way that for many investors a crash was in fact the best possible outcome (it is as if we produced a penal code in which there would be a premium on murder, rape and theft). Of course, the architects of the market did not do it deliberately. There was no conspiracy of bankers. They had simply made a mistaken assumption that the banking system or government finances were something much more than a social contract. They believed that banks must survive regardless of the circumstances.

The same naïve faith may be observed on the other side of the barrier, that of the indebted states. Icelanders, the Irish, Greeks and Californians exhibited a rock-solid faith in the indestructibility of the banking system. They assumed that regardless of what they do, the system would persist. For the banking system is like God. Or a car which emerges without a scratch from a 150 m/h crash test. As we know, such car does not exist. Despite their complete lack of experience in the investment sector, Icelanders came to the conclusion that they were born for this activity. A country with population equal to that of Peoria, Illinois, had become a centre of world finance. For a very short period—for the Iceland financial miracle was based on very fragile foundations. Valueless or outrageously overvalued assets were bought with borrowed money and then, of course for larger sums, resold within the newly founded financial family in Iceland (“It is a bit like we made an agreement that my cat was worth a million dollars and your dog too,” explains one of the people interviewed by Lewis). The results were to follow soon—in 2008, banking losses in Iceland were about 100 billion dollars, that is roughly 330 thousand dollars per capita, including infants. As for the Irish bankers, they had come to the conclusion that investments in the real estate sector offer a great opportunity for them. In 2007, Irish banks lent to developers 40% more money than to all inhabitants of Ireland (companies and private persons) in 2000. This is a ridiculous figure—in the EU, just 8% of all loans are taken for purchasing or building real estate. And one rather important fact was overlooked: that no one needs or will need these houses. In Greece the banking sector was sound, but the crazed government run it into the ground, for in line with its clientelist logic it offered gifts to all and sundry: before the crisis the Greek national railways earned 100 million euro and spent 700 million euro (average yearly salary was 65 thousand euro).

We know how it ended. Icelanders, Greeks or the Irish learned the lesson about the impermanence of banking systems. And what lesson was absorbed by those for whom until recently a crash was a happy ending—for it produced the largest profits? Their behaviour during the Spring instalment of the Greek crisis, when under the terms of the “haircut” they voluntarily renounced a large part of the money they had been owed seems to show that they understood quite a lot. They realised that today’s financial market is remindful of nuclear weapons. Perhaps we have entered an era of successful deterrence in world finances. An era of awareness that the death of EU countries would also kill the banks.

Maciej Nowicki

Maciej Nowicki is Deputy Editor In Chief of Aspen Review.

Share this on social media

Support Aspen Institute

The support of our corporate partners, individual members and donors is critical to sustaining our work. We encourage you to join us at our roundtable discussions, forums, symposia, and special event dinners.