MONEY MANIA
Bob Swarup
Bloomsbury India
311 pages; Rs 499
"Those who cannot remember the past are condemned to repeat it."
- George Santayana
The recent international financial meltdown following the failure of two hedge funds owned by the US investment bank Bear Stearns and the subprime crisis has spawned a large number of books that review similar episodes in the past, in an effort to trace the common threads through them and the lessons to be learnt. Bob Swarup's book belongs to this genre. He has organised the material not by chronology but around common human foibles. It deals with 25 centuries of financial bubbles, investment manias and human folly with historical details relating to the period from ancient Rome to the crisis of 2008. As the blurb on the back cover says: "Greek bailouts of the fourth century BC, the collapse of the Roman Empire, the Dutch love affair with tulips, bicycle and railroad booms in the 19th century, the Great Depression, the brief ascent of the Japanese to the Hollywood villain totem pole, virtual bank runs in cyberspace - each of these phenomena becomes a lens into human nature helping us understand why financial crisis seems to occur with such regularity and why we never seem to learn."
The episodes have one thing in common: they involve people. The collective emotions of hope, greed and fear ebb and flow over time, creating the booms and busts that we call cycles. The psychological factors are invariant in every recurrent episode of financial euphoria, panic and denial - whether it is Greece in the fourth century BC or in the 21st century AD. As the system becomes more complex and leveraged, its capacity to deal with even minor shocks rapidly declines. What is remarkable about financial crises is that so many miss the signs that are all too obvious in hindsight. Complexity is one part of the answer.
There are 17 chapters in the book, organised under five parts: "Dejà vu all over again"; "Man: the furnace within"; "Money: The catalyst without"; "Complexity: the alchemy of crisis"; and "Lifting the veil". In the first part, the author details the crises from Roman times to the Japanese bubble. Then he endorses the view of Paul Volcker, former US Federal Reserve chairman, that among the causes of the recent financial crisis was an unjustified faith in rational expectations, market efficiencies and the techniques of modern finance.
In the second part, there is a discussion of the human nature that leads to booms and busts. Dependence on the past to predict the future aggravates the mania. Ponzi schemes are well explained. The third and fourth parts deal with money, credit and leverage, and the growing complexity of the financial system that leads to booms and busts.
In the last part, the author comes to several conclusions based on his analysis. The most important of these are: (a) no institution is too big to fail; (b) we need to restore failure as an option at all levels; (c) our understanding of the role of money and credit in an economy needs to be reassessed; (d) institutions need to encourage heterogeneity and diversity across the economic ecosystem; (e) the role of regulatory oversight needs to change; (f) flexibility and countercyclical mechanisms should be created; and (g) the fetish for gross domestic product should be given up.
Many strands of thought in the book are illuminating, but there are a few with which one may not agree. The author argues rather provocatively that financial meltdowns are part of life, but our strategies to cope with them are increasing their frequency. Though he has not explicitly said so, he seems to agree with the Greenspan thesis that it is better to allow the financial bubble to burst and then pick up the pieces rather than take any action while it is growing. I understand that Alan Greenspan, former Federal Reserve chairman, made the comment in the context of the fact that we do not know when a bubble is being formed or progressing, and any action could be counterproductive. But today, with the abundance of data and information from various sources and analytical tools, is it really difficult to distinguish the chaff from the grain? Obviously, the author feels that regulation is a hopeless task, given the frailties and limitations of human nature. And his argument that complexity cannot be counterbalanced by complexity is difficult to accept, especially when one lesson from the recent financial crisis is the myriad ways that market operators use to get around simple regulations. One instance is that of the innovation of the credit default swap. Even today, no one seems to know the real magnitude of the underlying amount - running into trillions of dollars - and who owes how much to whom.
However, there is one contradiction in an otherwise well-documented story of booms and busts. On page 268, the author says: "However, the failure of almost no hedge fund has threatened to destabilise the system. It is because, first, hedge funds know that there are no rescuers waiting in the wings; and, second, they are too small to impact the system in more than a localised way." In the endnote, he has qualified the statement, pointing out the exception of Long-Term Capital Management in 1998. Yet, at the very beginning of the story (page five), he refers to how the subprime crisis began through the collapse of two overleveraged hedge funds owned by Bear Stearns.
