Entertaining Lessons in Finance from This Tour of Battered Economies

Entertaining Lessons in Finance from This Tour of Battered Economies
January 20, 2012

Jay Lehr, Ph.D.

Jay Lehr, Ph.D. (jlehr@heartland.org) is science director at The Heartland Institute, an... (read full bio)

Review of Boomerang: Travels in the New Third World, by Michael Lewis (W.W. Norton & Company, 2011, $25.95), ISBN 978-0-393-08181-7

I promise you will easily learn more about international finance between the covers of this book than you ever thought possible.

Michael Lewis is perhaps best known for his books that have become movies, namely The Blind Side and Moneyball. It is his penchant for telling great nonfiction stories that has enabled him to relate this amazing tale, which got its start while he was researching the U.S. financial debacle that began in 2008. Lewis learned a special few persons became very rich amid the insanity on Wall Street, where some clever people had invented financial instruments that made no sense, sold them to people who believed they did make sense, then took the opposite side of their bet.

No insurance company can legally sell you fire protection on another person’s house, but the financial markets can and will sell you insurance on another person’s investments. They are called credit default swaps. One prescient young man in Texas bought such insurance for $1,100 per unit, which paid him $700,000 per unit when things went bad for those he bet against. He became a billionaire.

There to Here

Research for his earlier book. The Big Short, was done primarily by talking to lots of people both smart and not so smart. This led his editor to ask him to jaunt around the world and find out what was going on abroad. His itinerary of Iceland, Greece, Ireland, Germany, and then our own headed-to-economic-Third-World-status state—California—makes for the most exciting and informative travelogue you are likely ever to read.

His odyssey began in Iceland, whose recent economic story you may have read about in publications including The Wall Street Journal. Iceland is a comfortable country of 300,000 persons, where cod fishermen and others realized they could borrow money in Japanese yen and Swiss francs at 3 percent and lend them in Icelandic krónur at 15.5 percent. They made fortunes in krónur and bought everything in sight in Iceland—until the house of cards collapsed.

Riches to Rags

The krónur became worthless, and Icelanders stuck with them had no way to pay interest on their Japanese and Swiss loans. It is a story of not rags to riches, but riches to rags. Every successful fisherman became a banker and now a much poorer fisherman.

Part of Iceland’s problem stemmed from an amazing naïveté among its politicians and educators. Iceland is one of the most fascinating countries on the planet, rich in cod and geothermal energy and not much else. It was a center of the 2008 economic bubble, and Lewis tells Iceland’s story with such warmth that you will think you are seeing it on TV.

Beyond Bailout

He lands in Greece, quickly to be overwhelmed by disbelief at a government that pays its workers three times what the private sector pays, a railroad that costs €700 million a year to run against revenues of €100 million and pays average annual salaries of €65,000, an education system considered the worst in Europe, a private sector that totally avoids paying taxes (there is a cottage industry of folks helping others avoid taxes), and early retirement pensions for persons in cushy jobs such as hairdressers, radio announcers, waiters, and musicians.

The story is astounding and quickly makes the reader understand the hopeless bankruptcy of that nation and the lack of any sound reason to bail it out. It is obvious why the Greeks salivated over the opportunity to trade their worthless drachmas for valuable euros. Their real debt was long hidden by those benefitting from it, including Goldman Sachs, which in 2001 engineered a loan of $1 billion dollars, from which Goldman Sachs carved out a fee of $300 million.

It was not until an ancient monastery of astute monks gamed the Greek financial system for billions of dollars that the system unraveled in plain view because at last the public became incensed. You will read no better spy novel than this. Lewis leaves Greece with a sober assessment of their chances

Boom and Bust

Then it’s on to Ireland, where Lewis discovered the remnants of a condensed boom and bust cycle that went so fast from rags to riches and back that it never went through a period of normalcy. The 1990s found land prices dirt cheap, a government offering low corporate taxes and free public education, a birth dearth leading to a high ratio of workers to non-workers, and an influx of 250,000 Polish workers, which to Ireland was the equivalent of 17.5 million immigrants to the United States.

The banks loaned so much money for housing that eventually Ireland had the highest homeownership rate in the world, 87 percent. This dwarfed the low-income housing boom in the United States.

In 2006 the unemployment rate in Ireland was 6 percent. When Lewis touched down there, it was 14 percent. Banks had loaned 40 percent of development costs. It was simply a national Ponzi scheme that worked when people thought it was sustainable and collapsed when they realized it was not.

Readers will find the path through the Irish banking debacle convoluted, but it becomes obvious that greed plus stupidity equals bankruptcy. Lewis weaves a childlike story of naive Irishmen building little communities in the middle of nowhere until the flow of money from the banks dries up, leaving communities of unfinished, never-lived-in homes.

Ireland’s banking laws, however, do not allow borrowers to abandon their upside-down mortgages. One day they will pay them off. In Greece, bankruptcy has led to public demonstrations of those unwilling to be left off the dole. In Ireland they are taking it with a stiff upper lip. The Poles have gone home, some Irish again are moving to the exit, but they will survive.

German Burden

Finally the author gets to Germany, where, if the European Union is to survive, they will have to pay the bill. His fascination with Germany is perhaps my only criticism of the book, because he tells the reader more than most will want to know. Lest you fail to buy this book, here is the story in a nutshell.

The Germans can afford to bail out all of Europe. Their population is fiscally conservative and never tempted by economic bubbles. The European Union was never a good deal for them because the deutsche mark was always worth more than the euro. Everyone benefitted but the Germans. And they have 3,400 tons of gold.

But will the Germans actually do it?

A condition of entering the European Union was for a nation to maintain a wide variety of fiscal restraint in measurable ways, but the facts show most governments cooked their books and gained admittance without changing their profligate ways. Are Germans responsible for their fellow Europeans or not? It is political suicide in Germany now to believe the former, which leaves Chancellor Angela Merkel on the hot seat.

Lewis writes, “For better or worse, the Germans now control the financial fate of Europe. If the rest of Europe was to continue to enjoy the benefits of what is essentially a German currency they’d need to become more German”. This is not likely.

An amusing part of the German story is that although the citizens maintain a conservative financial lifestyle, their bankers got caught in every get-rich scheme across the world with the possible exception of the Bernie Madoff scam.

California Like Greece

It is fitting that Lewis ends his sojourn through the New Third World in California, where a frenetic bicycle-riding interview through Santa Monica with former Gov. Arnold Schwarzenegger unearths the state’s major problems and how Schwarzenegger was swallowed by a system not unlike what Lewis found in Greece.

Lewis conveys the hopelessness of the current economic path by highlighting one of California’s richest cities, San Jose, and one of its poorest, Vallejo. In both cities government employee pension costs outweigh their potential tax and fee income.

If you are interested in economics on a large scale, enjoy a good read, and would look forward to showing your friends how much you know about international finance and the problems of the day, this book is a must. It will take you just eight hours to read its 212 pages, and every minute will be worth it.

Jay Lehr, Ph.D. (lehr@heartland.org), is science director of the Heartland Institute.

Jay Lehr, Ph.D.

Jay Lehr, Ph.D. (jlehr@heartland.org) is science director at The Heartland Institute, an... (read full bio)