What ‘Inside Job’ got wrong
I finally watched “Inside Job” this weekend. It was an excellent documentary for people who don’t want to understand the financial crisis but want to believe they would’ve seen it coming. Watching it, you’d think that the only people who missed the meltdown were corrupt fools, and the way to spot the next one is to have fewer corrupt fools. But that’s not true. Worse, it’s dangerously untrue. In telling the wrong story about how the financial crisis happened, it misinforms about how to keep it from happening again.
Michael Lewis is author of “The Big Short,” which many people consider the best book on the financial crisis. In a way, it’s a natural companion to “Inside Job”: where the documentary looks at all the people who got it wrong and asks how they possibly could have missed a crisis so obvious, “The Big Short” chooses a handful of people who got it right and asks how they were able to see a crisis everyone else missed. But the most telling piece Lewis wrote on the crisis wasn’t after it happened. It was before.
In 2007, Lewis wrote a piece mocking the worrywarts trying to sound the alarm at Davos. “Davos,” he wrote, “is where people with no talent for risk-taking gather to imagine what actual risk-takers might do.” The problem with trembling doomsayers like Nouriel Roubini was that “none of them seemed to understand that when you create a derivative you don’t add to the sum total of risk in the financial world; you merely create a means for redistributing that risk.” The reality, Lewis said, is that “the financial markets in 2007 are astonishingly robust. They seem to be working out how to absorb and distribute risk more intelligently than any member of the global economic elite could on his own.’’ Later that year, of course, the financial markets collapsed.
I’m not trying to pick on Michael Lewis. He’s the best financial journalist, and arguably the best narrative journalist, working today. He’s a smart guy, a brilliant reporter and a clear thinker. He knows financial markets, knows the people in financial markets, and knows the products in financial markets. But he missed it. Completely. And no explanation of the financial crisis that doesn’t have room for Lewis to miss it is sufficient.
There’s a lot to dislike about Wall Street. The pay. The culture. In many cases, the people. But that doesn’t explain what happened in 2007 and 2008. A lot of observers understood we had a housing bubble — Dean Baker, for instance, had been sounding the alarm for years — but few of the housing skeptics saw everything going on behind the bubble: That the subprime mortgages had been packaged into bonds, that the bonds had been sliced into tranches, that the formulas being used to price and rate the tranches got the variable expressing correlation wrong, that an extraordinary number of banks had purchased an extraordinary amount of insurance against getting that correlation wrong from AIG, that AIG had also priced the correlation wrong and would be unable to pay its debts in the event of a meltdown, that a meltdown would freeze the mostly unregulated shadow market that major financial institutions and players used to fund themselves, that the modern financial system was so fragile that an uptick in delinquent subprime mortgages could effectively crash the global economy.
What’s remarkable about the financial crisis isn’t just how many people got it wrong, but how many people who got it wrong had an incentive to get it right. Journalists. Hedge funds. Independent investors. Academics. Regulators. Even traders, many of whom had most of their money tied up in their soon-to-be-worthless firms. “Inside Job” is perhaps strongest in detailing the conflicts of interest that various people had when it came to the financial sector, but the reason those ties were “conflicts” was that they also had substantial reasons — fame, fortune, acclaim, job security, etc. — to get it right.
And ultimately, that’s what makes the financial crisis so scary. The complexity of the system far exceeded the capacity of the participants, experts and watchdogs. Even after the crisis happened, it was devilishly hard to understand what was going on. Some people managed to connect the right dots, in the right ways and at the right times, but not so many, and not through such reproducible methods, that it’s clear how we can make their success the norm. But it is clear that our key systems are going to continue growing more complex, and we’re not getting any smarter, or any less able to ignore risks that we know we should be preparing for. “Inside Job” may have missed that story, but the rest of us can’t afford to.