Extreme Money: Masters of the Universe and the Cult of Risk by Satyajit Das (2011)
This is a wildly funny and equally insightful book. Satyajit Das – with his encyclopedic knowledge, wide-ranging & esoteric references, and a razor-sharp wit – tells a spellbinding story of “money culture” and financialization of the world economy, starting in the latter half of the 20th century and leading up to the Global Financial Crisis. Das says, in this period money changed from a mechanism of exchange into something important in its own right – extreme money…which in turn created a powerful coalition of financiers, business interests, regulators, and politicians that increasingly dominated the economy. The book is punctuated with very funny anecdotes which are hard to capture in notes. I’d highly recommend reading this one.
Below are my notes –
• Max Weber, the father of social science, defined the state as the agency that successfully monopolizes the legitimate use of force.
• The strange thing is that gold has almost no value as a commodity and is not itself a great store of value.
• In the absence of the gold standard, there is no way to protect savings from confiscation through inflation.
• The banking system that evolved in the Renaissance survives remarkably unchanged to this day.
• Debt can be thought of as a monetized Ponzi or pyramid scheme. To be self-sustaining, the modern monetary system—printing money, reserve banking, and debt—requires a Darwinian scheme in which the only ones who survive are those who can induce others into even greater debt.
• Japan has the world’s largest pool of savings—estimated at more than more than $15,000 billion, built up through legendary frugality and thrift during Japan’s rise to prosperity after the Second World War.
• Following the 1929 stock market crash and the collapse of the banking system, the Glass-Steagall Act of 1933 separated commercial banking and investment banking. In 1999 the Act was repealed paving the way for financial supermarkets—one-stop money shops taking deposits, making loans, providing advice, underwriting and trading securities, managing investments, and providing insurance.
• In traditional banking, banks originate credits and hold them on their balance sheet until their maturity. Over time, however, banks began to replace the originate-to-hold model with the originate-to-distribute model, whereby they originate a credit and sell or securitize a portion of it at the time of origination or later.
• Banks decreased their equity and cash reserves, assuming they could always buy these resources from the market at a price in case of need—this came to be known as purchased capital and purchased liquidity.
• The Travelers/Citicorp merger would offer a one-stop-shop for payments, credit cards, mortgages, savings, and investment products. But as the baseball player Yogi Berra noted: “In theory there is no difference between theory and practice but in practice there is.”
• “The moment you cheat for the sake of beauty you are an artist.”
• An economic order where some nations save and others borrow this money to fund consumption, buying goods from the savers, is inherently unstable. China had effectively lent Americans the money to purchase its goods and now faced the prospects that the loans would never be repaid.
• In investing its reserves and savings heavily in dollars, China had stepped on a bounding mine, which does not explode when you step on it but when you step off.
• Friedmanites argued that Reagan and Thatcher’s policies reinvigorated the economy, paving the way for the Great Moderation. Coined by Harvard economist James Stock, the term referred to an era of strong economic growth, increased prosperity, and the perceived end to economic cycles and volatility.
• MIT economist David Durand argued that the new finance had “lost virtually all contact with terra firma…[being] more interested in demonstrating… mathematical prowess than in solving genuine problems; often…playing mathematical games.” Milton Friedman, sitting on Harry Markowitz’s doctoral dissertation committee, grumbled: “It’s not math, it’s not economics, it’s not even business administration.”
• The Modigliani-Miller propositions crucially introduced the irrelevance principle and arbitrage. They argued that the earnings of a firm were independent of financing decisions with the financing mix between debt and equity only determining how earnings were split between lenders and shareholders.
• Just as every art movement has its defining work, the Black-Scholes option pricing model is the masterpiece of financial economics. The Black-Scholes-Merton (BSM) option pricing model relied on the CAPM, itself reliant on the EMH, and arbitrage. While physicists searched, financial economists had arrived at their own version of the GUT (grand unifying theory).
• Theory should be judged not on its assumptions, but on the power of its conclusions. Karl Popper argued similarly that factual evidence could never prove a theory but could only fail to disprove it.
• LBOs are synonymous with KKR (Kohlberg, Kravis, and Roberts) and their $31.1 billion LBO of RJR Nabisco.
• LBO were about high levels of leverage—debt. Investors, financial sponsors, committed a small amount of the capital required to buy a company. The bulk was borrowed and repaid from the cash flow of the acquired business. The game was buying low and selling high, with other people’s money.
• LBO firms gobbled up quiet companies with reliable earnings and cash flow. Financial buyers and a stake for existing management and staff were attractive to a retiring generation of founders of family-owned businesses.
• In 1982, an investment group headed by William Simon, a former U.S. Treasury secretary, acquired Gibson Greetings, a producer of greeting cards, for $80 million. Some 16 months later the investors floated Gibson on the stock market for $290 million. Simon turned an investment of around $330,000 into approximately $70 million.
• The personal computer accomplished for Wall Street buyout boutiques what the advent of gunpowder did for Mongol warriors.
• Milken’s junk bonds became a high-octane fuel that transformed the LBO industry from a Volkswagen Beetle into a monstrous drag race belching smoke and fire.
• Rebranding LBOs as private equity was designed to distance them from the shameful history of Milken.
• Private equity firms paid themselves large cash dividends as soon as possible, sometimes from borrowings and asset sales, to improve returns. This was termed early return of capital; critics preferred strip mining.
• Securitization is a recipe for cutting and dicing debt into more debt. Like food recipes, securitization ranges from simple dishes to haute cuisine. The only ingredient is debt—mortgage loans, credit card loans, car loans, loans to companies, loans to people, loans to people who cannot pay, any loans at all.
• In the 1990s, securitization underwent a makeover, being rebranded CDOs (collateralized debt obligations), a term subsuming various types of underlying loans and securitization formats.
• In 1997 JP Morgan introduced synthetic securitization, overcoming the unwieldy need to transfer the underlying loans to the SPV and also lowering the cost of transferring the risk. Instead of selling the loans, the lender now purchased credit insurance against the risk of loss using a credit default swap (CDS).
• “Financial engineering is the science of structuring cash flows…credit analysis is the art of getting paid.”
• Investors relied on the rating agencies, who relied on banks, brokers, and various third parties to ensure the quality of the loans. Banks and lenders relied on the rating agencies. The brokers relied on the banks that were buying their loans and the investors buying the securities. Everyone relied on someone else to do their job.
• Bankers had not grasped painter Robert Motherwell’s observation that “the deep necessity of art is the examination of self-deception.”
• Peter Bernstein argued that: “The revolutionary idea that defines the boundary between modern times and the past is the mastery of risk: the notion that the future is more than a whim of the gods and that men and women are not passive before nature.”
• In the 1990s, Japanese companies and investors pioneered the use of derivatives to hide losses, a practice called tobashi (from the Japanese verb tobasu meaning “to make fly away”).
• Derivative professionals were taken in by an elegant vision of a scientific and mathematically precise vision of risk. As the English author G.K. Chesterton wrote: “The real trouble with this world [is that]… It looks just a little more mathematical and regular than it is; its exactitude is obvious but its inexactitude is hidden; its wildness lies in wait.”
• In June 2009, the global derivative market totaled $605 trillion in notional amount, up from less than $10 trillion 20 years earlier.
• In the global financial crisis, Buffett’s label of “weapons of mass financial destruction” was literal. After it filed for bankruptcy protection, Lehman was found to own enough uranium cake to make a nuclear bomb, acquired under a matured derivative contract.
• George Soros was honest: “I don’t have a particular style of investing or, more exactly, I try to change my style to fit the conditions…I assume that markets are always wrong… Most of the time we are punished if we go against the trend. Only at an inflection point are we rewarded.”
• Hedge funds do not measure the possibility of model failures when quantifying risk. They follow actress Tallulah Bankhead’s advice: “If I had to live my life again, I’d make the same mistakes, only sooner.”
• “There are those who know that they are in the game; there are those who don’t know they are in the game; and there are those who don’t know they are in the game and have become the game.”
• Amaranth was a $9.2 billion multistrategy hedge fund named after the Greek amarantos—“the never-fading flower.” In August 2006, Amaranth lost $6 billion, almost twice the loss when LTCM collapsed.
• What works on a small scale may not work on a larger scale. Some strategies need liquid markets. If you exploit inefficiency, then other investors must supply it. To be alternative, there must be a majority; the alternative cannot be the majority.
• The economist Hyman Minsky theorized that in the early stages of a business cycle money is only available to creditworthy borrowers, known ironically as hedge finance. As the cycle develops, financial conditions look rosy and competing lenders extend money to marginal borrowers, a phase known as speculative finance and ultimately Ponzi finance. The cycle ends in a Minsky moment when the supply of money slows or shuts off. Borrowers unable to meet financial obligations try to sell assets, leading to a collapse in prices that triggers a spiral of economic decline.
• Modern economies were built upon incorrect theories and flawed belief systems in a triumph of expediency over inconvenient truths. The brave new economy was built on debt.
• Charles Calomiris, an economic historian, wrote in 2008 that: “The most severe financial [crises] typically arise when rapid growth in untested financial innovations…[coincides] with…an abundance of the supply of credit.”
• The “Greenspan put” ensured that at the first sign of trouble central bankers flooded the system with money, lowering interest rates to protect risk takers. The strategy ensured successive, larger blow-ups in financial markets in 1987, 1991, 1994, 1998, 2001, and 2007.
• There are two superpowers in the world: there’s the United States and there’s Moody’s Bond rating service.
• Originally investors paid subscription fees for ratings information. Today, 90 percent of revenues are from issuers wanting to be rated.
• Harvard professor Eddie Riedl told his MBA class that “Accounting = Economic truth + Measurement error + Bias.” Accounting was now mainly “measurement error” and “bias”.
• Napoleon III: “We do not make reforms in France; we make revolution.”
• Sigmund Freud remarked that, “Illusions commend themselves to us because they save us pain and allow us to enjoy pleasure instead. We must therefore accept it without complaint when they sometimes collide with a bit of reality against which they are dashed to pieces”. The financial crisis was the reality on which the fake pleasure of the Great Moderation and the Goldilocks Economy was smashed.
• Greenspan’s Delphic obscurity and airbrushed history belied the fact that he wasn’t actually saying or doing much and had a term in office littered with mistakes.
• Greenspan’s genius was to grasp the need for an oracle to satisfy deep-seated longings for certainty and infallibility
• Keynes argued that models were weak expressions of conventional wisdom: “Like other orthodoxies it stands for what is jejeune and intellectually sterile; and since it has prejudice on its side, it can use claptrap with impunity”
• Keynes argued that “the difficulty lies not so much in developing new ideas as in escaping from old ones.” But as John Kenneth Galbraith realized, “faced with the choice between changing one’s mind and proving there is no need to do so, almost everyone gets busy on the proof.”
• (On Alan Greenspan’s selective amnesia about the events of Global Financial Crisis) He took the advice of author Gabriel Garcia Márquez: “What matters in life is not what happens to you but what you remember and how you remember it.”
• In the 1970s, Pierre Bourdieu, a French anthropologist, introduced the idea of habitus—how each society and culture orders its world subconsciously according to a cognitive framework based on its experiences. He argued that: “The most successful ideological effects are those which have no need of words but ask no more than a complicitous silence.”
• Sociologist Zygmunt Bauman’s metaphor of liquid and solid modernity captures the shift from a society of producers to a society of consumers.
• Finance and art share an abstract nature as well as constant debates about value and significance. Art was an expensive meta-object unrelated to anything else. It was self-referential, using itself as the point of departure and benchmark—it was the fact that it was an artist’s work that made it art. Modern money, too, was a meta-concept, capable of infinite expansion, circular and entirely trapped in its own ambiguous reality.
• The centerpiece of Soros’ philosophy is the idea of reflexivity. Markets do not tend toward equilibrium but feed on their own misconceptions to produce exaggerated price changes until they reach an inflection point when it changes. Soros suggests following the trend, selling as it reaches the peak.
• Iceland’s Kaupthing Bank, Landsbanki, Glitnir and the Central Bank were awarded the Ig Nobel Economics Prize, recognizing their work on how small banks could be transformed rapidly into big banks and vice versa. The Ig Nobel Mathematics Prize went to Gideon Gono, governor of Zimbabwe’s Reserve Bank, for printing bank notes with denominations ranging from 1 cent to 1 hundred trillion dollars to help Zimbabweans cope with hyperinflation.
• Keynes is always the economist for a crisis, providing desperate governments with the intellectual basis for massive and dramatic fiscal stimulus.
• When the facts are on our side, we pound the facts; when theory is on our side, we pound theory; and when neither the facts nor theory are on our side, we pound Keynes.
• Botox Economics: while the global financial crisis rolled on, a flood of money from central banks and governments, covered up unresolved and deep-seated problems. The prevailing thinking was from Will Rogers: “If stupidity got us into this mess, then why can’t it get us out?”
• “A bubble is a rising market that one is not invested in; if one is invested, then it is a bull market.”
• With rising inflation eating away savings earning low interest rates in banks, the Chinese who could afford to bought up property, betting that the government would ensure that real estate prices would keep rising. This was the “Wen Jiabao put”, consciously referring to the famed “Greenspan put”.
• Regulators and economists, who contributed to the crisis, offered solutions, confirming Goethe’s observation: “There is nothing more frightening than ignorance in action.”
• Regulators and legislators held educational sessions with banks and economists, ignoring author Thomas Pynchon’s warning: “If they can get you to ask the wrong questions then the answers don’t matter.”
• When the housing bubble collapsed, the American satirical magazine The Onion demanded that the American people be given another bubble to invest in.
• There are similarities between the financial system, irreversible climate change, and shortages of vital resources. In each case, society borrowed from the future, shifting problems to generations to come. In the end, you literally devour the future until eventually the future devours you.
• The law of unintended consequences is what happens when a simple system tries to regulate a complex system. The political system is simple. It operates with limited information (rational ignorance), short time horizons, low feedback, and poor and misaligned incentives. Society in contrast is a complex, evolving, high-feedback, incentive-driven system. When a simple system tries to regulate a complex system you often get unintended consequences.
• As John F. Kennedy knew: “The greatest enemy of the truth is very often not the lie—deliberate, contrived, and dishonest—but the myth, persistent, persuasive, and unrealistic. Belief in myth allows the comfort of opinion without the discomfort of thought.”
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