Some notes, some based on the review.

Tett explains how the banks effectively captured the regulatory system, and then all but dismantled it (not so much ‘regulatory capture‘ and ‘deregulatory capture’). In Hutton’s summary, “By 2000 the stage was set … : investment banks having balance sheets 30 times or more larger than their core capital, refinancing as much as a quarter of their trillions of dollars of liabilities every day from the so-called wholesale money markets, and lending/investing in a range of highly risky financial instruments. The system could not insure against its own systemic failure.”

Paul Mason documents the way in which the Glass-Steagall Act (introduced in 1933 to protect us from the banking sector), which created a legal separation between retail and investment banking, was eroded. In 1987 US law was relaxed so 5% of a bank’s deposits could be used for investment banking; and in 1996 relaxed again to permit 25%. The Act was repealed completely, by Clinton, in 1999.

The phrase ‘chasing alpha‘ describes the finance sector’s pursuit of high returns – the idea that you can beat the market over a long period. We’ve known enough about the nature of markets for long enough to know that they’re basically random movements around a long term trend (bear or bull). The best investors (think Warren Buffett) pretty much ignore the market and look at the fundamentals of the business instead. So if someone claims that they can out-perform the market, the best response is the ‘anti-drugs in sport’ refrain: that if something seems too good to be true, it probably is (think: Bernie Madoff and Icesave). Typically, investment performance which beats the market is based on fraud or recklessness – or riding a social or technology trend. If you can’t see the last one, you should ask questions (and you should probably ask questions anyway: Worldcom and Enron claimed that they were riding a trend, but were actually built on fraud and recklessness.)

Indeed, in Paul Mason’s book, he points out the role of fraud and deception in the market performance even of apparently reputable performers: “AIG admitted in 2005 that it had faked $500m of transactions to fool the auditors, and “misclassified” another $3bn to inflate its profits.” (And the recent suicide of the acting CFO of the US mortgage provider Freddie Mae might still turn out to be related to reported fraud investigations).

Of course, it might be wishful thinking for those on the left to blame all of this on 1980s deregulation, since casting Thatcher and Reagan as villains casts a warm glow. The list of wiling idiots clearly includes Clinton, Blair and Brown as well. But the effect of successive waves of deregulation over thirty years was to remove the resilience from the system. Augar and Tett, says Hutton, make it clear “that it was the structure of the financial system that created the havoc”.

Similar-scale dollar surpluses in the 1970s [as were seen in the 2000s] did not create such financial problems; but that was before the Thatcherite and neoconservative revolutions.

Augar spends a chapter on Gordon Brown’a Mansion House speech in June 2007 – just two months before the financial markets seized up – in which he lavishly praised the ‘global pre-eminence’ of the financial sector. In a review of Philip Augur’s book elsewhere, David Smith contrasts Mervyn King’s more sceptical tone (opens in pdf) at the same event:

He was worried about the banking system’s shift into risky financial instruments and the rise in its “leverage” debt. “Excessive leverage is the common theme of many financial crises of the past,” he said. “Are we really so much cleverer than the financiers of the past?”

Soros, for his part, argues that financial markets are never optimal. Instead they always swing between boom and bust.

Recovery will require regulation that compels banks to carry more capital and lend more judiciously. But until the international financial system is fairer to the less-developed countries on “the periphery”, the core of the world economy will always be at risk of being flooded by hot money fleeing from that risky periphery.

Hutton concludes that although these four books, between them, ‘indict modern finance … yet even now I am not sure that the politicians and officials get it.’

The deal to save the banks is one sided: socialised losses, private profits, as had been said many times since the crisis started. The bankers don’t understand why their business model needs to be changed, and politicians are in no hurry to press the point. There’s a fine explanation of this by Dave Pollard in an illuminating post about the American  ‘solutions’ to the banking crisis which measures them against Dana Meadows’ essay about the best ‘leverage points’ in a system. So far, most of the leverage that’s been applied to the collapsed banking system has been at the bottom end of the scale of effectiveness. The top end, where the scope for change is far greater, requires changes to the way the system is understood, designed, and managed.