Book review of Boomerang: Travels in the New Third World by Michael Lewis

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Genre: Business Travel Reference
Author: Michael Lewis
Title: Boomerang: Travels in the New Third World (Buy the Book)


Famed author Michael Lewis uses the analogy of a boomerang to describe the global behaviors that led to the most recent financial crisis. Why boomerangs? You know why. A boomerang is launched with great enthusiasm and excitement, and its initial flight is a majestic path far out into uncharted territory.

That part of the path is beautiful to behold, and seems it will go on forever. But it doesn’t. Somewhere along the way, a perfectly predictable thing happens. The boomerang suddenly reverses course and heads back in the direction from which it came. To an unsuspecting boomeranger, this is not only a surprise but a catastrophe.

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Over the past decade, entire societies have thrown out financial boomerangs and because of their naivety, greed, immorality, and lack of wisdom the entire world has suffered. The boomeranging nations were: Iceland, Ireland, Greece, and the USA. Other nations, like Germany, did not personally launch a boomerang, but they financed several and, in that way, attached themselves tightly to the entire flawed and catastrophic endeavor.

Iceland led the way. A country virtually entirely dependent on fishing initially found a way to contain excessive competition and then use fish as collateral for loans. This led to their discovery that by taking on increasing debt they could increase their personal standard of living, and for a while also increase their involvement in the world.

So a society which had previously been expert at catching too many fish became a society that believed it had become a nation of investment bankers, and they turned their entire society into a type of hedge fund. For a while the boomerang flew outward, and all was well. This was due to the most rapid expansion of a country’s banking system in the history of mankind.

However, when the boomerang turned on them, unbelievably, they had amassed debts amounting to 850% of their GDP (50% to 60% is generally reasonable) and 300,000 Iceland citizens were now responsible for the repayment of $100 billion in banking losses. Let me help you with the math. That is $333 million each. The boomerang is back.

Ireland was next. However, rather than seeking to acquire unproductive assets outside the country, as Iceland did, they chose to focus on creating unproductive assets inside their own country. The Irish loved their own soil, specifically Irish real estate. By 2006 one in every five Irish men was employed building houses, and the construction industry rose to 25% of the economy (2.5 times normal).

The growth in Irish home prices, if continued, would have left the Irish three times as rich as the United States within two decades; but the boomerang was about to reverse course. Irish bank stock prices fell dramatically. Soon thereafter the Irish government guaranteed all the obligations of the six largest Irish banks and, inadvertently, also guaranteed bank bond holders.

Merrill Lynch in its great “wisdom” claimed that all Irish banks were profitable and well capitalized. In the end, Irish banks are now owned by the government, and the Irish government has relinquished control to the IMF. As a result, Ireland is now essentially an occupied country.

Greece simply lied about the whole thing right from the beginning and indulged itself in utter incompetence wrapped in a veneer of corruption. The odd thing was that in this case the Greek bankers were not part of the problem. The government intentionally misstated its financial condition in order to enjoy the benefits of entry into the European Union (mostly low interest rates).

It is alleged by some that an American investment bank helped to devise a scheme to perpetuate their deception. The Greek people chipped in and did not pay their taxes and participated in massive distortions of economic productivity. One example should suffice. The Greek public school system is among the lowest ranked in Europe despite employing four times the number of teachers per pupil when compared to highest ranked Finland.

Finally, a group of Monks devised a scheme to use a track of land appraised at 55 million Euros to gain access to 1 billion Euros of government property. During its period of deception, Greece stated that its budget deficit was 3.7% of GDP. The truth was more than three times that figure (14%). Instead of being out of balance by their stated 2009 deficit of 7 billion Euros, the imbalance was actually 30 billion Euros. As rates rose to reflect that reality, Greece could not pay. Their boomerang had returned.

But who really cares about what happens in three tiny countries that offer little to the world and house an insignificant percentage of the world’s population? The answer is that while the boomerang flew out, nobody did. In fact, one of the world’s most conservative societies financed a lot of it, Germany.

Germany is a paradox in this entire mix. Borrowing for consumption is essentially antithetical to the German culture. And they did not do it personally. However, German bankers were the biggest creditors to the full spectrum of deadbeat nations.

Through their own bankers, Germany paid for the boomerangs and now must bear their share of the consequences. They themselves have lost hundreds of billions of Euros. Nonetheless, if Europe is to recover, Germany will be the central deciding nation. The flawed foundation of the European Union was a result of Germany’s misdeeds in WWII, and many seem to believe that their lending extravagance was yet another way to seek amends. The world will soon find out if Germans are now Europeans, or if they are still just Germans.

What about the United States? It came close to depression conditions itself after financing massive amounts of ridiculous sub-prime loans, both to increase short-term profits and to respond to a government agenda to get every man, woman and child into their own home, whether they could afford it or not.

Somehow they came to believe that regardless of price, collateral, or ability to pay that homes were the safest of all investments and everyone should participate. It was ignorance and stupidity on a colossal scale. The boomerang flew. Eventually places like California, Nevada, Michigan and Florida became America’s internal Iceland, Ireland and Greece. However, because America is a “United” nation the federal government simply used the capacity and assets of stronger states like Texas, and others, to fill the gaps, along with unprecedented federal acquisitions of dislocated assets and its printing press.

As a result, the USA has been downgraded, but in an odd, and extremely fortuitous outcome, has seen the interest rates on its debt decline. This has made its massive and unprecedented debt affordable, at least for the time being. Of course, the boomerang has a way of returning home.

Too many in the world have lost their financial, economic and moral bearings. In addition, our global banking community has proven that, while it may be filled with intelligent people, they are highly flawed and lack wisdom. Governments have performed no better. Their collective performances have been worse than miserable, so many either launched these catastrophic boomerangs or financed them. We have all been fools, and the boomerang is back.

Preface: The Biggest Short

Michael Lewis stumbled upon the idea for Boomerang accidentally, while doing research for another book, The Big Short. After the 2008 U.S. financial disaster, Lewis became interested in the 15 or so investors that had placed enormous bets on the subprime market collapse. These investors had made a fortune on the collapse and were already starting to think of where the next financial breakdown would be. One of these investors, Kyle Bass, pointed Lewis in precisely the right direction.

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Before the collapse in 2008, Bass could already see the writing on the wall that entire governments were positioned to default on their obligations. Starting in 2002, what appeared to be economic growth was really business driven by people borrowing money they could not afford to repay.

Worldwide debts had more than doubled since 2002 from $84 trillion to $195 trillion.

The big banks that issued many of these loans were no longer treated as private enterprises but as extensions of their national governments, sure to be bailed out in a crisis.

Iceland: Wall Street on the Tundra

One of the countries most affected by the subprime mortgage breakdown was Iceland. Iceland’s problems began when Prime Minister David Oddsson privatized the banks in 2002. Suddenly, an economy that had no experience in banking and little to sell to the outside world besides fish managed to turn their entire country into a hedge fund. Iceland was ground zero of the global calamity.

Iceland had been somewhat of an economic miracle.

They had transformed themselves from being one of the poorest countries in Europe circa 1900 to being one of the richest circa 2000. In 1954, H. Scott Gordon, an Indiana University economist, described the plight of the Icelandic people and explained why the fishermen were not wealthy despite the fact that fishery resources are the richest and most indestructible available to man.

The problem is that because the fish were everybody’s property, they were nobody’s property. Anyone could catch as many fish as he liked, so people fished right up to the point where fishing became unprofitable – for everybody.

It was not until the early 1970s, after a couple of years of a terrible fish season, that the Icelandic government took radical action to make fishing profitable again. They privatized the fish. Each fisherman was assigned a quota, based on his historical catches. From year to year, the number of fish he could catch changed, but his percentage of the annual haul was fixed. If he did not want his fish, he could sell his quota to someone who did. He could even take his quota to the bank and borrow against it.

With a single policy, the government had made the fish a source of real, sustainable wealth rather than shaky sustenance. Fewer people were spending less effort catching precisely the right number of fish. The new wealth transformed Iceland and created new free time for the arts and education. Since its new fishing policy, Iceland had become a machine for turning cod into PhDs. The problem is that people with PhDs do not want to fish for a living. This created the opportunity for investment banking.

Young Icelandic males were coming back from their education abroad and wanted to put their shiny new finance degrees to good use.

Even though they had little experience, they gazed upon the example of Wall Street, and thought, “We can do that.” In 2003, Iceland’s three biggest banks, Landsbanki, Kaupthing, and Glitnir, had assets of only a few billion dollars or 100 percent of the country’s gross domestic product. Over the next three and a half years, the banking assets grew to over $140 billion. It was the most rapid expansion of a banking system in the history of mankind.

At the same time, because the banks were also lending Icelanders money to buy stocks and real estate, the value of these two assets skyrocketed. From 2003 to 2007, while the value of the U.S. stock market doubled, the value of the Icelandic stock market multiplied nine times. In 2006, the average Icelandic family was three times wealthier than the average Icelandic family had been in 2003, and virtually all of this new wealth was tied to investment banking.

When the Icelandic banks sat down at the same table as Goldman Sachs and Morgan Stanley, they had only the roughest idea of what investment bankers do. The biggest American financial lesson that the Icelanders took to heart was the importance of buying as many assets as possible with borrowed money, as assets prices only rose.

When they lent money, they were not facilitating enterprise but bankrolling friends and family to buy and own things like Beverly Hills condos, British soccer teams, and Danish airlines. They bought stakes in businesses they knew nothing about and told the people running them what to do. Icelandic banks made so many bad leveraged buy outs that a hedge fund in London hired a private investigator to find out what was going on in the Icelandic financial system.

A handful of guys in Iceland who had no experience in finance were taking out tens of billions of dollars in short-term loans from abroad. They were then relending this money to themselves and friends to buy assets. Since the entire world’s assets were rising, they appeared to be making money.

They also created fake capital by trading assets amongst themselves at inflated values, causing the banks to grow and grow. In reality, they had only a portion of the asset values they claimed and were lightweights in the international markets.

Even the average Icelander got in on the new speculation. With local interest rates at 15.5 percent and the krona rising, when they wanted to buy something they couldn’t afford, they decided the smart thing to do was to borrow yen and Swiss francs. They only paid 3 percent interest on the yen and made a profit on the currency trade as the krona kept rising.

On October 6, 2008, Iceland effectively went bust, and their financial games were over.

Their three brand-new global-sized banks collapsed, leaving Iceland’s 300,000 citizens with the responsibility for $100 billion in banking losses. Icelanders amassed debts amounting to 850 percent of their GDP, and now have loans to repay in much more expensive yen and Swiss francs after the collapse of the krona.

One of the most interesting things about the Icelandic banking collapse is the lack of a female presence. According to a paper published in MIT’s Quarterly Journal of Economics in 2001, groups trade less rationally in the markets when there is less of a female presence.

Icelanders cherish a male-dominated past of conflict and heroism that influenced their decision to make risky bets and to try to be the heroes of Iceland’s banking system. Unfortunately, the past excluded females that might have been able to bring some moderation into Icelandic banking and prevent the massive losses.

Greece: And they Invented Math

The tsunami of cheap credit that rolled across the international marketplace between 2002 and 2007 offered entire societies the chance to reveal aspects of their character they could not normally afford to indulge.

What the Greeks decided to do with their cheap credit was turn their government into a piñata full of large sums of borrowed money and allow as many citizens as possible to take a whack at it. For example, in the past twelve years, the wage bill of the Greek public sector has doubled in real terms.

The average state railroad employee earns 65,000 euros a year! The Greek public school system is one of the lowest ranked systems in Europe, and yet it employs four times as many teachers per pupil as the highest-ranked, Finland.

What is interesting about Greece is that the bankers remain beyond reproach.

Unlike most of Europe’s bankers, they did not buy U.S. subprime-backed bonds, or over leverage themselves, or pay themselves huge sums of money. The biggest problem the banks had was that they had lent 30 billion euros to the Greek government that was then squandered. In Greece, the banks didn’t sink the country; the country sank the banks.

For most of the 1980s and 1990s, Greek interest rates were a full ten percent higher than German rates because Greeks were regarded as far less likely to repay a loan. There was no consumer credit in Greece, but of course, Greece wanted to be treated like a properly functioning Northern European economy.

In the 1990s, they saw their chance to enter the European Union to get rid of their own currency and adopt the euro. To be accepted into the EU, Greece needed to show annual budget deficits under 3 percent of GDP and inflation running closer to German levels. In 2000, after much statistical manipulation, Greece met the requirements.

To lower the budget deficit, the Greek government moved all sorts of expenses off the books. To lower Greek inflation, the government froze prices for electricity and water and other government-supplied goods and cut taxes on gas, alcohol, and tobacco.

After entering the EU, Greece could borrow long-term funds at roughly the same rate as Germany – 5 percent.

To remain in the euro zone, Greece was supposed to maintain budget deficits below 3 percent of GDP. In 2001, Goldman Sachs and Greece entered into an arrangement to help the Greeks conceal their debt. Goldman Sachs would effectively hand Greece a $1 billion loan for which only $300 million in fees were reported.

The investment bankers also taught Greek government officials how to securitize future receipts. Any future stream of income that could be identified was sold for cash up front and spent by the Greek government. The Greeks were able to disguise their financial mess for only as long as lenders assumed that a loan to Greece was as good as guaranteed by the European Union (aka Germany), and no one outside of Greece paid very much attention.

Inside Greece there was no market for whistle-blowing, as those who tried were usually punished. That changed on October 4, 2009, when the Greek government turned over. A scandal felled the government of Prime Minister Kostas Karamanlis involving the Vatopaidi monastery.

In the early 1990s, an energetic group of young monks led by Father Ephraim saw a rebuilding opportunity to restore Vatopaidi to its former glory during the Byzantine Empire as a monastery with global reach. Over the centuries, Byzantine emperors and other rulers had deeded to Vatopaidi various tracts of land, mostly in modern-day Greece and Turkey.

The Greek government had taken back much of this property, but there remained a title to a lake in northern Greece. By the time Ephraim discovered the deed to the lake in Vatopaidi’s vaults, it had been designated a nature preserve by the Greek government. Then, in 1998, someone allowed the designation to lapse. Shortly thereafter, the monks were granted full title to the lake.

The monks were able to use this lake to launch a real estate empire. Somehow the monks convinced government officials that the land around the lake was worth far more than the 55 million euros it was appraised at, and then used that higher valuation to ask for 1 billion euros’ worth of government property.

They turned around and created the Vatopaidi Real Estate Fund. Investors in the fund would buy the monks out of properties given to them by the government, and the monks would then use the money to restore the monastery to its former glory.

In a society that had endured total moral collapse, its monks had somehow become the universally acceptable target of moral outrage. The scandal with the Vatopaidi monks brought George Papandreou to power and everything changed.

After the new party replaced the old party, it found that the government had so much less money than expected that there was no choice but to come clean. Once the Prime Minister announced that Greece’s budget deficits had been badly understated, global creditors panicked. The new, higher interest rates Greece was forced to pay left the country bankrupt.

In October 2009, a new Greek minister of finance, George Papaconstantinou, was brought in to sort out the mess.

When he arrived, the Greek government had estimated its 2009 budget deficit at 3.7 percent. It actually turned out to be nearly 14 percent. So many expenses had been left off that the books that a projected deficit for 2009 of 7 billion euros was actually more than 30 billion.

Moody’s lowered Greece’s credit rating and in effect made all Greek government bonds junk. The resulting dumping of Greek bonds on the market was, in the short-term, no big deal, because the International Monetary Fund and the European Central Bank had already agreed to lend Greece up to $145 billion. Unfortunately, against $1.2 trillion in debts (including $800 billion in pensions), a $145 billion bailout was not a long-term solution.

The Greek government currently faces $400 billion of outstanding government debt. If Greece walks away from the debt, then the other European banks that lent the money will go down, and other countries now flirting with bankruptcy (Spain, Portugal) might easily follow.

Yet, the question of whether Greece will repay its debt is really a question of whether Greece will change its culture.

Currently, the only Greeks who pay their taxes are those who cannot avoid doing so – the salaried employees of corporations, who had their taxes withheld from their paychecks. Greece has ceased to behave as a collective body. Every Greek has grown accustomed to pursuing his own interest at the expense of the common good. The government has resolved to at least try to re-create Greek civic life, but one can’t help but ask: Can such a thing, once lost, ever be re-created?

Ireland: Ireland’s Original Sin

Until the end of the 1980s the Irish had failed to do what economists expected them to do: catch up with their neighbors’ standard of living. Yet, by the start of the new millennium, the Irish poverty rate was below 6 percent and Ireland was the second richest country in the world, according to the Bank of Ireland. How did this happen, and how did Ireland lose its wealth again so quickly?

In the 1980s, the Irish government made a series of reforms that were all conductive to business.

They eliminated trade barriers, granted free public higher education, and introduced a low corporate tax rate, which turned Ireland into a haven for foreign corporations. Perhaps though, the most important change in Irish society and a major cause of the Irish boom was a dramatic increase in the ratio of working-age to non-working age Irishmen brought about by a decline in the Irish birthrate. In 1979, Ireland decided to legalize birth control, and out of the slow death of the Irish Catholic Church rose an economic miracle. The Irish went from being abnormally poor to abnormally rich in a span of 20 years.

While the Icelandic male used his new wealth to conquer foreign places – trophy companies in Britain, chunks of Scandinavia – the Irish male used his new wealth to conquer Ireland. Since 2000, Irish exports had stalled and the economy had become consumed with building houses, offices and hotels.

By 2006, more than a fifth of the Irish workforce was employed building houses. The Irish construction industry had expanded to become nearly a quarter of Irish GDP – compared to less than 10 percent in a normal economy. Irish home prices implied a growth rate that would leave Ireland three times as rich as the United States in twenty- five years. Ireland was turning their entire economy into a housing bubble that was waiting to pop.

Since 2000, 100 billion euros – or basically the sum of all Irish bank deposits – had been lent out to Irish commercial property developers. By 2006, economists started to see signals that the real estate bubble was going to burst, but Irish journalists and bankers took a positive outlook on real estate prices claiming a love of country and a commitment to Team Ireland that was doing so well.

According to the economists, since the vast majority of construction was being funded by Irish banks, when the real estate market collapsed, those banks would be on the hook for the losses. Likewise, the banks’ losses would lead them to slash their lending to actually useful business. Irish citizens in response to their banks would cease to spend. And, worst of all, new construction, on which the entire economy now depended, would come to an end.

On September 29, 2008, the Irish economy started to slip. The stocks of the three main Irish banks, Anglo Irish, AIB, and Bank of Ireland, had fallen between 20 and 50 percent and a run on the Irish banks started. The Irish government was about to guarantee all the obligations of the six biggest Irish banks.

The people of Ireland did not really start to panic until the night of October 2, 2008. On that night, Ireland’s bank regulator, Patrick Neary, came live on national television to be interviewed. He looked insecure, stammered poor answers to questions he had not been asked, ignored questions he had been asked, and looked as if he badly wanted to return to the hole he came from.

Neary insisted that the Irish banks’ problems had nothing to do with the loans they had made, yet everyone could see the vacant skyscrapers and empty housing centers that served as evidence of the bad bank loans.

Everyone in Ireland had the idea that somewhere in Ireland there was a wise little old man who was in charge of the money. Once they saw who that man actually was, they panicked.

Merrill Lynch, the lead underwriter of Anglo Irish’s bonds and the corporate broker to AIB, had earned huge sums of money off the growth of Irish banking. Ignorantly, Brian Lenihan, the Irish minister of finance, paid Merrill Lynch 7 million euros of taxpayer money to advise the Irish government on how to handle the crisis.

Merrill Lynch kept whatever reservations they had to themselves. They claimed that all of the Irish banks were profitable and well-capitalized. Ireland’s problem wasn’t in the bad loans they had made but the panic in the market. The most sensible thing to do was to guarantee the banks. Merrill Lynch advised the Irish government to promise to eat all the losses and the markets would quickly settle back down. As Merrill Lynch assured them there would be no losses, the Irish government thought the promise would be free.

In January 2009, the Irish government took Merrill Lynch’s advice and nationalized Anglo Irish, absorbing its losses of 34 billion euros. In late 2009, they created the National Asset Management Agency, the Irish version of TARP, and bought 80 billion euros’ worth of poor assets from the Irish banks. What is interesting about the Irish bank bailout is that they did not just guarantee the deposits.

The immediate danger to the banks was that savers who had put money into them would take their money out, and the banks would be without funds. Yet, Irish financial market rules are patterned on English law, and under English law bondholders enjoy the same status as ordinary depositors. Thus, it was against the law to protect the people with deposits in the bank without also saving the big investors who owned Irish bank bonds.

Since September 2008, Ireland’s banks, now owned by the Irish government, have taken short-term loans from the European Central Bank of 85 billion euros. The European Union has asked the Irish government to invite the IMF in, relinquish control of Irish finances, and accept a bailout package. Dublin is essentially an occupied city now, run by American investment bankers, Australian management consultants and faceless Euro-officials trying to sort out the Irish mess.

Germany: The Secret Lives of Germans

The Germans were not only the biggest creditor of the various deadbeat European nations, but are now their only serious hope of future funding. It is left to the Germans to act as moral arbiter, to decide which financial behaviors can be tolerated and which cannot. The Germans can obviously afford to pay off the debts of their fellow Europeans, but will they actually do it? Are they now Europeans, or are they still Germans?

In order for the majority of EU countries to become financially sound again, one of two things must happen. Either the Germans must agree to integrate Europe fiscally, so that the tax dollars of ordinary Germans go into a common pool and are used to pay for the lifestyle of ordinary Greeks, Italians, and other Europeans. Or, every non-German must introduce structural reform and radically turn themselves into a people as efficient and productive as the Germans.

The only economically plausible scenario is that the Germans, with help from a rapidly shrinking population of solvent European countries, suck it up, work harder and pay for everyone else. Yet, when the Germans agreed to adopt the euro, their leaders explicitly promised them that they would never be required to bail out other countries. German culture very much so adheres to following the rules, and thus the German people are not going to pay for everyone without a fuss.

The euro was conceived as a tool for integrating Germany with Europe, and preventing the Germans from dominating others.

Instead, the euro has now allowed the Germans to control the financial fate of Europe. With the creation of a common currency, lots of non-Germans were able to use Germany’s credit rating to indulge their material desires. Yet, when offered the chance to take something for nothing, the German people ignored the offer. Real estate prices stayed completely flat in Germany, and there was no borrowing for consumption because this behavior is totally unacceptable in German culture.

While there was no credit boom in Germany, the Germans, through their bankers, used their own money to enable foreigners to behave insanely. In 2003, German banks shifted from being sleepy commercial banks to being American. Instead of making simple loans in which the bank gave money to some company, and the company paid them back, they lent money to American subprime borrowers, to Irish real estate barons and to Icelandic banking tycoons to do things no German would ever do.

What Germans did with money between 2003 and 2008 would never have been possible within Germany, as there was no one to take the other side of the many deals they did that made no sense. They lost massive sums, in everything they touched, from U.S. subprime loans to Greek government bonds. The German losses are still being totaled up, but at last count they stand at $21 billion in the Icelandic banks, $100 billion in Irish banks, $60 billion in U.S. subprime-backed bonds, and an unknown amount in Greek bonds.

One example of a bank that suffered large losses in Germany is IKB.

IKB was created in 1924 to securitize German war reparation payments to the Allies, became a successful lender to midsized German companies, and then morphed into a vehicle for hedging bets on American subprime loans. IKB created, in effect, a bank incorporated in Delaware and listed on the exchange in Dublin called Rhineland Funding. They didn’t call it a bank. IKB called Rhineland Funding a “conduit,” and thus, it was not regulated. Rhineland borrowed money for short periods of time by issuing commercial paper.

They then invested it in longer-term “structured credit,” which were really just bonds backed by American consumer loans. Rhineland’s profits came from the difference between the rate of interest it paid on the money it borrowed and the higher rate of interest it earned on the money it lent through its bond purchases.

In February 2004, all of this seemed like a good idea – so good that lots of other German banks copied IKB and either rented IKB’s “conduit” or set up their own offshore vehicles to buy subprime mortgage bonds. By the middle of 2005, the returns on the bonds backed by American consumer loans had collapsed.

Yet, IKB did not pull out of the American subprime market. Instead, to make the same profit with a lower risk spread, they bought more. By the middle of 2007, IKB’s losses on subprime bonds totaled $15 billion. The only reason IKB did not lose more on U.S. subprime loans was that the market ceased to exist.

During the boom years, extremely smart traders in Wall Street investment banks devised deeply unfair, complicated bets and then sent their sales forces to scour the world for some unsophisticated investor who would take the other side of those bets. A wildly disproportionate number of those investors were in Germany. The Germans took the bonds at their face value and believed that if they were triple-A bonds, they were entirely risk-free.

So how did people who seem as intelligent, successful, honest, and well-organized as the Germans allow themselves to be drawn into this financial mess?

The problem has its roots in German national character. The Germans agreed to enter Maastricht because the EU had all of these rules. Germans are gullible people. They like to trust and believe in rules. Another assumption is that the Germans entered into the EU and trusted so easily because they didn’t care about the costs, as they came with certain benefits. For the Germans, the euro isn’t just a currency. It’s a device for flushing away the past. It’s another Holocaust memorial.

America: Too Fat to Fly

On August 5, 2011, moments after the S&P lowered the U.S. credit rating for the first time in American history, the market for U.S. treasury bonds soared. Four days later, the interest rates paid by the U.S. government for new ten-year bonds had fallen to the lowest rate ever, 2.04 percent. The price of gold went up alongside the price of U.S. Treasury bonds while the prices of almost all other stocks and bonds in the Western world fell.

The effect of a major rating agency saying that the U.S. government was less likely to repay its debts was to lower the cost of borrowing for the U.S. government and to raise it for everyone else. It was as if the less stable the U.S. government appeared, the more cheaply it would be able to borrow. The fear that the United States would not be able to pay back the money it owed was still unreal in everyone’s minds.

On December 19, 2010, before the U.S. credit rating downgrade had actually become a reality, Meredith Whitney went on 60 Minutes. Whitney became famous after she correctly predicted that Citigroup’s losses in U.S. subprime bonds were far bigger than anyone imagined, and Citigroup would probably be forced to lower its dividend soon.

The 60 Minutes segment discussed that U.S. state and local governments faced an annual deficit of roughly half a trillion dollars and noted another trillion-and-a-half dollar gap between what the governments owed retired workers and what they had in their coffers. When asked about what she thought about the ability and willingness of the American states to repay their debts, Whitney replied that she didn’t see a real risk that the states would default because the states had the ability to push their financial woes down to counties and cities. She predicted that a crisis in local finances would occur within the next twelve months.

Whitney’s prediction caused the municipal bond market to tank.

People started worrying about municipal finance the minute the words were out of her mouth, and the cost of borrowing for cities went up. From 2002 to 2008, the states borrowed beyond their means just like their citizens. States’ level of indebtedness, as a group, had almost doubled, and state spending had grown by two-thirds.

In that time, they had also underfunded their pension plans and other future liabilities by almost $1.5 trillion. The pension money they had set aside was invested in even riskier assets than before. These pension funds were hoping they could earn 8 percent in a market where the Federal Reserve was promising to keep interest rates at zero.

Add in underfunded health care plans, less federal dollars available to the states, and the depression in tax revenues caused by a weak economy, and multi-trillion dollar budget deficits had been created that could only be dealt with in one of two ways – massive cutbacks in public services or a default.

Whitney thought the country was going to organize itself into two zones – zones of financial security and zones of financial crisis. Companies are more likely to prosper in the stronger states. Naturally, people will go where the jobs are, making the stronger states stronger and the weaker states even worse off financially.

This would create friction as people in states like Indiana and Texas would be frustrated with bailing out states like California and New Jersey. Through her research of municipalities and state finances, Whitney ranked the states from strongest to weakest. She found the state in the worst financial shape was California.

In 2011, the average Californian had debts of $78,000 against an income of $43,000.

The California legislative system was organized in highly partisan districts so that nothing ever got accomplished. In November 2005, Governor Arnold Schwarzenegger tried to appeal directly to the people. He called a special election that sought votes on four reforms: limiting state spending, putting an end to the gerrymandering of legislative districts, limiting public employee union spending on elections, and lengthening the time it took for public school teachers to get tenure. All four propositions were shot down. In the United States, California resembled Greece. They wanted all these services and benefits, but they didn’t want to pay for them.

One of the best examples of total financial breakdown in California is the city of Vallejo. Just a short boat ride from San Francisco and a stone’s throw from Napa, Vallejo should be prospering. Instead, in 2008, its government was forced to declare bankruptcy. The city’s police officers and firefighters had used their unions to get large pay increases that were out of line. In the city’s negotiations with unions, they had to submit to binding arbitration.

Each side made their best offer, and the judge picked one of them. The only problem was the judges were not neutral. Most were labor lawyers who tended to favor the unions. By the time it declared bankruptcy, 80 percent of Vallejo’s budget was wrapped up in the pay and benefits of public safety workers.

In America, the problem with police officers and firefighters isn’t a public sector problem; it isn’t a problem with the government; it’s a problem with the entire society. It’s a problem of people taking what they can, just because they can, without regard to the larger social consequences.

The richest society the world has ever seen has grown rich by devising better and better ways to give people what they want. Americans have lost the ability to self regulate and in order for meaningful change to occur, they need the environment to administer the necessary level of pain.


From 2002 – 2008, a tsunami of cheap credit rolled through the world that left entire societies in a dark room with a pile of money. What those societies decided to do with the money serves as a testament to their character. The Icelanders wanted to stop fishing and become investment bankers. The Greeks wanted to pump money into their government to dispense to as many citizens as possible. The Irish wanted to buy Ireland – from each other. The Germans wanted to be near the financial mess, but not in it. And the Americans wanted to grab as much as they could, without thinking about long-term consequences. would like to thank the Titans of Investing for allowing us to publish this content. Titans is a student organization founded by Britt Harris. Learn more about the organization and the man behind it by clicking either of these links.

Britt always taught us Titans that Wisdom is Cheap, and that we can find treasure troves of the good stuff in books. We hope this audience will also express their thanks to the Titans if the book review brought wisdom into their lives.

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