A Continuing Economic Puzzle

For me at least. I came across a fine article in Vanity Fair magazine from September 2011 in which Michael Lewis endeavors to explain pervasive German attitudes to finance and financial risk . Lewis is well-known for his incisive inquiries into finance. I first read his The Big Short (Allen Lane/Penguin, 2010), about the crash and why it happened, then Boomerang (Allen Lane/Penguin 2011) about what countries (sovereigns) had been doing, and I have just finished Flash Boys (Allen Lane/Penguin 2014), about high-frequency trading and how markets react to your transactions before you’ve completed them. Donald MacKenzie in the London Review of Books also has a fine article about the same phenomenon and the extremely small time frames in which it takes place

I am a civil servant in Germany and have been for about two decades. I spent a couple of decades in California (nice to see Lewis’s nod in his article towards Alan Dundes – a folk hero at one of my alma maters, U.C. Berkeley) and the couple before that in the UK, of which country I remain a citizen.

My university had its account with WestLB. WestLB was the state bank of my state, North Rhine-Westfalia. Those are the people who held the money which my employer gives me every month. I say “was”. WestLB just sort of disappeared. The state bank – gone. There was a short article on the front page of the local newspaper about it. Nobody asked. It wasn’t a topic of conversation.

I was flabbergasted, and still would be if I hadn’t run out of flabber. I was and am still reading acres of British newspaper articles about what UK banks had been doing, Libor and Forex rigging, handling drug-cartel money, selling inappropriate PPI, and so on, and how and what was being done to correct it. But move to Germany, and WestLB just disappeared. I got a hint as to the financial exposure which caused it to do so through reading, not the local or even a national newspaper, but Lewis’s book The Big Short. Apparently “Düsseldorf” was buying all the US-subprime-backed CDOs which no one else was buying. Lewis’s article explains in more detail that it was a Düsseldorf bank named IKB, which somehow was backed by WestLB.

It seems Lewis set himself in the article the task of trying to figure out what went wrong in Germany and why. I think he only scratched the surface but he got a deeper than anyone else I’ve read on the topic, including German sources.

How can it be that our state bank, which held all the money on behalf of all the state enterprises, all the state organisations, the state government and so on, just went belly-up and was seamlessly replaced without anyone batting an eyelid? Why weren’t all my colleagues the civil servants panicking, wondering where our next paycheck was to come from?

The answer may be something like this. People somehow thought that what the bank had was pieces of paper, promissory notes, and that somehow all that was backed up for purposes of the State by something more tangible and SOLID, real CASH, maybe GOLD, and all that SOLID material must somehow still be there even if someone couldn’t keep track of the promissory notes. And if WestLB couldn’t distribute it, then somebody else would just be asked to go over there, pick up all this tangible REAL stuff, convert it into money, and dole it out to the eligible recipients as usual.

Which seems to be what happened, thank heavens. The question which then arises is how this can happen without anyone pointing a finger at Düsseldorf and calling for divine retribution. Because when it happens with other accounts, say, Greece for example, fingers are pointing and tongues are a-tutting at very high volume and have been incessantly for six years. The other question is, if WestLB can be so simply liquidated without fuss, why the same mechanisms can’t be applied to Greek/Irish/Portuguese debt held in Germany.

There are some relevant phenomena which Lewis could have addressed. It is obvious in hindsight that policy around the euro was going to be dominated by its most influential member, which everyone has agreed is Germany. Apparently no one else in Europe, including Britain, noticed that neo-Keynesian mechanisms were largely frowned upon both by the German state and its most influential economists and ministers. For quasi-moral reasons, it seems. It seems to me that Keynes is largely regarded by Those Here Who Matter as a clever and influential man who just, unfortunately, got it wrong as clever men sometimes do. Pace Milton Friedman, “we” are not all Keynesians, or neo-Keynesians, now.

It is surely a recipe for a car crash when the most influential player in a monetary union has economic ideas at variance with those of almost all its partners. I’d like to know more about that. In August 2012 (Wednesday, 22nd August, 2012 to be precise), on the way back from Frankfurt I read an article in the newspaper “Die Welt” by the finance and tax lawyer and former member of the Constitutional Court (Verfassungsgericht), Paul Kirchhof, in which he used the word “Schuld”, which means both “debt” and “guilt” in German, to equivocate between the two concepts in a discussion about the legality of indebtedness in the eurozone. I remarked on it to some English colleagues. I can’t find the article any more on the newspaper’s WWW site. About a year later, George Soros observed that the words for “debt” and for “guilt” are identical so I am not the only person wondering about a connection.

I also want to know how come my neighbors are so incurious about a major bank failure. Why it happened and what the consequences are. In this land of banking rectitude, this seems to me to be anomalous. I’d really like to know how this all works, and am not content to assume simply that there is something SOLID sitting behind my monthly pay check. And my pension. And my savings. And the value of my house. And so on.

So who will tell us how and why WestLB failed? And why it won’t happen again? Will it?

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