The Big Short

Being a financial reporter in the aftermath of the greatest crisis since 1929 is a lot like being Bob Dylan.

“Who killed Davey Moore?” asks Dylan in a song about a boxer who died in the ring in 1963. “Why an’ what’s the reason for?”

Numerous people respond in the song: the referee who decided to let the fight continue; the bookmakers who profited from it; the audience who demanded a show; and the boxer who swung the blow. And all of them deny being the cause of Davey Moore’s death with the refrain: “No, you can’t blame me at all.”

It’s the same with the financial crisis. As anyone who’s seen The Big Short will know, there is a surfeit of villains: the bankers who lent the money; the borrowers who accepted it; the ratings agencies who assured investors the securities were safe; and the politicians who regulated the whole business.

And there are more villains than those featured in the film: the central bankers whose only answer to successive economic downturns was to make credit cheap; the economists who provided the intellectual backing; an aging society with a glut of money looking for something that could provide them with an income in retirement; even the heroes of the film aren’t free from blame — they were the counterparty to the synthetic CDOs that helped accelerate the crisis. Nearly everyone was complicit.

But people will selectively tell you who is responsible depending on their worldview. Right wingers will tell you it is the fault of the state through misguided regulation, easy monetary policy and the government-backed Fannie Mae and Freddie Mac. Left wingers will often point to the unrestrained free market, greedy bankers, overzealous brokers, and lazy ratings agencies.

Explanations differ in who they cast as subject and object; who acts on the world and whom is acted on by it. Some people are rendered as automatons reacting in a fixed way to the larger system — “they were responding to the incentives they faced” — while others will be viewed as having agency.

But this dichotomy in the way we respond to other people is not fixed but itself subjective, as the philosopher Peter Strawson pointed out in the essay Freedom and Resentment.

We can explain how people behave using either what he calls a ‘reactive’ attitude and viewing them as active participants in the world while others are seen through the ‘objective’ attitude, which he explains as such.

to see him, perhaps, as an object of social policy; as a subject for what, in a wide range of sense, might be called treatment; as something certainly to be taken account, perhaps precautionary account, of; to be managed or handled or cured or trained; perhaps simply to be avoided.

This ‘objective’ attitude is adopted by the penal system to those deemed mentally ill and therefore not responsible. Whereas the reactive attitude gets its name because we respond to people in the normal emotional ways: we get angry, we resent them, we’re grateful when they do something good.

You can see these two attitudes in the way different groups respond to the financial crisis. Technocratic types adopt the objective attitude and see it as a case of misaligned incentives, the ratings agencies behaved badly because clients could shop around for better ratings, for example. On the other hand, activist-types react like Steve Carell’s character in The Big Short and get angry.

Neither attitude is the definitively correct one. And in reality, most of us approach the non-obvious cases with some mix of the two approaches; we are capable of analysing behaviour dispassionately while also getting angry.

Likewise with the financial crisis. No-one chose the system that was created — policymakers themselves work within complex systems not of their own design — but many people chose their actions within that system. The candidates most at fault appear to be those who knew the most, had the most resources and had the most control over their actions.

So much for the evaluative side of responsibility, what about the purely descriptive side? What caused the financial crisis to happen?

This is no clearer. Economists are, in general, pretty poor at thinking about causation. Following the example of the Scottish enlightenment philosopher David Hume they have been chiefly concerned with separating out causation from correlation. His famous example in An Enquiry Concerning Human Understanding is of billiard balls striking one another. We see one billiard moving and then the second but at no time do we directly observe one causing the other to move.

Causation is not observable but is inferred from repeatedly experiencing two events happening in conjunction.

Economists will point out the flaws in making these inferences: people go to hospital and then they die but hospitals do not (usually) kill them, it is an underlying illness that caused both. Likewise, someone may be well educated and have a high paying job but it could be some underlying skill, personality facet or familial wealth that caused them to get both the education and their high income.

But they usually stop here and fail to ask deeper questions about the nature of causation. What is relatively simple when it comes to the interaction of bodies like billiard balls is a much more complicated matter when it comes to social phenomena, whose external existence themselves may be in doubt.

Why does the red ball move when the white ball hits it? The physical cause is well understood but what is the social cause? The intention of the man who wielded the cue? The general tendency of humanity to play games for fun? The rules of a game that made hitting balls important, and that are themselves the product of a wider culture? The economic system which allowed the manufacture and shipping of a billiard table — and balls — to a particular place?

All are good explanations and they are not mutually exclusive. In fact you could happily accept all of them of as being true on some level; some mediating the social processes rather than causing them and others being necessary requirements.

This is one of the reasons why we are poorly served in our understanding of the financial crisis: people look for an ultimate cause rather than acknowledging there were layers and processes stacked up on top of one another. Below is a rather good explanation of the problem economics faces from a brilliant review of Freakonomics:

To take an example, what does it mean to say that Mrs. O’Leary’s cow caused the Great Chicago Fire of 1871? Even if we were to agree with this version of events:

One dark night, when people were in bed,

Mrs. O’ Leary lit a lantern in her shed,

The cow kicked it over, winked its eye, and said,

There’ll be a hot time in the old town tonight.

As to the “ultimate” cause of the fire, we might say the cause of the fire was Mrs. O’Leary’s cow. We could also say that Mrs. O’Leary (and not her cow) was the cause of the fire since her placing of the lantern in the barn had the predictable consequence of igniting a blaze that would engulf much of Chicago. More policy relevant perhaps, we could cite lax fire regulations as the cause: perhaps Mrs. O’Leary would have been more cautious had the placing of a lantern in one’s barn had been illegal. In today’s language we might have talked about the failure to impose penalties that result in effective deterrence. More fancifully, we might even trace the cause back to U.S. agriculture subsidies. Without the government subsidies, maybe Mr. and Mrs. O’Leary would have not decided to take up dairy farming at all!

Aristotle, a very smart man, distinguished between four sorts of causes: material, formal, efficient and final. The “material” is what a thing is made from, in the case a marble statue it’s the marble itself; the “efficient” is the archetype or form of the thing, the shape of the statue; the “formal” is the source of the change, in this case the sculptor; and the “final” cause is the purpose for which it was done, and statues are made for all sorts of reasons: decoration, for example, or self-aggrandisement

We know what the financial crisis was made from: debt. And we know what form it took: mortgages. The efficient cause is harder but you can trace it, as they do in The Big Short, to increasingly lax lending standards, then a rise in interest rate payments that people could not pay, followed by panic and a liquidity crunch that led to bank failures.

But the final cause is the most obscure of all: why was it done at all?

There are many candidates including the ideological victory of liberal capitalism in the 20th century, the need for an ageing society to find something to invest in or the hopes of liberal politicians to create a home-owning democracy, or just the two most fundamental motives behind economic behaviour: fear and greed.

If you’re like me then you’re right back where you started: unsure whether or not anyone was ultimately responsible. Whether the whole mess was caused through a set of impersonal social forces, which can, at most, be resisted; or whether the people involved deserve a portion of the blame for creating and participating in a broken system.

The film The Big Short does a pretty good job of navigating this ambiguity through the difference between Steve Carell’s character, who makes money to get revenge on bad people, and the Ryan Gosling character, who works with the good guys out of pure self interest. Carell’s character responds to every little wrongdoing he sees by blowing up with anger, Gosling’s with a sardonic smile and a shrug that says “what you going to do?”