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John Lanchester, author of Whoops! Why Everyone Owes Everyone and No One Can Pay tells Patrick Freyne that economics is far too important to be left to the experts.

It's not that surprising that the most readable guide to the financial crisis would come, not from an economist, but from a novelist. John Lanchester grew up as the son of a British banking father and an Irish mother, but for most of his writing life he ignored his financial roots to write fiction. More recently, however, he realised that the rise and fall of western finance had all the hallmarks of good drama and decided that this was a story he wanted to tell. "As a story the financial crisis featured some victims, some villains and even some well meaning people," he says. "There were even a few Cassandras warning of catastrophe. But there weren't too many heroes," he adds sadly. 

What drew him to the subject? "Well, I live in London, and there the pull of The City is inescapable," he says. "I was writing a novel which I thought was going to be set against that background, so I started researching and reading about modern finance. I had also written a few articles on that sort of thing for the London Review of Books. Eventually the novel turned out to be about something else, but I had all this stuff in my head and I wanted to do something with it. Usually when I've finished a draft of a book, I stick it into a drawer for a few months before finishing it; then I take up Pilates or learn German or do a gardening course. This time I decided to use my research to write this book."

He says that it was clear to him that there wasn't that much material explaining the financial world to non-experts and that he felt he had an opportunity to fill the gap. "There's this huge gulf between people who knew the inside of the business world and everyone else," he says. "And when writing about finance, experts often assume a level of knowledge amongst outsiders that they just don't have. I think there's lots of good writing out there for people who already have a good understanding of economics but I wanted to talk to everybody else, the people who were being left out."

Lanchester argues that not only is it important for lay-people to learn about finance and economics for their own sake, but that their input is also important for finance's sake. He notes that in contrast to the cheerleading of experts, many ordinary people had an intuitive feeling that they were experiencing a bubble. "It seemed like common sense to me that this was a bubble, but then what I learned was that the new financial models had basically dispensed with common sense," he says. "I could see it was a bubble and I wasn't the only one. You could see it on the street I live on. There was never a time when there wasn't two or three skips. And there were all sorts of other things - dog walkers and wine deliveries. It looked like a bubble to me, and bear in mind that I'd lived through one before, in the 1980s. I also really felt that this was about to pop but there was this Emperor's new Clothes feeling because no one else was quite saying that. It was only when I learned more about finance that I began to understand why that was."

In Whoops!, he essentially tells the story of how economic models and financial instruments devised by mathematical experts to hedge against risk, were used by greedy and less mathematically astute people in the world of finance in a manner that obfuscated and thus amplified  risk.

 He has a historic understanding of where this numbers-focused economics came from. "Back in the 1960s, everyone was a Keynesian and in lots of ways, that was the default position in economics," he says. "Then there was this huge reaction against that in the form of monetarism, and we saw Margaret Thatcher essentially creating unemployment as a financial tactic. People were understandably repulsed by that - they saw what three million unemployed looked like and the human consequences. So increasingly, economists retreated into models and maths and maintained that was all about the numbers."

Lanchester argues that this new pseudo-scientific approach was underpinned by an almost religious belief in rational consumers and the market's inherent efficiency; ideas that were neither provable nor true. As an outsider, Lanchester found this strange ("I did feel like I'd gone through the looking glass") most notably because the maths itself didn't make a huge sense. "According to the models of the time, Black Monday in 1987 was so against the odds that even if the lifetime of the universe had been repeated a billion times over, it would still have been unlikely," he says. "Yet some of the experts still described it as ‘bad luck'. There's a disconnect from reality there. If something that unlikely happens, and then it happens two or three more times [he later references the dot com crash and the current crisis], you've got to accept that it's not bad luck but that the sums don't add up. You have to accept at some point that the models are wrong."

But this isn't what happened. Instead, traditional banking prudence was lost in a barrage of CDOs, CDFs and securitisations that had, according to financial lore, removed risk. The truth was that these complex mathematical models and instruments so adored by many, were understood by very few (Lanchester recounts the story of a corporate executive telling a treasury official: "I've got some good news! We're no longer going to get involved in things we don't understand!").

 The reality of the situation, however, wasn't that difficult to comprehend. "I travelled to meet some of the people receiving subprime mortgages in the US," he says. "American lenders were giving hundreds of thousands of dollars to people who'd never had a job and had never paid a utility bill, and this was then being chopped up and put into packages that had a triple A-rating. That's supposed to be a very safe investment. To put that into perspective, only nine companies in America have a triple A-rating. I wouldn't have believed it if I hadn't seen it."

The problem, as Lanchester describes it, is that those who devised these instruments understood how they worked and how they should be used, but in an unregulated environment, those who packaged and sold them were woefully under-qualified. Eventually, thanks to light regulation, the rot spread through the whole system leading to a giant collapse.

And Lanchester doesn't think that we've learned from these mistakes. "It's like there was a giant rumbling noise, the foundations shook, there was a crack in the altar and the golden idol fell down," he says. "And then there was a silence as they picked up the idol, polished it and put it back on the altar and now they're hoping that nobody had noticed. The fact is, we've had three or four supposedly unprecedented crises in the last couple of decades, and these events seem to be getting bigger and more frequent. That suggests to me that we really need to fix the whole architecture of world capitalism, but nothing I've heard suggests that anybody's doing that."

He feels that a global approach to regulation is required ("Otherwise things conveniently fall between the cracks"). And he also thinks that more people need to inform themselves about finance. "Democracy implies having an informed electorate," he said. "And I don't think that we have that. There are bright, well educated people who don't know anything about the business world and one of the consequences of that is that the bankers get to write their own rules."

He refers to one of the few places bankers didn't have the luxury of self-regulation - Canada. "The Canadian banks begged for deregulation in the 1990s like everyone else," he explains. "But their government just said no. There were historical reasons for that. The Canadians had terrible banking crashes in the first decades of the 20th century and so they've had tight regulation since 1923. Since then, they've only had two bank failures which is remarkable when you consider that America has had 21,000 bank failures in the same time period. Essentially, the banking crisis they had early in the last century had the same effect a small heart attack can have on someone's health.

"There was a strong folk memory amongst ordinary Canadians that told them that bankers couldn't be trusted. So when their banks came and, like everybody else, asked for deregulation, the politicians simply turned them down. It was the only country where that happened. Now two of the world's biggest banks are Canadian, precisely because they weren't allowed do what they wanted to do. There's a lesson in that for everyone."

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