Boomerang_ Travels in the New Third World - Michael D. Lewis [1]
And they had a shiny new investment thesis. It ran, roughly, as follows. From 2002 there had been something like a false boom in much of the rich, developed world. What appeared to be economic growth was activity fueled by people borrowing money they probably couldn’t afford to repay: by their rough count, worldwide debts, public and private, had more than doubled since 2002, from $84 trillion to $195 trillion. “We’ve never had this kind of accumulation of debt in world history,” said Bass. Critically, the big banks that had extended much of this credit were no longer treated as private enterprises but as extensions of their local governments, sure to be bailed out in a crisis. The public debt of rich countries already stood at what appeared to be dangerously high levels and, in response to the crisis, was rapidly growing. But the public debt of these countries was no longer the official public debt. As a practical matter it included the debts inside each country’s banking system, which, in another crisis, would be transferred to the government. “The first thing we tried to figure out,” said Bass, “was how big these banking systems were, especially in relation to government revenues. We took about four months to gather the data. No one had it.”
The numbers added up to astonishing totals: Ireland, for instance, with its large and growing annual deficits, had amassed debts of more than twenty-five times its annual tax revenues. Spain and France had accumulated debts of more than ten times their annual revenues. Historically, such levels of government indebtedness had led to government default. “Here’s the only way I think things can work out for these countries,” Bass said. “If they start running real budget surpluses. Yeah, and that will happen right after monkeys fly out of your ass.”
Still, he wondered if perhaps he was missing something. “I went looking for someone, anyone, who knew something about the history of sovereign defaults,” he said. He found the leading expert on the subject, a professor at Harvard named Kenneth Rogoff, who, as it happened, was preparing a book on the history of national financial collapse, This Time Is Different: Eight Centuries of Financial Folly, with fellow scholar Carmen Reinhart. “We walked Rogoff through the numbers,” said Bass, “and he just looked at them, then sat back in his chair, and said, ‘I can hardly believe it is this bad.’ And I said, ‘Wait a minute. You’re the world’s foremost expert on sovereign balance sheets. You are the go-to guy for sovereign trouble. You taught at Princeton with Ben Bernanke. You introduced Larry Summers to his second wife. If you don’t know this, who does?’ I thought, Holy shit, who is paying attention?”
Thus his new investment thesis: the subprime mortgage crisis was more symptom than cause. The deeper social and economic problems that gave rise to it remained. The moment that investors woke up to this reality, they would cease to think of big Western governments as essentially risk-free and demand higher rates of interest to lend to them. When the interest rates on their borrowing rose, these governments would plunge further into debt, leading to further rises in the interest rates they were charged to borrow. In a few especially alarming cases—Greece, Ireland, Japan—it wouldn’t take much of a rise in interest rates for budgets to be consumed entirely by interest payments on debt. “For example,” said Bass, “if Japan had to borrow at France’s rates, the interest burden alone would bankrupt the government.” The moment the financial markets realized this, investor sentiment would shift. The moment investor sentiment shifted, these governments would default. (“Once you lose confidence, you don’t get it back. You just don’t.”) And then what? The financial crisis of 2008 was suspended only because investors believed that governments could borrow whatever they needed to rescue their banks. What