With the holidays coming to an end, my little burst of reading books (as opposed to newspapers and blogs) is coming to an end with the recent collection Panic, edited by Michael Lewis, which I got for Christmas. (I also got Snowball, the new biography of Warren Buffett, but that’s 900 pages long, so it may be a while.) The book contains several as-it-happened articles on each of four recent financial panics: the 1987 stock market crash, the 1997-98 emerging markets crisis, the collapse of the Internet bubble, and the thing we’re going through now. It’s long on entertainment – both the entertainment of hearing people say things like, “The more time that goes by, the less concerned I am about a housing bubble,” and the entertainment of reading legitimately good writing, some of it by Lewis himself. But given the format, it’s necessarily short on analysis, and its main point, if any, seems to be that all panics are alike: people underestimate risk, they think they are different, they do silly things, Wall Street people make a killing, and then bad things happen.

I believe the book was released in November, but it seems like the final touches were put on sometime in late spring or early summer – Bear Stearns had fallen, but Freddie and Fannie were still independent, and Lehman was just another investment bank. So the book provides this past summer’s perspective on the crisis: a collapsing housing bubble taking down isolated hedge funds that had invested in mortgage-backed CDOs, and one investment bank (Bear Stearns) for no clearly explained reason: Lewis’s own essay on the topic focuses on the inherent complexity of Wall Street firms and how even their CEOs don’t understand them. Reading the articles from 2007 and early 2008 reminds you how few people if any foresaw the impact the collapsing bubble would have on the financial sector as a whole.

There were a few especially thought-provoking bits, however.

An April article by Matthew Lynn in Bloomberg cites a study by Veronika Krepely Pool and Nicolas Bollen, two finance professors, of monthly returns reported by hedge funds. Analyzing those returns, they estimated that 10% of the returns were distorted; for example, gains of 1% were reported much more often than losses of 1%, implying that at the very least hedge funds were fudging their 1% losses upward and making up for it (or not) by fudging their larger gains downward in later months – in order to minimize the number of losing months. I think today everyone will get the reference.

In a July 2007 essay on the Asian crisis, Joseph Stiglitz seems to foreshadow the emerging markets troubles of the past few months:

Before the crisis, some thought risk premiums for developing countries were irrationally low. These observers proved right: The crisis was marked by soaring risk premiums. Today, the global surfeit of liquidity has once again resulted in comparably low risk premiums and a resurgence of capital flows, despite a broad consensus that the world faces enormous risks (including the risks posed by a return of risk premiums to more normal levels.)

Stiglitz points out that because developing countries spent the past decade amassing war chests of foreign currency reserves, they were less vulnerable to the type of panic that struck in 1997: “the fact that so many countries hold large reserves means that the likelihood of the problem spreading into a global financial crisis is greatly reduced.” Unfortunately, however, this time the problem spread in reverse – from the wealthy countries to the emerging markets – with similar consequences for the latter.

You’ll probably experience the warm feeling of nostalgia reading this book (especially when coming across articles you read at the time they were written). For me, I actually experienced the most nostalgia reading about the Internet bubble, which I spent at Ariba. (In September 2000, Ariba was worth about $40 billion, on sales of about $350 million and negligible profits. Explaining this to people, I used to say, “at our peak, we were worth more than General Motors.” That line doesn’t work anymore.) My favorite bit was hearing Jim Cramer (yes, that Jim Cramer) saying, in October 2000, that the Internet was over: “The idea that you can develop something for the Net today and have it be commercially viable is crazy. . . . It was fun for about three or four years. Oh, it was fun. It was cool. It was a really cool thing. Now it’s just something I wish weren’t in front of me.” Which reminded me of one of the best things about bubbles collapsing: all the people who just jumped on for the ride go away.

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