The best books on Understanding High Finance

You chose these books because they help the layman to understand economics and finance.

Yes—there is a kind of ‘two cultures’ issue between the general literate public and the world of economics. It’s possible, for example, to be a functioning competent, literate, well-educated adult and not know what a bond is. If you listen to people very casually saying, ‘Well, the thing about the interest rate is …’, just those two words – ‘interest rate’ – imply a set of quite complicated linked ideas about the impact on business, the impact on the cost of borrowing, economic growth, employment, house prices, and exchange rates. No one is born knowing that.

I think the standard of writing in the world of economics and money is high, but pretty much everything is addressed at people who already ‘speak’ money. It’s very unlike, say, popular science where the books do walk you through the basics, until the point that you cease being unable to understand, for example, quantum mechanics in the comfort and safety of your own home. There’s a level of discourse about money that’s really interesting, but it does assume that you have that competence, and it’s quite striking how few books there are that properly address the general reader.

Tell me about The Money Game by Adam Smith.

Adam Smith is a pseudonym – he was an extremely successful professional investor called George Goodman, who also wrote a newspaper column. This is a real insider’s account of the way that the money markets and trading works. And the most helpful way of understanding it is as a sort of a game – taken dead seriously, but contentless, in the way that games are. He talks about Keynes’s idea of how investment is intolerably boring to anyone who lacks a gambling trait in their character. It’s very funny, very fluent, very well-written and also a real pro’s view. I don’t know why it isn’t famous any more.

“It’s possible…to be a functioning competent, literate, well-educated adult and not know what a bond is”

The first section is called “You: Identity, Anxiety, Money,” and it’s very good on the way that money touches on things about anxiety. In a way, it’s a reassuring book, because it tells you that the ways that the professionals are conflicted and confused actually pretty much exactly mirrors the way that the rest of us are. The professionals have more tools, but they have the same underlying complexities and ambiguities and ambivalences. George Goodman also wrote a very interesting book about counterculture, about transcendental meditation and yoga and so on. He has an unusually wide-ranging mind and set of interests.

Why did he write this book?

I think he also felt what I was talking about: That there was this sort of gap, that there wasn’t this kind of writing directed at the lay reader and that there should be. It’s so important that people should understand. It’s very obvious now after the blow-up, but this thing goes very deep in terms of how modern society works. There’s also a larger point, I think, which is that democracy implies an informed electorate.

Shall we talk about Liar’s Poker?

The great thing about it is, it’s still a wonderfully entertaining book: An absolutely hilarious, very, very dark, vivid account of how Michael Lewis came out of Princeton and, with basically no qualifications, got a job in the bond trading department of Salomon Brothers. This was in the early 1980s, just at the point at which the bond market really started to take off in terms of its size. They had complete free rein to invent all these new financial products and the Financial Products Division, where Lewis worked, wrote all the CDS, the credit default swaps insurance that ended up taking the system over the edge of a cliff. There really is a direct line in the narrative between them and the great crash, so there’s a real historic interest in the book, as well as anything else.

But the big thing about Liar’s Poker is that it’s still one of the very few books that actually describes the psychology of that world from the inside. Lewis actually was one of these guys, and I wouldn’t shy away from using the words genuinely important – it’s genuinely important to hear what they’re thinking and how they’re reacting. Lewis says that it was meant to be a book that completely put people off working in the world of money and made them want to be marine biologists, whereas in fact, as he says now, people just read it as a how-to book.

Didn’t he realise that it might have that effect?

Well, I think a lot of people who disapprove, or feel they’ve seen through the world of money are very slightly in love with it. There’s something exhilarating about baddies always, and about people who insist on the world as it is rather than on the world as it might be or should be. And the people in these worlds are really like that. There’s something very thrilling about the amorality of it. But, for all that, I think Lewis was also disgusted and had had enough. No doubt he’d always wanted to tell stories, which I think he does superbly well and it got him away from it all.

What is Against the Gods about? 

The package description of it is that it’s a ‘history of risk’ which makes it sound dry, but it’s an absolutely fascinating, for-the-layman account of how humanity mastered risk (in the mathematical sense) and came to understand probability.

Bernstein makes the point that, particularly in the Middle Ages, betting on dice was seen as a grievous sin by the church: Because God decided everything and chose whether it would come up six or one, so it was a form of blasphemy to do something so frivolous as to play with what God wanted. But what happened was that gamblers got interested in the fact that certain sorts of numbers came up more often, and you had this extraordinary thing of gambling and mathematics walking hand in hand, as people like Fermat and Pascal got interested in how probabilities were created. Effectively, the invention of probability came out of studying dice.

“Bernstein makes the point that, particularly in the Middle Ages, betting on dice was seen as a grievous sin by the church”

Bernstein brilliantly convinces you that it’s a kind of humanist project, it’s an attempt to put into the realm of human understanding things that were once seen as utterly capricious, and probably to do with divine will. Our mathematical understanding of probability and risk is actually saying: ‘No, this is in our domain, we can manage this.’ And that leads through to things like – well, derivatives have a terrible press now, but they’re used, for example, if you’re a farmer when someone gives you a price for your crop for next season, that’s a very important tool in ensuring safety and prosperity, and spreading it around, and it’s a way of mastering risk. And then OK, you’ve sold next season’s crop, and then the right to buy that crop is a financial derivative, because it can be sold, traded, and sold on, and its price will fluctuate; even though the coffee is still the coffee, or the corn is still the corn. That’s a really important, genuinely helpful, humanist tool.

So quite a positive view of derivatives? 

It is a pity, as I say, that they took us over the precipice, but there is a kind of heroic aspect to humanity having worked out how to manage and utilise and exploit risk. The thing that’s really good about Bernstein’s book is that you do get the way in which there’s a tremendous amount of social utility in what humanity’s done with risk and options and derivatives and probability, and also a kind of beauty in the maths of it.

“There’s absolutely no moral dimension at all to how the markets work in practice. I think it’s up to society to decide now the extent to which there is a moral dimension, and whether there should be moral constraints.”

I think also it’s easy to forget how extraordinary markets are. There’s a Costcutter down the road and it’s got everything I might want from Parma ham to bleach to Special Brew to thread to today’s FT to Maltesers, and it was markets that put them there. I know we’re having a kind of condemnatory moment in general about the operation of the unregulated free market and, in many very specific ways, clearly things went completely wrong, but we mustn’t forget the ways in which markets are extraordinary things and do work.

Tell me about Frozen Desire: An Inquiry into the Meaning of Money.

It’s a wonderful book. You don’t have to speak money to read it, but you do have to think quite hard. Buchan has that thing of very intelligent people that there are casual asides that leave you with things to think about for days afterwards. It’s quite compressed and dense, and it’s a very profound book, I think. It’s about our relationship with money, and money as one of humanity’s most amazing, extraordinary inventions: This thing which is so useful, and which is also a form of imagination, that frees us in so many ways, and at the same time enslaves us.

“Money is, in a sense, the secret order of things”

One of the things that’s very powerful about this book is the fullness of Buchan’s ambivalence. He absolutely gets money’s extraordinariness and the way that it takes over our lives and is a kind of solvent, which dissolves difference, and place, and art, and craft, and history, until everything stops mattering except money. That’s one of the things that I really admire about it. Lots of writers come down entirely on one side or the other in ways that don’t capture the fullness of money, but Frozen Desire is wonderful because it does both sides.

If you’re interested in how the world works, and why things are as they are and what’s the story behind the thing you see, you do end up being very interested in how money works. I share something of that view: That money is, in a sense, the secret order of things.

Does he look at whether there’s any moral dimension to the markets?

There’s absolutely no moral dimension at all to how the markets work in practice. I think it’s up to society to decide now the extent to which there is a moral dimension, and whether there should be moral constraints.

I think that the missed opportunity was after the bailout, after we, the Western taxpayers, wrote these huge hundred-billion-dollar cheques. Some of the banks paid back their loans, and even some of the nationalised banks are heading back towards profitability, but the fact is that the rest of the economy is paralysed, and in the longest recession since the 1930s – and that was directly triggered by the banks.

The amazing and appalling thing is that none of that has been addressed. It’s been addressed purely through rhetoric, but there’s no legislative instrument anywhere that’s done anything to change that. If Barclays tomorrow were to announce, ‘Really sorry, we’ve just lost a trillion dollars betting on whether the Chinese renminbi would appreciate, and it hasn’t, and can we have our bailout now?’, the state would have no choice but to say, OK. They’re too big, and too systemically important. The implosion is all completely unfixed. It’s as if they’d performed some heroic feat of steering and then immediately fell asleep at the wheel.

Does Sorkin address that lack of legislation in Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System – And Themselves? 

No, he doesn’t. This is purely a narrative – a minute-by-minute account of how the whole financial system nearly went over the brink in 2008, and the astonishing sense of tension and danger involved. It starts with Bear Stearns in trouble and then just charges along. I thought it would take 10 years before anything like this came out. It shows the behind-the-scenes deliberation – why did they allow Lehman’s to fail, which was clearly the thing that precipitated the crisis, and why exactly did they do the bailout in the way they did.

Andrew Sorkin covers the markets for The New York Times, and he’s a real insider. The book makes no judgements, which I suppose is why he has such good access. But the thing that’s amazing about it is it’s an absolutely in-the-room, vivid story of the unravelling. When the guys who are running these institutions are swearing and having tantrums and storming out of the room and having panic attacks and ringing each other at 4am, his sources are just so good that he has complete credibility.

There’s a scary sense sometimes that there’s no adult supervision – Sorkin’s book leaves you under no illusion that it’s people like us making these astonishingly consequential minute-by-minute decisions, who don’t miraculously know more than we do.

Looking at Sorkin’s book, and Michael Lewis’s book, what good does it do to understand the mentality of those in charge in the world of high finance?

The important thing is we have to have rules to prevent things like the recent crash from happening again. The problems are in the design and the structure, and that we can’t rely on enlightened self-interest and the magical power of the markets to self-regulate, because the sums involved are too big, the flows of capital are too quick and the modern financial instruments are too opaque and too powerful. When you have flows of capital of trillions and trillions and trillions of dollars, the risks are just very high to the general polity. People don’t have to be very stupid or very wrong. They just have to be a little bit wrong. And only once.

Britain’s four biggest banks added together are five times the size of our entire economy, and these financial instruments are so powerful that they create enormous potential for damage. The self-regulating market just doesn’t function in this area any more. We have to have rules and structures that make it not just unlikely, but impossible for banks to blow up and bring the whole system down with them, because if we don’t do that, to me it’s self evident that it’s going to happen again. A lot of it’s quite boring – to do with liquidity and capital ratios and things like that, and some of it’s more dramatic – about separating retail banks from the investment banks. But we have to get on with it now.

And in the meantime we, the public, have to educate ourselves. 

Yes. The more we know about this the better; because, by and large, the more you know about it the less you think, ‘oh, it’s all fine.’ And I think, broadly speaking, ‘oh, it’s all fine’ is a concise summary of what governments and regulators have been thinking about the unregulated markets for about 30 years. ‘Oh, let ’em get on with it, it’s fine, markets cannot create any problems that markets cannot solve.’ We now know for sure that that’s not right: The markets can create huge problems that the markets can’t solve. But men make markets, they’re created in spaces that we shape – and now we have to reshape that space. And knowing enough about it to have a view about it is an important part of that.