I.O.U.: Why Everyone Owes Everyone and No One Can Pay by John Lanchester

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Chapter 1 Summary

John Lanchester begins I.O.U.: Why Everyone Owes Everyone and No One Can Pay by admitting that as a child he was scared of ATM machines. Looking back, he now realizes, he may have been on to something. He explains that the frictionless way money moves around the world can be frightening. Few people can really conceptualize the numbers involved in the global economy. What is the difference between a million seconds and a billion seconds? It is the difference between roughly twelve days and thirty-two years. By the end of 2008, Icelanders went to their ATMs and discovered that the frictionless withdrawal of money was no longer frictionless. Their banks, which had twelve times as many assets as their national economy, had failed. Lanchester seeks to explain how the “Reykjavíkization of the world economy” came about.

Lanchester tracks the process back to the fall of the Berlin Wall. Until that point, Western liberal democracies had an ideological counterpoint, and though Lanchester maintains that the Western liberal democracies are the most admirable societies humanity has ever seen, they are admirable in part because they sought to show that they provided citizens with a better standard of living than their Communist adversaries. Therefore, the “jet engine” of capitalism remained hitched to the “oxcart” of equality and fairness. With the defeat of the Soviets, the capitalists were under less pressure to provide equality and fairness. Consequently, previous bans on torture were lifted, the income for the middle class remained stagnant, and the income gap between the super rich and everyone else grew. A mystical faith in capitalism became normal, and the financial sector’s wealth skyrocketed. Unfortunately, notes Lanchester, the victory party following the fall of the Berlin Wall was neither fair nor sustainable.

Oddly, few people are able to explain how the financial sector works, even though banks are essential to the system everyone lives in. Banks are machines for making money. They take in money, lend some of it at interest, and when they collect their money, they have more money, which means that they can lend more. Lanchester explains that a bank’s balance sheet differs from other balance sheets because a bank increases its assets by lending credit to others. During the 1990s and 2000s, bankers began to lend credit to anyone, increasing the banks assets and the bankers’ bonuses. Additionally, many banks began to over-leverage their assets. When it turned out that many of those assets would not be recovered (known as toxic assets), the banks suddenly became insolvent and were bailed out by taxpayers.

Lanchester explains that now no one knows which banks are actually solvent. They do not lend credit because they are waiting for their toxic assets to regain value. However, a bank that cannot lend credit is useless. It becomes a “zombie bank.” An economy with zombie banks will grind to a halt because there is no machine for making money.

Chapter 2 Summary

Banking should be simple: banks take in money, which they lend out at interest. The bank must reduce risk by lending only to reputable customers. However, during the 20th century, banking became modern, which means that it became self-referential, abstract, and separated from common sense. The arrival of modernism in finance was the management of chance and risk. Lanchester illustrates by explaining the financial instruments called derivatives.

Say a farmer agrees to sell his or her crop ahead of harvest for an agreed upon price. That contract can then be bought and sold; it is a derivative because its value derives from the crop. The simplest derivatives are options and futures. An option is the right, but not the obligation, to buy or sell something in the future for a specified price. A future carries the obligation and is therefore riskier. Lanchester explains that someone might spend $500 on an option to buy a sports car for $50,000 in a year’s time. If the price goes up,...

(The entire section is 3,590 words.)