What’s Wrong with the World

This is a good discussion of usury we've had. Let's stick with it a bit.

Proposed, that usury really ought to be seen as an offense against property. According to the Angelic Doctor usury is unjust because it is "to sell what does not exist." Now what does not exist cannot have property. Therefore usury (in our current case) may be understood as to offer property in nothing. It is to trade fraudulent property.

At best what the exotic finance engineering of Wall Street did was trade in property in something that did not yet exist. That is, at best this exotic finance assumed a temporal projection was accurate with undo certainly, and on that basis converted future potentials into contemporary abstractions. We may charitably say that the element of fraud is lessened because the aggravating element of intent was not supplied. They were most of them mere fools, not criminals.

They were usurers. And since durn near every last one of us was invested in a fraction of the usurious economy, in some fund or account somewhere, the blame falls in a widespread pattern indeed. They is we.

G. K. Chesterton, demonstrating his genius at the art of paradox, once referred to optimism as "morbid." Since the moment I read that (it appears in the second chapter of The Everlasting Man), I have felt in my bones that it is true, and have accordingly nurtured a healthy repugnance for the braggarts of optimism. But as with many paradoxes, it is difficult to explain without vitiating its power to surprise and thus enlighten. A true paradox is not a mere turn of phrase, a linguistic subtlety. It is attempt to fill a gap in man's power of understanding. It is a rhetorical reach, a heuristic device to explain what is in the end a mystery to our meager powers of mind. The paradox is a human reflection of the mystery of being.

So in the hands of a master like Chesterton, the paradox becomes an instrument of extraordinary explanatory power. It can show us, as in a flash, a principle or precept which might by other means require hours of lecture to impart. (There is an obscure masterpiece, long out of print, called Paradox in Chesterton, by a critic named Hugh Kenner, which lays all this out with great elegance. It ends with the astonishing claim for GKC that he be called a Doctor of the Church; and more astonishing still, the reader finds himself convinced.)

In this case of the problem of optimism, Chesterton's paradox opened my mind's eye to the surprising truth that optimism, being so engrossed with the potential for good things, courts ruin and despair by minimizing bad things -- or, in the parlance of finance, by minimizing the downside risk. Especially when abetted by the modern doctrine of progress, optimism is morbid because of its tendency to induce blindness concerning man's limitations.

Now I have a concrete, factual illustration of the problem of optimism, right in front of everyone's eyes.

A collection of posts discussing the nature of usury, and its role in the current recession.

The image is Rembrandt's Christ Drives Money-Changers from the Temple, 1626.

"The 300 Optimists," March 16

"Usury is an offense against property," March 9

"Hypotheticals don't exist," March 4

"Securitized fish," March 4

"Aquinas on usury," March 2

"Electric brinkmanship," March 2

"Socialism and the crisis of usury," February 27

I've suggested in a number of places that it is possible - I am not committed to it being definitely true - that much of the circulation of abstracted risk which led up to the current crisis took the form of something like a horizontal Ponzi scheme. It is horizontal because it involves circulation of abstracted risk among peers, and it is like a Ponzi scheme because it involves selling something which doesn't exist. We know that Aquinas thought charging interest on a loan was usury, and therefore morally wrong, precisely because he believed that it involved selling what does not exist.

All that discursive abstractness isn't everyone's cup of tea. But if you can just imagine the Escher waterfall lined with investment bankers, lenders, homeowners, and who knows who else all dipping in their goblets for a nice deep drink, I think you'll get the basic picture.

Over the years, a number of friends and correspondents have pressed me on the somewhat arcane subject of political anthropology. The very origins of political man. The disputes can be bewilderingly subtle, and not a few times I have managed to argue myself into a real mess. But the gist of it concerns the question of the political development of man — how government or the state first enters the world and how it develops as an institution.

Now the modern philosophers have tended to rest a great deal upon what seem to me fairly hasty and unsupported speculations about the historical facts of political development; and many of these speculations have tended to uphold of view of the political life of man which may be described Progressive. Man has progressed in his political arrangements, at times haltingly, but still with an observable trend which associates the passage of time with advancement or perfection.

Thus, according to the moderns, we may say as a general statement that man has progressed up from tyranny and backwardness to liberty and enlightenment.

My answer is that I would sooner trust Chesterton’s arguments about the origins of man and state, than any of these reckless rationalists of modern political philosophy. I would not, mind you, insist that anyone embrace Chesterton’s own often fanciful speculations; I would only say that Chesterton’s speculations are no less trustworthy than Hobbes’ or Locke’s, that the truth is probably closer to the younger Englishman, and that, therefore, much of the foundation of modern political philosophy is quite unreliable.

In short, far from laying down a Chestertonian dogma, I only say that his insights are sufficient to show the fundamental inadequacies of the modern dogmas of politike episteme.

Writing at The New Ledger, Francis Cianfrocca lucidly explains the precarious financial condition of the Republic. In the course of this he also provides some very useful economic history about how we got where we are. The answer to how we got here is deeply entangled with the geopolitics that emerged after the devastation of the World Wars and the Depression.

One way of looking at it is that we got here because after those historic calamities, concentrated in Europe, no one was left with the credibility to anchor world finance -- no one except America. "The bottom line is that the United States exports dollars, which function as a store of value in the global trading system much as gold did in the past."

Let it be noted that this settlement -- generally referred to as Bretton Woods, after the resort in New Hampshire where the victors in the Second World War met to begin the work of bringing to the ravaged world to a workable system of finance -- faciliated an expansion of wealth almost unparalleled in history. Under the operation of this settlement, both Germany and Japan were restored to a level of prosperity which would have been unthinkable to most observers at point of their ruin and subjugation after the war. Under the operation of a modified version of this settlement, China, India, and other nations in Asia have similarly witnessed an explosion of productive economic activity which has lifted countless millions out of grinding privation. And under the operation of the settlement, Americans became the richest people ever to walk the earth. The accomplishments of Bretton Woods should not be overlooked.

The problem here, as I see it, is that the position of the United States as the fons et origo of the world's reserve currency, the primary "store of value in the global trading system," presented extraordinary moral and even spiritual vulnerabilities. In a word, it exposed us to Usury on a staggering scale.

You know things are getting grim when sophisticated economists writing in the Financial Times begin contemplating Biblical solutions. Here we have Willem Buiter, who ably relates the general failure of governmental policies since the Crash, and concludes by proposing a Jubilee on household debt.

The essay is quite technical at times. Parts of it go over my head. But the gist of it is that thrift has come back in a major way. The usefulness of debt as an instrument of finance has vanished, and households around the Western world and beyond now favor savings over consumption so dramatically that no tool of governmental policy so far applied can counteract it.

Meanwhile, the vast interventions by governments in the banking and non-bank finance industries have insured that big corporations have access to capital (much of it government-backed), but smaller businesses are rigidly fettered. Credit lines are disappearing; banks are exceedingly cautious; consumers even more so. Governments and central banks may have managed to rescue the financial system; but they have done little to alleviate the deeper structural problems of the economy as a whole.

In a word, the Usury Crisis continues apace, and few in positions of authority dare face it.

The road not traveled, intellectually, is the one where savings is recognized as at base a healthy response to the exuberance of usury that has sown such ruin. We have answered a crisis brought on by excessive debt with yet more debt. The Keynesians have already begin to call for more. The frozen rigidity of their thinking is remarkable. They talk like it is 1932.

But Buiter with his half-facetious steps toward a vast cancellation of usurious debt, biblical in scope, may be signifying some breaking of the ice. Maybe.

Paul Cella's post Biblical Solutions is especially timely not just in light of the current recession, but also because of the publication of Pope Benedict XVI's new encyclical Caritas in Veritate. I'll have more to say about CV once I've read the whole thing. In the meantime, it would be useful to issue a little primer about how Catholic social teaching applies in today's dire circumstances.

What I've seen of CV so far is quite in line with how Catholic social teaching (see here for its official "compendium") has been developing since Leo XIII's Rerum Novarum (1891). By endorsing private property and the pursuit of profit, it is compatible with some forms of capitalism and thus needs no defense around here. But it also insists on conditioning those goods by such principles as "the universal destination of goods," "solidarity," "subsidiarity," and "the preferential option for the poor." As moral injunctions for the faithful, those principles are not terribly controversial either, at least among Christians. Most of the debate about applying Church social teaching concerns the extent to which such conditioning principles call for civil legislation and regulation, especially concerning the economy. On that question, the political (and theological) Left is generally maximalist; the political (and theological) Right is generally minimalist.

As a conservative in the American sense of the term, I come down mostly with the minimalists. Thus I believe that the principle of "subsidiarity" calls for private over public solutions when the former are feasible. From a theological standpoint, though, the question whether to be a political minimalist or a political maximalist is a matter of prudential judgment, rather than doctrine, about what's "feasible." The question is essentially empirical, and boils down to how to balance, in practice, the principle of subsidiarity with the other principles "conditioning" the goods of private property and profit. Subsidiarity is generally more popular with the Right than with the Left. But for Catholics, and a fortiori everybody else, Rome generally treats the balancing act as a matter of opinion. For the social teaching of the Church is logically compatible with a rather broad range of prudential judgments about how to implement it in the concrete.

In fact, what conservative critics of the Church's social teaching often fail to realize is that, seen as a whole, it is less palatable to the Left than to the Right. Liberal Catholics generally embrace Church teachings on, e.g., the death penalty, health care, and the treatment of immigrants, and want them enshrined in secular legislation; but on abortion, euthanasia, same-sex "marriage," and other issues called "social" in American political parlance, the song changes dramatically. True, the precise converse holds among many Catholics who are politically conservative, especially in the U.S.; but in my view, the conservatives hold the theologically stronger position. As Fr. Robert Sirico of the Acton Institute notes:

It is quite a spectacle to see Catholic progressives — who in other circumstances contort themselves into exegetical pretzels when they want to undermine clear, emphatic, authoritative, and repeated magisterial prohibitions on same-sex relations, female “priests,” and contraceptive acts — morph into virtual Ultramontanists on prudential matters such as the precise level of a minimum wage.

And the same could be said, mutatis mutandis, about many other political issues, such as whether the advantages of government-run health care would outweigh the disadvantages. As I argued in this post, the trouble with the Catholic Left is that it often presents as morally binding certain political proposals which, from Rome's standpoint, are really matters of opinion, and presents as matters of opinion certain political proposals which, again from Rome's standpoint, are morally binding. So not only is the Catholic Right's general sense about Church social teaching theologically sounder than the Left's; said teaching is more easily reconciled with American "conservatism," or at least with some strains thereof, then with American "liberalism."

But in some cases, applying the Left/Right dichotomy is simply unilluminating. The "usury crisis" Paul has described is a good example. Although people can debate from now till doomsday how much state regulation of debt instruments is wise, and probably will, it cannot be denied either (a) that some degree of regulation is necessary, and (b) that the explosion of public and private debt, all slated to be repaid with interest, has been bad for everybody. Ignoring the traditional moral strictures of the Church about debt and interest fosters a systemic greed which is eventually self-defeating. We are now in a situation where bankrupt governments are shoring up bankrupt sectors of the economy with funny money that will burden the next generation and beyond with unsustainable debt service. That wouldn't have been necessary if both the private and public sectors hadn't reduced themselves to pigs feeding at the trough. Because both private and public greed have driven this crisis, it's really not a Left/Right issue. It's a rather elementary moral issue.

Michael Lewis has a long article reporting the story of the rise and fall of AIG, the institution that over the course of a single day — Monday, September 15, 2008 — faced collateral calls on its derivatives portfolio in excess of $80 billion.

We're talking about the heart of the financial storm: the infamous AIG Financial Products unit — and Lewis is here to explain it, in his usual engaging style.

He spends a good portion of the article examining the character of Joe Cassano, the AIG executive who oversaw the Financial Products office during the crucial years. There are some fascinating conjectures in this discussion, but I think that for all the interest in Cassano's "cartoon despotism," the real story is this: What Lewis is describing is usury.

Observe.

"Financial risk had been created, out of thin air, and it begged to be either honestly accounted for or disguised."

"There was a natural role for a blue-chip corporation with the highest credit rating to stand in the middle of swaps and long-term options and the other risk-spawning innovations. The traits required of this corporation were that it not be a bank — and thus subject to bank regulation and the need to reserve capital against the risky assets — and that it be willing and able to bury exotic risks on its balance sheet. There was no real reason that company had to be A.I.G.; it could have been any AAA-rated entity with a huge balance sheet. Berkshire Hathaway, for instance, or General Electric. A.I.G. just got there first."

"In a financial system that was rapidly generating complicated risks, A.I.G. F.P. became a huge swallower of those risks . . . Its success bred imitators: Zurich Re F.P., Swiss Re F.P., Credit Suisse F.P., Gen Re F.P. All of these places were central to what happened in the last two decades; without them the new risks being created would have had no place to hide, but would have remained in full view of bank regulators. All of these places have been washed away by the general nausea now felt in the presence of complicated financial risks, but there was a moment when their existence seemed cartographically necessary to the financial world. And A.I.G. F.P. was the model for them all."

Etc, etc, etc.

Two recent reports in The Wall Street Journal really put flesh on the bones of my argument about what has become of the real estate and finance sectors of the American economy since this crisis of usury began. One might almost fancy these articles were written uniquely for me, so neatly do they support my contentions. (Though, as I’ll try to note throughout this post, not always so neatly.)

To summarize, my argument is that the pattern of real estate development in America has been driven for two decades or more by a very peculiar system of finance; one which depends mostly on various instruments of speculative debt, and one which, it turns out, can only be maintained, in a pinch, by intervention from the state.

Put another way, the dislocations and shocks of the past year or so have produced some striking revelations and as well as some transformations. One of the former is the revelation that this sort of speculative real estate development cannot be sustained; and one of the latter is the decision by policymakers to substitute for the private capital that once financed real estate development, the public capital of the commonwealth.

The real estate market has been socialized to such an extent that talking about a free market in it is errant silliness.

Those bald and polemical summaries set down, I will proceed to lay out in brief the evidence provided by the two recent lengthy reports from the Journal (which I encourage the reader to carefully read in full), and then add some sketchy notes of my own at the end. That I am approaching all this finance talk from the view of the simplest layman should be plain to anyone who really knows this stuff.

There are plans afoot to establish structures for global regulation of high finance. Some of these plans were adumbrated recently at a G20 conference in Pittsburgh last week. What form these plans will be take and when is anyone’s guess; but the trend of the past few decades suggests that these globalization measures, over time, do accumulate deployable power, until eventually they become part of the structure of supra-national government.

Historians will likely record that the globalization of finance capital inevitably led to the globalization of government. The panic of 2008 acted as the shock that provided clarity: and now it is clear the features of finance capitalism were as much an instrument of state policy as they were a genuine example of free enterprise.

These huge conduits by which capital from all over the world was plowed into the American real estate market, and before that the tech bubble, can be seen in political science terms as a vital element of the consolidation of government on an ever larger scale, which is the distinct trend of modernity.

Structurally-mercantilist countries like China, Japan, Germany, oil rich Gulf states, etc., with their highly-productive manufacturing or commodity wealth, generated enormous piles of capital, which naturally sought after profitable fields of investment. Financiers speak in terms of “basis points” — hundredths of a percentage point — because when one operates in hundreds of millions or billions of dollars, even a difference that small means serious cash. So capital from around the world, some private, some public, some a kind of hybrid of the two, was chasing after higher yields. Its facilitators were a collection of institutions operating in arcane securities and instruments which, in time, became “the biggest U.S. export business of the 21st century,” as Bloomberg News put it.

US regulators released some signal financial numbers last week. As the Financial Times reported, “The US financial sector's losses on large loans exploded in 2009, exceeding the combined losses since 2001, with hedge funds and other members of the ‘shadow banking system’ hit the hardest.” These non-bank institutions “held 47 per cent of problem loans in spite of accounting for only 21.2 per cent of the total loan pool.” Shadow banks, which generated such handsome returns in good times, today, in bad times, are on the floor.

Shadow banking. The invidious edge in the term is not, in my mind, unjust. There is definitely a shadowy aspect to this; but it is not so much, as liberals would have it, in the fact that the shadow banks were nefariously unregulated, real free radicals of capitalism betting like gamblers; it is in the fact that, off at the end, public capital would have to be substituted for the private capital that once drove their business.

To those who would answer that public capital should never have been committed, I must say there are certain considerable difficulties that confront you. (a) Virtually all the participants, from both government and industry, did truly believe that, whether we knew it or not, we all faced in that moment the possibility of irremediable calamity; the very crack of doom yawned before us. (b) Even if that judgment is wrong, there is still the fact of the actual statutory obligations of, say, a Fed Chairman. Does Bernanke even have the authority to adopt a policy of studious neglect of the unraveling of the financial system? It seems to me that his office entails an allegiance to stability which precludes running the experiment of an advanced capitalist economy operating with no banking system.

One of the real problems we face is confusion about the interaction between economics and philosophy. Men are seen constantly arguing across a chasm of pedagogic division, with one shouting fiercely about certain principles of nature and man qua man, and another gesturing sharply toward the empirics of a science. The fact-value distinction has left some of us unable to communicate.

Megan McArdle wrestles with some of the same difficulties in this essay on the statistical history of Gross Domestic Product.

I propose that we need to repose in that discipline or field of study which proposes to bridge this divide; which proposes to make some balance or unity of facts and values. I mean, the field of politike episteme, a Greek phrase which translates directly to political science but (following Voegelin) I would say more closely resembles what we call political philosophy.

Consider this exchange:

“Efficient-markets theory says only that markets will give us the best estimate of value. Price is our best estimate of factual value. So on the evidence, all of our banks should have perished in 2008. They were ruined institutions. If I, as trader in bank-related credit derivatives, could have had my view made policy, all of your nationalization wishes could have come true. The banks were dead. We derivatives traders glimpsed it first. Policy should have reflected it. So why should I be blamed for a political system that won't let banks fail?”

“Any derivatives trader, by virtue of his labor activity, is complicit in the very trade which brought down the banks; all of which is to state that a derivatives trader creates the conditions of his own claims to knowledge, much like oil speculators in 2008 driving up the price of oil, after real estate tanked, and then claiming that the increased ‘demand’ for oil made it a great investment. One doesn't get to create one's own knowledge and then claim an especial prescience for ‘knowing’ it, or teasing out the implications of it. The implications of the derivatives trade were that the big Wall Street banks were insolvent, and ought to have been liquidated by the Feds; the derivatives trade caused this, more than any other factor. Moreover, the derivatives trade was not a necessary condition of this knowledge; one doesn't need a trade in occult financial instruments to know whether banks are insolvent or not; one needs only the information that banks have been required to disclose, even before derivatives emerged as a critical orgy site for Wall Street.”

Here is an argument which combines factual claims with philosophic principle. The speakers refer to facts and propose principles for weighing and interpreting said facts, with an eye toward applicable policy.

In far off Dubai, where human engineering has converted deserts into vast golf resorts, ski slopes with real snow, and enormous glittering towers, another debt crisis has for some days threatened to unravel parts of the byzantine infrastructure of world finance.

“This is punishment day. Why didn’t we sell last week? This is punishment for the unexpected news from Dubai World last week.” Thus the lament of a trader in Dubai.

The punishment news last week concerned the short-term debt securities of a quasi-private investment entity, formed by the Dubai government and dedicated to commercial real estate; more specifically, the debt securities of a company best known for fabricating man-made islands. This company, evidently an aggressive employer of engineering wizardry, both ecological and financial, has floated the idea of postponing the rollover of some maturing bonds, until it achieves such visibility as to “fully inform the market.”

The uncertainty is palpable. Dubai World has some characteristics of a sovereign wealth fund, meaning an enterprise run like a high-finance satrapy of the state. In any case it far from a truly private enterprise. Meanwhile, it appears from reports that the biggest banks exposed to the disputed debt and other aspects of the Dubai enterprise, are regional, European and UK banks that, due to the recent usury crisis, now have some characteristics of sovereign wealth funds. So we have, as it were, a quasi-state holding company in a staredown over some of its debt with its foreign creditors, many of which are quasi-state banking conglomerates.

Now, one of the lessons of the past 18 months is that these distant rumors of far-off finance machination gone bad cannot be safely ignored. Much as we might want to leave the capital structure of Gulf State holding companies to the financiers and their engineered devices, the financiers will not return the favor. Readers may recall that in 2008 such far off detonations triggered ruin and bankruptcy across the world. Giant insurance companies, industrial behemoths, small towns in Australia, whole nations — they were all, in various ways, shown to be subject to the machinations of high finance.

It is a distinct temptation to concentrate one’s attention, and therefore one’s censure, on the intrigues of Wall Street. And often mere intrigues are what they are. I am have been perusing a handful of books by business and finance journalists, which among other virtues provide the reader with some picture of the human personalities behind the boom and busts of high-finance engineering. For instance, there seems to have been a very clear personal rivalry, an archetypal clash of masculine ambition, concomitant with the rise of the mortgage-backed bond market. The very invention and early development of this new trade in debt securities confected out of hundreds of mortgages, tracked rather neatly for some years, starting in the early 1980s, with the competitive enmity between Laurence Fink and Lewis Ranieri, of First Boston and Salomon Brothers, respectively.

The portrait that emerges from stories like this is that ritual denunciations of “greed” can easily blind us to the deeper motivations of the men who built up the infrastructure of usurious finance. Simple avarice, the desire for material gain or possession, is only one aspect of the libido dominandi.

There is an old song by a guy named Ben Harper, a successful, engaging and occasionally electrifying singer-songwriter from California’s Inland Valley, called “Walk Away.” It could provide the supremely perfect soundtrack for this report from the Wall Street Journal.

sometimes, sooooometimes, you just have to walkaway, walk away

Anyway I wonder what reaction commenters would have if I said, they are only emulating the principle and sentiment of the banks and securities firms.

This Bloomberg report on the financial crisis at Harvard University last year is worth reading, even if you just breeze through all the technical talk about interest rate swaps.

There is, first, the almost epic poetry of this fact: that a big player on seemingly every side of this web of contract and abstraction and folly… is a Harvard man!

In the midst of the crisis that triggered this Great Recession, Harvard University suddenly faced a crisis of its own. The University owed a Harvard man’s company (a fragment of the old Morgan empire), along with other banks, huge sums in collateral calls. It had sought to trim its capital costs with purchases of interest-rate and forward swaps. The degraded swaps went precipitously illiquid last fall, and far from lowering the school’s capital costs, instead opened a gaping hole in its available capital. “Harvard was so strapped for cash,” according to the Bloomberg report, “that it asked Massachusetts for fast-track approval to borrow $2.5 billion.”

The University survived, but its endowment fund lost close to $10 billion. A big chunk of the cash collateral went to JPMorgan Chase & Co., a firm whose history intertwines with the august Cambridge institution. (J. P. Morgan, Sr., himself had bequeathed to Harvard Medical School $1 million in 1901.)

And one of the men from the Government hired to clean up the crisis that wounded Harvard and most of American high finance — well he used to be the President of Harvard when the school purchased the toxic swaps, and indeed, he answers to a President who graduated from Harvard Law School. Many of the deputy financiers in this story also have Harvard ties.

Is there a useful distinction between Capitalism and Free Enterprise? I am convinced that the answer to that is an emphatic yes; and that the distinction is vital to a proper understanding of the wreck of our political economy.

Free enterprise is characterized, above all, by a wide private field for business competition and innovation, operating under a structure of laws analogous to a good referee in a ball game. Savers, under free enterprise, extend their capital to the successful enterprisers in the community. The economy is not isolated — some of its magnates aspire to national or even world prominence — but its core is local or regional. Its health is the effective and trustworthy lending of the capital of the older folks of the community, who have savings, to the industrious and virtuous of the younger businessmen. The old generation earns a return on this lent capital; and the younger businessmen are able, when successful, to build and distribute new wealth.

There is definitely risk in the system, but it is risk faced primarily on a personal level. Risk is intimately linked to trust. The man of means wants to know the men he invests his capital in. He'll ask about their families. He'll do his homework, but often he’ll have to take his risks based on his gut sense about men.

The great seaports of New England in colonial and early Republican America are exemplars of the free enterprise system. It is manifest that remarkable risk was undertaken in the whaling trade, when ships and stores and whalers were out to sea for a year and more, or any of the other thousand seafaring enterprises the New Englanders developed to generate their wealth. It is manifest that the trade by which this wealth was generated was a global operation. But the core of the capital at back of it was anchored in the integrity and independence of the New England towns.

With regard to particular assets — say, mortgage securities or Italian bonds — each bank knew only its own exposure to Long-Term [Capital Management]. Goldman Sachs had no idea that Salomon might be financing a similar trade; J. P. Morgan would not have known that Merrill Lynch was duplicating Morgan’s loans. So in theory, each bank had no notion of how big Long-Term was in any particular trade. But in practice, the banks were in a good position to estimate. The world of bond arbitrage is relatively small. Certainly the banks knew enough to ask for more specific disclosures. And of course they could have declined to do business with Long-Term if satisfactory answers were not forthcoming.

But the banks were fighting to do more hedge fund business, not less. Five years into a bull market, the banks were awash in liquidity, and the hedge fund trade was a lucrative way for Wall Street to employ its surplus capital. The banks accomplished this by a practice known as “renting out the balance sheet” — literally, transferring their enormous borrowing power to hedge funds with lesser credit ratings,* a service for which they charged mere pennies on every $100 of credit. Long-Term, which was easily the Street’s biggest hedge fund customer, was reputed to be throwing off $100 million to $200 million in fees to Wall Street each year, and each of the banks wanted as big a share of the money as possible.

That’s from When Genius Failed, Roger Lowenstein’s very highly-regarded story of the rise and fall of the hedge fund Long-Term Capital Management. What was Long-Term’s business? Well, it carried out investments according to the vision of John Meriwether and his band of academics and traders, who brought to Wall Street in force the analytical subtlety and brilliance of advanced mathematics, wed it to modern computing power, and produced a dazzling new field of “financial technology.” They used their mathematical tools to identify tiny fractional irrationalities in bond markets, and then piled up enormous capital behind their bets through huge leverage.

Into this business banks and other financial institutions poured their surplus capital through most of the 1990s. It continues to this day. “High-frequency trading” and “dark pools of liquidity” the latest terms for this arbitrage of the infinitesimal.

The harbingers of doom are back in the news: the infamous credit-default swaps. Several nations of southern Europe — most prominently Greece — have seen prices on swaps on their sovereign debt skyrocket, meaning that it is growing increasingly costly to purchase protection against a sovereign default. The credit-default swap market is a very liquid one; whatever may be said against these derivative instruments, they at least have the virtue of sending clear market signals about the debt instruments, which are usually far less liquid, to which they are attached.

These debt fears have roiled markets all week. There are even whispers that the European currency union is threatened. Germany, buoyed by a structurally mercantilist economy and sounder public finances than most Western nations, is playing hardball, wanting no part of a bailout of debtor nations on the EU periphery. Certainly if Italy were dragged into the debt crisis, the euro would be deep, dark trouble.

Now a default on Greek sovereign debt would surely be painful for Greeks and not a few investors, but the real worry is that this is all, as a German strategist puts it, “a dress rehearsal” for what could be in store for the US and UK down the road.

Last week the bond expert Bill Gross released a commentary on sovereign deficits entitled “The Ring of Fire,” in which he examined the rapidly accelerating deficit position of a number of major economies. His language was stark. UK Treasury bonds “are resting on a bed of nitroglycerine.” The coming decade is “likely to be fed by the melting snows of debt deleveraging.”

On Capitol Hill, the AIG debacle continues to dismay and outrage. Treasury Secretary Geithner and former Treasury Secretary Paulson endured some stern questioning from Congress. At issue: why Goldman Sachs and other investment firms should have been made whole, with public capital, on their swap contracts with the ruined insurance company. Could these financiers not been made to absorb a 10% haircut? That Paulson was a former CEO of Goldman does not reinforce his claims of probity. Geithner was formerly the President of the New York Federal Reserve bank, a quasi-private entity whose major shareholders are . . . New York finance firms. There is no want of cause for suspicion in all this.

Meanwhile, it is worth keeping in mind the fact that just this week a number of the Federal Reserve’s extraordinary liquidity support programs — a mass of peculiar acronyms — have officially concluded. There were the emergency measures undertaken in late 2008 to facilitate trading in markets that had frozen solid. Of course, anyone with any sense knows these programs will spring back to life the moment they become necessary again. But the devil is in the details: what exactly would constitute “necessary”? The markets may have been testing this all week.

The uncertainty in the world of finance is palpable. The only certainty is that the interesting times will persist.