The novelist John Lanchester has written one of the best books I've read on the financial crisis (although I haven't read them all by any means, and anyway they'll keep on coming). Whoops! isn't an exhaustive history of how the crisis unfolded. Nor does it definitively assign blame. What it does do incredibly well is set out some central elements of how the financial markets had come to operate by 2007, and the political and cultural context which formed an environment in which a boom and bust on steroids could happen.

The book starts by rooting the emergence of red-raw capitalist financial markets in the collapse of communism in 1989. In both its direct impact on the economy and financial markets, and its moral impact in removing an external constraint which had made capitalism kinder, Lanchester sees the fall of the Berlin Wall as a key turning point. He stresses that there was absolutely no 'moral equivalence' between communist and western regimes, as some leftist apologists used to claim, but nevertheless: “The population of the west benefited from the existence, the policies and the example of the socialist bloc.” The west had to show that ordinary people had better lives under capitalism. After the end of the Cold War, that imperative evaporated.

I think understanding this context is important: the political causes of the financial crisis have been oddly overlooked. One exception is in Simon Johnson's brilliant Atlantic Monthly article of May 2009, The Quiet Coup. Margaret Thatcher came to power in 1979 determined to deregulate finance in the UK as a political principle, with no thought about the practical consequences. One of the junior ministers in that government once told me that there had been no attempt to assess the impact of removing exchange controls overnight. I worked in the Treasury from 1985-86 and one of my jobs (as a newly minted PhD)  was to write a paper explaining derivatives to senior officials and ministers. This was after, not before, the legislation deregulating the City for its 'Big Bang' had been passed.

Other chapters in Whoops! look at the mathematization of finance, the introduction of fancy but wrong models of risk; at the creation of securitization and key moments at which the regulators blinked and permitted banks to create financial instruments with inadequate capital held in reserve; and the outright fraud and misselling scandals of the sub-prime mortgage market, with devastating human consequences.

However, the key point I take away is a simple one. Lanchester sees the fundamental problem as the industrialization of banking. The son of a banker (a manager at the Hong Kong and Shanghai Bank in Hong Kong), he writes that banking is very simple: pay interest on deposits, lend the money out at a higher rate of interest. It's a recipe for making money as long as you properly assess the risk of the loans. That can only be done case by case, in detail. Securitisation appeared to make it possible to avoid the effort and cost of assessing risk but in reality led to an increase in risk which was ultimately bound to end in disaster. “The invention of securitization broke banking, in separating the lender from the borrower by selling on the loan to somebody else” This is what created the predatory mortgage lending of the sub-prime market. (p103).

Not surprisingly, Lanchester joins all other sane observers in concluding that it's time to put finance back into its earlier, restrained framework. From Paul Volcker on down, almost everyone not depending on bankers for election campaign contributions thinks the huge banks need to get smaller. (A small ad: a paper I've co-authored with four other economists on competition in European banking will be published next week by the CEPR: we conclude there is a need for a more rigorous application of competition policy than we've seen so far.)

The book concludes: “It's time to ….. decide how to make the finance industry back into something which serves the rest of society rather than predating on it.” He links this to the much wider debate under way now about what the economy is for, a question I've been writing about in the draft of my next book and indeed will be debating with Professor Michael Sandel and the Archbishop of Canterbury later this month.

I'm very glad I've read Whoops! as it does absolutely clarify the moral issues. There can't be any doubt that what happened in many instances in global financial markets in the mid-noughties was without question immoral. The book is beautifully written too, as you'd expect from such a fine novelist, and to cap it all a page-turner. One of the crisis must-reads.