Stay Informed!

By Bill Schweke on 02/15/2011 @ 04:42 PM

Tags: Ideas in Development, Recommended Reading, Global Economy

If the reader has any interest in the Great Recession and reads books, not just articles, he or she would have been struck by the virtual avalanche of books on the subject. I have probably read a dozen, as well as read some refresher pieces on Keynes, macroeconomics, history of Wall Street, and so forth. There are some great journalistic articles and scholarly tomes and lots of great stories out there.

Many claim that they are done with the general reader in mind. But they deal with a tough, complicated subject for the uninitiated in High Finance.

Two recent books move to the top of the list, regarding Meltdown 101 – Howard Davies’ “The Financial Crisis: Who Is To Blame?” and David Skeel’s “The New Financial Deal: Understanding the Dodd-Frank Act and its (Unintended) Consequences.”

The first volume does a superlative job of summarizing 38 different causes of the Meltdown – some that were more flippant (video games) and some were large, serious and even after the reform, hard to avoid in the future (“The Rich Get Richer, the Poor Borrow”). These three dozen-plus factors and events were grouped into 7 big categories:

1. The Big Picture
2. The Trigger
3. The Failures of Regulation
4. Accountants, Auditors and Rating Agencies
5. Financial Firms and Markets
6. Economics and Finance Theory: Irrational Expectations
7. Wild Cards
8. And Finally . . . A Combustible Mixture

Howard Davies, the current Dean of the London School of Economics, sought to present the origins and key traits of the so-called “Great Recession” in a fairly objective manner, while leaving space for some opinionated judgments when the time and specifics were right.

The book is based on materials collected for readings on a course on the Meltdown at LSE. Each of the 38 chapters identifies about half of a dozen, well-selected and current readings.

Since the book is a summary, it is a bit difficult to summarize. So, I will now just note a few of the issues and trends that seemed to matter, when trying to get a handle on the root causes of the recent recession.

• Uneven global trade and savings between China, India and the US. (And, leading of course, to America’s persistent trade deficit.)
• Loose monetary policy which created a larger bubble.
• The “inherent” tendency of capitalism to still move from boom to bust. (Prior to the meltdown, many claimed that the business cycle had been tamed. Wrong!)
• The subprime collapse, due to poor underwriting and high leverage.
• Numerous regulatory failures – inappropriate pro-cyclicality “incentives”, hidden off-balance sheet vehicles, derivatives, insufficient funds allocated to liquidity concerns, confusing regulatory complexity and division of labor in US, and many more.
• Lousy oversight of Fannie Mae and others similar institutions. (Interestingly, Davies saw this as a negative factor, but did not view, on the other hand, that the federal Community Reinvestment Act as a problem.)
• Multiple conflicts of interest – accountants, auditors, rating agencies and others.
• Breakdown in financial models used to predict economic fortunes in the future, which then contradicted the Efficient Market Hypothesis, which underpinned so much of the development of new securitization products.
• Much more . . .

Especially disturbing is the fact that we are still very ignorant about the causal chain of events, the “weight” of many of the factors, the identification of the most needed and efficacious reforms.

The Skeel book provides very little reassurance to the reader, who waded through the Davies text, regarding whether the problem has been really fixed.

The author is a bankruptcy attorney and law professor, with ties to the American Enterprise Institute. “The Financial Deal” is the first book-length independent analysis of the Dodd- Frank law. On the negatives, he notes the following points:

The legislation was designed by many of the parties involved in “making” the Meltdown happen and developing the first response to the liquidity crisis.

• The auto bailouts set bad precedents for future crisis, which could either lead to corporate domination of the bankruptcy process or governmental abnegation of rule by law.
• It makes federal bailouts more likely in the future.
• It avoids taking any anti-trust actions on those banks that are too big to fail.
• The law fails to clarify cross-border challenges and ambiguities between nation states.
• It foments a shift in the direction of “corporatism.”
• So much still depends on the rules that still need to be written and debated.
• The creation of the Consumer Financial Protection Bureau with Elizabeth Warren as the first director.
• The transparency requirements for derivatives.
• The potential of the Volker Rule to separate commercial from investment banking. (Some dangers here though because of some ambiguities in wording. The rule-making might or might not help.)
• New rules for capital and liquidity requirements.
• Most of the weaknesses are relatively achievable via a number of simple changes.

The last few chapters and its conclusion outline the author’s reform recommendations. Although I do not agree with all the author’s suggestions and assessments, he is very thoughtful and the book is a judicious summary of a very big law.

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