A Trio of Books that Help Explain the Recent Crisis

I recently posted about an excellent book on the financial crisis--Gary Gorton's SLAPPED BY THE INVISIBLE HAND. I now have two additional books to recommend. The first is by Carmen M. Reinhart & Kenneth S. Rogoff, THIS TIME IS DIFFERENT: EIGHT CENTURIES OF FINANCIAL FOLLY, and hte second is by Raghuram G. Rajan, FAULT LINES: HOW HIDDEN FRACTURES STILL THREATEN THE WORLD ECONOMY. One can get a good understanding of the causes of the crisis by reading these three books.

Reinhart & Rogoff look at eight centuries of data concerning financial crises. The information is sobering on at least two accounts--the frequency of the crises and the severity of the recession following a banking crisis. They also not that crises often follow a period when the belief at the time is that "this time is different" and complacency or hubris leads to problems. It is interesting to note that for many of the crises, a run-up of housing prices preceeded the collapse.

Gorton shows how much what happened can be described as a bank run in the shadow banking sector. Since I wrote on it previously, I won't add more here. Rajan's book tries to be the most comprehensive regarding the recent crisis. He pins the blame on the places I have suggested in the past--policymakers, the financial firms, the global saving glut, and poor regulation. He also discusses the problems caused by policymakers responding to a downturn given that the safety net in American society is less secure than in Europe. He notes a key pointsthat I think has not received adequate attention. Low interest rates have two negative effects--it reduces incomes of savers and it encourages people who want more return to take on more risk by increased leverage.

I highly recommend all three books for a greater understanding of the crisis. Hopefully, a better understanding can aid in determing how best to encourage a sustainable recovery.

Obama in My Hometown Dissing my Representative

President Obama appeared briefly in Holland, Michigan today for the groundbreaking ceremony for a new factory built by LG Chen, a Korean manufacturer. The factory will build batteries for GM's Volt. The $351 million plant is receiving $150 million from the stimulus bill passed last year. While giving his talk, President Obama diverted from his prepared text to say, "Some made the political calculation that it's better to obstruct than lend a hand. They said no to the tax cuts, they said no to small business loans, they said no to clean energy projects. It doesn't stop them from coming to ribbon cuttings -- but that's OK. " Obama had earlier acknowledged the presence of Pete Hoekstra, representative to Congress from the district that includes Holland.

Hoekstra's response was, "It demeans the office of the president. It's disappointing. It is unpresidential....This is my home district. These people are paying the taxes that he's handing out today. I'm here to respect the office of the president, and I don't think he reciprocated."

I agree that it was unpresidential. In a news report from a local tv station, Hoekstra referred to another small business owner who was expanding and hiring more people without government funding. Why isn't that owner getting any coverage.

In previous posts, I have commented on the fact that much of the stimulus was not actually stimulus spending. The Holland plant is an example. Yes, it will create jobs in an area that has unusually high unemployment. But, the batteries used in Volts are instead of other devices used in cars that are not battery operatred or hybrid. The reduced demand for those devices mean that some people are not working that would have been working but for the government grant to LG Chen.

In the past, I have often disagreed with President Obam but tended to respect him and wish hime well. The pettiness he showed today may make me reconsider.

Good Book on the Finanical Crisis

I finished reading SLAPPED BY THE INVISIBLE HAND: THE PANIC OF 2007 by Gary Gorton. It is the best book I have read on the crisis. The only drawback to the book is that it is mostly a collection of previously written articles. Most such books lack some continuity. It is less true for this book though since two long chapters were written after the crisis began.

Gorton's book isn't the complete story, but it covers a key component to the crisis--how did problems in subprime markets lead to the collapse of the banking system? He shows how it happened and shows that it was basically a bank run. The difference between the recent situation and traditional bank runs is that it took place out of sight in the "shadow banking system." That is, the run was by firms on other firms and didn't involve tradional depositors.

Unfortunaely, Gorton's book is unlikely to get the wider readership that it deserves since it is more technical and doesn't focus on the conflicts among different business and government leaders or see evil around every corner. I found the book very enlightening and highly recommend it.

Krugman on Business Climate

Paul Krugman's lastest op-ed piece in the New York Times challenges the view that business is not spending because they see the Obama Administration as antibusiness. He claims there is no truth to the claims that business is not spending because of concerns over taxes, regulation, and budget deficits. As evidence, Krugman cites data like capacity utilization and surveys of business leaders that show that more of them cite the poor economy than political climate as the major problem. Hence, says Krugman, the government should ignore the alleged reports of business unease and pump up the economy. An improved economy will get business spending again.

There is a problem with Krugman's analysis though. He assumes an either/or situation when it can be a both/and situation. Yes, the economy is doing poorly and if we had a stronger and faster recovery, business would spend more and hire more workers. But, one of the reasons for the poor economy may be nervousness on the part of business, especially if it manifests itself in putting off hiring new workers due to uncertainty.

Uncertainty is a key concern that Krugman ignored in his piece. I agree with him that business people will always complain about taxes and regulation, just as most citizens complain about taxes as April 15th approaches each year. But business investment spending concerns the future, and when the future is more uncertain than normal, business leaders are more likely to be cautious. Given that some of the administration's policies affect the cost of hiring workers, the caution affects hiring decisions. A concern that the administration is antibusiness just feeds into the fear.

Finally, it appears to me that the Administration sees its problem with business as false perceptions. This may be due, in part, to a president and many leaders, who have no experience in or with business.

Can We Learn from the Financial Crisis Inquiry Commission?

Good article in the New York Times today about the work of the Financial Crisis Inquiry Commission. Joe Nocera describes the commission as seriously seeking answers to what went wrong--unlike the Congressional hearings. It is six months still before their report will be due. It should provide interesting reading once it is available.

According to the French, Google is a Monopoly

Article in the NY TImes today says that the French have declared Google a monopoly. The article goes on to say that Google dropped ads from a French firm that sells products enabling people to know where police are. Again, I wonder if Google was a French firm if the ruling would be the same. We will continue to see firms in the tech sector having "monopoly" positions because they are producing network goods--goods that are more valuable to a consumer when most other consumers use the good. Finally, the article notes that this could have an effect of Google's future creativity since antitrust lawyers will now have more influence on what they do.

Taylor on the Financial Overhaul Bill

Good op-ed piece in the WSJ today. Stanford economist John Taylor, known for the Taylor Rule that tracked well the Fed's interest rate setting until the mid-2000s, argues the financial overhaul bill will be ineffective in preventing another crisis because it doesn't address the causes of the crisis.

There may be good reasons for some of the changes in the bill. One needs to examine the details more closely, as well as the actual regulations developed after the bill is passed, to have an idea whether this is so. Even then, we may need experience with the regulations to have a better idea about the efficacy of the regulations. But we have better ideas today about the causes of the crisis and clearly the bill does not address them.