A Measly One-Horse Institution

As noted earlier, I am spending a ridiculous amount of time reading books about the financial crisis this semester.  And, it didn’t take me long to realize that reviewing them one by one would get pretty tedious.  So, herewith is a Trio of Reviews.

The general review: All three of these books are pretty good, but they have very different audiences.  It is also will worth noting that these books are still part of the preliminary studies of what happened in 2007-2008; it will be a few more years before we start getting anything remotely resembling definitive studies. 

1. Michael Lewis, The Big Short

Michael Lewis is an Institution.  His first book, Liar’s Poker was all about a curious episode in the 1980s when these guys at Solomon Brothers starting putting together these interesting little assets called mortgage backed securities.  Fast forward 20 years and those same securities are in the middle of the financial crisis of 2007-08.  So, it was inevitable that Lewis would write a book, and it was also inevitable that it would be an attempt to be The Book.  It isn’t.  Fortunately, Lewis has a few things going for him. 1) He writes really well; 2) He has a good sense of humor; 3) He understands financial markets; 4) He writes for normal people.  The end result—it’s a pretty good book.  If you only want to read one book about the financial crisis and (importantly) if you don’t really care about what exactly went on but you just want to have a rough idea what went on, then this is the book for you.  I suspect you’ll enjoy it.  Lewis has a great eye for digging up curiously bizarre people and telling their story in an amusing way.  Lewis also skipped trying to write a book about the people at the heart of the crisis (lots of people will write that book); instead, he looks at a few truly odd individuals who made a fortune in 2008 because they guessed that things would go bad a little bit sooner than everyone else realized things would go bad.  The book does portray the financial crisis as Inevitable;  it’s not obvious to me how inevitable it really was—clearly some individual markets and assets were going to go bad, but there isn’t an obvious reason why the failure of a few assets would bring down Wall Street and then the US economy.  In other words, not surprisingly, there is more to this story than the slice presented by Lewis.  That isn’t a problem with Lewis’ book at all, though; at present, it is impossible to write the complete story.  What do we learn from Lewis’ book?  We learn a lot about the complicated nature of the securities at the heart of the crisis.  I knew before I read Lewis that these securities were really hard to figure out, but I learned they are even harder to figure out than I thought.  As it turns out, the guys who did guess that something was wrong also didn’t understand the assets—they just guessed that if they couldn’t understand them, then maybe the assets weren’t particularly solid assets.  The best stories in the book are about how these guys gradually learned that their own personal ignorance was no less than the collective ignorance of the participants in the market as a whole.

2. Lawrence Kotlikoff, Jimmy Stewart is Dead

You know those people in 2008 who screamed non-stop about how everyone on Wall Street was corrupt, evil, stupid and greedy?  Those people annoyed me because they didn’t actually understand the nature of the industry about which they were outraged.  Kotlikoff's book is thus a bit of a surprise.  It has all the Moral Outrage of the Screamers, but Kotlikoff is actually a very good economist and the book is solid economics.   (Kotlikoff, by the way, is a co-author of the single best book on the looming Social Security Crisis (The Coming Generational Storm).  Apparently, Kotlikoff really wants to be the bearded guy on a corner holding a sign saying “The End is Near.”)  The first half of this book is thus perfect for anyone who wants his outrage to be informed.  The second half of the book is Kotlikoff's argument for “limited purpose banking” which is just a variant on the old idea of a 100% reserve bank.  The banks in the limited purpose banking world are perfectly safe, there is no need for deposit insurance, and there won’t be a meltdown of the banking system.  In my younger years, I really liked the 100% reserve bank idea.  But, over time, I realized it wouldn’t work, and for reasons which also afflict Kotlikoff's version.  Suppose you make a perfectly safe bank.  The money supply is then safe.  Everything looks great.  But, along comes a thing that looks like a bank, but isn’t really a bank.  This new not-a-bank-thing offers an account that looks artificially close to a checking account, but isn’t exactly a checking account.  But the new not-a-checking-account-at-a-bank-thing is riskier and not insured.  It also pays a higher interest rate than an old-fashioned safe checking account at a bank does.  People move their funds from the bank to the non-bank.  The money supply is now at non-banks.  And, lo and behold, we are back where we started.  I never could solve this problem, so I lost my enthusiasm for 100% reserve banking.  When I started Kotlikoff’s book, I was hoping to rediscover my earlier love, but, alas, she still has the same flaws she had when she was younger.

And a depressing by-the-way:  I asked my class if anyone knew who Jimmy Stewart was.  None of my students did.  (Before anyone asks, here is the relevant clip.)  (Best movie ever (and it’s not a contest).)

3. Gary Gorton, Slapped by the Invisible Hand

This is The Book about the financial crisis…if you are a Geek.  Gorton wrote the single best paper on the gory details of the financial crisis, and the book has that paper, plus a later paper with even more gory details, plus an introduction and conclusion (and an earlier paper) to make that pair of papers with gory details look like a Book instead of just a Couple of Papers Put Between Hard Covers.  The details are fascinating for those who like that sort of thing.  Surprisingly, and I am seriously surprised, I have heard from several students that they loved this book.  My students are bigger Geeks than I thought.  I loved it too, but that is a surprise to nobody.