Only the other week Desert Island Discs host Kirsty Young joined the Queen in directly asking the now former governor of the Bank of England Sir Mervyn King why no one had seen the beginning of the current crisis coming.
King responded that while there had been warnings, primarily there had been a misreading of the market and that all the things that had been seen as dispersing risk, the endless dicing up of debt to markets and so-called sophisticated financial markets, had actually just amplified and spread that risk on a global scale. So when US housing market tanked it dragged down everything else with it.
But as Nouriel Roubini contends in his book Crisis Economics, the real misreading has been of financial crashes in general.
In the first chapter he gives a brief description of what sounds like the current crisis – but two pages in he explains that what you’ve actually just read is a description of the Great Depression in the 1930s. Economic breakdowns it seems are pretty formulaic when it comes down to it.
He goes on to describe the different theories that came out of the early part of the last century in the wake of the Great Depression. So you have the Government intervention as espoused by John Maynard Keynes vs the keep Government out approach favoured by the likes of Joseph Schumpeter, Fredreich Hayek and the Austrian school.
But interestingly the book contends that rather than Keynes and the Austrian school being two diametrically opposed rivals, a synthesis of the two could be actually one potential solution to dealing with crises in the future.
The book goes through a couple of the theories of both sides of the divide and how they viewed economic instability.
For example he describes the ideas of a chap called Hyman Minsky, a professor of economics at Washington University who was a keen follower of Keynes’ ideas, who argued that Keynes had made the case that instability was an inherent and inescapable flaw of capitalism.
Minsky developed a Financial Instability Hypothesis which categorised debtors into three groups. Hedge borrowers who can repay both the capital and interest, speculative borrowers whose income will cover the interest but can’t repay the capital and ponzi borrowers who can’t afford either the interest or the capital repayment.
By contrast he says US Austrian economist Scumpeter believed instability to be the necessary consequence of the kind of innovation that made capitalism possible in the first place with his phrase creative destruction. The Austrian school largely believed Government should butt out and banks and businesses should be allowed to fail.
As the book says both camps have merits – bailouts, stimulus spending and lender of last resort have their place but there is also needs to be a final reckoning.
There are also some interesting things said on the securitisation market – it likens collateralised debt obligations, which combine hundreds and hundreds of securitisations together, to massive meat factories that churn and dice hundreds of animals. In other words, we shouldn’t be surprised when quality is so poor and calls for them to be banned.
Overall this is an extremely interesting book with plenty to say on the current crisis and how we deal with the the economic meltdowns for the future.
It provides a careful retelling of the crisis, mixed with the writings and ideas of centuries of economic theorists, from Karl Marx to chairman of the US Federal Reserve. And it concludes by saying that we need to jetison outdated ideas about markets having an inherent stability or efficiency and likewise that the current crisis was an unpredictable, unheralded event.