Nouriel Roubini, nicknamed “Dr. Doom”, accurately predicted the start of the Great Recession in the 2007-2008 era. Teamed up with Stephen Mihm, a journalist and professor of history in New York University, the authors start the book by going back in history to reveal that economic boom and bust cycles are as old as economy itself, as China inflated its way out of financial messes in 1075. “Black swans,” to match Alan Greenspan’s mentioning of the Great Recession as once per century, are actually predictable and common in degrees of probability across history. It is hard to defuse the bubbles because there are too many stakes on the table held by major stakeholders as strong political barriers. When the bubble becomes really big, nobody dares to deflate it, worrying about its disastrous economic impact.
The authors go on by analyzing various economic philosophies in history. From the last two decades, people normally view the economy as a self-sustained entity that stabilizes at low inflation and full employment. Occasionally, it swings between the two extremes as economic peaks and recessions. It is government’s responsibility to make sure that the economy will efficiently, according to presidential cycles, return back to the equilibrium. A prominent representative is Alan Greenspan, taking notes from the philosopher Ayn Rand. In the early days of capitalism, Karl Max was the first to notice its instability. He contended that continuous cost-cutting would eventually leave most of people out of a job. Thus, a revolution would follow. Keynes observed that deflation is unavoidable unless governments create the needed demand under deflationary scenarios. Hyman Minsky further points out that the biggest issue of capitalism is caused by an excess of borrowers, classified as hedgers, speculators and “Ponzi” borrowers. Irving Fisher reiterates the idea that the government needs to reflate the economy out of stagnation, as Benanke religiously followed in the 2007-2008 era. The Chicago school simplifies the Great Depression as the failure of the Fed to cut the discount rate as well as the decline of bank deposits and reserves. The Austrian school, on the other hand, argues that even Hoover has done too much. The burden of supporting zombie banks and financial institutions would eventually force the government either to default or to inflate out of debt. The authors believe that the Austrians are correct in the long run while they would cause a disastrous impact on society in the short-term. The best solution is to apply the right solutions in the right time frames.
The authors spend a lot of pages analyzing the Great Recession that is still ongoing. They conclude on four major contributors to the bubble:
- Our ’shadow banking system,’ that greatly exceeds the impact of banks, has never been regulated like banks.
- Financial wizardry made it difficult or impossible to value the financial instruments, such as CDO or CDS, by conventional means. Compounded with the fundamental fraud in the model - as the Great Depression era data was not considered in the mathematical model, the opaqueness has caused big losses to investors.
- Moral hazards, intensified via continued government bailouts in the past decades, simply encourage people’s excessive risk taking and largely inappropriate business practices.
- Former senator Phil Gramm has successfully put much of the derivative market off the government radar, followed by the SEC lifting the leverage to 25x for investment banks.
The authors continue providing effective suggestions to get out of the current boom-and-bust business cycles. These measures include, but are not limited to, agency consolidation and termination of ‘regulation arbitrage’, re-institution of Glass-Steagall Act, and break-up of ‘too big to fail’. Unfortunately, this is unlikely to happen with the same stakeholders who set the rules decades ago and who are still benefiting from these rules.
With 368 pages, the book is thick and not light. What I have revealed above is only the tip of the iceberg. There are more details underneath the covers worth the time.