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Before 2007, economists thought that financial crises would never happen again in the United States, that such upheavals were a thing of the past. Gary B. Gorton, a prominent expert on financial crises, argues that economists fundamentally misunderstand what they are, why they occur, and why there were none in the U.S. from 1934 to 2007.
Misunderstanding Financial Crises offers a back-to-basics overview of financial crises, and shows that they are not rare, idiosyncratic events caused by a perfect storm of unconnected factors. Instead, Gorton shows how financial crises are, indeed, inherent to our financial system. Economists, Gorton writes, looked from a certain point of view and missed everything that was important: the evolution of capital markets and the banking system, the existence of new financial instruments, and the size of certain money markets like the sale and repurchase market. Comparing the so-called "Quiet Period" of 1934 to 2007, when there were no systemic crises, to the "Panic of 2007-2008," Gorton ties together key issues like bank debt and liquidity, credit booms and manias, moral hazard, and too-big-too-fail--all to illustrate the true causes of financial collapse. He argues that the successful regulation that prevented crises since 1934 did not adequately keep pace with innovation in the financial sector, due in part to the misunderstandings of economists, who assured regulators that all was well. Gorton also looks forward to offer both a better way for economists to think about markets and a description of the regulation necessary to address the future threat of financial disaster.
- Sales Rank: #270615 in Books
- Published on: 2012-11-02
- Original language: English
- Number of items: 1
- Dimensions: 6.30" h x .90" w x 9.40" l, 1.25 pounds
- Binding: Hardcover
- 296 pages
Review
"BEN BERNANKE, the chairman of the Federal Reserve, was once asked for his recommended reading on financial crises. He named the work of Gary Gorton, a Yale University professor. Misunderstanding Financial Crises demonstrates why.
Mr. Gorton brings to the question a combination of historical perspective, academic expertise and, unlike most academics, personal experience...his book is a refreshing and valuable account that should take its place among the essential reading of any student of crises." --The Economist
"The book offers essential insights into the mysteries of the recent financial crisis. Gorton has the rare depth of understanding to explain the elements and similarities of a wide array of historical crises. Fascinating reading."--Robert J. Shiller, Arthur M. Okun Professor of Economics, Yale University, author of Irrational Exuberance and Finance and the Good Society
"Professor Gorton has produced an excellent, readable and incisive account of the recent financial crisis in historical perspective. We, as economists, have an obligation to understand our own profession's failings in the policy framework leading up to the financial crisis. Gorton shows us that blind faith in mathematical models of idealized economies can lead to blind spots in regulators' view of economic reality. This phenomenon had disastrous consequences during the 2008-2009 financial crisis, as intricately documented in this book. The book presents important lessons for how financial regulatory reform should be designed and implemented in the future. In addition, it provides a cautionary tale for economists to rethink their approach to policy advice more generally."--Justin Yifu Lin, Chief Economist and Sr. Vice President, World Bank
"Financial Crises have been a feature global finance for centuries, but economists and other analysts still struggle with the subject. If anything, since the events of 2007-2009 and the more recent crisis in Europe our fears have only grown larger. In this timely new book Gary Gorton reviews history, theory and evidence concerning financial crises, their causes and possible research and policy responses. It is at the same time very thorough and very interesting, and will no doubt appeal to academics and practitioners." --Arminio Fraga Neto, former President, Central Bank of Brazil, Founder, Gavea Investimentos
"An important book." - The Financial Times 3/12/12
"Written in a very accessible style, the book makes the reader not only question what caused the financial crisis of 2008-09 but also think analytically about what made possible the moderation or the 'Quiet Period' from 1934 to 2007, during which time there were 'no systemic financial crises.' His book provides immensely useful information about the policies that led to the crisis. This volume is must reading for undergraduates in economics and finance as well as business leaders and future policy makers. Graduate students, faculty, and general readers will find it a pleasure to read. Essential."--CHOICE
About the Author
Gary B. Gorton is the Frederick Frank Class of 1954 Professor of Finance at the Yale School of Management. He is the author of Slapped by the Invisible Hand: The Panic of 2007.
Most helpful customer reviews
35 of 38 people found the following review helpful.
A Worthwhile Read
By George Hariton
Gorton makes four very important points:
(1) Financial crises always arise when the public (individuals or businesses) lose faith in bank debt. According to Gorton, creating debt is the main business of banls. It is this debt that enables our economy to function. Unfortunately, in times of rapid expansion, banks create debt too quickly and so become fragile.
(2) Financial crises are always characterized by bank runs. These can be very visible, e.g. depositors lining up to get their money back. Or they can be invisible, e.g. lenders in the shadow banking system, who typically lend for a day or so at a time, refusing to roll over the loans to suspect banks. It follows that the real problem is not banks that are under-capitalized, but banks that are illiquid, i.e. they don't have enough cash on hand to meet demands. (They could have lots of illiquid assets, but so what?)
(3) The banking sector is so essential to the economy that governments will not let it go under. In this sense, banks have been "too big to fail" for at least two centuries. The tool used by the government evolves over time -- suspensions of withdrawals and "bank holidays" in the nineteenth and early twentieth centuries, the Fed as lender of last resort and deposit insurance in the twentieth century, bailouts via purchase of toxic assets in the twenty-first. Each time the popular reaction is fury: Populists wanted to hang the bankers a hundred and fifty years ago, a hundred years ago, etc.
(4) Both fortunately and unfortunately, financial innovations allow banks to create new forms of bank debt to satisfy the growing demand for such debt. Asset-backed securities and CDOs are just the latest in a long line, e.g. checking accounts, credit cards, and so on. Government is usually one or two steps behind. Indeed, with the disappearance of the physical queue of depositors clamoring to be paid, the government now has difficulty recognizing when a bank run occurs, and tends to intervene too late.
Gorton's solution is more regulation. That may be controversial, but Gorton's case is very well argued. He examines in detail financial crises over the past two hundred years (although he limits himself almost exclusively to the U.S.). The lessons he draws lead him to the above conclusions, plus a number of other insights.
Unfortunately, as with his previous book, Slapped by the Invisible Hand, this book is very badly written and could use a strong editor or even a rewrite. It is repetitious in many places, the author jumps around a bit, and may sentences are just plain awkward. When he quotes at length a nineteenth-century author, that comes as a relief. For this reason, I'm giving it four stars instead of the five that the content richly deserves.
18 of 20 people found the following review helpful.
Useful Historical Perspective
By Ira E. Stoll
If there's a conventional wisdom about how to respond to the financial crisis, it's that banks need higher capital requirements. President Obama, in his first presidential debate with Mitt Romney, said the Obama administration had said, "banks, you've got to raise your capital requirements." Mr. Romney agreed: "you need to have leverage limits." The free-market-oriented Wall Street Journal editorial page editorializes in favor of tougher capital requirements as a "critical reform," while the left-of-center New York Times editorial page mentions the Dodd-Frank Law imposing "higher capital requirements for banks" as a reason to vote for Mr. Obama.
For that reason alone, Gary Gorton's new book is worth a look. Mr. Gorton, a professor at Yale and a former consultant to AIG Financial Products, challenges that conventional wisdom on capital requirements. "Crises are about cash and not capital," he writes. "High capital ratios cannot prevent runs." In case that is insufficiently clear, Mr. Gorton goes on, "There is almost no evidence that links capital to bank failures."
Mr. Gorton brings to bear a historical perspective along with his refreshing willingness to challenge the conventional wisdom. He says the lack of such a historical perspective is one reason that the economics profession failed to see the crisis coming: "It used to be that economics PhD programs required at least one term of economic history, but this has disappeared. Many top economics programs that previously had two or three economic historians now have none."
Among the episodes that Mr. Gorton recovers from the past are the 1857 case Livingston v. Bank of New York, in which a New York court found "the mere fact of suspension of specie payments" was not sufficient to force a bank into liquidation. Another is the 1934 case Home Building & Loan Association v. Blaisdell, in which the Supreme Court upheld the Depression-era Minnesota Mortgage Moratorium Act.
The author also has an eye for illuminating quotes when it comes to more recent events. He reminds readers that White House economic adviser Austan Goolsbee said of AIG executives, "It's almost like these guys should have gotten the Nobel Prize for evil." And that Charles Grassley, a Republican senator, suggested that AIG executives resign or commit suicide.
Given that level of hostility from government officials, it is somewhat surprising that Mr. Gorton concludes by recommending regulatory changes that "would place the government in an oversight role in the securitization and repo markets." Which government overseer would Mr. Gorton like for those markets, one wonders? Senator Grassley, or Professor Goolsbee?
The answer to that question aside, this slim and lively volume makes a useful addition to the vast library of books about the financial crisis. I learned from and enjoyed this one even though I have already read many of the others.
14 of 16 people found the following review helpful.
Not Just Another Bank-Bashing Book
By Atlantico
This is a highly informative analysis of American financial crises and bank runs since the 18th Century. Gorton's historical perspective, as opposed to the purely journalistic approach of most "insider" books--though he too was an insider at AIG--allows him to describe the 2007 crisis as the latest in a long series of sudden losses of public confidence in financial institutions. Gorton explains why it is hard to prevent such crises without absolutely foolproof government insurance ("bailouts") against every loss of every type on Main Street and Wall Street, a backup that is almost impossible to arrange because the government's own solvency isn't absolute. Nor is anyone else's in a money-based economy. There was no bank run in 2007 (the runs were on the investment houses) because we trust the FDIC to keep our bank deposits fully safe. I'll let you follow the details of this argument yourself, but I guarantee you will learn something.
I deduct one star because of the writing. For one thing, like most contemporary books--all of these comments apply to most contemporary books--this one seems not to have been professionally copy-edited. Sometimes it reads like a first draft. I don't mean Gorton is a bad writer. Even the most famous and skillful writers (including Shakespeare, Balzac, Dickens, Tolstoy, Stephen King, etc.) are not competent to edit their own manuscripts. Maybe there are no professional editors any more. Maybe publishers don't care to pay for them. In Gorton's case, thorough editing would have eliminated not only the misused words and confusing sentences but more importantly some of the wordiness and repetition. Again like many current books this one is probably half again as long as it needs to be to make its case. Often it seems that each sentence or even paragraph is totally unaware that other sentences or paragraphs in the book exist and have already used a certain fact or made a similar point (like the causes of bank runs). Modern non-fiction in particular often seems to lack a sense of overall organization. Like a dumbed-down documentary on the History Channel where the story begins all over again after every commercial, it's Back to Basics in every chapter.
Still, four out of five ain't bad. If you are interested in economic ideas and the real roots of the Great Recession, Gorton's book will amply reward your patience.
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