Crisis Economics: A Crash Course in the Future of Finance [ペーパーバック]

Nouriel Roubini gained great notoriety as one of the few economists who correctly predicted our current financial crisis, specifically pointing to the 90 percent increase in home prices from 1997 to 2006. While Roubini has written other books, "Crisis Economics" is his first foray into economic literature aimed at the mass market and serves to expound on his argument that most financial bubbles are not only predictable, but avoidable. To borrow a phrase from Nassim Taleb, these are not unpredictable "black swan" events, but can be forecasted with some degree of probability. The authors aptly point out the difficulty in defusing bubbles as they inflate as no one within the financial markets or the regulatory structure typically wants to take the punchbowl away from the party. As bubbles inflate they typically open the door for schemers and opportunists who become the inevitable scapegoats for the inevitable crisis, conveniently deflecting criticism from those who deserve it. Worse still there's little accountability in either the public or private sector for those who should have known the bubble was over-inflated and took no corrective measures to stop it. What compounds the problem this time is governments are re-leveraging the system by taking on massive debt to prop up the private sector, leaving them vulnerable and unable to respond when the next crisis inevitably comes. Worse still, these "balance-sheet" crises hobble government finances resulting in anemic recoveries that drag on as happened in Japan in the 1990s. And for all the talk of the private sector de-leveraging there's little real proof that's occurring and instead it appears to be stabilizing at unsustainably high levels, setting the stage for the next liquidity crisis.

The authors look over economic history and point out a well reasoned argument, namely that economic collapses are both likely to occur and are predictable. They are not freakish, unforeseen occurrences, but oncoming events whose warning signs are ignored by policy makers, executives, and politicians. Even recent history proves this to be correct, pointing out crises limited to specific countries over the past few decades (Thailand, Mexico, Argentina, Indonesia, etc) that have led to more large scale economic problems. By now you'd be inclined to feel that Roubini truly is living up to his "Dr. Doom" nickname, but he is hardly finished. The authors roundly criticize the current tendency to socialize losses and privatize gains and calls on governments to do more to break up too-big-to-fail institutions before they do fail, as the temptation to bail them out when they do fail (and they will) will prove irresistible for policy makers and politicians alike. The sad reality is that policy makers have not yet learned their lessons and are tinkering at the margins when a more massive overhaul is required. While keeping interest rates near zero percent has kept the economy from totally collapsing it is unsustainable and new bubbles are appearing in the form of commodities prices, which have surged greatly in price.

But the authors do offer ways in which policy makers, executives, and politicians can get out of our current situation and avoid recurrences. Sadly they are not easy or palatable situations, and its all to easy for all three groups to ignore taking hard steps to reign in economic growth during robust growth periods. And that's the problem. Societies are predicated on growth and expansion. We detest the idea of tamping down economic growth as it is so contrarian, yet that's what essential. Thankfully Roubini and Mihm make economics and finance relatable and easy to understand, yet without dumbing it down significantly. As academics both write with a flair and élan uncommon in economics, yet they certainly do tend to get readers to despair at times. Their solutions seem reasonable; one can only hope that policy makers, executives, and politicians would not only read this but find the will to actually do what is necessary to prevent the next crisis.

Dr. Doom sounds more dire than ever...and with good reason. As a college instructor and business writer, Nouriel Roubini has been a personal favorite since properly predicting the real estate and resulting financial fiasco. However, this book takes everything to the "next level". Here is why you MUST buy this book (and a copy for friends or family)...

1. Compares alternatives...doesn't just complain. Many economists make a living from finding fault in current policy but when it comes time to making a suggestion they fall silent. Not so with Roubini and co-author Mihm. This book sorts through the clutter to discuss the pros and cons with each course of action, the limitations and the illusions to current and past policy...and the missed opportunities.

2. Future Trends...unlike other books that focus on the past, this book provides a firm foundation for what you can expect next. Unfortunately, the news isn't good. In fact, it's more than a bit troubling but those that fail to heed good advice are the ones likely to suffer the most. At times such as these there are two types of people...those that prepare and those that simply believe it is all "doom and gloom" so ignore it all at their own peril.

Roubini provides the reader with a firm foundation to understand how we arrived at this point and what the likely outcomes will be in the future. In fact, he clearly spells out exactly the type of scenario currently taking place with Greece...the default of nations rather than just banks and the resulting social-political and financial outcomes. There are no quick/easy fixes - just tough choices.

3. Inflation/deflation/gold and other debates. Although not the focus of this book, the authors don't shy away from taking on these hot button debates. Inflation versus deflation, the role of gold (if any), the position of the dollar, China and global positioning plus much more.

Other points. The book provides the novice with exceptional history surrounding the current economic condition while managing to include sufficient detail sure to entice the informed reader. Elusive points including the role of Basel Committee on Banking Supervision and other pertinent organizations/entities are explored without becoming tedious or boring. The book is data packed and does not rely on filler or fluff to make a point. Pure information, exceptionally balanced with positive and negative considerations on each and every point made.

Bottom Line: Must read for every informed citizen, investor or anyone else interested in the current financial situation and the likely aftermath to be experienced by the nation. This time things are different...find out why and what is likely to be coming soon to a nation near you.

Most books on economics are boring and predominately filled with vacuous philosophy. Not so with "Crisis Economics." Nouriel Roubini, Professor of Economics at New York University, is best known for his detailed forecasts of the recent U.S. financial meltdown. Co-author Stephen Mihm, is a journalist and professor of history at the same school. The authors begin by demonstrating that financial cataclysms are as old as capitalism itself (China inflated its way out of financial problems in 1075), not 'Black Swans' (rare events, per fellow author Nassim Taleb). Then, the authors provide an excellent summary of varying economic schools' perspectives on today's problems.

Today it is fashionable to see the economy as a self-regulating entity that, left alone, stabilizes at full employment and low inflation. A prominent example is Alan Greenspan, who took his basic economics lessons from philosopher Ayn Rand. Karl Marx, on the other hand, was the first thinker to see capitalism as inherently unstable; Marx contended that capitalism would inevitably plunge into chaos because continual cost-cutting by owners would eventually leave so many unemployed that a revolution would result. 'Behavioral economists' try to explain why markets are inefficient - explanations include the naive jumping on the bandwagon, and various other biases and irrational inclinations. Keynes, like Marx, also undercut conventional wisdom, stating that deflation will occur and demand will fall if wages are cut and workers fired. Keynes' solution was to have the government create the needed added demand. Milton Friedman et al (the Chicago school), explained the Great Depression as a result of the decline in bank deposits and reserves, coupled with the Federal Reserves' failure to cut the discount rate. Hyman Minsky recently revitalized Keynesians by pointing out that capitalism contains the potential for runaway expansion powered by an investment boom. The problem is due to an excess of borrowers - 'hedgers' can cover their interest and principal payments, but 'speculators' can only cover their interest payments and 'Ponzi' borrowers can't cover either. Irving Fisher added the idea that government should revive a stagnant economy by flooding it with easy money ('reflation') - that's what we did in 2007 and 2008, in addition to throwing out lifelines of liquidity out to one financial institution and business after another. Finally, the Austrian school (Schumpeter et al - 'creative destruction') argue that even Hoover did too much in the Great Depression, and our recent actions only ensured the survival of zombie banks and firms needing endless lines of credit and special legislation. This burden, however, eventually causes the government to default or inflate its way out of debt. FDIC deposit insurance and the 'Greenspan put' are folly, per Shumpeterians.

Who's right? The authors contend the Austrians are heartless and wrong in the short-term, but have validity in the median to long-term. Roubini believes "the successful resolution of the recent crisis depends on a pragmatic approach that takes the best of both camps, recognizing that while stimulus spending, bailouts, lender-of-last-resort support, and monetary policy may help in the short term, a necessary reckoning must take place over the longer term in order to achieve a return to prosperity."

Many bubbles begin when an innovation heralds the dawn of a new economy. Examples include the 1840s railroad boom in Great Britain, the Internet dot.com boom of the 1990s, and the financial services boom in the 2000s. The 'good news' is that society was left with additional rail assets in the 1840s, and unused Internet cable lines in the early 2000s. Today's latest excess - vacant houses, are not such a boon as they are subject to vandalism and deterioration, in addition to having been grossly overpaid for.

Roubini and Mihm contend that our most recent crisis is not the result of sub-prime mortgages infecting an otherwise healthy financial system, but rather a system sub-prime in its major aspects - from 'top to bottom.' The first problem is our 'shadow banking system' that looks and acts like banks, greatly exceeds the impact of banks, but has never been regulated like banks. The second is the financial services industry's moving beyond the 'originate and hold' model for home loans that had gotten S&Ls into trouble earlier when they held onto bad assets. Unfortunately, this new paradigm eliminated concern over loan quality, and was expanded to student, car, and credit card loans.

Financial wizardry was the second major contributor. "Tranching" took a bunch of risky eg. BBB-rated sub-prime loans and put about 80% into senior tranches given an AAA-rating. The more exotic products had 50-100 levels, and others involved CDOs of CDOs (CDO-squared), and even CDOs of CDOs of CDOs (CDO-cubed). These complexities made it difficult or impossible to value the instruments by conventional means - instead mathematical models were used that relied on optimistic (eg. no real estate value declines) assumptions. The result was completely opaque and ripe for panic.

'Moral hazard' was the third major piece of our latest bubble, and consisted of several components. Inappropriate bonuses (based on single-year performance, paid in dollars instead of the dodgy securities being created) was the first. In 2006 the average bonus accounted for 60% of total compensation at the five biggest investment banks, and encouraged excessive risk-taking and leverage. Shareholders didn't have much incentive to rein these practices because the firms were employing high levels of leverage, giving shareholders 'little skin in the game' and over-sized upside potential. Even bank depositors, the ultimate source of much of the funding, had no reason to care, thanks to FDIC insurance. Regardless, in the event of a downturn, the Federal Reserve could be counted on as a lender of last resort, and even that protection was backstopped by the 'Greenspan put' (his being always ready to lower interest rates). In fact, the 2007 bubble was preceded and fed by low rates instituted to get out of the 2000 dot-com bubble.

The fourth major component of this bubble was largely courtesy of former Senator Phil Gramm, who successfully had much of the derivatives market ($60 trillion of CDS by 2008) placed off-limits to regulation. (Senator Gramm, along with Robert Rubin (Clinton's former Sec. of Treasury), Greenspan ('The Maestro'), and others also brought about the repeal of Glass-Steagall limitations.) This was followed by the SEC allowing investment banks to increase leverage to 25X+ vs. 12.5X for their more regulated commercial bank brethren.

Debt-levels increased everywhere. In 1981 U.S. private sector debt was 123% of GDP, and by 2008 it was 290%. Household debt increased (48% GDP in 1981, 100% in 2007) more than industrial debt, and financial sector increased the most of all (22% of GDP in 1981, 117% in 2007). Nor did leverage stop there. Roubini relates how a borrower would obtain eg. $3 million from a bank, add $1 million of his own, and then invest the $4 million in a hedge fund. The hedge fund would then borrow another $12 million (still 4:1 leverage) and have $16 million to invest - backed by as little as $1 million. Hedge funds often didn't even stop there, increasing leverage even further.

Some blame the Community Reinvestment Act of 1977 as a major contributor to the real-estate bubble. Roubini believes this is misplaced, even though the law was augmented in the 1990s to require 42% of loans to come from those with below average income within their areas. Roubini adds that most of the growth in sub-prime came from private lenders like Countrywide. (I suspect the truth lies somewhere in the middle. Freddie and Fannie both ended up operating with 40:1 leverage ratios.)

Citibank and others then added another twist - 'Structured Investment Vehicles' (SIVs) used as off-balance-sheet vehicles to hold mortgages prior to their being sold off as CDOs, etc. The applicable reserve ratios for SIVs were only 10% those for ordinary bank assets. Citibank held $100 billion in 7 SIVs, and was ultimately forced to take them back onto its balance sheet when things went sour. Meanwhile, woe to unaware investors.

The U.S. was not alone in these new frontiers of perilous finance. Fortunately, not all participated - India benefited from greater regulation and reserve requirements.

Everyone knows how it all began falling apart. Roubini focuses instead on what the government did. Initially the Federal Reserve faced a 'liquidity trap' (akin Japan) in which the central bank was unable to spur loans, even by lowering the discount rate to 0%, because banks were afraid of the future, and had too great a proportion of toxic assets. The Fed/Treasury then bought up many of their toxic assets, provided added capital (preferred stock) and looked the other way while the banks placed overly high values on their remaining assets. The Treasury also bought up a great deal of government obligations in an effort to force down their yields and encourage banks to move their money out of these safe havens and back into loans. The key points, per Roubini, are that these actions again strengthen the moral hazard pattern, set up a possibly even worse situation down the road, and added trillions to the federal deficit. (Roubini is not against these moves, believing there was no alternative. However, he's emphatic that we're nowhere near out of the woods.)

"Crisis Economics" recommends more effective government regulation (consolidating existing agencies, and ending 'regulation arbitrage' - shopping for the most lenient regulation; re-instituting a stronger Glass-Steagall Act - "on steroids"), and breaking up those 'too big to fail' (eg. Citigroup and Goldman Sachs) . Unfortunately, we are mostly back to business as usual, and Roubini is concerned that these changes will not take place.

We now owe $3 trillion to the rest of the world, and are running current account deficits of $400 billion/year. Increasingly the U.S. will have to borrow shorter term, making us more vulnerable to future crises and sudden collapse. Roubini is worried this will lead to disruptions to Free Trade (I hope so), even though he recognizes that there are 2.0 billion people in developing nations ready to join China and India in selling to America, and former Federal Reserve Vice-Chair Alan Blinder foresees up to 25% of Americans vulnerable to additional off-shoring. The dollar's days may be numbered in years, rather than decades, though the Chinese don't seem to want the lead currency role - yet.

The unemployment rate + discouraged + underemployed (< 40 hours) now approximates 17%. Many/most offshored jobs won't return. Adding the fall in averge work-hours (equivalent to 3 million more unemployed) to the 8.4 million jobs lost by the end of 2009, recognizing that 30% of capacity is now idle in the U.S. and Europe, that 42 states and the District of Columbia have already articulated plans to cut government jobs, and that the 2003-07 'boom-years' fueled by a credit bubble won't return, leads Roubini to conclude that this recovery will be U-shaped, not a "V," and fortunately not a "W" (double-dip). But, because U.S. interest rates are near zero, speculators are borrowing dollars and investing in risky assets elsewhere, then repaying the loans in depreciated dollars. Roubini asserts this technique has easily created 50-70% profits since March, 2009, can't continue, and is building the "mother of all asset bubbles."

Roubini sees Japan and Europe in no better economic shape. The U.K. is having problems, but taking corrective steps. However, problems with the 'PIIGS' (Portugal, Ireland, Italy, Greece, Spain) may break up the European Monetary Union. China needs to boost consumer spending, and its infrastructure exceeds current needs, says Roubini. (I'll take their problems, and their economists!)

Roubini's 'Bottom-Line' - the coming era may best be described as one of "Great Instability."