By James Kwak
The first generation of financial crisis books was largely blow-by-blow, behind-the-scenes accounts, like David Wessel’s In Fed We Trust and Andrew Ross Sorkin’s Too Big to Fail — long on characters, events, and dramatic suspense (or at least as much dramatic suspense as you can have when writing about something that unfolded on the front pages of the newspaper), but relatively short on analysis. There were also more analytical books, like Justin Fox’s The Myth of the Rational Market and John Cassidy’s How Markets Fail, which seem like books about free market economics that later turned out to be about the crisis. But one thing this crop had in common is that, for the most part, they ended with the near-collapse of the financial system.
The current generation of books is not just about the crisis and what caused it, but also about the response to the crisis, and what went wrong — that is, why the large banks are bigger, more powerful, and more concentrated than ever before and why the unemployment rate is still languishing around 10%. Joseph Stiglitz’s Freefall (which I haven’t finished reading) falls into this category, focusing more on the governmental responses of 2008-2009 than on the causes of the crisis. So does Yves Smith’s ECONned, which just came out this week. (I have the early version that the publisher sent to Simon a while back.)
Unsurprisingly for readers of naked capitalism, ECONned stands out for its treatment of the complex securities and especially the trading strategies that helped inflate the bubble and exacerbate the crisis. I’ve been reading about this stuff for a long time now, and there was still a lot I learned, particularly from Chapter 9, “The Heart of Darkness,” which describes how trading in CDOs built out of mortgage-backed securities drove mortgage lending, and not the other way around. In the conventional account, unscrupulous lenders and investment banks were the creators of those toxic assets; in Smith’s account, at the peak in 2006, it was traders who were shorting the housing market who provided the equity that funded all those subprime mortgages.
But there’s another point that Smith makes that I found particularly memorable. She tells the fictional story of XCrop, a new, bioengineered food that is nutritionally complete and cheap to produce — a solution to malnutrition and obesity all in one. But twenty years after becoming popular, and after having become the mainstay of the food system (replacing today’s current staples), XCrop is found to have serious harmful effects on human health. Shifting back to today’s foods would be healthier, but it would be difficult and expensive.
Recent financial technology, Smith says, is like XCrop. The point she is making is that our policy objective should not be to get us back to the good old days of cheap mortgages and widespread securitization as quickly as possible so we can return to the outsized consumption of the past decade. We need to have a healthier financial system, and to get there we have to give up the wonder food that turned out to be so harmful to the economy. Instead, however, Smith argues that much of the government has been captured by the financial services industry — the inventors and manufacturers of XCrop. And so, at the end of the day, and despite the central role that free market economic orthodoxy played in producing the crisis, the problem we face is ultimately one of politics.