Wall Street, the Depression and the Lords of Finance
Published: December 24, 2009
Crisis brings out the best in some people, or so it is said. It certainly produced some excellent books this year.
What follows is my list of six for 2009, books that I found informative and enjoyable this year. Three of the books cover aspects of financial history, including one on the greatest capitalists ever and two on the era that led to the Great Depression. The other three deal with how economics went astray.
It is not necessarily a best of 2009 list, in part because it purposely excludes books by my colleagues at The New York Times. But all are books I recommend with enthusiasm.
The books are discussed in alphabetical order, by author.
We are now in the midst of the second great disenchantment with previously omniscient central bankers, a fact that echoes through more than a few of this year’s books. In “Lords of Finance: The Bankers Who Broke the World,” Liaquat Ahamed tells the story of how the Great Depression began by focusing on the four revered central bankers of the 1920s — Montagu Norman of Britain, Hjalmar Schacht of Germany, Émile Moreau of France and Benjamin Strong of the United States. “They were all great lords of finance, standard-bearers of an orthodoxy that seemed to imprison them,” writes Mr. Ahamed.
To Mr. Ahamed, the Depression was not an economic earthquake, but a result of a series of bad policy decisions, beginning with the peace conference that ended World War I. He traces those decisions in detail, along with prescient warnings from John Maynard Keynes, whose views were largely ignored time and again. He ends the book with a famous statement by Keynes, that economists are the “trustees, not of civilization, but of the possibility of civilization.”
How did the economists fail so badly as trustees in the years running up to this financial crisis? Part of the answer is that one of the greatest economists of the 20th century, Hyman Minsky, was forgotten. It was Minsky who identified the way financial stability can breed overconfidence and thus produce the very types of market failures that created the crisis. But he was not a mathematical genius, and thus was out of the mainstream of postwar economics.
It became possible to get a Ph.D. in economics without ever hearing of Minsky. If Alan Greenspan and Ben Bernanke knew of him, they certainly disregarded his theories, to the detriment of all of us.
In “The Cost of Capitalism: Understanding Market Mayhem and Stabilizing our Economic Future,” Robert J. Barbera, one of the best Wall Street economists, sets out to explain Minsky’s importance and, in the process, to demolish some of the absurdities that came from the mathematical models of neoclassical economics, including the belief that, since markets always produce equilibrium, rising unemployment simply reflects a decision by workers to choose leisure rather than work for less.
“Ask an unemployed guy in a bar if he is enjoying his extended vacation,” Mr. Barbera writes, “and you may well have asked your last question.”
John Cassidy, a writer for The New Yorker, knows his Minsky and he knows financial markets too. The result is a lengthy book, “How Markets Fail: The Logic of Economic Calamities,” that brilliantly dissects much of what has passed for economic wisdom, and decries the lack of humility from those whose theories helped cause the disaster.
Early on, he tells the story of a speech delivered in 2005 to the Kansas City Fed conference at Jackson Hole, Wyo., by Raghuram G. Rajan, then the chief economist of the International Monetary Fund, whose warnings about how the system could blow up now seem prescient. He was greeted with scorn. Larry Summers, then the president of Harvard and now an adviser to President Obama, dismissed the paper’s premise as “largely misguided” and warned it could harm the world by encouraging unwise additional regulation.
Mr. Cassidy also quotes a column by Harvard’s Greg Mankiw, in The Times last May, in which Mr. Mankiw wrote that “despite the enormity of recent events, the principles of economics are largely unchanged.” Students, he said, still needed to learn about “the efficiency properties of market outcomes.”
Mr. Cassidy asks, “What do you suppose that refers to? Builders constructing homes for which there is no demand? Mortgage lenders foisting costly subprime loans on little old ladies of limited education?” Nothing so specific, says Mr. Cassidy. Textbook economics overlooks such inconvenient realities. “In the world of Utopian economics, the latest crisis of capitalism is always a blip.”
Larry Summers comes out a lot better in “The Myth of the Rational Market: A History of Risk, Reward and Delusion on Wall Street,” by Justin Fox of Time magazine. That is because Mr. Fox focuses on the younger Summers, who delighted in pointing to the illogic of much financial economics. “He constructed a model of an alternate financial universe in which investors weren’t rational and prices didn’t reflect fundamental values — and showed that, over a 50-year observation period, there was no way to differentiate it statistically from a rationally random market,” Mr. Fox writes.
Mr. Fox sets out to explain the efficient market hypothesis, a hypothesis that, as Mr. Summers observed, could never be proved but that was accepted as gospel by many economists until behavioral economists like Yale’s Robert Shiller pointed to clear evidence that many of us do not act rationally. This perceptive and penetrating book does a good job of tracing how that hypothesis led to the creation of markets that produced excesses and then ceased to function.
Sometimes history books say as much about the era in which the book is written as about the era being described. So it is in “The Match King: Ivar Kreuger, the Financial Genius Behind a Century of Wall Street Scandals,” by Frank Partnoy, a law professor at the University of San Diego who has written previous books critical of the Wall Street where he once worked.