I just finished reading Capital in the Twenty-First Century by Thomas Piketty, the economics work du jour that has been called the most important book of the century. Rather than take the time to collect my thoughts and organize them into a coherent, sensible review, I decided I’d just dump my initial impressions in a scattered fashion and let you wade your way through. I’m not sure why anyone would even by interested in what I have to say about the issue (as opposed to people much more informed than I am), but this is the Internet and being unqualified never stopped anyone before!
—It seems to me that, in all the discussion of Piketty’s book, a lot of people are misconstruing the argument he’s really making. The summary you’ll see a lot is that Piketty is saying inequality has been getting worse for the last 30 years or so. And that is sort of what he’s saying, but that’s not the crux of his argument, and he’s very open about the lack the clarity on that issue. Indeed, he says, “It is by no means certain that inequalities of wealth are actually increasing at the global level.”
Still, inequality is the central theme of the book, and Piketty paints a harrowing portrait. But the full picture he creates is not just one of the present and recent past. He goes all the way back to the eighteenth and nineteenth century and illustrates a few key points. The first is that inequality decreased substantially throughout the twentieth century. This is kind of obvious, but his next point is crucial: This decrease was essentially a historical accident. It was the result of a global Depression and two world wars of unprecedented scale, which destroyed a ton of wealth* and, as Piketty puts it, “wiped the slate clean” for the generation after World War II.
*The way this happened was not as obvious as you might think. Some of it was just the physical destruction of the wars, sure, but it also came from nationalizations caused by the war, loss of European colonies, and the huge national debts and subsequent inflation that followed. Piketty explains it all better than I could.
In other words, the decrease in inequality wasn’t some natural result of the forces of capitalism, but the legacy of specific disasters we’re only now emerging from.
It’s the final post of The Great Read-cession! Just shut up and read!
What should the government have done differently?
This is a very loaded question. When I first started reading about the issue, while it was going on in 2008-09, I got the sense that this was really a rare case where the government was not at fault. This wasn’t like Watergate or Iraq, where people in power abused that power—it was just a case of private companies going wrong. But it becomes a lot trickier when you look closely at how intermeshed the government and the financial world actually are.
A lot of the conversation about the government’s role in the collapse has surrounded the issue of deregulation, specifically the issue of Glass-Steagall. On the other end of the political spectrum, Republicans have focused on the GSEs as responsible for the decline in lending standards. But both of these issues seem more like scapegoats than real sources of the problem.
As most of the data makes clear, the Community Reinvestment Act of 1992, which directed Fannie and Freddie to purchase more mortgages from certain minority groups, had very little to do with the subprime boom and decreased lending standards. Fannie and Freddie bonds defaulted at a lower rate than those sold to wholly private firms, and there was clear market demand for housing securities absent any government pressure.
The repeal of Glass-Steagall, on the other hand, at least bears some of the blame for allowing companies like Citigroup and Bank of America to get so big. While the law had, since 1933, separated the activities of commercial and investment banks, its repeal allowed the biggest commercial banks in the country to expand their proprietary trading.
With that said, the repeal of Glass-Steagall was mostly symbolic—banking regulators had been allowing more trading at commercial banks for decades before its official repeal in 1999. And the most notable failures of the financial crisis—Lehman, Bear, AIG, Fannie, Freddie—would not have been affected at all by the law. Continue reading
We’re wrapping up the financial crisis book reviews with today’s look at two books on the reform efforts that followed the crash of 2008.
Confidence Men: Wall Street, Washington, and the Education of a President
by Ron Suskind, 2011
The last two books I read focused mainly on the government’s response to the crisis, as opposed to the crisis itself. Confidence Men, which got a lot of attention when it came out for its revelations of in-fighting in the Obama Administration, showcases Obama’s response to the financial crisis, both as a candidate and as a new president.
As a candidate, of course, the financial crisis and the housing bubble were a boon to Obama. The sluggish economy of President Bush’s last few years helped Obama’s message of change resonate with the electorate, and John McCain’s incoherent response to the crisis—including his assertion that “the fundamentals of our economy are strong” on the day Lehman failed—helped doom his campaign.
But once Obama was elected, the crisis became a tremendous albatross. One problem was that while many within the campaign anticipated a crisis of some kind, nobody really expected it to come so fast and be so severe. Suskind details a scene from early in Obama’s campaign—August of 2007—in which Obama’s economic advisers warn him that, as president, he will need to respond to a housing crisis. But they estimated that the crisis would hit in “year two” of an Obama presidency, and it would cost about two million jobs. In reality, of course, it came before Election Day, and ultimately cost about eight million jobs. Continue reading
It’s Part VII! (Remember, if you’re having trouble keeping up, check here for a complete list of all posts in the series.) Today John S looks at the magical world of hedge funds.
The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It
by Scott Patterson 2010
“Quant” is a word that pops up over and over again in descriptions of the financial crisis, but it never really gets defined. It tends to be used on Wall Street the way “sabermetrician” gets used in baseball or “Nate Silver” is used in politics: It just means someone who uses math in a slightly unconventional way while doing his job.
Nevertheless, these “quants” were blamed for much of the financial crisis, as those industry “experts” who concocted elaborate formulas showing that housing prices would never fall and homeowners would never default. I turned to Patterson’s book to find out who, exactly, these “quants” were and why their formulas—unlike Nate Silver’s and Billy Beane’s—went so awry.
Patterson’s title bills the book as a story of these “new… math whizzes,” and the cover even contains a quote from Warren Buffett: “Beware of geeks bearing formulas.”* Unfortunately, Patterson’s book focuses primarily on the world of quantitative hedge funds. In other words, instead of focusing on those within the banks themselves and how these whizzes were used to justify massive trading strategies, Patterson’s book is about some of the most successful outsiders. Continue reading
We’re up to Part VI, which means we’re over halfway through the breakdown of financial crisis literature. Today John S looks at what might be the best book about the crisis, and what might be the most fun.
All the Devils Are Here: The Hidden History of the Financial Crisis
by Bethany McLean and Joe Nocera, 2010
If I had to recommend just one book about the financial crisis, it would probably be All the Devils Are Here. It’s not necessarily the best-written or most thrilling book on the subject, but it’s the most comprehensive, and perhaps the only book that captures just how nuanced the causes of the crisis were. Instead of focusing on one bank or one cause or one period of time, McLean and Nocera trace the origins of the crisis back decades, and examine precisely how things evolved.
One thing they illustrate well is how Wall Street tends to create something useful, and then, in the course of trying to find new ways to make money off it, turns it into a weapon of wealth destruction. In the 1980s, for example, mortgage-backed securities seemed like a great idea. Grouping mortgages together into one security allowed investors to introduce capital to the industry without being subjected to the inefficiencies or risks inherent in one mortgage or even one region. They also helped the GSEs’ bottom lines, of course.
But as time went on, these securities changed the mortgage market itself. Wall Street’s demand for mortgages to securitize lowered lending standards and increased shady lending practices, like ARMs and NINJAs. Continue reading