Five Books on the Financial Crisis

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Mutual funds are considered the safest way for most people to reap the long-term benefits of economic growth, but they don’t insulate investors from the speculative fevers that occasionally turn markets into casinos, with predictably disastrous results.

Six years out from the latest panic—the 2008-09 housing-triggered financial crisis—this is as good a time as any to examine what happened, ask who was to blame and weigh the likelihood of it happening again.

The aftermath of the bust produced a whole genre of books to help with those questions. Here are five that stand out:

Mr. Cassidy, a finance writer for the New Yorker, provides the context essential to understanding any bubble. They are generally the same, whether you’re talking about U.S. stocks in the 1920s or Japanese real estate in the 1980s: A new technology or a period of easy money generates a rise in asset prices, which reach some unsustainable level.

Mr. Cassidy coins a handy term, “utopian economics,” for the theory that unregulated markets necessarily produce optimum social outcomes. Even Alan Greenspan, the high priest of belief in self-regulating markets, famously conceded in 2008 that there was a “flaw” in this theory.

So markets can fail. Does that make failure inevitable? Mr. Cassidy does readers a service by introducing them to the late economist Hyman Minsky, whose answer was an unambiguous yes.

‘13 Bankers’
Simon Johnson and James Kwak (2010)

For the authors—who also run the Baseline Scenario blog—the story of the latest crisis is that of an ideology that has waxed and waned over time but had a particularly consequential moment of triumph in the 1990s, when Congress, informed by the free-market ideas of people like Mr. Greenspan, dismantled or vetoed some restraints on financial risk-taking. (The 13 bankers of the title are the chief executives who, the authors say, prevented the regulation of over-the-counter derivatives, which many observers say amplified the severity of the panic.)

They aren’t sanguine about the future. “Absent fundamental reform,” the authors write, “there is no reason to believe bankers will refrain from inventing new toxic products and precipitating another crisis in the future. What’s more, given the growth in the size of the leading banks, the next crisis is likely to be even bigger.”

‘The Financial Crisis and the Free Market Cure’
John A. Allison (2012)

Mr. Allison, who heads the free-market Cato Institute, doesn’t buy the view that greedy bankers run amok were the sole cause of the crisis. Instead, he argues that the crisis was ultimately a product of meddling by the federal government, whose politically motivated intervention in the housing market and the broader economy created moral hazards and perverse incentives that led to excessive risk-taking and ultimately disaster.

His culprits are a familiar cast of characters: a lax Federal Reserve that inflated the housing bubble; the housing giants Fannie Mae and Freddie Mac (whose implicit—and, it turned out, actual—government backing fueled risk-taking that a purely private market wouldn’t have); the Federal Deposit Insurance Corp., in effect a publicly underwritten safety net that “destroys market discipline” and encourages risky lending; and the 1977 Community Reinvestment Act, which its critics say forced lenders to take on bad credit risks.

‘Age of Greed’
Jeff Madrick (2011)

The title alone pretty much conveys Mr. Madrick’s take. Where Messrs. Johnson and Kwak walk us through the evolution of Big Finance, Mr. Madrick is its biographer. “Age of Greed” is a series of vignettes on the movers and shakers who, mostly since the 1970s, pushed to liberate finance from its New Deal constraints.

What is most striking here isn’t the power of a rational, self-seeking industry to bend public policy toward its private advantage. That’s what powerful industries do. What is striking is the visceral dislike of Mr. Madrick’s key figures for the regulatory regimes of the New Deal and after.

Citibank CEO Walter Wriston, who led the dismantling of interest-rate regulations—a step many regard as the opening shot in the financial liberalization of the next three decades—was driven, Mr. Madrick writes, by “an almost inchoate anger against government intrusion.” Washington, the author writes, has yet to reorient the financial industry to “do what it is supposed to do: channel savings to productive uses.”

‘The Big Short’
Michael Lewis (2010)

If you have never understood the speculative nuts and bolts inside the housing boom, this is a good place to start. Mr. Lewis is entertaining, as always, painting vivid pictures of a handful of people who saw what was coming.

But he also provides a primer on the food chain of risk that led to the crisis—from the origination of mortgages to their securitization to the creation of the exotic and dangerous securities called synthetic CDOs—and the perverse logic that underpinned the whole racket.

From the early failures of subprime loans in the 1990s, Mr. Lewis writes, “The market might have learned a simple lesson: Don’t make loans to people who can’t repay them. Instead it learned a complicated one: You can keep on making these loans, just don’t keep them on your books.”

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