Nouriel Roubini and Stephen Mihm -- Crisis economics: a crash course in the future of finance
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This is a fairly typical explanation of the recent financial
crisis, where it came from, how it proceeded, what the causal
mechanisms were, and what threats and risks are still there.

But, it's a well done, clear explanation.  Roubini and Mihm are a
great pair.

There is a bit in the way of prediction near the end of the book,
but the real strength is the understanding it gives you so that you
can picture for yourself what the future possibilities are.

This book has significant sections on reforms and cures.  But, do
not expect a simple prescription.  Roubini and Mihm describe
various remedies, and they explain in detail the ways that that
each will work and will not.  By doing so, they will help you to a
deeper understanding of possible fixes and their consequences. 
But, you will need some perseverance to get through it all.

A very fundamental issue is their discussion of "white swan
events", that it, events that are rare, but that should be
expected.  When you have a system that is unstable, you should
expect large events.  For example, a financial system that contains
high levels of debt and in which participants use lots of leverage,
we should expect significant crashes.  It's foolish to be
surprised.  Those crashes are inevitable; they will happen; and
they will be dealt with at taxpayer expense.

Sovereign governments and central banks have taken on the
responsibility to back-up and bail out the consequences of risky,
high leverage behavior in the financial system.  In effect,
sovereign governments like the U.S. and those in Europe have become
part of the larger financial system, stepping in to react to crises
and crashes.  We are past the point where we can believe that this
will not happen again.  And, so we citizens and our governments
should at the least demand influence over and regulation of that
risky behavior, because we *will* be the ones who will bear the
cost.

A few specific things you will learn from this book:

- How shadow banks effectively function like banks, creating
  leverage and debt, with the risks that entails even though they
  escape the regulation that pertains to banks.

- How the financial system creates the structures which result in
  the chain of events that cause a crisis and that freeze lending
  and liquidity.

- Why transactions and trades done in a non-transparent way cause
  a panic.  Hint: in part it's because no one knows how much
  exposure their counter-parties have.

- How leverage leads to crashes in the values of a range of assets.

- Something about the huge changes in the structure of the
  financial system and how some very large institutions (banks,
  investment banks, and shadow banks) have been swallowed up or
  have disappeared entirely.

- How securitization, for example of home loans, leads to problems
  when those who create the securities have an incentive to create
  those securities and do not fully shoulder the risks of those
  securities (perhaps because they can sell them to others in the
  securitization food chain).

- How bank regulation and bank capitalization requirements, or more
  importantly, their failure, led us to the current crisis.

- An account of how the financial system collapsed, step by step. 
  Importantly, how the crisis was a collapse of the shadow banks,
  i.e. institutions that act like banks but are not regulated like
  banks.

- How the crisis spread across the world.  How it became a *global*
  crisis.  What mechanisms and markets and connections enabled that
  to happen.

- Some of the possible reforms.  But, also some of the ways that
  existing financial institutions are likely to try to slither away
  from those reforms.

And, finally Roubini and Mihm provide a few considerations about
where the global financial system is headed.  In particular, as the
U.S. financial hegemony erodes and as the U.S. dollar loses its
strength as the world reserve currency, what is likely to replace
that hegemony and reserve currency.

And, I have (at least) one question:  I've always believed that the
financial markets in the U.S. are reasonably transparent and fair. 
Roubini and Mihm's book, as well as others that I've read about the
recent financial crisis, say or suggest that much of what goes on
in these markets, especially the activity that happens directly
between counter-parties and not on regulated exchanges is not
transparent.  It would, it seems to me, be of much value to have a
study of the extent and the consequences of this lack of
transparency.

06/16/2010

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