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Crisis Economics: A Crash Course in the Future of Finance

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Nouriel Roubini gained great notoriety as one of the few economists who correctly predicted our current financial crisis, specifically pointing to the 90 percent increase in home prices from 1997 to 2006. While Roubini has written other books, "Crisis Economics" is his first foray into economic literature aimed at the mass market and serves to expound on his argument that most financial bubbles are not only predictable, but avoidable. To borrow a phrase from Nassim Taleb, these are not unpredictable "black swan" events, but can be forecasted with some degree of probability. The authors aptly point out the difficulty in defusing bubbles as they inflate as no one within the financial markets or the regulatory structure typically wants to take the punchbowl away from the party. As bubbles inflate they typically open the door for schemers and opportunists who become the inevitable scapegoats for the inevitable crisis, conveniently deflecting criticism from those who deserve it. Worse still there's little accountability in either the public or private sector for those who should have known the bubble was over-inflated and took no corrective measures to stop it. What compounds the problem this time is governments are re-leveraging the system by taking on massive debt to prop up the private sector, leaving them vulnerable and unable to respond when the next crisis inevitably comes. Worse still, these "balance-sheet" crises hobble government finances resulting in anemic recoveries that drag on as happened in Japan in the 1990s. And for all the talk of the private sector de-leveraging there's little real proof that's occurring and instead it appears to be stabilizing at unsustainably high levels, setting the stage for the next liquidity crisis.

The authors look over economic history and point out a well reasoned argument, namely that economic collapses are both likely to occur and are predictable. They are not freakish, unforeseen occurrences, but oncoming events whose warning signs are ignored by policy makers, executives, and politicians. Even recent history proves this to be correct, pointing out crises limited to specific countries over the past few decades (Thailand, Mexico, Argentina, Indonesia, etc) that have led to more large scale economic problems. By now you'd be inclined to feel that Roubini truly is living up to his "Dr. Doom" nickname, but he is hardly finished. The authors roundly criticize the current tendency to socialize losses and privatize gains and calls on governments to do more to break up too-big-to-fail institutions before they do fail, as the temptation to bail them out when they do fail (and they will) will prove irresistible for policy makers and politicians alike. The sad reality is that policy makers have not yet learned their lessons and are tinkering at the margins when a more massive overhaul is required. While keeping interest rates near zero percent has kept the economy from totally collapsing it is unsustainable and new bubbles are appearing in the form of commodities prices, which have surged greatly in price.

But the authors do offer ways in which policy makers, executives, and politicians can get out of our current situation and avoid recurrences. Sadly they are not easy or palatable situations, and its all to easy for all three groups to ignore taking hard steps to reign in economic growth during robust growth periods. And that's the problem. Societies are predicated on growth and expansion. We detest the idea of tamping down economic growth as it is so contrarian, yet that's what essential. Thankfully Roubini and Mihm make economics and finance relatable and easy to understand, yet without dumbing it down significantly. As academics both write with a flair and élan uncommon in economics, yet they certainly do tend to get readers to despair at times. Their solutions seem reasonable; one can only hope that policy makers, executives, and politicians would not only read this but find the will to actually do what is necessary to prevent the next crisis.

Dr. Doom sounds more dire than ever...and with good reason. As a college instructor and business writer, Nouriel Roubini has been a personal favorite since properly predicting the real estate and resulting financial fiasco. However, this book takes everything to the "next level". Here is why you MUST buy this book (and a copy for friends or family)...

1. Compares alternatives...doesn't just complain. Many economists make a living from finding fault in current policy but when it comes time to making a suggestion they fall silent. Not so with Roubini and co-author Mihm. This book sorts through the clutter to discuss the pros and cons with each course of action, the limitations and the illusions to current and past policy...and the missed opportunities.

2. Future Trends...unlike other books that focus on the past, this book provides a firm foundation for what you can expect next. Unfortunately, the news isn't good. In fact, it's more than a bit troubling but those that fail to heed good advice are the ones likely to suffer the most. At times such as these there are two types of people...those that prepare and those that simply believe it is all "doom and gloom" so ignore it all at their own peril.

Roubini provides the reader with a firm foundation to understand how we arrived at this point and what the likely outcomes will be in the future. In fact, he clearly spells out exactly the type of scenario currently taking place with Greece...the default of nations rather than just banks and the resulting social-political and financial outcomes. There are no quick/easy fixes - just tough choices.

3. Inflation/deflation/gold and other debates. Although not the focus of this book, the authors don't shy away from taking on these hot button debates. Inflation versus deflation, the role of gold (if any), the position of the dollar, China and global positioning plus much more.

Other points. The book provides the novice with exceptional history surrounding the current economic condition while managing to include sufficient detail sure to entice the informed reader. Elusive points including the role of Basel Committee on Banking Supervision and other pertinent organizations/entities are explored without becoming tedious or boring. The book is data packed and does not rely on filler or fluff to make a point. Pure information, exceptionally balanced with positive and negative considerations on each and every point made.

Bottom Line: Must read for every informed citizen, investor or anyone else interested in the current financial situation and the likely aftermath to be experienced by the nation. This time things are different...find out why and what is likely to be coming soon to a nation near you.

Most books on economics are boring and predominately filled with vacuous philosophy. Not so with "Crisis Economics." Nouriel Roubini, Professor of Economics at New York University, is best known for his detailed forecasts of the recent U.S. financial meltdown. Co-author Stephen Mihm, is a journalist and professor of history at the same school. The authors begin by demonstrating that financial cataclysms are as old as capitalism itself (China inflated its way out of financial problems in 1075), not 'Black Swans' (rare events, per fellow author Nassim Taleb). Then, the authors provide an excellent summary of varying economic schools' perspectives on today's problems.

Today it is fashionable to see the economy as a self-regulating entity that, left alone, stabilizes at full employment and low inflation. A prominent example is Alan Greenspan, who took his basic economics lessons from philosopher Ayn Rand. Karl Marx, on the other hand, was the first thinker to see capitalism as inherently unstable; Marx contended that capitalism would inevitably plunge into chaos because continual cost-cutting by owners would eventually leave so many unemployed that a revolution would result. 'Behavioral economists' try to explain why markets are inefficient - explanations include the naive jumping on the bandwagon, and various other biases and irrational inclinations. Keynes, like Marx, also undercut conventional wisdom, stating that deflation will occur and demand will fall if wages are cut and workers fired. Keynes' solution was to have the government create the needed added demand. Milton Friedman et al (the Chicago school), explained the Great Depression as a result of the decline in bank deposits and reserves, coupled with the Federal Reserves' failure to cut the discount rate. Hyman Minsky recently revitalized Keynesians by pointing out that capitalism contains the potential for runaway expansion powered by an investment boom. The problem is due to an excess of borrowers - 'hedgers' can cover their interest and principal payments, but 'speculators' can only cover their interest payments and 'Ponzi' borrowers can't cover either. Irving Fisher added the idea that government should revive a stagnant economy by flooding it with easy money ('reflation') - that's what we did in 2007 and 2008, in addition to throwing out lifelines of liquidity out to one financial institution and business after another. Finally, the Austrian school (Schumpeter et al - 'creative destruction') argue that even Hoover did too much in the Great Depression, and our recent actions only ensured the survival of zombie banks and firms needing endless lines of credit and special legislation. This burden, however, eventually causes the government to default or inflate its way out of debt. FDIC deposit insurance and the 'Greenspan put' are folly, per Shumpeterians.

Who's right? The authors contend the Austrians are heartless and wrong in the short-term, but have validity in the median to long-term. Roubini believes "the successful resolution of the recent crisis depends on a pragmatic approach that takes the best of both camps, recognizing that while stimulus spending, bailouts, lender-of-last-resort support, and monetary policy may help in the short term, a necessary reckoning must take place over the longer term in order to achieve a return to prosperity."

Many bubbles begin when an innovation heralds the dawn of a new economy. Examples include the 1840s railroad boom in Great Britain, the Internet dot.com boom of the 1990s, and the financial services boom in the 2000s. The 'good news' is that society was left with additional rail assets in the 1840s, and unused Internet cable lines in the early 2000s. Today's latest excess - vacant houses, are not such a boon as they are subject to vandalism and deterioration, in addition to having been grossly overpaid for.

Roubini and Mihm contend that our most recent crisis is not the result of sub-prime mortgages infecting an otherwise healthy financial system, but rather a system sub-prime in its major aspects - from 'top to bottom.' The first problem is our 'shadow banking system' that looks and acts like banks, greatly exceeds the impact of banks, but has never been regulated like banks. The second is the financial services industry's moving beyond the 'originate and hold' model for home loans that had gotten S&Ls into trouble earlier when they held onto bad assets. Unfortunately, this new paradigm eliminated concern over loan quality, and was expanded to student, car, and credit card loans.

Financial wizardry was the second major contributor. "Tranching" took a bunch of risky eg. BBB-rated sub-prime loans and put about 80% into senior tranches given an AAA-rating. The more exotic products had 50-100 levels, and others involved CDOs of CDOs (CDO-squared), and even CDOs of CDOs of CDOs (CDO-cubed). These complexities made it difficult or impossible to value the instruments by conventional means - instead mathematical models were used that relied on optimistic (eg. no real estate value declines) assumptions. The result was completely opaque and ripe for panic.

'Moral hazard' was the third major piece of our latest bubble, and consisted of several components. Inappropriate bonuses (based on single-year performance, paid in dollars instead of the dodgy securities being created) was the first. In 2006 the average bonus accounted for 60% of total compensation at the five biggest investment banks, and encouraged excessive risk-taking and leverage. Shareholders didn't have much incentive to rein these practices because the firms were employing high levels of leverage, giving shareholders 'little skin in the game' and over-sized upside potential. Even bank depositors, the ultimate source of much of the funding, had no reason to care, thanks to FDIC insurance. Regardless, in the event of a downturn, the Federal Reserve could be counted on as a lender of last resort, and even that protection was backstopped by the 'Greenspan put' (his being always ready to lower interest rates). In fact, the 2007 bubble was preceded and fed by low rates instituted to get out of the 2000 dot-com bubble.

The fourth major component of this bubble was largely courtesy of former Senator Phil Gramm, who successfully had much of the derivatives market ($60 trillion of CDS by 2008) placed off-limits to regulation. (Senator Gramm, along with Robert Rubin (Clinton's former Sec. of Treasury), Greenspan ('The Maestro'), and others also brought about the repeal of Glass-Steagall limitations.) This was followed by the SEC allowing investment banks to increase leverage to 25X+ vs. 12.5X for their more regulated commercial bank brethren.

Debt-levels increased everywhere. In 1981 U.S. private sector debt was 123% of GDP, and by 2008 it was 290%. Household debt increased (48% GDP in 1981, 100% in 2007) more than industrial debt, and financial sector increased the most of all (22% of GDP in 1981, 117% in 2007). Nor did leverage stop there. Roubini relates how a borrower would obtain eg. $3 million from a bank, add $1 million of his own, and then invest the $4 million in a hedge fund. The hedge fund would then borrow another $12 million (still 4:1 leverage) and have $16 million to invest - backed by as little as $1 million. Hedge funds often didn't even stop there, increasing leverage even further.

Some blame the Community Reinvestment Act of 1977 as a major contributor to the real-estate bubble. Roubini believes this is misplaced, even though the law was augmented in the 1990s to require 42% of loans to come from those with below average income within their areas. Roubini adds that most of the growth in sub-prime came from private lenders like Countrywide. (I suspect the truth lies somewhere in the middle. Freddie and Fannie both ended up operating with 40:1 leverage ratios.)

Citibank and others then added another twist - 'Structured Investment Vehicles' (SIVs) used as off-balance-sheet vehicles to hold mortgages prior to their being sold off as CDOs, etc. The applicable reserve ratios for SIVs were only 10% those for ordinary bank assets. Citibank held $100 billion in 7 SIVs, and was ultimately forced to take them back onto its balance sheet when things went sour. Meanwhile, woe to unaware investors.

The U.S. was not alone in these new frontiers of perilous finance. Fortunately, not all participated - India benefited from greater regulation and reserve requirements.

Everyone knows how it all began falling apart. Roubini focuses instead on what the government did. Initially the Federal Reserve faced a 'liquidity trap' (akin Japan) in which the central bank was unable to spur loans, even by lowering the discount rate to 0%, because banks were afraid of the future, and had too great a proportion of toxic assets. The Fed/Treasury then bought up many of their toxic assets, provided added capital (preferred stock) and looked the other way while the banks placed overly high values on their remaining assets. The Treasury also bought up a great deal of government obligations in an effort to force down their yields and encourage banks to move their money out of these safe havens and back into loans. The key points, per Roubini, are that these actions again strengthen the moral hazard pattern, set up a possibly even worse situation down the road, and added trillions to the federal deficit. (Roubini is not against these moves, believing there was no alternative. However, he's emphatic that we're nowhere near out of the woods.)

"Crisis Economics" recommends more effective government regulation (consolidating existing agencies, and ending 'regulation arbitrage' - shopping for the most lenient regulation; re-instituting a stronger Glass-Steagall Act - "on steroids"), and breaking up those 'too big to fail' (eg. Citigroup and Goldman Sachs) . Unfortunately, we are mostly back to business as usual, and Roubini is concerned that these changes will not take place.

We now owe $3 trillion to the rest of the world, and are running current account deficits of $400 billion/year. Increasingly the U.S. will have to borrow shorter term, making us more vulnerable to future crises and sudden collapse. Roubini is worried this will lead to disruptions to Free Trade (I hope so), even though he recognizes that there are 2.0 billion people in developing nations ready to join China and India in selling to America, and former Federal Reserve Vice-Chair Alan Blinder foresees up to 25% of Americans vulnerable to additional off-shoring. The dollar's days may be numbered in years, rather than decades, though the Chinese don't seem to want the lead currency role - yet.

The unemployment rate + discouraged + underemployed (< 40 hours) now approximates 17%. Many/most offshored jobs won't return. Adding the fall in averge work-hours (equivalent to 3 million more unemployed) to the 8.4 million jobs lost by the end of 2009, recognizing that 30% of capacity is now idle in the U.S. and Europe, that 42 states and the District of Columbia have already articulated plans to cut government jobs, and that the 2003-07 'boom-years' fueled by a credit bubble won't return, leads Roubini to conclude that this recovery will be U-shaped, not a "V," and fortunately not a "W" (double-dip). But, because U.S. interest rates are near zero, speculators are borrowing dollars and investing in risky assets elsewhere, then repaying the loans in depreciated dollars. Roubini asserts this technique has easily created 50-70% profits since March, 2009, can't continue, and is building the "mother of all asset bubbles."

Roubini sees Japan and Europe in no better economic shape. The U.K. is having problems, but taking corrective steps. However, problems with the 'PIIGS' (Portugal, Ireland, Italy, Greece, Spain) may break up the European Monetary Union. China needs to boost consumer spending, and its infrastructure exceeds current needs, says Roubini. (I'll take their problems, and their economists!)

Roubini's 'Bottom-Line' - the coming era may best be described as one of "Great Instability."

The economic crisis of 2008 has caught almost all observers unaware. Here and there, a few voices issued warnings, pointing out the existence of the housing bubble and the dangerous effects of the global financial imbalances and America's growing deficits. Chief amongst these Cassandras, the man whose dire predictions proved most accurate, was Nouriel Roubini. Nicknamed "Dr. Doom" in a New York Times article written by Stephen Mihn, Roubini's reputation as a forecaster, almost a prophet, is today unmatched.

Roubini's sterling reputation was the reason I chose to read "Crisis Economics", a further collaboration between Mihn and Roubini. Of the half a dozen or so books about the crisis that I have read (Richard Posner's A Failure of Capitalism: The Crisis of '08 and the Descent into Depression and The Crisis of Capitalist Democracy, Robert Shiller's The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do about It, Vince Cable's The Storm: The World Economic Crisis & What It Means, etc), Roubini and Mihn offer the most wide ranging look, discussing the roots of the crisis, the government's response, and suggestions for reform. Roubini and Mihn write well, and their book is an excellent introduction for the crisis to the uninitiated. Unfortunately, "Crisis Economics" offers rather less to those of us who have spent some time on the subject. Those readers might, like me, find little new in the early chapters of the book (the ones discussing the origin of the crisis) and much to disagree with in the later chapters (the ones outlining the authors' suggested way out of it).

The first half of the book described combines a run of the mill description of the crisis's formation, mixed with standard history of economic thought (from Smith to Keynes), only partially enlivened by the rather unorthodox focus on economic crisis and failure rather than success.

The authors employ mostly conventional Keynesian perspective on the crisis, and so should be applauded for their discussion of the Austrian school views about it. But although they explain the Austrian position in full, they ultimately discard it with a superficial analysis that would not convince any Austrian. Later they argue that they are offering a synthesis of the Austrian and Keynesian perspectives, but no self respecting Austrian could possibly accept their call for massive government intervention, while Keynesians would find little to disagree with the notion that the problems of twisted incentives caused by the necessary intervention should be addressed, or at the very least taken into account.

For me, the book only became interesting in earnest about halfway through, when the authors discussed the response to the crisis. Particularly, they emphasize the role of Fed. I knew that the Federal Reserve played a huge part in the bailouts of such players as Goldman Sachs and AIG. But Mihn and Roubini's account highlighted a fact that I was insufficiently aware of - how America's central Bank acted not only as a lender of last resort, saving the financial system from collapse, but also as an almost ordinary lender, lending money to more and more non-bank institutions in order to stop the credit freeze. It seems to me that while the Fed's action as lender of last resort was probably necessary, the active intervention in the markets more questionable. Monetary tools are effective in restraining an overheated economy (as Paul Volker did in the early 1980s), and in unleashing willing investors, but they are generally no good for promoting economic activity when there's no will for it. Ben Bernanke took very extreme actions to try to encourage economic activity and especially lending, and it is far from obvious that the relatively meager results were worth the effort.

The classic Keynesian account places the onus of reigniting the economy on the government's fiscal rather than monetary powers: Crudely speaking, Keynes taught that governments should spend their way out of depressions. Oddly enough, beyond criticizing the stimulus for being a political bargain and thus far from ideal, the authors have little to say about the government's direct role in creating demand, focusing their discussion on the various ways it underwrote risks taken by other institutions.

The bottom line may be that both fiscal and monetary policy focused excessively on "reigniting" markets rather than on stimulating the economy via government spending on public works and other government projects. This arguably prevented the "work" of the crisis - culling out the weak firms from the good ones - from taking place, and increased the amount of irresponsible players who gained from the bailouts.

Moving forward, the authors make several proposal for reforms. Unfortunately, I think many of these proposals are extremely problematic. Take compensation - the authors point out that traders and managers in financial firms to excessive risks, because they had wrapped incentives - they would make a fortune if the gambles paid off, but would lose very little if they didn't. In the short run, the traders and the firms both did very well, but in the long run, the firms had to be bailed out, while the trader's bank accounts remained as healthy as ever. The authors therefore make a series of proposals, all meant to link the compensation of executives with the long term prospects of the firm they work in. The problem with these plans is that in the long run, the well being of the firm is likely to be determined by a host of factors, few of them in any person's control. Delaying compensation cuts the link between the employees' pays and their performance - which is, ironically, exactly what self dealing executives want (see Pay without Performance: The Unfulfilled Promise of Executive Compensation). Furthermore, in trying to align the interests of firms with those of the executives, the authors ignore the fact that part of the cost of a firms' downfall is carried by its creditors and suppliers (and as we see in this crisis, by the taxpayers). When the a cost of an activity are born by those other than the parties involved in the activity, the cost is what's known in economic terms as an externality. Negative externalities (costs), unborn by the firm, are not taken into account by it. Which means that from a social perspective, even rational, income maximizing firms are taking excessive risks.

Another problematic proposal is an overhaul of America's financial regulators. The authors point out that America has a host of bodies meant to regulate finance, all of them work in an uncoordinated and inefficient way. The argue that America should reform its regulators to make them more streamlined and centralized - somewhat like Britain's Financial Services Authority. But the FSA did not seem to spare Britain the crisis. Is it really a great model for a regulating agency?

The book's final chapter describes the global financial imbalances - namely the huge deficits incurred by the United States and other rich countries, contrasted with the enormous surpluses amassed by such emerging countries as South Korea and especially China. The authors disagree with the "Global Saving Glut" hypothesis (advocated by the likes of Paul Krugman and Martin Wolf - see Fixing Global Finance (Forum on Constructive Capitalism)). They argue, in effect, that America and Americans are responsible for their choice to borrow excessively (p. 250).

But whether to save or spend is a question of benefits versus costs. As long as Americans are offered amazingly cheap credit (and correspondingly, few avenues for profitable and safe long term investments), they are unlikely to stop taking advantage of it. It is natural to borrow when the costs of borrowing is low - it is unnatural to lend money for meager returns

"Crisis Economics" is therefore an eloquent introduction to the financial crisis, and a thoughtful program on how to get out of it. I disagree with many of the authors' recommendations, but they are worth considering very carefully. After all, Roubini has been proven right before.

Any review of this book would have to start with the intended audience for this book. That audience would definitely not be PhD or MA level economists, graduate students or financial professionals. The book is geared primary to the layman with little in the way of a macroeconomic or financial background. This is not to say that some knowledge of the theories of Keynes, Friedman, Hayek or Schumpeter would be unhelpful (it would provide some good perspective to the reader) but the book provides the necessary relevant background of these where necessary. This is also not to say that the book would be of no or little value to the more knowledgeable, however. Roubini provides many insights and tangents in this book that even they would find interesting.

In a nutshell, the book describes the problems that have caused the current economic and financial crisis (along with historical perspective), the steps that have been taken by various nations (with emphasis on the U.S.), the future dangers underlying those steps and actions that he believes would help mitigate, but by no means eliminate, the problems that have led to the current crisis (and will probably lead to future crisis).

With respect to the causal problems, Roubini discusses seven in-depth. They are moral hazard in the financial system, leverage, regulatory arbitrage, securitization, principal agent risks, loose monetary policy and current account balances. Moral hazard has led to financial institutions taking far too large risks due to an expectation of being bailed out by central banks. Leverage, primarily through the introduction of new financial instruments, has led to a massive expansion in lending vis-à-vis reserve requirements and the monetary base (thus greatly increasing both the volatility of aggregate financial instruments available as well as their quantity in dollar terms). Regulatory arbitrage involves financial institutions minimizing (or altogether avoiding) financial regulations currently in place by, in very sophisticated ways, moving themselves or the relevant financial instruments to spheres those regulatory agencies that either do not have the authority or ability to regulate. Securitization, combined with principal agent risk, has led to two problems. One is that it has permitted banks to off-load their loan portfolios to third parties and hence has eliminated the need to make decent and secure loans to begin with. After all, if the bank does not have to keep the loan on its own books, why would it have to worry about making a good loan to begin with? Related to this, third parties have done a very poor job at due diligence with respect to checking the quality of the loans they purchase... This, in turn, according to Roubini is due to 2 facts. The first is that they do not (in general) plan to hold them long themselves (and hence why worry about the risk inherent in them?). The second is that the rating agencies have done a poor job at rating the quality of these instruments due to conflict-of-interest and the fact that they are quite difficult to rate. These facts, combined with the fact that many players in the financial sector are only rewarded on a short term basis, has insured that far too much risk has been undertaken by the financial sector leading to a huge bubble. Not that these have been the only problems. The fact that many of the world's central banks had loose monetary policies in place too long after the 2000-2001 crash has not helped. Neither has the fact that huge current account deficits (especially in the U.S.) has led to a flood of capital flowing back from lending nations (particularly Asian surplus countries) thus further inflating financial instrument prices. These inflows have also made it much more difficult to control nations' money supplies. For example, when Greenspan tried to raise interest rates to cool down the economy in the mid to late 2000s very large capital inflows into the U.S., to a very large degree, counteraccted his attempts.

Roubini also discusses how the world's central banks have dealt with the crisis. In short, they have pumped a huge amount of liquidity, many times in a very haphazard way, into the banking system to prevent it from collapsing. This, he points out, has not only dramatically increased debt (thus creating a serious inflation risk in the future) but has also caused serious moral and principle agent problems in that financial institutions may, as a result, take more risks in the future than prudent due to expectations of being bailed out the next time around.

Roubini, toward the conclusion of the book, provides steps to mitigate against the current and future crisis. A few (but by no means all) include the need for tighter links in the financial sector between risk and reward (so that risk and return can be better matched as opposed to just passing risk on to third parties or to the future); reduction in rating agency conflict-of-interest by preventing agencies from issuing ratings to issuers of financial instruments (this could, more logically, be done by purchasers); separation of banking functions from investment banking; and more transparency (and standardization of transparency) to make it easier for third parties to better judge the true value of collateralized debt obligations. It would a serious loss to not mount this reforms now, in Roubini's opinion, as they will be almost impossible to enact into law in a non-crisis environment. Even then, although Roubini does not come out and explicitly state it, he seems to imply that he is not optimistic that much of what needs to be done here will implemented.

For financial professions, PhD level Economists and those actively engaged and closely following the markets (i.e., reading Financial Times, Euromoney, Economist on a regular basis) what is mentioned above is not exactly a revelation. Hence the book would be of limited value to such persons albeit Roubini still have many interesting insights that may intrigue this group whether or not they may agree with them (i.e., his belief that gold is currently [as of December 2009, when book was completed] more an overpriced commodity, in a speculative bubble, than an anti-inflationary hedge). For the layman, however, the book is a five star.

I have a masters in economics, but I doubt people without one will have a difficult time following this book. It is definitely very easy to follow and understand, although at times I was uncertain about what the authors' overriding message was meant to be. They have attempted to incorporate aspects of several rival schools of economics, but this syncreticism produces few surprises. Not being strongly Keynesian, they are far more worried about US public deficits than, say, Paul Krugman; but they are also much more worried about trade deficits than New Classical economists (Michael "Potato Chip" Boskin) would be.

The main concern here is with debt and money.(1) Specifically, it is with what might be referred to as the "new Triffin dilemma."(2) The Triffin dilemma arose from the need for the US to incur ever-larger financial liabilities to the rest of the world because central banks had to have growing reserves of US dollars. For reasons never explained very well (I'll get to that later), the dissolution of the Bretton Woods system in 1971 did not significantly alleviate the problem. When major currencies were allowed to float, this did not eliminate the need for dollar reserves; instead, it actually made the problem worse, because entire national banking systems now needed dollars, not just central banks.

The US became one node of a bipolar global conveyor; the other node was Northeast (later, East) Asia. The US node was a huge trade deficit, financed in part by loans and purchases of stocks by foreigners. The East Asian node (initially Japan and Taiwan, later supplemented by China, South Korea, and Vietnam) was a huge trade surplus. This conveyer failed to clog up because of the world financial system needed the belt to run as it had before, in an ever-increasing speed. The reasons for this are difficult to explain, but Roubini understandably focuses on the guilt of US-based institutions: Wall Street's hubris, Washington's political gridlock, and Main Street's delusions of normality.

This is certainly proper and fitting; most of Roubini's readers are in the USA, and while he mentions the folly of European entities as well, it's undeniable that a huge array of social and political failures in the USA ensured that it would be ground zero of the global financial meltdown. While European banks were excessively eager to buy CDOs and European regulators were excessively permissive in letting them do so, it is indeed the case that it was mostly US real estate and consumer credit card debt contained in those CDO's.

However, as Roubini and Mihn try to bring together the manifold forces that brought about the current crisis, they remain excessively focused on the financial sector itself. They frequently refer to the political side of the equation as if it were a single actor, who only needed to pay attention and follow good advice. Having discussed the huge accumulation of debt permitted by an overly lax financial regulatory regime, they seem to putter around with the tweaking of that regime, when the real problem is far broader.

It's not really fair of me to complain that the authors ignored this or that pet concern of mine; but after sketching out the global character of the financial crisis, and its linkage to the crisis in the US banking sector, it seems odd to overlook the way in which the Triffin dilemma completely dominated economic issues. The US dollar remained the world currency despite accumulated imbalances that would appear to make it illiquid.(3) Roubini has been writing about exactly this concern for several years, so it's an even stranger omission. But when currencies floated, central banks around the world became less concerned about defending exchange rate pegs (which required gold or dollars) and more concerned about defending against capital flight. The most effective method was to run perennially tight monetary policy so that capital was more likely to flow into non-dollar economies . This had the added "advantage" of suppressing domestic demand in non-dollar economies. Triffin's dilemma had returned after the 1982 debt crisis in developing economies. At the same time, the conversion of the US into a plutonomy has had devastating effects on industrial competitiveness.

Looking to the future, the authors also ignore the ecological dimension. The coming global shortage of energy and water is well known and massive. Consumers of economic analysis ignore its impact on the world industrial system at their peril. Economic systems that have positioned themselves to adapt and profit from the imbalances in resource demand and need will become market dominant. This will be far more decisive in explaining future developments than options regulation.
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(1) Money is actually a form of debt "owed" by the banking system to the bearer; to varying degrees in different countries, the national government assumes some of the liability represented by the money supply. In this case, I'm using "debt" to refer to debt that does not circulate as money. In the USA, the linkage between the two is somewhat tenuous.
(2) Yale University economist Robert Triffin observed that, if US dollar was the world's principal reserve currency, the United States had to run large balance of payments deficits in order to provide the rest of the world with reserves required for a growing world money supply. See Robert Triffin, Gold and the Dollar Crisis: the Future of Convertibility(1960).
(3) In other words, the sum of US current account deficits over the last 40 years is so large that it seems extremely hard to see how there could be any unmet demand for dollars ; it's not obvious why anyone would part with a euro to buy any number of dollars. But obviously people do.

If you haven't read much about the crisis, Roubini and Mihm write a comprehensive summary of what I would describe as the lawmakers' view of the Financial Crisis. If you've read much at all, you won't find anything new here.

I would describe the lawmakers' view as one where greedy and incompetent bankers facilitated by incompetent or laissez-faire regulators took too much financial risk and bankrupted the worldwide financial infrastructure. As such, the solution is to pass more laws and beef up our regulatory organizations to prevent it from happening again. I believe this is a narrow view of the crisis.

For example, there was a large build up of institutional short-term debt, which unlike retail deposits is not afforded guarantees by the US government, at least not until the crisis. Banking's raison d'ętre is putting short term funds to work. Investors willing to bear duration, liquidity or credit default risk, don't need banks. That money panicked and withdrew from the economy rendering banks insolvent long before homeowners defaulted. Roubini asserts that banks should match the duration of their funding to their loans but that's not possible because of the long-term nature of investments other than efficient market arbitrage. How do we solve that? Pass a law that mandates it. What if the short-term funds flow elsewhere? Regulate every non-bank and coordinated regulations worldwide to control every inch on the planet. And if the funds flow into financial arbitrage as a way to match short durations? Restrict it. And if large quantities of short-term savings then get stuffed into mattresses and the economy grinds to a crawl as it did in the recession? Well, the book never addresses that because at its core it's really a one-sided debate.

Should banks or borrowers hold substantially more equity to mitigate the risk of panicked withdrawals? If so how much? What is the cost to borrowers, mainly homeowners who ultimately bear these costs through higher prices? What impact will using our equity this way have on long-term growth? Not a mention. The role of Fannie and Freddie, who are purported to have purchased or guaranteed half of the sub-prime and alt-mortgages? Nothing.

By turning a blind eye to what are probably the most important issues, Roubini and the eager lawmakers who espouse his logic can elevate what is probably a second or third tier issue - Wall Street incentives and moral hazard - to their narrow list of culprits. Then we simply pass laws that regulate their behavior. It's a wishful lawmakers' perspective.

The authors similarly ignore the fact that with surplus exporters eager to supply the US with risk-adverse capital the task of Wall Street has shifted away from raising capital and toward the pricing, underwriting, syndication and trading of risk that goes hand-in-hand with employing risk-averse hair-trigger capital. When the central problem is risk management, restricting derivatives, credit default swaps, syndication, proprietary trading and other devices that separate risk from capital, as the book recommends, seems counterproductive and likely to have far-reaching consequences unaddressed by the book. Two-side analysis would have be insightful.

If Roubini truly had fresh insights about our contemporary economy his evaluation of the government's monetary response (Chapters 6) wouldn't have been limited to a mere narrative summary of the actions taken without analysis and conclusions. His evalaution of the fiscal response (Chapter 7) wouldn't have been limited to the non-committed "on the one hand... and on the other ..." His analysis of his own proposals would have illuminated both pros and cons.

Similarly, his analysis of the real economy would explain why housing prices rose less than the prices of most other assets despite there being a housing bubble. He would explain why US productivity has achieved record growth rates relative to our peers despite a dearth of household savings and what he claims is a lack of investment and reckless borrowing solely for the sake of consumption. He would explain why assets have grown even faster than debt which he laments for having reached unprecedented portions and why household net worth has grown in line with historic averages - even at post-recession valuations - despite all his claims. And he would fit all his assertion of recklessness into a framework that explained why the import-oriented US economy grew 60 plus percent over the last two decades employing 40million new workers including 10 of millions of poor immigrants and offshore workers while our export-based peers in Northern Europe and Japan only grew 15 to 20%. Instead, we get a superficial rant about the reckless US economy.

This turn-a-blind-eye approach to tradeoffs sets him up to give a long list of proposals without ever truly examining their unanticipated effects on the economy. It's a do-whatever-it-takes times three to-make-sure-it-never-happens-again laundry list of proposals. Like so many one-sided arguments costs are irrelevant. If you haven't read much about the crisis and are looking to load your gun with the lawmakers' arguments, this book is for you. If you are looking for fresh perspectives, you'll be disappointed.

I purchased this book with a real sense of anticipation. This was because I was very much aware of Nouriel Roubini's professional reputation, particularly for his well publicised prediction of the GFC before it came to pass. Had the name "Roubini" not been part of the authorship I very much doubt I would have purchased this book.

That being said, I was (to say the least) disappointed in what I thought was the rather lacklustre and quite ordinary explanations concerning the cause and effect of the GFC. Added to that was the lack of any real insight concerning the economic prognosis for the near term other than, as most economists do, simply taking an each way bet on what the economic future holds. I thought this failure to grapple with taking a position on where the US, for example, is heading only added to a feeling of deflated expectations.

And then the `icing on the cake', came from the very direct and unapologetic "political" nature of the commentary. This was highly opinionated and, in my view, adversely impacted on the integrity of the authors. With each passing chapter the political scorn became more and more overt, was repeated ad nauseam and had an unnatural shrill to it. Much of this blatant and explicit commentary could (or should) have passed as opinion pieces in daily newspapers rather than being included in a book on economics where readers, like me, would have had high expectations. I certainly did not expect to read out-dated political opinions; rather, I would have expected to peruse unbiased statements of historical fact.

It also seemed to me that the authors padded out the book by repeating much of what was said in earlier chapters. So, by the time I had completed reading the book, I'd felt that I had read and reread repeated excerpts from the book.

In a nutshell, I felt completely let down.

There are already many good reviews so I will only suggest reading the following interesting books dealing with the crisis, economic ideas and /or long-term economics in addition to this engaging work: 1) "This Time is Different: Eight Centuries of Financial Folly" by Carmen M. Reinhart and Kenneth Rogoff; 2) "How Markets Fail: The Logic of Economic Calamities" by John Cassidy; 3) "The mind and the market: capitalism in Western thought" by Jerry Muller; 4) "Power and Plenty: Trade, War, and the World Economy in the Second Millennium" by Ronald Findlay and Kevin H. O'Rourke; and 5 - 6): "The world economy. A millennial perspective" (2001) plus "The world economy: Historical Statistics" (2003) by Angus Maddison (a combined edition of these two volumes appeared on December 2007);
.

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 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 take
their place.

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.