Customer Reviews

Financial Shock: A 360º Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis

5 star:		(48)
4 star:		(32)
3 star:		(20)
2 star:		(4)
1 star:		(2)

 

 

In this age of full disclosure, I received this book free from the Amazon Vine program....with the condition that I publish a book review.

I may have purchased this book anyway. Back in the middle of 2007 when the sub-prime problem first surfaced......I remember a talking head on TV saying the sub-prime issue would not become a problem. His rationale was that sub-prime only represented a single digit percentage of the total mortgage market......and therefore it would have no major impact on financial markets......even if all sub-prime debt went bad. Boy was he wrong!! I have been curious how the sub-prime fiasco almost brought down the entire world financial markets.

Another disclaimer is that I have not personally been involved much with mortgage loans. My first mortgage was back in 1978. It was a 30 year fixed mortgage, and since I only put 10% down, it was mandatory to have mortgage insurance......until my equity reached 20%. I got additional 30 year fixed mortgages in 1980, 1994, and 1995 due to job location changes. In 1999, I got a variable rate loan on a new home.......put 50% down......and then converted to a 15 year fixed rate in early 2007. I also live in Illinois, not one of the national hotbed markets for sub-prime lending.

Zandi says there has been a financial markets panic about every 10 years. He predicts the next one will involve U.S. government debt with all our under-funded liabilities. Other authors have said there is a stock market crisis about every 25 years........because it takes this long for the "burned" generation to retire and be replaced with youngsters who have no memory of the last bubble.

Zandi explains the sequence of the sub-prime fiasco like this:

1. Fed lowered interest rates after 9/11 to stimulate the economy
2. Fed was not worried about creating inflation because the shift in manufacturing to China actually threatened deflation, not inflation
3. With returns on savings accounts being so low, plus the stock market going nowhere after the Tech stock bubble burst.......people chose to invest in their homes
4. Foreign countries could not get decent returns on fixed income investments due to low interest rates......so they chose to buy slightly higher yielding mortgage backed investments
5. Local banks changed from being prudent lenders holding mortgages to simply financial intermediaries driven by loan processing fees. Since they no longer held any mortgages, they didn't have to worry about making sure they were issuing loans that homeowners could really afford.
6. New companies jumped into the mortgage lending market ...with the same motives as the banks. The majority of borrowers did not even realize how risky their new loans were....especially if home prices declined.
7. Wall Street created exotic mortgage backed financial instruments and marketed their higher returns.
8. The Federal Reserve Chairman and all the regulators were asleep at the wheel.
9. Financial rating firms completely missed the boat on how risky these new financial instruments really were.
10. Eventually the music stopped.....there were no people left to keep bidding up the prices of homes. The house of cards came tumbling down.


Zandi points out that sub-prime mortgages peaked at ½ of all mortgage originations.

A way was found to avoid the mortgage insurance if you put down less than 20%. You simply borrowed 80% on the first loan, then immediately took out a 2nd loan for the remaining 20%......apparently mortgage insurance is not required on either the 1st or 2nd loan.

Verification of income also went out the window.

Zandi points out that Americans lead the world in terms of how much housing cost we incur. Americans spend 33% of spending on their homes, while New Zealand spends 25%, France 20% and Japan 14%.

Zandi points out that at the peak of the boom in 2006, foreign investors owned 1/3 of all U.S. mortgages.

Zandi also points out that the price-to-rent ratio is a good bubble indicator.......analogous to the PE ratio in stocks. This ratio has been about 17 the last 25 years......but it peaked at 25 at the height of the boom. For this ratio to return to its 25 year average of 17, national U.S. house prices must drop 25%........and the hottest markets must drop 35%.

The author says the sub-prime bubble is 4 times as bad as the S&L fiasco ($1 Trillion versus $250B).

The author has some recommendations to avoid another sub-prime crisis including:

1. Lenders must verify income and assets
2. Lenders must verify borrowers are able to pay back the loan
3. Mandatory escrow for taxes and insurance
4. Start teaching personal finance in high school

I found the book easy to read and entertaining. However, I got very frustrated with the color coding of his charts. I could not distinguish what the variables were in most of his charts. Maybe he made them in color, and then the black-white conversion process made them illegible.

Given my background, I am shocked at how loose the lending process has become compared to 20 or 30 years ago. As the author points out, everyone in the lending food chain assumed "the other guy" had checked out the quality of the loan made...and in reality nobody checked it out.

After reading about the Tulip bulb and South Seas bubble......plus living through the 1989 S&L crisis, the 2000 Tech wreck, and the 2007 sub-prime fiasco.........this book has help give me a better idea of how to recognize the next financial bubble.

Some of the key indicators of bubbles include:

1. "It's different this time"
2. TV shows and advertisements on speculating including store owners who sell stock instead of their normal goods (Tulip craze), ads showing taxi drivers who quit hauling passengers and day-trade (Tech Stocks), and TV shows dedicated to flipping houses
3. Historic valuation ratios are far exceeded (Tulip bulbs, PE ratios of 100 for Tech Stocks, Price-to-rent ratio for housing)


All in all, I thought the author did a good job of exposing the role of each member in the housing loan food chain had in creating the sub-prime mess.

In this age of full disclosure, it can be noted that I am the author and publisher of the book INDEX MUTUAL FUNDS: HOW TO SIMPLIFY YOUR LIFE AND BEAT THE PROS. This book is an introduction to the concept of index funds is and is sold on Amazon. I am also a contributing author to the book THE BOGLEHEADS GUIDE TO RETIREMENT PLANNING available from Amazon with an estimated release date of October 2009. I have also written 21 short stories on investing which are also available on Amazon.

If you are done speculating in the housing market, these books on conventional stock and bond investing may help you slowly grow more wealthy:

The Richest Man in Babylon
Bogle on Mutual Funds: New Perspectives for the Intelligent Investor
The Millionaire Next Door
The Four Pillars of Investing: Lessons for Building a Winning Portfolio
A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing, Ninth Edition
The Coffeehouse Investor: How to Build Wealth, Ignore Wall Street, and Get On With Your Life
The Bogleheads' Guide to Investing

I've learned how securitization, unsavory lending, lies by borrowers and lenders, the effect home flippers had on the market, the accounting standard of "mark to market," and other various lending practices and financial instruments have caused the economic havoc we are now experiencing. Lenders are currently leary of lending money to financially sound borrowers due to fears of further financial crises. There are also more rigid lending criteria which further compounds the problem.

The author does a fantastic job of explaining the complexity that evolved in the mortgage market over the last 10+ years. As a result, this book is a plethora of information on how the housing crisis has snowballed into what we are experiencing now.

The author explains everything in detail in an engaging and easy-to-understand narrative that even the most financially illerate person can understand. I would have rated this book TEN STARS if that option were available. "Financial Shock" is an outstanding text!

The present financial crisis seems to never stop echoing and reechoing through the American, and indeed world, economy. But, what really happened? In this book, author and economist Mark Zandi, takes an in-depth look at what happened, how and why.

Now, I did find this to be a very interesting book, one that really opened my eyes on what has been going on, and what is still going on. Admittedly, towards the middle, the book got a little too technical for me, but one cannot look at a problem as broad and deep as this without getting technical somewhere along the line.

If you want to understand how we got to where we are, and what steps we need to take, then you really must read this book. I do recommend it to everyone.

(Review of Financial Shock: A 360º Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis)

If the book had been written four months later, it may have been more relevant. It is a partial primer for college educated professionals and policy makers who want to understand the mechanisms behind the financial current crisis. However, it is missing a large chunk of recent events as well as the credit rating agencies' role in the crisis.

Most economists agree that the incestuous relationship between credit
ratings companies and bond issuers are a significant factor to the current economic meltdown. Being employed by Moodys, the author could not comment. The cup is about 1/4 full, and I recommend that you wait for a more unbiased opinion.

On a positive note, this book provides a good explanation of how the current financial crisis developed. Published in July 2008, it necessarily misses many of the huge developments that have occurred in recent months. To be fair, let's give Mr. Zandi credit for accurately predicting upcoming problems in the CDS market - see page 230. He is also the first critic I have found that notes the role of REITs in this crisis.

However, as many of the reviews have noted, there are numerous shortcomings that seriously limit the value of this work. His ten recommendations are in most cases absurdly simplistic (with the exception of revising mar to market rules),e.g. suggesting that people get better education on financial issues. His announcement that the worst is over has also proven to be hopelessly optimistic.

Here are some of the really important questions that Zandi ignores (in the first case intentionally):

1. How could both financial rating agencies (like S&P and Moody's) and CPA auditors completely miss the nature of the correlated risks that were emerging, especially given the repeated use of off balance sheet special purpose vehicles that were much publicized in the Enron collapse?

2. What are the implications of these failures to the Sarbanes Oxley law - has this legislation done anything positive? Or should it be repealed? What are the lessons learned here?

3. In a similar vein, what about the role of GLB ("financial modernization") law and the repeal of Glass Steagle - should this law be re-invoked?

4. What is the new normalcy that we can expect over the next decade? Zandi properly mentions that this crisis is an "inflection point" with long term implications, but he does not give us much of a picture on what the new world will look like.

Bottom line: There is a better choice that is far more prescient. Charles Morris' Trillion Dollar Meltdown - published in early 2008 - answers all the above questions. It is also short and easy for normal people to read with zero economic training. If you just buy one book on this subject, the Morris book is the best one I have yet read, by far.

Zandi's book is the latest in an explosion of well prepared and documented books which carefully dissect and examine the sub prime mortgage backed bonds fiasco that threatens the basic foundation of the American financial and banking system.Zandi does a very good job of explaining the interconnections between the mortgage lenders and brokers,ratings agencies(Moody's),underwriters,commercial banks(Bank of America),savings and loans(Washington Mutual),the Wall Street investment banks(Bear Stearns,Merrill Lynch,Lehman Brothers,etc.)and the spread of 6 trillion dollars worth of bonds that were both highly risky and uncertain in the sense that there was very little knowledge on how this particular application of banker securitization would perform over time.
The heart of Zandi's analysis is that "...hamstrung government regulators couldn't keep up with lenders who were constantly devising ways to elude oversight..."(p.18)."An even more important factor was a philosophical distaste for regulation that seemed to pervade the Federal Reserve...Without Fed leadership....the... Comptroller of the Currency,the Federal Deposit Insurance Corporation,and Office of Thrift Supervision were deterred from taking action." Zandi also mentions the abject failure of the Securities and Exchange Commission(SEC)to act.Zandi overlooks the fact that a competent regulatory board has not existed at the SEC since Bill Casey was at the healm of the SEC.None of this fiasco could have occurred under his watch.Unfortunately,the SEC has been run by pro Wall Street types who have worked overtime to undermine the regulatory powers of the SEC.This ,ofcourse,is the result of the deregulation and privatization wave pushed by Milton Friedman and his University of Chicago allies during the Reagan administration, based on their incorrect Subjectivist ,Bayesian belief that there is no such thing as uncertainty,only risk.There is only risk that can be calculated and insured against by using VAR models.Risk can always be represented by the standard deviation of a normal probabiltiy distribution even though no University of Chicago economist ever did a single goodness of fit test to chack and see if the time series data actually fit the normal distribution
Zandi also is correct in emphasizing the connections between speculative banker behavior and the constant attempt by the private profit maximizing banking industry to apply securitization to all types of debts(credit card debt ,car loans,etc.),and not just home mortgages.

I have deducted 1/2 of a star because Zandi does not provide the reader with a beginning chapter that provides a historical overview of what is in fact a constant and recurring problem in American and World history-speculative behavior by the private commercial banking system that systematically creates a series of bubbles that inevitably leads to manias,panics,and crashes that create inflationary,deflationary,or stagflationary problems that negatively impact hundreds of millions of people worldwide.Bernanke's decision to try and save the big Wall Street banks has led to a severe case of stagflation,collapse of the dollar,and bubbles in commodity prices and oil.These costs are borne by the consumer.
Adam Smith had already arrived at the solution in his the Wealth of Nations(WN) back in 1776.Smith carefully examined the commercial banking industry on pp.250-340 of the WN.His conclusion was that there had to be an independent central bank that would enforce a policy of credit restriction against the member banks.They would be required to maintain low fixed rates of interest in the long run and be prohibited from making loans to projectors(J M Keynes's speculators and rentiers),imprudent risk takers,and prodigals(see Smith,pp.339-340,Modern Library(Cannan) edition)

Another problem I have is Zandi's reference to "..what economists call the ' animal spirits' of investors and entrepreneurs"(2008,p.2,p.243).Actually,there is realy only one economist who has emphasized the problems of pessimism and optimism in the financial markets when using the term 'animal spirits' and that economist's name is J M Keynes.Keynes's use of the term occurs in chapter 12 of the GT(General Theory,1936)and is used to complement his analysis of the impact of uncertainty(Ellsberg's ambiguity)on stock market outcomes, as opposed to the risk concept overwhelmingly used by the economics profession.It would have been a good idea for Zandi to have made it clear to the reader exactly who, historically,is the individual who recognized and emphasized the importance of this variable,especialy when connected to the extremely important uncertainty versus risk conflict. I recommend that this book be purchased along with the much earlier exposition made by Warren Brussee on the sub prime loan mortgage fiasco in his 2004 book that is,unfortunately,mistitled.

I enjoyed reading this book. The information is timely and although it appears the information will fly over a novice's head, Zandi does a good job of keeping it simple. Simple enough that even the average person with no economic understanding can pick up this book and read it and have a total understanding of the subprime mortgage crisis.

Zandi details how the housing market boomed between the years of 2004 to 2006 and when the boom busted and why it burst.

Zandi used numerous charts and graphs that I don't think are necessary for how many times he attempts to show the reader the levels of the crisis. The information written tells a more compelling story of this implosion.

In Chapter 14, Zandi outlines policies he thinks need to be enacted to spear any future major financial crisis. Some of the policies are common sense policies that would probably would have been enacted if deregulation wasn't so predominate.

Probably really a 4-1/2 star effort in my view...

This is a pretty extensive autopsy of the bursting of the Greenspan/W bubble economy of the 2000's. It pulls together most of the threads, which range into all areas of the global economy (as the magnitude of the continuing collapse indicates). This work is objective to a fault (hence a few lines relay some pretty colossal gaffes by those in charge without any editorial comment).

I haven't read any other book length treatments so far, so don't have other comparisons on the subject matter, but this book is certainly very readable and strikes a good balance of detail and pedagogy.

Essentially non-partisan in nature, it provides a well-rounded overview of what happened with the latest economic bubble, though one may then want to look a little deeper into the flawed practices and philosophies that grew unabated until (to paraphrase) they just about took this whole sucker down. There's blame to go around just about everywhere, but the author (perhaps wisely in this broad an overview) takes care not to dwell on that aspect.

There are a lot of reviews here that go into fairly great depth on the specific content and conclusions of this book. One can't argue with the facts or the methodical presentation. There are some useful insights and a few carefully chosen charts that provide compelling dimension to the analysis. The author also does excellent yeoman's work in explicating the finer points of the financial practices and the terminology behind the issues, which is important since it all seemed to get so arcane and opaque that those who should have been regulating those practices lost track of them and/or lost the ability, or resources (or maybe just the will) to regulate them.

Another good place to get somewhat of an inside view of this (in an entirely different and fast paced format) is the radio show: "The Global Pool of Money" from This American Life, which can be found (for a nominal price) in their archive.

We can hope we (and more particularly our leaders) finally learn from this, but there has been an unending chain of deregulation followed by disaster, and of bubble economies. Some things actually have to be regulated and managed, unless we want to ride the booms and busts perpetually. We can probably fix what happened to allow this (at great cost after the fact), but without some fundamental changes and a forward looking approach we will just be moved on to the next one. Similarly we're not going to get the solution to moving beyond this situation right without some philosophical changes in the shape of the immediate solution. Stabilizing home values will stop it, but that requires dealing effectively with the millions of individuals impacted, which so far is just not in the consciousness of those in charge.

I'll be honest, Mark Zandi is not my favorite economist on the financial channels. However, I salute him for his work. The timing of this could not be better, and Mr. Zandi said he is donating the profits of this book to charity.

I didn't find this book partisan; it was easy to read. I'm at a slight advantage because I understand the industry. Most people are financially clueless. We trust government to make our decisions and we get duped by corporations who know how to exploit all of this.

All of us need to understand the timeline of the mortgage mess. Read this book and get informed. There are other potential disasters lurking around the next corner.

Mark Zandi did an incredible job in writing Financial Shock and the book couldn't come at a better time. You don't need to be a finance professional or an accountant to understand this book. It's written in plain language for the average person who is interested in how our economy got into the present crisis. It reads almost like a novel. This type of book isn't normally a page turner, but this one is. It was hard to put it down and I ended up reading until 2:00 in the morning the day it arrived.

The most important thing I got from this book is how involved the whole subprime mortgage thing had become. There isn't one place to place the blame. There are so many financial products or ways of slicing up the risk behind these loans that it's mind boggling. We've all heard that Japan, China and other countries around the world own a lot of our debt, but before reading this book it was hard to understand how that worked. This book made it clear. There are so many involved and so much that contributed to this crisis; the trade deficit with China and other countries, deregulation on Wall Street, the push to make homes affordable to low income families and the price of oil that made things worse. I'm not sure I feel better about knowing how involved and serious this all is, but at least now I can watch the news reports and listen to different opinions on what needs to be done and understand what they are talking about.

Mark Zandi, at the time he finished this book thought that the worst of the crisis was over in the spring of 2008 and that by now we would be digging our way out and looking forward to an improved economy. I wonder what he's thinking this week? I hope he writes another book.

This is a timely and very interesting book. Don't wait to order it.