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Financial Shock (Updated Edition), (Paperback): Global Panic and Government Bailouts--How We Got Here and What Must Be Done to Fix It Paperback – April 25, 2009

ISBN-13: 978-0137016631 ISBN-10: 0137016638 Edition: 1st

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Product Details

  • Paperback: 304 pages
  • Publisher: FT Press; 1 edition (April 25, 2009)
  • Language: English
  • ISBN-10: 0137016638
  • ISBN-13: 978-0137016631
  • Product Dimensions: 6 x 0.6 x 9 inches
  • Shipping Weight: 12 ounces (View shipping rates and policies)
  • Average Customer Review: 4.0 out of 5 stars  See all reviews (14 customer reviews)
  • Amazon Best Sellers Rank: #873,190 in Books (See Top 100 in Books)

Editorial Reviews

About the Author

Dr. Mark Zandi is chief economist and cofounder of Moody’s, an independent subsidiary of Moody’s that provides economic research and consulting services to businesses, governments, and other institutions. His recent research has included studying determinants of mortgage foreclosure and personal bankruptcy; analyzing economic impacts of tax and government spending policies; and assessing policy responses to bubbles in asset markets. He has appeared on NBC’s Meet the Press, NBC News, CBS News, CNN, CNBC, and has served as an economic advisor to John McCain’s presidential campaign and the Obama administration. Zandi holds a Ph.D. from the University of Pennsylvania where he did research with Gerard Adams and Nobel Laureate Lawrence Klein.

Excerpt. © Reprinted by permission. All rights reserved.

Praise for Financial Shock

Praise for Financial Shock

“The obvious place to start is the financial crisis, and the clearest guide to it that I’ve read is Financial Shock by Mark Zandi....It is an impressively lucid guide to the big issues.”

David Leonhardt, The New York Times

“If you wonder how it could be possible for a subprime mortgage loan to bring the global financial system and the U.S. economy to its knees, you should read this book. No one is better qualified to provide this insight and advice than Mark Zandi.”

Larry Kudlow, Host, CNBC’s Kudlow & Company

“Mark Zandi provides insightful analysis, thoughtful recommendations, and a comprehensible explanation of the financial crisis that is accessible to the general public and extremely useful to those who specialize in the area.”

Barney Frank, Chairman, House Financial Services Committee

“In Financial Shock, Mr. Zandi provides a concise and lucid account of the economic, political, and regulatory forces behind this binge.”

The Wall Street Journal


“If it’s growing like a weed, it’s probably a weed.” So I was once told by the CEO of a major financial institution. He was talking about the credit card business in the mid-1990s, a time when lenders were mailing out new cards with abandon and cardholders were piling up huge debts. He was worried, and correctly so. Debt-swollen households were soon filing for bankruptcy at a record rate, contributing to the financial crisis that ultimately culminated in the collapse of mega hedge fund Long-Term Capital Management. The CEO’s bank didn’t survive.

A decade later, the world was engulfed by an even more severe financial crisis. This time the weed was the subprime mortgage: a loan to someone with a less-than-perfect credit history.

Financial crises are disconcerting events. At first they seem impenetrable, even as their damage undeniably grows and becomes increasingly widespread. Behind the confusion often lie esoteric and complicated financial institutions and instruments: program trading during the 1987 stock market crash, junk corporate bonds in the savings and loan debacle in the early 1990s, the Thai baht and Russian bonds in the late 1990s, and the technology-stock bust at the turn of the millennium.

Yet the genesis of the subprime financial shock has been even more baffling than past crises. Lending money to American home buyers had been one of the least risky and most profitable businesses a bank could engage in for nearly a century. How could so many mortgages have gone bad? And even if they did, how could even a couple of trillion dollars in bad loans derail a global financial system that is valued in the hundreds of trillions?

Adding to the puzzlement is the complexity of the financial institutions and securities involved in the subprime financial shock. What are subprime, Alt-A, and jumbo IO mortgages; asset-backed securities; CDOs; CPDOs; CDSs; and SIVs? How did this mélange of acronyms lead to plunging house prices, soaring foreclosures, wobbling stock markets, inflation, and recession? Who or what is to blame?

The reality is that there’s plenty of blame to go around. A financial calamity of this magnitude could not have taken root without a great many hands tilling the soil and planting the seeds. Among the elements that fed the crisis are a rapidly evolving financial system, an eroding sense of responsibility in the lending process among both lenders and borrowers, the explosive growth of new and emerging economies amassing cash for their low-cost goods, lax oversight by policymakers skeptical of market regulation, incorrect ratings, and, of course, what economists call the “animal spirits” of investors and entrepreneurs.

America’s financial system had long been the envy of the world. It had invested the nation’s savings incredibly efficiently—so efficiently, in fact, that although our savings are meager by world standards, they bring returns greater than those in nations that save many times more. So it wasn’t surprising when Wall Street engineers devised a new and ingenious way for global money managers to finance ordinary Americans buying homes: bundle the mortgages and sell them as securities. Henceforth, when the average family in Anytown, U.S.A., wrote a monthly mortgage check, the cash would become part of a money machine as sophisticated as anything ever designed in any of the world’s financial capitals.

But the machine didn’t work as so carefully planned. First it spun out of control, turning U.S. housing markets white-hot. Then it broke, its financial nuts and bolts seizing up while springs and wires flew out, spreading damage in all directions.

What went wrong? First and foremost, the risks inherent in mortgage lending became so widely dispersed that no one was forced to worry about the quality of any single loan. As shaky mortgages were combined, diluting any problems into a larger pool, the incentive for responsibility was undermined. At every point in the financial system, there was a belief that someone—someone else—would catch mistakes and preserve the integrity of the process. The mortgage lender counted on the Wall Street investment banker, who counted on the regulator or the ratings analyst, who assumed global investors were doing their own due diligence. As the process went badly awry, everybody assumed someone else was in control. No one was.

Global investors weren’t cognizant of the true risks of the securities they had bought from Wall Street. Investors were awash in cash because global central bankers had opened the money spigots wide in the wake of the dotcom bust, 9/11, and the invasion of Iraq. The stunning economic ascent of China, which had forced prices lower for so many manufactured goods, also had central bankers focused on fighting deflation, which meant keeping interest rates low for a long time. A ballooning U.S. trade deficit, driven by a strong dollar and America’s appetite for cheap imports, was also sending a flood of dollars overseas.

The recipients of all those dollars needed some place to put them. At first, U.S. Treasury bonds seemed an easy choice; they were safe and liquid, even if they didn’t pay much in interest. But after accumulating hundreds of billions of dollars in low-yielding Treasuries, investors began to worry less about safety and more about returns. On the surface, Wall Street’s new designer mortgage securities were an attractive alternative. Investors were told they were safe—at most, a step or two riskier than a U.S. Treasury bond, but with significantly higher returns—which itself should have served as a warning signal to investors. But with more U.S. dollars to invest, the quest for higher returns became more concerted, and investors warmed to increasingly sophisticated and complex mortgage and corporate securities, indifferent to the risks they were taking.

The financial world was stunned when U.S. homeowners began defaulting on their mortgages in record numbers. Some likened it to the mid-1980s, when a boom in loans to Latin American nations (financed largely with Middle Eastern oil wealth) went bust. That financial crisis had taken more than a decade to sort through. Few thought that subprime mortgages from across the United States could have so much in common with those third-world loans of yesteryear.

Still more disconcerting was the notion that the subprime mortgage losses meant investors had badly misjudged the level of risk in all their investments. The mortgage crisis crystallized what had long been troubling many in the financial markets: Assets of all types were overvalued, from Chinese stocks to Las Vegas condominiums. The subprime meltdown began a top-to-bottom reevaluation of the risks inherent in financial markets and, thus, a repricing of all investments, from stocks to insurance. That process would affect every aspect of economic life, from the cost of starting a business to the value of retirees’ pensions, for years to come.

Policymakers and regulators had an unappreciated sense of the flaws in the financial system, and those few who felt something was amiss lacked the authority to do anything about it. A deregulatory zeal had overtaken the federal government, including the Federal Reserve, the nation’s key regulator. The legal and regulatory fetters that had been placed on financial institutions since the Great Depression had broken. There was a new faith that market forces would impose discipline; lenders didn’t need regulators telling them what loans to make or not make. Newly designed global capital standards and the credit rating agencies would substitute for the discipline of the regulators.

Even after mortgage loans started going bad en masse, the confusing mix of federal and state agencies that made up the nation’s regulatory structure had difficulty responding. When regulators finally began to speak up about subprime and the other types of mortgage loans that had spun out of control, such lending was already on its way to extinction. What regulators had to say was all but irrelevant.

Yet even the combination of a flawed financial system, cash-...

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Customer Reviews

I thought this was a very enlightening read.
This is an excellent overview of the Economic Crises of 2007 & 2008.
Timothy I. Miller
The book explains it all in much elaborated detail.
B. Compani

Most Helpful Customer Reviews

21 of 24 people found the following review helpful By Hans G. Despain on May 5, 2009
Format: Paperback
This is an impressive little book. It is both a comprehensive and accessible analysis of the 2007-9 financial crisis. If you are interested in understanding the genesis of the financial crisis and its structural causation, this is the book to begin with. Zandi's book is the best of its kind.

Zandi does not shy away from describing the structural causes behind the current crisis. This is important, because popular versions attempt to place blame on bad decision making of individuals. Zandi certainly does not deny that speculation fed the unsustainable real estate boom. Speculation, however, was a minor culprit generating the frenzy and structural dynamic of the real estate boom.

Too many homebuyers facing foreclosure internalize their fate. Zandi's book convincing suggests this is an emotional mistake. Numerous forces made homebuyers highly vulnerable. The majority of federal agents (e.g., elective officials, regulators, etc.), quasi-federal agents (i.e., the Federal Reserve board), and private agents (e.g., builders, real estate agents, mortgage brokers, and Wall-Street financers) simply failed to understand how vulnerable homebuyers had become. Consequently they failed to comprehend the fragility of the financial system.

Sincere and innocent homebuyers became the `collateral damage' of a financial system which had rapidly metamorphosed into a structural coordinated Ponzi scheme. Zandi certainly does not put it as strongly. He is painstakingly fair in his explanation of how the modern financial system came into being. There was no conspiracy to enrich mortgage brokers or Wall-Street financiers.
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4 of 4 people found the following review helpful By Paul Benoit on September 6, 2012
Format: Kindle Edition Verified Purchase
This book reviews the origins and evolution of the financial crisis of 2005 to the present. It is certainly worth reading for those interested in financial markets. On the plus side, the author presents a fairly balanced analysis and doesn't just heap all the blame for the crisis on the banks, or the government. The author has a fluid writing style and is careful to explain financial concepts and acronyms that are outside the realm of most people.

On the negative side, there is a lot of repetition in the content, with some concepts being re-explained multiple times. The author's approach is more subject-oriented than time-oriented, so the reader has to follow numerous jumps back and forth in time. The author also does not delve into details or present new interview material on major figures in the crisis. Thus, for example, virtually none of the major banks involved or their leaders are mentioned by name. This is perhaps safer for the author, given that the events are still ongoing and that the companies and leaders (and their lawyers) are, for the most part, still very much alive. but I expected at least the major players to get a piece of the discussion. The author does cover the governmental angle is some detail, but even these are from the public record rather than interview.

Overall, this book is an approachable work on a complex topic with ramifications in politics and finance.
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7 of 9 people found the following review helpful By Loyd E. Eskildson HALL OF FAME on June 16, 2009
Format: Paperback
Central bankers had opened the money spigots wide after the dot-com bust, 9/11, and the invasion of Iraq combined with the Bush tax cuts. China had forced prices lower for so many manufacturing goods that central bankers also focused on fighting deflation (keeping interest rates low). In addition, there was the ballooning trade and federal deficits. At the same time, deregulatory zeal overtook the federal government - market forces would impose discipline. Rising home prices allowed homeowners to refinance again and again, lenders, investment bankers, and rating agencies got more and more fees.

Meanwhile, securitizing mortgage loans greatly expanded the supply of funding, dicing those loans into tranches allowed selecting the desired risk and return level. When risk premiums shrank, leverage built them back up. Investors could also sell default insurance to each other - default was seen as a remote possibility. Derivatives such as CDOs (bond-like securities whose cash flows are derived from other bonds, which in turn might be backed by mortgages or other loans) became particularly attractive, even though little understood. The Internet also contributed, cutting transaction costs and boosting loan competition. Then, as loans became tougher to obtain, ARMS, IO, and no-down-payment loans (second mortgage avoided mortgage insurance costs) came into vogue.

Housing price gains became increasingly attractive because interest payments of mortgage loans were tax deductible, and since the mid-1990s, even capital gains on most home sales hadn't been taxed. Homeowners also became adept in taking equity out of their homes through home-equity loans and refinancings.

All the makings of a great financial conflagration were there, and the results didn't disappoint.
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2 of 2 people found the following review helpful By Thamanjimmy on October 27, 2009
Format: Paperback Verified Purchase
This is a great book for an overview of the housing bubble and its effects.

It is short and very easy to read. My only problem with it, besides his weak recommendations to avoid another bubble, is that the book is basically the first twenty pages repeated over and over again.

It is worth the read, however.
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