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September 5, 2010
David Warsh, Proprietor


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Now The Real Work Begins

So much for summer vacation.  It’s back to work for Economic Principals.  Doing what?  Plowing through the torrent of literature of the 2007-09 crash, among other things. The experts’ deciphering of the crisis is nearly complete. Now the real work begins.

The best account of what happened, packaged as a book and intended for the intelligent lay reader, still seems to me, as it did in April, that of Gary Gorton, of Yale University, Slapped by the Invisible Hand: The Panic of 2007, which described the problem as the high-tech equivalent of an old-fashion nineteenth-century banking panic.

Federal Reserve chairman Ben Bernanke shares my opinion, I was gratified to learn, first from Wall Street Journal reporter Michael Corkery on the WSJ’s Deal Journal blog, then from reporter Sewell Chan, writing Friday in The New York Times.

We can look forward to the report of the Financial Crisis Inquiry Commission, at whose hearings Bernanke was testifying last week. The FCIC’s investigation, undertaken in the spirit of various Congressional inquiries, including the Report of the 9/11 Commission and stretching all the way back to the 1932 Pecora Hearings (which led to the passage in 1933 of a long-lasting banking reform, the Glass-Steagall Act), is due to be submitted to Congress on December 15.

Its narrative, which to be written by former Time magazine columnist Matt Cooper, a staff member, will be published as a commercial venture by Little, Brown. But Cooper has resigned, Sewell Chan and Eric Dash reported in The New York Times last week (“Staff Losses and Dissent May Hurt Crisis Panel”), following an earlier report of the resignations by Shahien Nasiripour of The Huffington Post. ( It doesn’t help, either, having California Congressman Darrel Issa peering over the Commission’s shoulder in his capacity as the top Republican on the House Oversight and Government Reform Committee.  The FCIC report  clearly will be a close-run thing.)

Meanwhile, behind the scenes, university economists continue to weave together an explanation sufficient to command the widest possible consensus of how a global crash in trade and asset prices eventuated from problems in the subprime mortgage lending sector.

Besides Gorton’s, the most perspicacious of these accounts may be, as Bernanke indicated last week, the work of Markus Brunnermeier, of Princeton University, whose early article in the Journal of Economic Perspectives, “Deciphering the Liquidity and Credit Crunch of 2007-08” is, like the rest of that rejuvenated journal, now available free online.

Tobias Adrian, of the Federal Reserve Bank of New York, and Hyun Shin, of Princeton University, contributed “The Changing Nature of Financial Intermediation and the Financial Crisis of 2007-2009,” in the second volume of Annual Review of Economics.

And Jeremy Stein, of Harvard University, has provided a lucid article on “Securitization, Shadow Banking and Financial Fragility” in a special issue of  Daedalus devoted to the crisis due to appear in October.. .

All agree that the culmination of a thirty-year pulse of financial innovation simply swamped regulators’ abilities to cope with – or even at certain key points to understand – the nature of the unfolding crisis. This vast new infrastructure, known collectively as  the “shadow banking system,” consists principally of the proliferation of investment instruments known as “securitization,” on the one hand; and, on the other, the advent of  myriad other institutional investors including money market mutual funds. There is probably no reason to want to dismantle this system, or even to think any longer that it could be done. But new methods of regulation are definitely needed to prevent the industry from seizing up in panic again a few years hence.

Almost none of the structural problems involved are addressed in the Dodd-Frank Wall Street Reform and Consumer Protection Act, which President Obama signed into law in July. Among a small circle of economists and market participants, the deciphering is nearly complete. But popular news media haven’t yet tackled the task of translating their findings of malfunctions into political discourse. That probably won’t begin in earnest before the FCIC report appears in December.

So perhaps the most interesting occasion on the calendar will be the meeting of the Brookings Panel on Economic Activity scheduled for September 16-17. Gorton and Andrew Metrick, also of Yale, are scheduled to present a paper there – “Regulating the Shadow Banking System” — that includes a concrete proposal to bring the securitization industry under the regulatory umbrella.

How? By chartering – and closely supervising – a new kind of bank (narrow-funding banks) whose sole business would be to buy asset-backed securities from their originators and use them to conduct the banking activities known as “repo” that were at the heart of the 2007-09 crisis.

Sound complicated? It is. Fanciful?  Probably not. It was strict standards for collateral that stabilized national banking in the nineteenth century. The new market will be designed by experts, as opposed to a popular reform. Even so, get ready for more stories  than you will want to read about the mechanics of big-league financial intermediation.

Meanwhile. the last of the big narrative accounts of the most dangerous episode in global finance since the Great Depression is scheduled to appear in November: All the Devils Are Here: The Hidden History of the Financial Crisis, by Joseph Nocera, of The New York Times,  and Bethany McLean, of Vanity Fair. Nocera and McLean are superb storytellers, but they’ll have to stretch to match  at book-length the pungent pith of this column by John Kay in the Financial Times last month, even if, in the interest of economy, Kay had to leave much out. But then that is the nature of columns.

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2 Comments

  1. Indeed, “Now the Real Work Begins,” not only on the “Fault Lines” at home referred to in this column but all the others so clearly identified in Raghuram Rajan’s recent book, referred to in the July 19 column, “The Economist as Political Philosopher.”

    Not that equivalent fault lines haven’t afflicted the world economy in earlier eras. Not that other recent work hasn’t covered them in all but exhaustive detail – and suggested constructive prescriptions. But perhaps not so likely to come to the attention of readers of this column a recently published intellectual biography – in English – by a political scientist – of the French economist Jacques Rueff.

    As a young government official early in his career, not unlike Rajan in this era, Rueff cut his teeth on the fault lines that grew out of the inflations of the 1920s that followed the Great War. Comparably, at the root of today’s fault lines, lie the inflations that have unfolded since World War II, if on a slower pace.

    For wisdom on how best to manage the world economy, when the universal trust required of human institutions to do so on a global basis has yet to emerge, this biography and Rueff’s original technical analysis in French, referred to in its footnotes, also bear reading: http://www.amazon.com/Monetary-Conservative-Jacques-Twentieth-Century-Thought/dp/0875804179/ref=sr_1_1?s=books&ie=UTF8&qid=1283712716&sr=1-1.

    The Monetary Conservative: Jacques Rueff and Twentieth-Century Free Market Thought by Christopher S. Chivvis $21.56

    Editorial Reviews:

    “A deeply thoughtful, nuanced, and erudite analysis of one of the 20th century’s most profound and principled monetary thinkers. With the renewed global angst over the sustainability of the dollar-based international monetary system, Chivvis’s masterful study of Jacques Rueff could not be more timely.”­ Benn Steil, Senior Fellow and Director of International Economics, Council on Foreign Relations and co-author of Money, Markets, and Sovereignty

    “Mr. Chivvis has written an interesting and clear account of the major elements in the thought of the French economist and civil servant Jacques Rueff.”­Harold James, Princeton University

    “An interesting, highly readable account of the career of one of Europe’s most important economists. Chivvis lifts the smokescreen of simplicity which has served to obscure the economist’s true contribution to twentieth century economic thought and practice. This is the clearest history (in my view) of twentieth century French monetary policy. Nothing else compares.”­Timothy Smith, Queen’s University

    Product Description

    First major English work on France’s counterpart to Keynes provides a view of the global economy that resonates with current thought. One of the 20th century’s most prescient critics of the role of the U.S. dollar in the global economy, Jacques Rueff (1896-1978) was also one of Europe’s foremost free market thinkers, a proponent of the gold standard, and a major expert on the perils of inflation. In Rueff’s day, moderate conservatism was linked with liberal political economy, and Rueff considered himself a ‘liberal’ in the sense that he believed in the free market. This first major English-language work on Rueff explains his economic philosophy and its significance for the present, placing it in the context of the Great Depression and Europe’s post-World War II recovery. Chivvis presents a new angle on the history of free market ideas and their alternatives, illuminating a conservative strain of free market thought hitherto much ignored. Rueff’s thought remains highly relevant in the current economic climate, and “The Monetary Conservative” will be of broad interest to policymakers and educated lay readers. It is also essential reading for economists, political economists, and historians of neoliberalism, France, and modern European politics.

    About the Author

    CHRISTOPHER S. CHIVVIS is a political scientist with the RAND Corporation and teaches International History at the Johns Hopkins University, School of Advanced International Studies.

    Product Details:

    Hardcover: 248 pages
    Publisher: Northern Illinois University Press; 1 edition (April 30, 2010)
    Language: English
    ISBN-10: 0875804179
    ISBN-13: 978-0875804170

    Thursday, September 9, 2010 at 11:44 am | Permalink

  2. M Pearle wrote:

    ***Meanwhile, behind the scenes, university economists continue to weave together an explanation sufficient to command the widest possible consensus of how a global crash in trade and asset prices eventuated from problems in the subprime mortgage lending sector.***

    I wonder if Austan D. Goolsbee, the newly appointed chairman of the President’s Council of Economic Advisers, still defends subprime mortgages?

    http://www.nytimes.com/2007/03/29/business/29scene.html?

    Friday, September 10, 2010 at 5:23 am | Permalink

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