Lost Decades: The Making of America's Debt Crisis and the Long Recovery [Hardcover]

I thought this was a pretty clear, well articulated book by two academics [an economist and a political scientist] explaining broadly what caused America to go down a series of wrong turns. It reads quite well for a book written by academics and its easily possible to read it in one sitting if you have 8 or so hours lying around [like on a plane].

But there are a number of problems with the book, that if you have read other 'economic crisis porn', quickly jump at you. First, when discussing the 'shadow banking system' they lump in private equity funds like Blackstone with macro hedge funds like Bridgewater with investment banks. I think in a video symposium [very good by the way and found here [...] Menzie admitted that academic economist didnt usually pay attention to finance and their lumping of all the previously mentioned financial institutions shows this pretty well. Private equity funds may do a lot of fishy things but they generate their income by arbitraging US tax code's preferences of debt over equity and capital gains over income gains. They do not loan out money. And macro hedge funds like Bridgewater may have been involved in some aspects of buying synthetic instruments but since they usually make big bets on broad economic movements its hard to imagine those types of hedge funds buying up a lot of SIV paper.

The second and more glaring mistake was the total absence of 'repos' in the discussion. Repos and the need for increased margin payments on them were one of the principal reasons Bear/Lehman/AIG all went down [repos also just brought down MF Global, the 8th largest bankruptcy in the US.] I think if anyone wants to understand this crisis they have to read up on the repo market, as the the rise of this market was without the doubt one of the key reasons for the crisis turning out the way it did. Bernake, and the book quotes him, has a historically terrible quote from 2007 when he says something like "Subprime is contained, its a tiny market, no big crisis is coming." Now many people view this as a "aha" moment, in the sense that they caught Bernake being incompetent. Rather, I would argue that like other academic economists [like the writers of this book too] Bernake simply didnt care about the repo markets and did not understand how a relatively small, 30 billion dollar market in sub prime mortgages could destroy financial institutions like Lehman, Aig and Bear Sterns.

So again, if as Berry Eichengreen says on the back cover of the book "If have only time to read one book on the crisis" make it this one. But if you are a bit more curious you will need to search out other sources to get the full picture. And I mean sources that deal with the technical nature of the financial markets in the developed words, not books like "Too Big To Fail" or the "Big Short" (both excellent by the way but are too much written like morality plays that focus on the really big characters that were in place in 2008.)

These authors offer a valuable overview of complex processes surrounding the recent/current/on-going financial crises. The focus is on U.S. conditions and policies, but this (inevtably) includes critical issues of how the U.S. is tied into international lending, trade, finance, etc.

The authors do not focus on minute details of events and personalities, unlike many it not most of the books I have seen (which favor a more thrilling, gossipy approach). Rather, they offer a lucid presentation of basic structures and processes in economics, finance, and politics. Though unavoidably somewhat technical, the presentation is readily comprehensible to the reasonably sophisticated reader - anyone comfortable reading a good newspaper (NY Times, etc.) or news magazine (The Economist, etc).

The authors link economic conditions and practices to politics and government (political economy), as must be done to comprehend these events and processes. They also give valuable historical perspectives on debt crises. The analysis is not partisan. Rather, the most severe criticisms regarding government policies focus on abdication of responsibilies, including disregard of economic and financial best practices in favor of short-term political (electoral) expediency.

The format is gratifying, with reasonably large print nicely spaced. The book is hard to put down (for its content and writing style) and physically easy to read.

As an afterthought, I also recommend Jeffry Frieden's book, Global Capitalism: Its Rise and Fall in the Twentieth Century, for its history and insights about globalization. For example, this book offers the most succinct, clearest description I have seen about the rise of fascist and other authoritarian states (1920s and 30s), not for their well-publicized brutality, rather as resistance and an economic alternative to discredited forms of globalization/global capitalism.

The 2001 and 2003 tax cuts during the Bush administration, combined with increased spending for the Iraq and Afghanistan wars and the new Medicare drug benefit, resulted in the largest and fastest fiscal deficit turnaround in 'peacetime' history. (That effort grew out of the 2001 recession and dot-com bubble.) Alan Greenspan, Federal Reserve Chairman at the time, played a very harmful role by supporting the 2001 tax cuts, giving political cover for the Bush administration claims that the tax cuts wold be self-financing (aka Laffer Curve). This borrowing was acerbated by borrowing to finance the housing boom and our merchandise and energy trade deficits. The effects of these combined debt crises are exacerbated by the current U.S. political impasse - fed by short-term expediency, economic demagoguery and ideology instead of fact-based decision-making, China's unlikeliness to support continued borrowing at past levels, and the fact that much of the debt was used to create a speculative bubble instead of raising profitability/productivity.

Federal government spending was also consumption focused - on health care spending that far exceeds that of our strongest competitors, defense spending exceeding that of the rest of the world - combined, and education spending that has increased at all levels without benefit. Meanwhile, our infrastructure was largely ignored - estimates are that we've accrued about $5 trillion in 'deferred maintenance.' That's in addition to the $5 - 7 trillion in new foreign debt incurred just between 2001-07.

We have lost the opportunity to maintain or strengthen our economic position during the first decade of the new millennium; the fear now is that we will lose the second. Our recovery is lagging, our trade imbalances unabated and unaddressed, and political gridlock over who will bear the burden of adjustment has become the order of the day. Cries of 'class warfare' have become commonplace, bolstered by the fact that unemployment among the top one-third is barely 4%, vs. 4X that for the lowest one-third. (Tax increases, stimulus spending, and increased regulation are blocked.) This is partly facilitated by the fact that borrowing costs are at their lowest levels ever, and as of yet there is no forced adjustment from the outside - as there is in Europe.

The U.S. entered this situation believing it was part of a normal economic cycle that would soon end. The authors, unfortunately, are among the many that believe increased spending on education will pay for itself in the long run - reality is that the U.S. has quadrupled inflation-adjusted per-pupil spending since the early 1970s, with very little, if anything to show for it. Similarly, college/university education costs have risen at rates 4X that of the CPI, for decades. Worse, the long lead times involved in successfully improving education outcomes would likely preclude taking other actions that hopefully would be more useful. The authors conclude that our debts won't go away anytime soon.

The authors' recommendations include regulatory reforms and genuine economic discipline. Unfortunately, most Americans have not experienced austerity since the WWII/Korean War era, and it has proven impossible to-date to unify the nation behind any direction. Stimulus efforts have delayed confronting this new reality. (Standard & Poor's downgrading America's credit rating is symptomatic of the delays.) Other nations' continued willingness to absorb dollars has also helped, but cannot continue in perpetuity - especially with China nervous about its existing dollar holdings (the dollar has lost about 25% of its value over the last 5 years) and jockeying to give its currency a larger role. (This influence is also currently mitigated - by the Greek etc. debt crisis creating a surge of investment in the U.S. as a safe haven.)