- Hardcover: 240 pages
- Publisher: OUP USA (29 April 2010)
- Language: English
- ISBN-10: 0199734151
- ISBN-13: 978-0199734153
- Product Dimensions: 23.6 x 2.5 x 16.3 cm
- Amazon Bestsellers Rank: 182,465 in Books (See Top 100 in Books)
- See Complete Table of Contents
Slapped by the Invisible Hand The Panic of 2007 (Financial Management Association Survey and Synthesis) Hardcover – 29 Apr 2010
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Gorton's book contains extensive insights into the crisis, and anyone interested in undertanding what went wrong and why is recommended to read it. (Bill Allen, THE BUSINESS ECONOMIST, Vol 42, No 2)
Slapped by the Invisible Hand is essential to understanding the deep weakness in the banking sector that led to the financial crisis. Like consumer banks before the Great Depression, the 'shadow banking market' is vulnerable to runs and panics and hysteria, and we are all, in turn, vulnerable to it. By looking beyond this financial crisis to the systemic flaws that make us vulnerable to all sorts of crises, Gary Gorton has created a necessary guidebook for what's happened, and what needs to be done. (Ezra Klein, Washington Post)
Gorton has produced the clearest account yet of what has happened...Slapped By the Invisible Hand is not a conventional retrospective. Instead it is a real-time chronicle of what the authorities were told at key points in the drama by a practitioner who was steeped in the history of banking as well...it is a major contribution. (David Warsh, Economic Principals)
It's must-reading for anyone who wants to understand the recent economic unpleasantness. (Matthew Yglesias, Think Progress)
Gary Gorton has written an important book, one that clearly identifies the issues surrounding the recent financial crisis and separates them from the ongoing macroeconomic policy turmoil...quite an accomplishment, given that many of us are still trying to figure out happened in earlier panics and crises... By narrowly focusing on the events and institutions of the Panic of 2007, how the economy got to where it is today becomes much clearer. (EH.net)
Think about it. If porcine greed, by itself, is enough to crash the financial sector, why doesn't Wall Street crash every year? For that matter, why should the crash of the subprime market result in a recession so much worse than the one that followed, say, the dotcom bubble? To answer these questions, you should read [this] book. (National Post)
Scholars like Gorton do not get enough attention as we try to understand what caused the crisis and how to prevent a repeat he is one of the people that will play an important role in shaping reform. (TheStreet.com)
The definitive history of the 2007 meltdown. (The Electric Review)
Slapped by the Invisible Hand is certainly "groundbreaking", it is also technical...[If you] have longed to understand the difference between CDO and CDS, and MBS and SPV, then this could still be the book for you. (Victoria Bateman, Times Higher Education Supplement.)
About the Author
Gary B. Gorton is Professor of Finance for the Yale School of Management, previously taught at Wharton for 24 years, and worked in the Federal Reserve System. He is also a former consultant to AIG Financial Products.
Most Helpful Customer Reviews on Amazon.com (beta) (May include reviews from Early Reviewer Rewards Program)
This book raises the theme of the substantial change in banking, the shadow banking system, and shows that its importance and fragile nature, which had for so long been ignored, was the major cause of the recession and the "new" bank run. It's a well documented book and worthy of reading. But not without flaws. For example, as mentioned earlier, it's really three research papers. No problem, but one of them veers far from the tenet of the book and is actually an analysis of private label securitization structure. While subprime securitization was the catalyst of the crash, do we suddenly three years later need to revisit the basic structure of securitization?
In closing, if you want a serious discussion with flaws about why we had the crash, this is the book for you and I'm strongly recommend this for the serious students of financial history.
What is a bank--can you define it? If banks are regulated, but certain non-banks engage in similar activities as a bank, what types of issues arise? I step away from all the books I've read on the issue and come away with two definitions of a bank:
1. An entity that creates a riskless, information insensitive, liquid asset for a customer and funding that asset by creating a relatively risky, information sensitive, illiquid liability for itself.
2. An entity that borrows short and lends long.
Gordon gives some insight into earlier U.S. banking panics that I was unaware of. In 1907, bank consortiums facing a run basically united behind the castle walls of a clearinghouse. Deposits at any individual bank could not be redeemed and customers were instead given a makeshift loan from the clearinghouse. In a panic no one knows which bank is safe, therefore even the healthiest ones are at risk of failure, so the clearinghouse protected all the banks until the panic subsided. Creation of the Federal Reserve eliminated this local clearinghouse concept as the Fed became the clearinghouse, and later allowed banks to fail en masse.
Today, the repo market acts as the banking system for large firms. This activity is performed largely by non-banks and allows firms to earn interest on their large amounts of cash in exchange for collateral-- usually Treasury or other AAA assets. This collateral is generally information insensitive, liquid, and riskless.
"Repo trading has been likened—by repo traders—to speed chess; that is, there is no time to do due diligence on the collateral offered and indeed almost none is done."
As the repo market grows, so does demand for AAA collateral. As subprime lending increased, the collateral more and more became claims on CDOs backed by mortgages. Once doubts began to arise about the worth of that collateral, the repo market began to seize up. There became a general panic about which assets were safe, everyone started to demand larger haircuts and Treasuries. As lending seized up, firms like Lehman Brothers went under and the dominoes fell.
If you have to read one book explaining the Panic of 2007, this is the one. Gorton isn't providing much narrative here, he is an academic looking at the data. As such, much of it is fairly technical. He delves into the prospectuses of various ABS and details how CDOs operate. He looks at econometric analyses to try and develop a theory about why banks and non-bank entities make the decisions they do under regulatory regimes.
If you piece together a narrative, it looks like this:
1. Deregulation of the financial sector led to increased competition and lower profits for banks who were now competing with non-banks.
2. "(I)n attempts to maintain profitability, banks enter new activities which are not necessarily a source of public policy concern per se, but become entwined with traditional banking activities and, hence, a source of concern." Capital requirements were navigated by doing off-balance-sheet activities and increasing securitization.
3. As this continued, the activities of banks and non-banks were increasingly "off the radar" of bank regulators. The repo market was one example of this, the Fed stopped trying to measure the activity altogether.
4. Eventually, ABS and CDOs were created from loans that required housing prices to keep going up in order to be profitable. A sub-prime loan was made with an initial 2-3 year fixed rate that then adjusted upward, with the expectation that in 2-3 years the borrower would refinance the loan having earned equity as the value of his house increased; this could be repeated indefinitely. The loan was sold and securitized as part of a bundle, which was then sliced and diced again into CDOs, CDO-squareds, etc.
5. In 2006, the ABX was introduced, for the first time introducing a price index for subprime securities. People could then bet/trade on what they thought they were worth, and the ABX started to decline as the market started to short subprime.
5. When housing prices stopped going up and the ABX started going down, the CDOs started to take major losses.
6. This triggered even more losses on CDS issued on the CDOs.
7. Adherence to mark-to-market accounting rules forced major write-downs of firm assets, instantly causing many firms to become insolvent.
7. Panic ensues.
Gorton empirically examines two common hypotheses of the crisis and finds them wanting:
1. Lender's increasingly lower lending standards created the problem. This isn't backed up by the empirical evidence.
2. Originate-and-distribute (securitization) created misaligned incentives that created the problem. Gorton points out that all the originators suffered major losses, many going bankrupt. All originators kept a great deal of risk on their books.
The problem was, basically, the creation of assets that were a one-way bet on housing prices. Once assets created from those started to rated well by rating agencies and considered riskless collateral, the system quickly spread soon-to-be-toxic risk all over the world. (I take issue with people who in hindsight say "everyone knew housing prices would fall," because if everyone knew that they wouldn't have made the loans and willfully taken billions in losses and gone bankrupt, would they?)
Gorton takes issue with a few recommendations in regards to regulation. He sees higher capital requirements as only effective in shrinking the banking sector, which may not be what a society really wants or needs. He also notes that until "banking" is better defined, we're always going to have a hard time policing banking activity. Better to create a system that aligns incentives and eliminates information assymetry problems. Mark-to-market accounting adherence during a crisis is ill-advised as well.
There aren't any grand political statements in this book, or vilification of demons. Mostly facts and analysis and some stylized examples.
I only give it 4 stars out of 5 because a lot of the information is jumpy and overlapping. Some of it, like his letter at the end to someone in 2107 was also a little...odd. I also read it on the Kindle and some of the equations and charts were hard to read in Kindle format. But I highly recommend the book.
It is somewhat disconnected and not altogether clear in some places. In part this is because this is a report from the front lines, written during or shortly after the battle. It will take a long time, as Gorton repeatedly emphasizes, to develop real clarity about what happened and why. Many of the details he goes into truly are mind-numbing, this is a feature rather than a bug, because in Gorton's view the details truly made a big difference, and if we don't understand that then we have much less chance of modifying the system so as to avoid repetition.
By precisely identifying a mechanism for the crisis Gorton puts himself in a position to offer precise proposals for action. In the process, he casts a great deal of doubt on the efficacy of much of what has been put forward and in part adopted so far.
He notes with regret that he has not been able to able to test his theses about the causes and mechanisms of the crash, but as he observes, it is scarcely possible to do so for a truly singular event such as this. We are left with no alternative but a case-study approach, and this is a very important start.
Most of the book simply is a compilation of three previously-published papers, which may be read separately, if one prefers. I have been glad to have them in book form, however, and found that the introductory chapter added significantly to their value.
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