Crisis Economics | Nouriel Roubini

Summary of: Crisis Economics: A Crash Course in the Future of Finance
By: Nouriel Roubini


In ‘Crisis Economics: A Crash Course in the Future of Finance,’ Nouriel Roubini delves into the recurring patterns of financial crises throughout history, including the Great Recession of 2008 and 2009. Roubini argues that these crises have common factors: easy credit, reckless leveraging, negligent regulation, central bankers and politicians asleep at the wheel, and financial innovation. The book examines the economic principles behind these crises and offers a critical perspective on the limitations of the Efficient Markets Hypothesis and the importance of understanding the theory of crisis economics.

Crises Are Inevitable

Despite the orthodox view that markets are efficient and logical, financial meltdowns are not unique events. This summary explores how crises are inevitable in an ever-riskier financial world, and how the 2008-2009 Great Recession was just one more event in a long continuum of financial collapses.

If you think that the 2008-2009 Great Recession was unique, you might want to reconsider that notion. Throughout history, there have been numerous financial meltdowns that have striking similarities to the one we experienced in the last decade, such as the South Sea Bubble of 1720 and the crash of 1825, the Great Depression, the 1980s US savings and loan debacle, and the Japanese Lost Decade of the 1990s.

One common denominator in financial crises is easy credit that leads to reckless leveraging by consumers, investors, and business owners. Negligent regulators and enabling politicians add to the speculative excess, while financial innovation provides more ways to invest in the craze of the moment. To make matters worse, the more interconnected nature of global markets contributes to the spread of the contagion.

For years, economists have honed the idea that free markets work, and the Efficient Markets Hypothesis, contending that the free market always values assets accurately. However, the 2008-2009 Great Recession exposed the folly of the notion that the markets are always right. If market participants behave rationally, then why did the rapid run-up and sudden crash in the value of US homes or of shares in Lehman Brothers happen?

Some major economists rejected the perfect markets idea and believe that financial market crises are inevitable. Crises are part of capitalism, and crises wane before waxing anew; a period of calm may even precede worse outbreaks of panic and disorder.

Before the Great Depression, financial calamities and bank runs were common, followed by decades of stability in US markets. The 2008-2009 recession, a “19th-century panic moving at 21st-century speed,” surprised investors since risk seemingly had disappeared from financial markets. But in retrospect, the warning signs were apparent. Real estate had become overvalued, and banks were overleveraged. Investment banks’ leverage ratios soared.

Panic set in with astonishing speed when the bubble burst, and banks stopped taking giddy risks, hoarding cash, and creating a “liquidity trap” that hampered economic growth. The Federal Reserve, transforming from “lender of last resort” to “investor of last resort,” cut interest rates to nearly zero. The Fed’s balance sheet ballooned from $900 billion in 2007 to $2.3 trillion in 2009 as it took ownership of assets ranging from Fannie Mae and Freddie Mac’s debts to home loans, car loans, and credit card debt.

As the US government began to play an outsized role, the ideas of British economist John Maynard Keynes returned to prominence, and the government embarked on a new round of Keynesian stimulus. Some of the stimulus was wise, but some were misguided. The government injected capital into banks, an aggressive response that created good news and bad news. To the good, the United States averted an all-out financial collapse. To the bad, the rescue was costly.

In conclusion, crises are inevitable in an ever-riskier financial world, and the 2008-2009 Great Recession was just one more event in a long continuum of financial collapses. Despite the orthodoxy that free markets work, financial market crises are inevitable. Regulators, lawmakers, and policymakers can only do their best to mitigate the impact of the crises on the broader economy.

How to Prevent Future Financial Crises

This book summary argues that government intervention in market activities exacerbates financial crises. It suggests solutions to prevent future crises, including reinforcing compensation standards, standardizing esoteric securities, banning exotic securities like CDOs, reforming the business model of ratings agencies, breaking up large banks, and reviving Glass-Steagall Act. Additionally, the book suggests that the Fed should not bail out investors and that China is poised to take over the US’s position as the world’s largest economy.

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