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An Economic Prophet Criticizes Wild Wall Street Profiteering
Crisis Economics: A Crash Course on the Future of Finance. By Nouriel Roubini and Stephen Mihm. 353 pp. The Penguin Press. $27.95
By Paul M. Barrett
I recently finished reading the book reviewed below and agree with the reviewer that the message of this book should be taken seriously. In the book of Acts economic prophets are spoken of, one by the name of Agabus spoke of a coming famine in the land. What prophet to listen to in today's world is an important decision for people of faith, I suggest this book as one to consider.
In late March, the former Federal Reserve chairman Alan Greenspan told Al Hunt of Bloomberg Television that the financial crisis had been a “once in a century” shocker. “We all misjudged the risks involved,” Greenspan said. “Everybody missed it — academia, the Federal Reserve, all regulators.”
Well, not everyone. A number of prominent scholars warned long before the meltdown of 2008 that something awful was approaching. Greenspan and his successor, Ben Bernanke, chose to ignore the alarms.
One of the most articulate pessimists was Nouriel Roubini, nicknamed Dr. Doom by the news media. Roubini, a professor at the Stern School of Business at New York University, told an audience of fellow economists at the International Monetary Fund as early as Sept. 7, 2006, that the United States faced a catastrophic housing bust, a crash in the market for mortgage-backed securities, the collapse of major investment banks and a deep recession. Most listeners seemed “skeptical, even dismissive,” Stephen Mihm reported in The New York Times Magazine. The moderator of the event joked, “I think perhaps we will need a stiff drink after that.”
Now Roubini is taking his victory lap. Writing with Mihm, an associate professor of history at the University of Georgia and the author of that admiring August 2008 Times Magazine profile, Roubini clearly relishes an I-told-you-so opportunity in his book “Crisis Economics: A Crash Course in the Future of Finance.” Why shouldn’t he? Readers hungry for more of the professor’s grim analysis will appreciate his erudition. Even people who aren’t finance buffs ought to read and heed his words.
To his credit, Roubini doesn’t merely recount how right he was. After a brisk recap of Wall Street’s scariest hours since the Great Depression, he turns to the question of the moment: how to prevent such debacles in the future?
That’s no graduate school exam question. As I write this, the United States Congress is trying to iron out kinks in a broad financial regulatory reform bill. Sadly, lawmakers have been debating halfway measures whose inadequacy becomes all the more striking in comparison with Roubini’s bracing agenda. His ideas aren’t all politically feasible, but that doesn’t make them any less sensible.
Roubini begins with an indisputable paradox. The government’s emergency rescue plan — the distasteful but necessary Wall Street bailouts and deficit-enlarging stimulus spending — staved off global depression and brought about a dramatic stock market recovery. It also drained whatever fleeting political will existed to rein in Wall Street in a serious way. The surviving megabanks have brazenly paid out record bonuses, even though they owe their very survival to taxpayer largess.
Let’s start with those fingernails-on-the-blackboard bonuses. Roubini notes that the main problem isn’t their size, grating as that may be. The real trouble is that investment bank traders are paid huge bonuses for making reckless bets that yield short-term returns. They aren’t penalized when their gambling ultimately costs their employers money (or drives the firms out of business). This leads to a casino culture lacking common-sense caution. One potential remedy: put bonuses into a pool held in escrow for several years. If a trader’s record proves solid, he or she gets a payout. If not, the bonuses are nullified. Greater prudence would kick in, and, not coincidentally, overall compensation would shrink.
Only government could impose across-the-board pay reform. Since Wall Street would have collapsed without the taxpayer-financed rescue, Roubini says, Congress should have mandated a bonus-escrow system as a condition of the bailouts. Mesmerized by Wall Street campaign dollars and terrified of being branded “socialists,” lawmakers never seriously considered the idea. It didn’t help that President Obama surrounded himself with bank-friendly economic advisers like Lawrence Summers and Timothy Geithner.
The sorry performance of the three major private credit-rating agencies — Standard & Poor’s, Moody’s Investors Service and Fitch Ratings — played a critical role in the financial mess. Over and over, they stamped AAA ratings on the sausage-like securities made up of poisonous minced mortgages. Congress has debated imposing modest new requirements that the rating agencies make their operations more transparent. Roubini demands more drastic action. He would have government end the tradition of the sausage-making investment bankers paying the raters for their grades, a whopping conflict of interest if ever there was one. Roubini recommends that the agencies should be limited to accepting pay from investors in securities. Further, he urges a smart deregulatory move: removal of the agencies’ certification by the Securities and Exchange Commission as “nationally recognized statistical rating organizations.” This publicly blessed oligopoly, intended to maintain high standards, has only inhibited competition that would bring down the price of security-rating services.
Lawmakers have been debating provisions that would shed some additional light on the opaque market in derivatives. Those are the voluminous Wall Street deals that were supposed to dilute risk by spreading it but instead contributed to a risk epidemic. Heck, Roubini writes, let’s just identify the most dangerous ones and ban the suckers. He nominates credit default swaps, the quasi-insurance policies sold by American International Group, among others, which paid off when designated bonds went bad. Since we don’t allow people to insure their neighbors’ houses against fire, for fear of encouraging arson, why allow traders to bet on bonds blowing up? We shouldn’t.
Eliminating all bad loans will never happen. Since banks will always make mistakes, Roubini argues, they should be required to retain more capital and maintain higher levels of liquid assets (cash and securities that can be sold quickly). The legislation under consideration by Congress would authorize regulators to stiffen capital and liquidity rules. But the legislation would leave it to regulators to provide specific numbers. Roubini wouldn’t give the civil servants so much discretion.
Capital requirements are connected to Roubini’s most radical suggestion. He would force financial conglomerates to retain capital relative to all the risks posed by their various units. “This requirement would reduce leverage and, by extension, profits,” he writes. “Ideally, sending the message that bigger isn’t better would lead these firms to break themselves up.”
That’s right, break themselves up. Unfortunately, the implicit assumption that some banks have grown “too big to fail” has become explicit. Roubini maintains that we should pressure the biggest of them to contract, until they’re small enough that their demise wouldn’t bring down the rest of Wall Street.
With the federal safety net removed, an organization like Citigroup would act more prudently. Repeatedly rescued by the government since the Great Depression, Citigroup shouldn’t continue in its current unmanageable form, Roubini asserts. “Any bank that needs that much help doesn’t deserve to exist.” If Citigroup’s board of directors doesn’t share this view, the N.Y.U. economist advocates legislation that would authorize regulators “to break up banks and other financial institutions that are so large, leveraged and interconnected that their collapse would pose a danger to the entire financial system.” The plutocrats might well perk up and do the job themselves.
Dr. Doom operates far beyond the horizon of what most experts consider plausible. Based on his track record, we would be wise to catch up to him.
Paul M. Barrett is an assistant managing editor at Bloomberg Businessweek. This review was published in the Sunday Book Review of the New York Times.
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