A Teachable Collapse

Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System---and Themselvesby Andrew Ross Sorkin, Viking, 600 pages, $32.95

How Markets Fail: The Logic of Economic Calamities by John Cassidy Farrar, Straus and Giroux, 390 pages, $28.00

Freefall: America, Free Markets, and the Sinking of the World Economyby Joseph E. Stiglitz, W.W. Norton, 320 pages, $27.95

The financial crisis has already produced dozens of books, and they generally fall into two categories. One is insider reporting, told with novelistic flourishes, of the day-to-day drama as the crisis unfolded. The value of these books to the readers is that major players tell their stories, the reporter pieces them together, and the narrative fleshes out details of what was known only in outline as events were breaking. The risk is of a whitewash because the reporter is tempted to play a kind of confidence game in which he trades access for kind treatment. (Bob Woodward is the master of this technique.)

One of the better earlier books in this genre is David Wessel's In Fed We Trust, which draws heavily on the world as seen by Hank Paulson, Tim Geithner, and Ben Bernanke. The latest entry is Andrew Ross Sorkin's Too Big to Fail. Both books provide tell-all accounts of the deals brokered by the same crisis team in the fall of 2008, when the economy was on the brink of collapse. Sorkin goes far deeper than Wessel because he somehow got all of the major players, public and private, to go on the record.

The other sort of book doesn't include the juicy reporting detail but offers a serious analysis and critique of what occurred. Two of the best recent works in this category are Joseph Stiglitz's Freefall and John Cassidy's How Markets Fail. The two kinds of books complement each other. The novelistic treatment leavens the heavier stuff with human interest, and the serious analysis provides context and helps keep the tick-tock books honest.

Stiglitz is the world's leading scholarly expert on market failure, and this crisis vindicates his life's work. There have been other broad-spectrum books on the genesis and dynamics of the collapse, but Freefall is the most comprehensive to date, grounded in both theory and factual detail. Stiglitz also offers one-stop shopping if you are seeking an alternative set of remedies to the ones embraced by the Bush and Obama economic teams.

Stiglitz begins by thinking hard about what banks are supposed to do and what they actually did. "America's financial markets had failed to perform their essential societal functions of managing risk, allocating capital, and mobilizing savings while keeping transaction costs low," he writes. "Instead, they had created risk, misallocated capital, and encouraged excessive indebtedness while imposing high transaction costs."

Stiglitz usefully takes on the free-market myths that attempt to deflect responsibility for the crisis from the deregulation that allowed banks to behave like casinos. Along the way, he demolishes what's left of laissez-faire theory, explaining in detail how the expected "market discipline" failed to prevent speculative bubbles and mispricing of risk. Some of what he tells us, such as his description of the mortgage meltdown, is not new. But the book is a nice mix of the descriptive and prescriptive and offers several innovative policy proposals to solve the foreclosure crisis.

In an especially forceful chapter, Stiglitz eviscerates the Paulson-Geithner-Bernanke ad hoc rescues of September 2008 for their lack of transparency, consistency, and concern for the larger public interest -- and bemoans the policy continuity of the Paulson team with the Summers team. In Stiglitz's view, it will take stringent regulatory reform to get banks back to their appropriate mission as well as an ultra-Keynesian program of social investment to compensate for the collapse in asset prices and the decline of consumer and business demand. On both counts, Stiglitz contends, the administration's blueprint falls far short, and his book is the definitive critique to date of how the Summer-Geithner strategy fails, both as economics and as politics.

As a military metaphor, he invokes the Powell doctrine -- "attacking with decisive force." He writes, "There should be something analogous in economics, perhaps the Krugman-Stiglitz doctrine. When an economy is weak, very weak as the world economy appeared in early 2009, attack with overwhelming force." The real problem, though, was not the total amount of ammunition but where it was fired: too much on the banks and far too little on stimulating the economy and helping homeowners.

Stiglitz's view of the crisis describes a possible road -- a better road -- than the one taken by the Obama administration. And his book concludes with broader proposals for a better balance between market and civil society, domestically and globally. What makes Stiglitz special is that, along with Paul Krugman, he is the rare progressive in a profession whose norms resist tampering with the verdicts of markets or the power of private capital and also one of the few world-class technical economists who can write lucidly for a lay audience. The tone of this book is good-humored and public-minded.

One of the reasons why this crisis has resisted reform is that so many of the details are esoteric and difficult for the public to grasp. How many ordinary Americans can explain a credit-default swap? Books such as Freefall can increase general economic literacy, which in turn can increase the popular constituency for New Deal?scale reform.


John cassidy, a leading economics journalist who writes for The New Yorker, provides a fine companion to Stiglitz. His new book is really two books, but he brings them together elegantly. The first roughly 200 pages offer a very readable summary of what he calls "Utopian Economics," followed by another brisk tour of "Reality-based Economics." The former takes us from Adam Smith to Alan Greenspan. The latter is a very useful précis of the ideas of the critics, from John Maynard Keynes, best known for advocating deficit spending but also a brilliant student of financial irrationality, to Hyman Minsky, a prophetic analyst of the structural instability of money markets. Others have attempted this project, but if you are seeking an accessible read on 200 years of laissez-faire ideology and its critics, you can't do better than this one.

Then Cassidy gives us his account of the financial catastrophe. Some of this covers well-known ground, but Cassidy's value added is to connect the practical failures to the failures of theory, and to do so in a way that doesn't require the lay reader to have a Ph.D. in economics. Of the influential theories of Chicago economist and Nobel laureate Robert Lucas, Cassidy writes, "There was no place [in his theory] for stupidity, ignorance, or herd behavior. Economic slumps and mass joblessness were ruled out by assumption. In a Lucasian economy, unemployment is a matter of choice." How could such preposterous theories command influence, much less win the Nobel? Despite practical, real-world refutations, theory resisted contradictory evidence because free-market ideology has been so congenial to those with the most economic and financial power.

Cassidy is especially good at demonstrating the culpability of Greenspan for the current mess, tracing how his policy of combining extremely low interest rates with lax regulation made a bubble economy inevitable. He is also deft at explaining how the business models of the big banks interacted with the false assumptions of theory and the bad regulatory policies. His narrative is a nice blend of rebuttal, narrative, and telling anecdote.

Did you know, for example, that one reason why big banks such as Citi, Merrill Lynch, and UBS took such a bath on sub-prime securities was that once these securities stopped fetching customers in 2006?2007, the investment arms of these banks, often using off-balance-sheet affiliates, were used to bail out their own deals? It has become fashionable to assert that the repeal of the Glass-Steagall Act in 1999 had no connection to the financial collapse, but as Cassidy demonstrates, this sort of incestuous conflict of interest would not have been possible if commercial banking had been kept separate from investment banking.

Cassidy does a superb job of tracing the various interconnections and feedback loops that made this speculative bubble so much more serious than an ordinary recession and then connecting the story back to the failures of economic theory. In July 2007, Chuck Prince, then the CEO of Citigroup, expressed reservations about the risks of a "disruptive event" but famously added, "As long as the music is playing, you've got to get up and dance." Cassidy comments, "Whether he knew it or not, Prince was channeling Keynes." He then quotes Keynes from 1936, using the same metaphor as Prince but with a different ending: "When the music stops some of the players will find themselves unseated."

The drama of the collapse produced many novelistic moments, but until Sorkin's Too Big to Fail, none of the several books offered the drama of such earlier classic Wall Street takedowns as Barbarians at the Gate or Liar's Poker. However, Sorkin's book, like its author, is a phenom. Upon publication, it immediately hit the Times bestseller list at No. 4. Sorkin, just 32, was already a wunderkind for his "DealBook" column and blog, and he has no shortage of detractors. New York Magazine, in a very snarky cover profile, accuses Sorkin of going gently on celebrity sources who give him inside stories, and he has also tangled with other Times business writers who accuse Sorkin of stealing their stuff without attribution. According to New York Magazine, several Times colleagues describe young Sorkin as the financial pages' equivalent of Judith Miller.

Having read Sorkin's apologias in the Times for various Wall Street misdeeds -- for instance, he defended the American International Group bonuses -- I was prepared to hate the book. But it is an absolute tour de force. Whether or not Sorkin intended to go gently on friendly sources, the book tells one devastating story after another. He managed to get deep, on-the-record accounts from the senior executives of every major bank, the key government and Federal Reserve players, lawyers, and other power brokers, and the narrative he recounts has fewer heroes than knaves. Sorkin's technique is to reconstruct an event from several different sources. He plays somewhat loose with direct quotations that nobody could have recollected in such detail unless they were wearing a wire, but then again nobody has stepped forward to call him a liar, and we can assume that his scenes are roughly accurate despite some poetic license.

Here, for example, is Sorkin's account of just one scene. It is Sept. 14, Lehman Brothers is about to go bust, but thanks to the brokering efforts of Paulson and Geithner and several of their Wall Street pals such as power-lawyer H. Rodgin Cohen (who shows up everywhere, Zelig-like), Britain's Barclays Bank is prepared to buy Lehman Brothers:


The door to Geithner's office opened and out walked Geithner, Paulson, and [then?SEC Chair Christopher] Cox, all looking alarmingly dour.

"We got the banks to agree to fund, but the U.K. government has said no," Paulson announced.

"Why? Who?" Cohen asked, incredulous.

"It came from Downing Street. They don't want U.S. problems infecting the U.K. system," Paulson said.

While [then?Lehman Brothers President Bart] McDade just stood mutely in shock, Cohen, who was famous for his equanimity, virtually shouted, "I cannot believe this! You have to do something!"

"Look," Paulson said sternly, "I'm not going to cajole them and I'm not going to threaten them."


The government decides not to bail out Lehman, so Lehman goes down. A day later, as AIG threatens an even bigger collapse with even worse cascading effects, the government magically discovers that it has unused "exigent" powers under the Federal Reserve Act and bails out AIG. Paulson (and Geithner and Bernanke) cajole plenty of other bankers, merging weak banks into bigger banks (often creating bigger, weaker banks such as Bank of America) and remaking the financial system in exactly the manner of private investment bankers.

Now, it is inconceivable that this dialogue is transcribed exactly as it occurred. Though Sorkin footnotes material from public sources, he does not cite any sources for the scenes reconstructed from his reporting (or his imagination). In his "Notes and Sources" section, he writes a bit wishfully, "I was lucky to have found sources who often took incredible notes" (incredible indeed!), adding that "much of the dialogue that appears in this book came from the best recollections of participants. As a result ... the dialogue cannot be considered to be the same as an exact transcript." Yet he gives himself license to compose dialogue. No wonder reporters who hew to higher standards are irritated.

Nonetheless, Sorkin has performed a huge service by getting all these people to talk, even if he takes substantial liberties with direct quotations. I suppose that if you were predisposed to think that Hank Paulson saved the republic, you could read that conclusion into Sorkin's account, since he bends over backward to present Paulson as a decent man doing his best in perilously uncharted territory. But for me, Sorkin's reporting leaves two overwhelming impressions. The first is of a tight little Wall Street club, some of its members on temporary duty at the Treasury, resisting any kind of transparency or accountability, exercising arbitrary authority over who was to live and who was to die, and lying to Congress when that seemed convenient or necessary. The second is of extraordinary incompetence, on the part of both the private-sector geniuses who crashed the economy and Paulson and company.

In one telling section, Sorkin recounts how Paulson disingenuously goes to Congress in July 2008 and asks for a blank check in the form of standby authority to pour money into Fannie Mae and Freddie Mac, based on his knowledge that they are going bust. The Senate Banking Committee is more than skeptical. "When I picked up my newspaper yesterday," says Sen. Jim Bunning of Kentucky, "I thought I woke up in France. But no, it turned out it was socialism here in the United States of America."

Paulson replies, knowing that he is shading the truth, "I think our idea is that by having the government provide an unspecified backstop, the odds are very low that it will be used and the cost to the taxpayers will be minimized." Sorkin writes, with great compassion for the manipulative treasury secretary, "A socialist. Mr. Bailout. Hank Paulson believed he was fighting the good fight, a critical fight to save the economic system, but for his efforts he was being branded as little less than an enemy of the people."

Two months later, when Paulson throws $200 billion at Fannie and Freddie, Congress is predictably furious for having been misled. That in turn, gives Paulson ammunition for his belief, in his serial ad hoc backroom bailouts, that Congress needs to be kept in the dark because its members just won't understand. Sorkin is very sympathetic to this view, too.

Despite Sorkin's disclaimers and his efforts to be flattering, there is also devastating detail on Goldman Sachs, whose present and former executives are omnipresent, advising the government, advising parties to various deals, and gleaning inside information on which to base their own trading strategies. At one point, Paulson is promoting a deal to have Goldman buy a shaky Wachovia (headed by a former Goldman man, Bob Steel, former deputy Treasury secretary to Paulson) and it takes Warren Buffett to warn, "By tonight the government will realize they can't provide capital to a deal that's being done by the firm of the former Treasury Secretary with the company of a retired vice chairman of Goldman." Sorkin makes fun of the hyperbole in Matt Taibbi's now famous Rolling Stone piece on Goldman Sachs ("The world's most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money") and disparages "conspiracy theories" of Goldman's ubiquitous influence. But Sorkin's own reporting, if not his tone, entirely confirms Taibbi. Goldman was everywhere.

To read these three books is to realize just how powerful Wall Street still is and how far removed the financial economy has been from the real economy, and to appreciate that other policy paths were possible but not pursued. Stiglitz poses the question: Why didn't Obama hire a different team and provide a more radical break with the past? Stiglitz, a leading candidate of the opposition team, doesn't answer that question. But Sorkin's reporting does. The president can be named Bush or Obama, but Wall Street, despite its practical disgrace, still wields inordinate power and puts the rest of the economy at grave risk.

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