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The Origin of Financial Crises: Central Banks, Credit Bubbles, and the Efficient Market Fallacy (Vintage) | 
 enlarge | Author: George Cooper
Publisher: Vintage
Category: Book
List Price: $12.95
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Rating:  13 reviews
Sales Rank: 2977
Media: Paperback
Pages: 208
Number Of Items: 1
Shipping Weight (lbs): 0.5
Dimensions (in): 7.9 x 5.1 x 0.7
ISBN: 0307473457
Dewey Decimal Number: 330
EAN: 9780307473455
ASIN: 0307473457
Publication Date: October 29, 2008
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Product Description
In a series of disarmingly simple arguments financial market analyst George Cooper challenges the core principles of today's economic orthodoxy and explains how we have created an economy that is inherently unstable and crisis prone. With great skill, he examines the very foundations of today's economic philosophy and adds a compelling analysis of the forces behind economic crisis. His goal is nothing less than preventing the seemingly endless procession of damaging boom-bust cycles, unsustainable economic bubbles, crippling credit crunches, and debilitating inflation. His direct, conscientious, and honest approach will captivate any reader and is an invaluable aid in understanding today's economy.
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| Customer Reviews: Read 8 more reviews...
un buen libro de introduccion a la economia y la crisis January 6, 2009
Edgar Stevens Piamba (Bogota, Colombia)
ESP. Buen libro, facil de leer. Con un recorrido interesante sobre historia y teoria economica.
 interesting, but seems to argue both sides January 5, 2009
David C. Fischer (Chesterfield, MO)
He begins the book placing everyone into two camps. Either, 1) laissez faire adherents who have to believe in the Efficient Market Hypothesis (EMH) or 2) Keynesians/Minsky-ites (government interventionists) who don't believe in the EMH. Now, I really wondered if this dichotomy is so easy to state. I consider myself a laissez faire person who also believes in behavioral finance (a form of denial of EMH). He goes on to say that 2) is the right camp, and tells you he will let you know later in the book why.
He does describe central banking nicely for the layperson. He writes clearly what could "go wrong" if central bankers choose bad policy.
And on p. 171 he basically admits that the Fed should take a lot of the blame for the 2008 crisis. In the next paragraph he then states that the blame for the current crisis comes from the academic community for their clinging to the EMH. Isn't he trying to have it both ways?
The lessons from the 2008 financial crisis are that human beings made a lot of bad judgments. And these human beings were making bad judgments in their roles as lenders, borrowers, central bankers, investors, legislators, regulators, and consumers. Everyone was too optimistic. This over-optimism is mostly a product of a belief that the economy can be stabilized by human beings. I came out believing exactly the opposite at the end of the book that he was trying to argue.
To me the problem is that laissez faire has not been tried and found wanting, it is that it has not been tried.
Worth the exposure to asymmetrical financial market concept December 7, 2008
R. Jeans (San Pedro, CA. USA)
Short with big print. I like the big print. Defends applying an asymmetrical market concept to credit and financial markets. A gallant effort that I took very seriously. I think his position has merit. He provides sufficient evidence for it.
The book starts out dry. Don't let that deter you. It cranks up beginning around his story about the history of money. I had hoped for a more robust conclusion. Still, one of the best books I have read.
well written but not convincing December 5, 2008
Read and think (Canada)
8 out of 9 found this review helpful
This book is well written. It is very well organised and structured, engaging, easy to read, clear and interesting.
According to the author, one can hold one of 3 views:
1) one can think that the markets are efficient (auto-equilibrating) and believe the central banks are required (mainstream thinking). According to the author, this is logically untenable because if the markets are efficient, then logically one would not need a central bank to correct desequilibria as they would not occur.
2) one can think that the markets are efficient and therefore no central banks are required (Friedman). According ot the author this is more logical but empirically false as reality shows that markets are inefficient and severe crisis do occur on such a regular basis as to invalidate the theory of automatic auto-regulation of the markets
3) one can think that the markets are inefficient and that we needed an interventionist central bank. This is the point of the author. In one chapter, the author recommend a strategy of "monetary regulation" copied from Maxwell's "governors" in physics: this is required precisely because (again according to the author) markets are as inherently instable as the Eurofighter plane is (the plane though is this way by willful design for manoeuvrability purpose and the instability is corrected electronically by a "governor").
There can be little argument against discarding 1).
So the difficult part is deciding on between 2) and 3).
Let's say we go along with the author and choose 3). Then we are facing with a nightmarish situation. You would need to have always a very competent (actually a genius) economist to direct the "governor" of the central bank. Although it needed not be perfect (and the author make it seem almost easy to design), most people can express doubt about this and the actual result. And then consider what happens when one day a president names his loyal (but incomptetent) friend (of course, this could never happen in the real world!) at the helm of the central bank and this friend is seated on the cockpit to pilot the "inherently unstable" eurofighter/economy! You guess it... we might not enjoy a soft landing but a terminal crash! Scary prospect. No wonder there is a market for gold, even nowadays.
Let's now consider option 2). Like another reviewer I was stunned when the author discarded the option by merely writting (p. 55):
"It soon became apparent through repeated waves of financial crisis, that this new credit generation system was highly unstable. However it was equally apparent that this new system was also leading to dramatic economic expansion, wealth generation and improving living standards. Going backward to a world before depository banks and credit creation was not an option. The process of credit creation had opened up a whole new channel for economic growth and prosperity. Venture capital in the truest sense of the word was now possible. Equally the new banking system permitted channels by which risk could be pooled and shared; larger ventures became feasible."
Wow! We are to take this at face value! Lots of details follow as to why the instability occurs but zero further explanation why the credit generation system is required and is the actual cause of the prosperity. It is supposedly "self-evident". This is like my mathematical teacher would say: the weak point in an argument is always the line where someone writes the disputed "obviously formula xyz applies in all case" and then spend all the rest of the article explaining, at great length, the obvious. In this case, the author spend virtually the entire book trashing the efficient market hypothesis, and zero line defending the most contentious point!
Indeed, there is a growing number of very knowledgeable economist who do believe that the central bank is not necessary and that fractional reserve banking not only is the no 1 source of instability of the system, but should be abandonned.
Now let's respond to the author point by point:
1) "venture capital in the truest sense of the word was now possible". Hummm. It ALWAYS had been possible. People have always pooled their money and give it to an adventurer going to India or America; people have always pooled their money to give to the inventor to create a new machine. You don't need a fractional reserve bank AT ALL to do this.
MOREOVER, without a fractional rerve banking system, you remove the main instability: if the endeavor/project fails, only the venture capitalist lose and they had themselves accepted the risk, no surprise. In a fractional reserve system, either the bank disappear (about 9,000 failed in the 30's in the USA...) destroying hard-earned savings of people who never thought their money was used for risky endeavor, or, the central bank is used to save the bank (2008 situation) and its risk-takers (or plain gambling as it now the case with derivatives the extent of which I doubt not even 0.1% of the population is aware of) at the expense of the entire unwitting population.
2) "the new banking system permitted channels by which risk could be pooled and shared": this is almost the dictionary definition of an insurance company! You don't need any fractional banking system for this! Again, with an insurance company in a world of fractional banking system it only worsens: they are rendered more instable and can only be resuscitated by a central bank otherwise the entire economy will collapse (think AIG). In a non-fractional banking reserve system, only the insurance company collapse - it is isolated from the rest of the economy penalising only its imprudent shareholders and customers.
Fractional reserve banking leads to instability and require a central bank. I think everybody agrees on this.
THE controversial point is: can the author show us why we NEED the (inherently unstable) fractional reserve banking? Why?
I am quite open to contrary viewpoint and could even change my mind about the subject.
Indeed I'd be delighted (and without a doubt, many others would also be) to purchase and read a book from the author titled "Why we need a fractional reserve banking system and its ensuing economic instability that can then only be rendered rendered stable by a eurofighter style "governor" piloted by a agile central bank".
It would especially be a delight reading that new book because I do enjoy the author's clear and well organised writing style. And I would love to write a review of that new book on Amazon!
I'll be patiently waiting...
Well-written critique, but affirmative points less convincing December 2, 2008
A. J. Sutter (Tokyo, Japan)
22 out of 24 found this review helpful
There's a lot to like in this book. George Cooper (GC) provides one of the most lucid and concise descriptions of the role of central banking you're ever likely to encounter. He carefully distinguishes among the philosophies of different central bankers, such as between the Federal Reserve and the European Central Bank. His critique of the Efficient Market Hypothesis (or "fallacy", as he prefers to call it) is trenchant and clear, as is his analysis of why the "fundamentals" of a stock aren't fundamental. He highlights the heterodox theories of Mandelbrot and Minsky, which are closer to the truth than the orthodox ones Ben Bernanke used to teach at Princeton. And he writes with a wry sense of humor, including a nice one-liner about boom-bust cycles that I'm surprised other reviewers haven't mentioned: "The invisible hand is playing racquetball" (@105).
That said, this book won't give you the whole story in understanding the current financial crisis. For one thing, GC never mentions credit default swaps or other derivatives, which in the aggregate dwarf the "real" economy. Even when GC describes why balance sheets are misleading, he doesn't mention any off-balance sheet instruments, of which derivatives are one category.
For another, GC tends to be overly accepting of microeconomics, and even of the diligence of lenders. For example, he says, in a kind of defense of bond ratings analysts, "When ratings analysts are assessing the quality of a loan, ... or the mortgage broker is assessing the safety of a mortgage, they evaluate each loan against the prevailing market prices for the loan's corresponding assets. In this procedure the tacit assumption is that the asset in question can be sold to repay the loan. At the micro level this is always a reasonable assumption" (@115). GC's point is that there is a "fallacy of composition" in reasoning from the micro scale to the macro -- the macro-level reality is not simply the sum all the micro transactions. OK. But why is the assumption he mentions *always* reasonable at the micro level? And why doesn't GC mention that in the current financial crisis, ratings agencies, mortgage brokers et al. did NOT follow the careful procedures he describes? (to say nothing of explaining *why* they didn't). The recent books by George Soros, Charles Morris and especially the fantastic "Structured Finance and Collateralized Debt Obligations" (2nd. ed. 2008) by Janet Tavakoli will tell you much more about this aspect of the story.
GC rightly points out that many economists' arguments operate on the principle of "proof by assertion" (@6), but he doesn't entirely avoid this trap himself. For example, GC's simplified descriptions of the history of finance are mostly based on "toy model" analogies, such as bakers and farmers selling their wares in a town square (Chapter 3). This picture isn't entirely historically accurate; e.g., when he asserts that central banking was necessary for the development of venture capital "in the truest sense of the word," whatever that means (@55), he overlooks the venture investments of the Medici during the medieval period, as well as many forms of Islamic financial transactions. None of those investment structures relied on central banks. This gave me the feeling that other aspects of his explanation might be a bit too pat, as well, especially when he says that some particular institution or practice led to or enabled another.
As he shifts his argument to a more constructive point of view, GC invokes an ingenious analogy (Chapter 6) to 19th-Century physicist James Clerk Maxwell's mathematical theory of mechanical "governors" (gizmos that kept machines from spinning out of control; Maxwell's original paper is reproduced as an appendix). Ingenious, but problematic. Most of standard neoclassical economic theory is based on ingenious analogies to physics, too (see especially P. Mirowski's 1989 book, "More Heat Than Light"). Some of those analogies, such as to "equilibrium" in supply and demand for consumer goods, sound at first blush as plausible as GC's analogy to Maxwell: ask any mainstream economist. But that plausibility doesn't mean that any of the theories are right -- and indeed, in the neoclassical case, the theory is wrong. GC doesn't use any empirical data stronger than anecdotal evidence to show that his Maxwell analogy is apt to the real world. Nor does he provide evidence that the policy recommendations he deduces from that analogy are feasible.
GC's failure to enagage with the derivatives issue is pertinent in this context too. One of GC's main constructive ideas is that central bankers should "prick" asset price bubbles as soon as they can identify that they've begun. (BTW, GC uses the word "asset" not as you might have learned if you took an accounting class, but in the finance pro's narrow sense of referring to stocks, bonds and other financial instruments.) If this sends the economy into small cycles of good times and tougher times, so be it -- in GC's view, that's better than the long ride up and crashing ride down we've experienced so often under Greenspan and his successor. However, GC says *the* key macroeconomic variable for identifying bubbles is the rate of credit creation (@125). Many derivatives contracts, like the ones that made trouble for A.I.G. in autumn 2008, are a form of credit creation -- just like bets placed with a bookie, any form of gambling creates debts. But derivatives are notoriously non-transparent: it's hard to know how many of these contracts are out there at any time. In that case, the visible data (mainly loans, bonds, etc.) might understate the amount of credit in the economy and also understate the rate of credit creation. So how's a central banker supposed to know the right time to prick? Since GC doesn't show how this approach has worked in the past, it's a matter of faith as to whether it might in the future.
This is a clear, witty book from which you can learn a lot. And some of GC's recommendations aren't so controversial, such as his suggestion for using a different form of statistical analysis (e.g., a la Mandelbrot) for looking at financial markets. But ultimately, the book is stronger when criticizing current practice than when proposing new policy.
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