How I Taught Myself What the Whiz Kids on Wall Street and the Crackerjacks in The City Did to My Nest Egg

Do you remember where you were on September 29, 2008?  That’s the day the U.S. House of Representatives voted down the TARP bill to bail out those too-big-to-fail U.S. financial institutions, which resulted in the Dow plunging 778 points.  We thought we were staring at the abyss that day.  But it turns out we were a couple weeks past the abyss.  As James B. Stewart revealed a year later in an adrenaline-racing story entitled “Eight Days” in the September 21, 2009 issue of The New Yorker, we actually skirted the edge of the abyss during the 48 hours of Wednesday and Thursday, September 17 and 18.

The Monday, September 15, bankruptcy of Lehman Brothers set off a chain of events that brought the global financial system to what then-Treasury Secretary Henry Paulson privately called at the time “the precipice.”  Only determined intervention by Paulson and Fed Chairman Ben Bernanke staved off utter collapse.  (Had they not, martial law was next.)  Out of that experience, they surfaced on Friday, September 19, with the original TARP plan.  Knowing what we know now, think back to the looks on their faces as they faced TV cameras that Friday.  As dramatic as the House vote on TARP turned out to be, for those in the know, it paled in comparison to the calamity averted two weeks before.

In September 2008, I knew very little about finance.  But after that month, I resolved to learn more because, apparently, this topic required my attention.  No one else seemed to be watching out for me.  I figured I’d better catch up quickly.  I did, and it turns out that I was amazingly ignorant about something that has affected me enormously.  I may still only know just enough to be dangerous, but dangerous is exactly how the outraged American public views itself these days.

Here’s what I’ve read over the past year in my self-education about finance.  If you are similarly motivated and looking for some holiday reading, here’s what I would recommend:

Start with the April 8, 2009 episode of the NPR show This American Life.  It’s entitled “The Giant Pool of Money,” produced by Alex Blumberg and narrated by Adam Davidson.  This provides the broad outlines of what happened, and introduces an idea that you won’t fully appreciate until much later, namely, that without the huge capital account surpluses of nations like China, the housing bubble in America would never have happened.  After all, somebody had to finance American debt, not to mention all the encouragement that was given to consumers to take on more debt.  This doesn’t excuse Americans, but it does offer some perspective on why macroeconomists are saying that unless Chinese consumers start spending more and saving less, the global economy won’t recover.  (On this subject, see the two Financial Times pieces here and here by Martin Wolf.)

 Then read the Stewart story in The New Yorker mentioned above.

With these two articles as background context, you’re now ready to take on some of the core concepts in finance, mortgage financing in particular, that you have to master if you’re really going to understand what happened and how things need to be fixed.  Read the Uber-Nerd posts at the Calculated Risk blog that were written by the late Doris Dungey, who blogged under the pseudonym Tanta.  You have to put on your thinking cap when you read these.  They are long posts and the concepts are involved.  But it’s necessary reading, and it’s interesting.

To close the circle on fundamentals, read Financial Shock by economist Mark Zandi.  But read the 2009 updated edition, not the pre-September 2008 first edition.  Each chapter of this book provides an accessible overview of a particular facet of the housing bubble.

• Federal judge and law professor Richard Posner’s 2009 book, A Failure of Capitalism, is the same sort of book as Zandi’s, although not as succinct and sharp in its explanations of finance concepts.  However, it does provide a more overarching perspective on what happened that points to a number of public policy priorities.
• Economist Robert Shiller was an early Cassandra about the housing bubble in the revised 2005 edition of his book Irrational Exuberance.  While Shiller does not dig into specific finance concepts and instruments like Zandi and Posner, he does offer a pre-crisis look at the economic measures and psychological dynamics of impending doom.

The next book to read is Past Due, the excellent 2009 book by New York Times reporter Peter Goodman.  Goodman paints a picture of the bubble as it unfolded and tipped over into a crisis.  He focuses on the bigger picture of economic events, but does so without ignoring the very human dimension of it all.  Alongside his economic narrative, he narrates the stories of the ever-changing prospects of several actual people as they ride the wave and then crash on shore, where they find themselves drowning in debt and diminishing job prospects.  Your appreciation of this book is much greater if you understand the basic finance concepts that you will have learned from your prior reading.

The next step in your self-education is to read The Myth of the Rational Market, another excellent 2009 book by Time magazine writer Justin Fox.  This is an accessible, and essential, intellectual history of the concept of the “rational market” in economics and finance since the 1930s.  This may seem like pedantry, but if you want to understand how financiers came to believe in the infallibility of the financial instruments that nearly brought down the global financial system then you must understand their intellectual underpinnings.  This book also helps you sort out the different sides in the on-going debate among economists over what this crisis means for public policy as well as for the discipline of macroeconomics itself.

• One really interesting book for those who, at this point, find themselves deep in the uber-nerd thicket is the 2009 book This Time is Different by economists Carmen Reinhart and Kenneth Rogoff.  This is an extended, 800-year look at financial crises around the world.  After painting the big picture, they assess the current crisis.  It turns out that in the broader sweep of history, the current crisis is run of the mill.  It followed the standard path as it was in the making, thus it was entirely predictable, and, while brutal, is well within historical norms in terms of its severity.  This is not a casual read, though.  It has lots of detailed charts and is largely an analysis of a huge database assembled by Reinhart and Rogoff.
• If you find yourself interested in this kind of detail, then you will want to catch up with the three Lionel Robbins Memorial Lectures delivered in June at the London School of Economics by Nobel Prize-winning economist Paul Krugman.  These outstanding lectures revisit themes from the 2008 edition of his classic book The Return of Depression Economics, but add to them in order to shed light on the current financial crisis.  These lectures are available in video, podcast or PDF here, here and here, respectively.
• In addition, you will be interested in the discussion about global unemployment by three University of California at Berkeley economists at an October 2009 panel sponsored by the Berkeley Center for Law, Business & the Economy in conjunction with the Institutions and Governance Program.  It is available as video.  Brad DeLong’s presentation is the most essential of the three, and it is also available as podcast or PDF.

You are now ready to make sense of all that is being said and debated about global finance and the future of the global economy.

Interesting books that follow the collapse of various financial institutions will be no longer seem steeped in unexplained arcane financial alchemy lurking in the background that defies ordinary comprehension, such as House of Cards about the collapse of Bear Stearns or A Colossal Failure of Common Sense and The Murder of Lehman Brothers about the collapse of Lehman Brothers or Too Big To Fail about the meltdown of the entire Wall Street/Washington complex of power, hubris and greed.

You will have a deeper appreciation of books that take the long view like The Lords of Finance or The Ascent of Money.  And the eerily prescient trilogy of books by Kevin Phillips published during the early 2000s warning of the inherent dangers accompanying the rise of finance will make more sense – Wealth and Democracy, American Dynasty and American Theocracy.  (Not that these were the first warnings sounded by Phillips.  He wrote of this in another well-known trilogy published during the 1990s – The Politics of Rich and Poor, Boiling Point and Arrogant Capital.)

You will be prepared to more intelligently follow the threads on economics and finance blogs.  A comprehensive listing of these blogs is available here in the form of a periodic table.  My personal favorites are Economix, Calculated Risk, Marginal Revolution, Economist’s View, The Conscience of a Liberal and Grasping Reality.

Just for fun, I also follow the videos and posts of North San Diego County realtor Jim Klinge at BubbleInfo.com.  Knowing more about the inner workings of the market, I am able to better appreciate his ground-level view of the real estate market.  He has an ironic sense of humor that keeps you honest and puts our collective foibles into perspective. 

Indeed, I try not to get too cynical about all of this, notwithstanding what I’ve learned.  To do that, I make a weekly visit to ReasonsForOptimism.com, a Web site maintained by Cooper Carry and Iconologic to remind us that no matter how bad things look on the finance front, there are lots of other things still going on in life that give us reasons for optimism.  [J. Walker Smith]

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