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8 September 2017 Financial Analysts Journal Book Review

Time for a Visible Hand: Lessons from the 2008 World Financial Crisis (a review)

  1. Martin S. Fridson, CFA

This book’s contributors emphasize ways in which the evolution of global markets has necessitated a fresh look at financial regulation. It features extensive discussion of emerging countries, an aspect little dealt with in the developed world’s media.

Gerard Caprio, Jr., professor of economics at Williams College and a contributor to the volume under review, commenced work in the spring of 2007 on a co-authored paper on banking crises.Comments on the authors’ outline said that it needed a section about the end of crises, reflecting the widespread view that financial engineers had permanently stabilized the markets by optimally redistributing risk throughout the financial system. This editorial suggestion had become painfully irrelevant when the paper’s deadline arrived in late 2007. By then it was clear that the notion of permanently neutralizing risk by spreading it around was illusory. Less obvious were the causes of the severe financial calamity that ensued and the policy changes most likely to prevent a recurrence.

Time for a Visible Hand: Lessons from the 2008 World Financial Crisis  derives from a July 2008 seminar organized by Columbia University’s Initiative for Policy Dialogue and the University of Manchester’s Brooks World Poverty Institute. The 17 contributors had the opportunity to update their comments in light of the worsening of the crisis after Lehman Brothers’ collapse in September 2008 and the massive amelioration efforts of governments and central banks. The volume was finally published in February 2010, potentially enabling it to influence the U.S. Congress’s postcrisis debate over financial market reform. At the very least, the book demanded notice because of the stature of its three co-editors, Nobel Laureate in Economics Joseph E. Stiglitz, former Under-Secretary-General of the United Nations for Economic and Social Affairs José Antonio Ocampo, and Stephany Griffith-Jones, the financial markets director at the Initiative for Policy Dialogue at Columbia University.

As telegraphed by its title, which alludes to Adam Smith’s metaphor for the salutary impact of laissez-faire policies,  Time for a Visible Hand  comes down strongly on the side of greater government intervention in the market. Even so, readers who view the profit motive as a positive force in the world may find merit in certain proposed reforms in the book. For instance, Avinash Persaud, chairman of Intelligence Capital, advocates replacing government-provided deposit insurance with a requirement that all deposit-taking institutions purchase some minimum level of insurance from the private sector or a combination of private and public providers. Persaud points out that unlike the government, profit-motivated insurers would discriminate on the basis of risk, charging lower premiums to the safest banks and declaring manifestly unsound banks uninsurable, thereby eliminating them from the market.

The contributors emphasize ways in which the evolution of global markets has necessitated a fresh look at financial regulation. For example, monetary authorities’ traditional concentration on deposit-taking institutions is no longer effective in view of the derivatives market’s vast capacity for creating liquidity. Another key theme is the need to redirect regulatory focus from the soundness of individual financial institutions to the overall health of the financial system. To some extent, regulations need to be updated simply because time has elapsed since the last update. “Any static rules,” writes Caprio, “will end up inducing innovations that help evade the same rules.”

What sets  Time for a Visible Hand  apart from the many other books on the global financial crisis is its extensive discussion of emerging countries, an aspect little dealt with in the developed world’s media. Fernando J. Cardim de Carvalho, professor of economics at the Institute of Economics at the Federal University of Rio de Janeiro, notes that since the late 1990s, many emerging countries have adopted a strategy of building up their foreign reserves to avoid the combined jolt of debt crises and austerity programs imposed by the International Monetary Fund. Roberto Frenkel and Martin Rapetti of the Centro de Estudios de Estado y Sociedad (CEDES) report that in a sample of 29 developing countries, the number showing current account surpluses rose from 4 in 1997 to 14 in 2006.

Although the book’s level of argument and documentation is generally high, there are some disappointing lapses. For instance, Charles Goodhart of the London School of Economics states that the “charge is surely justified and has been empirically demonstrated” that the bond rating agencies badly lag events in adjusting ratings, yet he devotes none of his 27 footnotes to substantiating the remark. Stiglitz absolves Fannie Mae and Freddie Mac of responsibility for the subprime mortgage debacle when he claims “the worst practices did not occur in government housing programs.” As Barron’s  economics editor Gene Epstein has pointed out,  27 million of the 55 million first mortgages in the United States in mid-2008 were either subprime or in the next riskiest category, “Alt-A.” Of that 27 million, 19.2 million were held or guaranteed by Fannie Mae or Freddie Mac, held by the U.S. Federal Housing Administration, or held by private institutions under requirements of the Community Reinvestment Act or the U.S. Department of Housing and Urban Development. These figures belie Stiglitz’s claim that the private sector created the bad loans without the government’s encouragement. Stiglitz, a former chairman of the Council of Economic Advisers, also suggests that corporations’ long-standing practice of filing separate and substantially different financial statements for tax and financial reporting purposes is a gimmick made possible by recent liberalization of accounting standards.

Despite the book’s long gestation, a surprising number of gaffes eluded the copy editors. Text on the back cover proclaims that “the world economy is in unchartered [ sic ] territory.” A box labeled “Four Stages of Crisis” is referred to just two pages earlier as a description of “Four Phases of Crisis,” and the Institute of International Finance is also called the “Institute for International Finance.” Within a single paragraph, the investment bank that failed in March 2008 is rendered accurately as “Bear Stearns” and also as “Bear Sterns.” Financier Michael Milken’s surname is transmuted into “Milkin.”

Although the editing stumbles on occasion,  Time for a Visible Hand  enriches the reader’s understanding of the financial crisis. For instance, the contributors highlight the role of badly designed executive compensation schemes and the repercussions of bailouts that socialize losses while privatizing profits. They describe a problem with using the U.S. dollar as the world’s reserve currency known as the Triffin Dilemma: To make the reserve currency available, the United States must run deficits, which undermines confidence in the reserve currency. Stiglitz astutely notes that maximizing complexity is a conscious strategy of U.S. financial institutions because standardized, transparent markets are the most competitive and hence the least profitable. In short, even if one regards some of its policy prescriptions as regulatory overreaching, the book’s analysis represents a valuable addition to the debate.


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