Review - The Fearful Rise of Markets, by John Authers
John Authers
Let's face it, the bookstores are completely over-saturated with books about the financial crisis. Specifically, the role of large American banks in creating and orchestrating disaster before the crisis, during the crisis -- and well into the future. We've learned several things from the experience, so what could we expect from a book for those who have already taken in the basics and yearn for a more advanced expose?
Authers offers such a book with The Fearful Rise of Markets
Main Thesis / Main Idea:
The global synchronization of markets has made them inherently instable and any dramatic fluctuations to one market now have global repercussions.
Ideas Addressed:
--How interconnected are the world's markets?
--How much did the financial crisis of 2008 affect markets on a global scale?
--What is the state of markets around the world?
Point-driven. Fact-driven.
For people that want to know what they need to know, this one cuts out all the nonsense and simply offers necessary information.
Only offering necessary information sometimes alienates the reader. Specifically anyone unfamiliar with terms and concepts used.
Does not contain many solutions to global economic instability, though it does offer some.
Has the ripple effect in chaos theory become the best economic model around?
Authers first asks,
World markets are synchronized, and far more prone to bubbles and meltdowns than they used to be. Why?
Consider The Fearful Rise of Markets
1. The rise of the financial sector.
Because of the colossal size of the "too big to fail" banks, they began taking outrageous risks with other peoples' money -- counting on a government bailout should things go south. As well, "riskier" business started seeping outside the borders and basing itself on international development programs. When riskier portfolios pay off, they pay off huge -- but if they fail, bank managers who simply "manage" your investment dollars don't receive the ultimate penalty of going bust. Only you do. Authers puts this succinctly when he says,
When people make decisions about someone else’s money, they lose their fear and tend to take riskier decisions than they would with their own money.
And in describing the ridiculous financial contrivances that bankers were able to concoct, by repackaging horrendous loans and selling the interest received from unfit debtors, Authers gets right to the crux of the matter.
These toxic ingredients combined to create the conditions for the now notorious mess in the U.S. subprime mortgage market, as financiers extended loans to people with no chance of repaying them, and then repackaged and dispersed those loans in such a way that nobody knew who was sitting on losses when the loans started to default. That led to a breakdown of trust in the U.S. financial system and—thanks to interconnected markets—global finance.
2. The loss of an anchor for the market.
In the past, gold once anchored the world's financial system. Everything could rise and fall in value, but only in relation to a standard -- which often beset the possibility of dramatic economic growth. When Nixon dropped gold as the economic standard, he allowed for the possibility of relative value to rise, also allowing for something else to create market value.
The key elements of the new system that has evolved are that the value of money rests on the credibility of central banks; that exchange rates, which set the terms of international trade, are set by markets, not governments; and that the price of oil has replaced the price of gold as the system’s anchor.
Ultimately, a standard based on gold is probably unworkable in the twenty-first century because of its limitations on economic expansion and the degree to which global markets have already grown. But, on the other hand, it did guarantee less excessive devaluations within the market and inflation -- and, the primary concern of The Fearful Rise of Markets
3. An increase of "global bank" loans to emerging markets (also known as developing countries).
New countries love to get their hands on money to spreadhead new initiatives -- just like any new business. Just like you might invest in a budding business and see dividends later, large financial institutions have seen fit to create dramatic profits by investing in entire countries. Often, these have been Latin American countries.
To the financial institutions, including the likes of the IMF and the World Bank, the rationale was that entire countries simply cannot go bust. But, of course, sometimes they do -- or come pretty close. There are several examples, but you can find an easy one in Mexico:
But in some circumstances, countries do go bust. The circumstances that led Mexico and the U.S. banks into each other’s arms in the first place also bore the seeds of eventual disaster. The money ignited an unsustainable boom in Mexico, where inflation took hold. Meanwhile higher rates and lower inflation in the United States under Volcker pushed up the value of the dollar, and with it the cost for Mexicans of servicing their debt. López Portillo vowed to defend the peso “like a dog,” but in the summer of 1982, just as the U.S. stock market started to rise, he had no choice but to devalue. That meant disaster for Mexico and its creditors, which deepened when the president nationalized all of Mexico’s banks.
4. Foreign exchange rates were monetized and turned into another market within the financial sector.
Does betting on the increase or decrease in value of another country's currency lead large financial betters to make managerial decisions to make those prophecies self-fulfilling? It does. Global industry leaders can take steps toward strengthening or devaluing any nation's currency, which is why leaders on Forex always have at least one foot inside the door for those decisions whenever they get made.
Authers offers several other contributing factors, some marginal, but nevertheless adding to the tiered global economic setup. An increase of general, overall credit. Hedge funds predominate large-place investing because they can increase returns by using borrowed money. Increasingly deregulated investment banks moved "risk" into the realm of something you could wager on (with collateralized debt obligations, credit default swaps and the like).
So are there solutions? Authers offers a few. Mostly piecemeal and commonplace within literature of its kind, but worthy of noting in a review.
The condition is easily diagnosed. Over the last half century, the rise of the investment industry has created overwhelming incentives for investors to follow one another into risks they often do not understand. As a result, world markets are hopelessly synchronized. This obstructs rational pricing and, in a capitalist world that relies on markets to set prices, endangers our prosperity. Finding a cure, however, is more difficult.
Some fixes are easy. The absurdly complicated instruments that created the subprime bubble, like synthetic collateralized debt obligations, should of course go. But the roots of the problem lie deeper. The institutionalization of investment cannot be reversed. Most of the financial innovations that created the synchronized bubble, like index funds, or even securitized mortgages, are in any case good ideas, so finding fixes will involve hard choices.
As usual, human nature stands in our way. The human, all too human tendencies of investment managers to get greedy, go risky, move in herds (and therefore create synthetic market bubbles where there isn't actually any more guarantee of profits) -- and a belief in the cushy bailout coming from the government should you fail.
The most obvious solution would be to tighten regulation of investment banking and to give managers within banks which are too big to fail -- a reason to be afraid of failure.
Discuss