Easy, topical reading

The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash (Hardcover)
by Charles R. Morris

Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis (Hardcover)
by Paul Muolo and Mathew Padilla

A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation (Hardcover)
by Richard Bookstaber

Irrational Exuberance (Paperback) -- 2nd edition
by Robert J. Shiller

The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do about It (Hardcover)
by Robert J. Shiller

The New Financial Order: Risk in the 21st Century (Paperback)
by Robert J. Shiller

Manias, Panics, and Crashes: A History of Financial Crises (Wiley Investment Classics) (Paperback)
by Charles P. Kindleberger

Extraordinary Popular Delusions and the Madness of Crowds (Paperback)
by Charles MacKay

The Great Crash 1929
by John Kenneth Galbraith

Devil Take the Hindmost: A History of Financial Speculation (Paperback)
by Edward Chancellor

Confessions of a Subprime Lender: An Insider's Tale of Greed, Fraud, and Ignorance (Paperback)
by Richard Bitner

Financial Shock A 360º Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis (Hardcover)
by Mark Zandi

The World Is Curved: Hidden Dangers to the Global Economy (Hardcover)
by David M. Smick

The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means (Hardcover)
by George Soros

The Alchemy of Finance (Wiley Investment Classics) (Paperback)
by George Soros

The Black Swan: The Impact of the Highly Improbable (Hardcover)
by Nassim Nicholas Taleb

Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets (Paperback)by Nassim Nicholas Taleb

The Clouds in the Silver Lining

The blog Naked Capitalism really, really dislikes the bailout plan.

The Treasury has been using the formula that it will buy assets at "fair market prices". As we have noted, there is simply huge amounts of cash ready to bottom fish in housing-related assets (we saw an estimate of $400 billion a couple of months ago). The issue is not lack of willing buyers; it's that the prospective sellers are not willing to accept prices that reflect the weak and deteriorating prospects for housing. Meredith Whitney, the Oppenheimer bank analyst who has made the most accurate earnings and writedown calls of her peer group, has noted how the housing market price decline assumptions used by major banks fall short of where the market is likely to bottom, given traditional price to income ratios and expectations reflected in housing futures prices. In addition to the factors that Whitney (and others) have cited, the duration of the 1988-1992 US housing bear market and major financial crises suggests that that a peak-to-trough decline of 35-40% is realistic (obviously, this average masks substantial variation across markets and housing types). We are thus only a bit more than halfway through, as measured by the fall in prices.Yet as we discussed, the plan makes no sense unless the Orwellian "fair market prices" means "above market prices." The point is not to free up illiquid assets.

I like optimism

From Anatole Kaletsky's Times article

If banks are stabilised with government support, and then gradually slimmed down, the non-financial economy should suffer only a modest slowdown. In America, by contrast, an outright recession would be avoided if financial stability could be quickly restored. The worst of the housing slump there appears to be over, consumer confidence is rising and a gradual economic recovery should soon be under way. In Britain, further big job losses and falls in house prices, especially in London, because of the economy's dependence on the financial sector are likely. The recession, however, could still be a fairly mild one, assuming that financial stability is quickly restored.

The Cause of the Housing Crisis

As described by a true expert. Listen to this Podcast with Robert Shiller, author of several books on the topic and professor at Yale.

Are Bailouts Socialistic?

Not so, says the Angry Bear. They are kleptocratic.

Socialism is a form of government that seeks to equalize the playing field for all, insuring that that the fruits of labor are shared equally (but not fairly, necessarily. That’s one of the major reasons why socialism doesn’t work). Does anyone seriously think that captains of finance have embraced the philosophy of “workers of the world, unite!”? The same guys with multi-million dollar “golden-parachutes”, sometimes taking home more than a billion dollars in a year. The same guys who have embraced shady accounting practices so that they and their companies pay as little in taxes as possible, sometimes percentages of income far less than the average American worker. The same guys who have broken union after union over the decades. We’re supposed to believe that just this week this crew has decided to abandon Friedman and embrace Marx with open arms? Come on…

Roundup of Opinions

Great post at EconLog by Arnold King.

Who was asleep while financial markets ran amok? On Freddie and Fannie, the Bush Administration says, not us. Read the whole timeline. Greg Mankiw, who is mentioned in the statement, provided the pointer.

Is Henry Paulson a hero? Not to Luigi Zingales. Zingales articulates a concern that has been near the surface of some of my own recent posts, which is that the government officials making these decisions are seeing things from the perspective of Wall Street, which is kind of like seeing the auto industry from a Detroit viewpoint or seeing the movie industry from a Hollywood viewpoint or seeing elections from a Washington viewpoint. Tyler Cowen found this one.

Tyler also dug up an old blog post from an investment banker who used the pseudonym Mindles H. Drek. He points out that the expanded use of derivatives was largely a response to regulation. He points out, en passant, that the credit rating agencies' role in financial markets is driven by regulators, as well. I've talked about the credit rating agencies in recent posts. I'll talk about the role of derivatives in another post, soon.

Brad DeLong has a long post. It is worth reading to understand his point of view. Basically, he throws the kitchen sink of market imperfections at financial markets--moral hazard, adverse selection, multiple equilibria, and so on, and then says that we should never again allow private decisions to be made without wise technocrats like himself overseeing things. He and I could have a long, long debate. Thanks to Mark Thoma for the pointer.

Stiglitz's diagnosis and prescription

Nobel Laureate Joseph Stiglitz gives his diagnosis and prescription:

This is not the first crisis in our financial system, not the first time that those who believe in free and unregulated markets have come running to the government for bail-outs. There is a pattern here, one that suggests deep systemic problems — and a variety of solutions:

1. We need first to correct incentives for executives, reducing the scope for conflicts of interest and improving shareholder information about dilution in share value as a result of stock options. We should mitigate the incentives for excessive risk-taking and the short-term focus that has so long prevailed, for instance, by requiring bonuses to be paid on the basis of, say, five-year returns, rather than annual returns.

2. Secondly, we need to create a financial product safety commission, to make sure that products bought and sold by banks, pension funds, etc. are safe for "human consumption." Consenting adults should be given great freedom to do whatever they want, but that does not mean they should gamble with other people's money. Some may worry that this may stifle innovation. But that may be a good thing considering the kind of innovation we had — attempting to subvert accounting and regulations. What we need is more innovation addressing the needs of ordinary Americans, so they can stay in their homes when economic conditions change.

3. We need to create a financial systems stability commission to take an overview of the entire financial system, recognizing the interrelations among the various parts, and to prevent the excessive systemic leveraging that we have just experienced.

4. We need to impose other regulations to improve the safety and soundness of our financial system, such as "speed bumps" to limit borrowing. Historically, rapid expansion of lending has been responsible for a large fraction of crises and this crisis is no exception.

5. We need better consumer protection laws, including laws that prevent predatory lending.6. We need better competition laws. The financial institutions have been able to prey on consumers through credit cards partly because of the absence of competition. But even more importantly, we should not be in situations where a firm is "too big to fail." If it is that big, it should be broken up.

These reforms will not guarantee that we will not have another crisis. The ingenuity of those in the financial markets is impressive. Eventually, they will figure out how to circumvent whatever regulations are imposed. But these reforms will make another crisis of this kind less likely, and, should it occur, make it less severe than it otherwise would be.