Yves Smith runs the popular financial blog naked capitalism. This is a review of her first book ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism.
It puts forward the case that flawed economic theory, and the influential followers of those theories, have played a large part in the economic crisis which started in 2007, and which is still not over as of 2010.
Chapters 1-5 which form the first half of the book, focus on standard economic theories and what is wrong with them. She goes through topics such as supply and demand, neoclassical economics, free markets, and normal distribution. She gives the background and history to these theories, and then picks them apart, with plenty of examples as to why the standard thinking is wrong. I’ve never studied economics but had no problem following the arguments in these chapters.
One example is that the normal distribution (or bell curve), calculated the odds of a 10% move in the Dow Jones as only being possible one in every 73 to 603 billion years. And yet this move happened twice in the same month. Yes – it would be possible in these odds – but much more likely is that the odds were devastatingly wrong due to relying on flawed bell curve assumptions.
If you have read the Fooled by Randomness and Black Swan books by Nassim Nicholas Taleb, you may notice some overlap in the people, stories and opinions in the first 5 chapters. That’s not a bad thing though, as Nassim and Yves both make very good arguments.
Chapters 6 and 7 are different, and tell of financial people and companies making very stupid decisions, and losing a lot of money. I always like reading about people who make massive financial mistakes. It you like these chapters then see Traders, Guns and Money by Satyajit Das for more. Chapter 7 also details the problems with Value at Risk (VaR), and compares the differences in power structures between the banks and the military.
Chapters 8 and 9 get into details as to how the crisis happened. She gives a great explanation as to how risky loans were turned into complex financial instruments with AAA ratings – meaning they should be as secure as government bonds.
Chapter 10 is one of the scariest as it details what happened after the major crashes, when government money was pumped into the worlds banking systems as lightning speed. Rather than going toward propping up the stability of the critical banking elements, much of the money was going straight (or nearly straight) into the pockets of those highly paid bankers who got us into this mess in the first place.
Yves then gives her suggestions for how to make the financial system more stable, and how it can better serve the needs of the general population, rather than only serving the needs of the rich.
This is definitely a recommended book, well written, and with good arguments put forward from someone who clearly knows their subject. I hope that whoever is our next Chancellor of the Exchequer after the May 2010 elections will read a copy.
Ref Trading Diary