Sunday, April 07, 2013

Gary Gorton's Missed Opportunity

In Misunderstanding Financial Crises, Gary Gorton has such an important point to make that it is a shame he sat on the execution.

The one-line takeaway is, as I take it, that we don't pay nearly enough attention to the concept of "financial crisis"--by which he means, I think, crisis narrowly defined like the mensis horribilia when Lehman went down--also Fannie and Freddie, WaMu, Merrill Lynch and the reputation for invulnerability of the American banking system.

I think that much is inarguable, although there may be some issues about cause and definition.  Gorton says it is because economists are too analytical. not willing to  grant history the respect it deserves.  I think there is a core of truth here but I suspect his own analytical focus wobbles a bit when he concedes implicitly that actually we do pay attention to history--we just don't go back far enough.  That is: almost any consideration of slumps and booms, shocks and suchlike, confines itself to what he calls "the quiet period"--1934-2007, during which there was not a single disruption in the system (October 1987 and Long Term Capital Management would not count as exceptions, I suppose ironically because they ended so quickly and  painlessly).  

We can see at least two errors at work here.  One, we assumed that because we had escaped for 73 years, we seem to have figured there must have been some fundamental change in the system that made us invulnerable to dislocation--the "great moderation," or whatever.  And two, we failed to notice that even in "the quiet period," shocks continued to occur--it was just that they occurred in Mexico or Argentina or Thailand or Russia or (again) whatever.  Apparently we blew them off either because we weren't paying attention or because we didn't think they had anything to do with us.

Well, time for a rethink. And here is where Gorton has done some important work.  His Slapped by the Invisible Hand demonstrated how the critical events of aught eight could be understood as an old-fashioned bank run in new garments.  Slapped was brief, crisp, elegant, and squarely on point, or so it seemed.  It invited generalization.    That is what Misunderstanding purports to offer, but aside from remaking the core points of Slapped, there is surprisingly little that's new.

Gorton does offer up a sort of history of previous crises.  But it's perfunctory, amateurish--mostly just rip-and-read quotations from old court cases.  Unless I missed something, he seems not even to specify precisely why,  he is replowing the old ground although I guess I can surmise a good reason: he wants to say "hey guys, you see what happened before?  Well it happened again--and can be expected to happen yet again, quiet period notwithstanding."
I'll grant that this is a point worth making, even if somewhat slapdashingly presented.   But convinced as we may be (and my guess is that most readers were probably convinced before they open the book), there remains the larger question--okay, so?  We've seen that they happen, you've persuaded us (more or less) that they'll happen again.  Giving credit where credit is due, you've even shown how sometimes the great and good have handled them right.  So what do we do now to get our thinking back on track?

It is perhaps one of the lesser disappointments of this book that Gorton hasn't disposed of all the questions on the agenda he presumes to create.  Setting the agenda is an achievement in itself and it is probably asking too much to expect him to flesh out a fullscale response.  Still, I suspect he might have stood a better chance of getting everybody's attention if he had done a more polished job of laying it out.


CrocodileChuck said...

"October 1987 and Long Term Capital Management would not count as exceptions, I suppose ironically because they ended so quickly and painlessly."

After the '87 crash, (3/'88) the shift in gov't policy to promote financialisation (at the expense of mfg) was made explicit: the establishment of The President's Working Committee on Financial Markets, aka 'PlungeProtectionTeam' (see Bruce Bartlett)

'98's LTCM: ushered in the Lehman collapse (when no other IB would lend to it) when Lehman then refused to participate in bailing out the hedge fund (all other IB's chipped in to do so)

brad said...

Having just finished the book "Railroaded" on the history of the transcontinental railroad build out and finance it seems the gilded age is much closer to the recent past than the great depression. Replace railroad with internet and much of the finance, worker issues and globalization issues are exactly those faced in the period 1860-1900. Even the names of the large banks suffering are the same(ie Goldman, Barring,etc.).