Friday, November 20, 2009

The Best Finance Book I've Read So Far This Year
[aka, Cliff Notes for Finance Professors]

The best finance book I've read so far this year (and I've read a slew of them) is Robert C. Pozen's Too Big to Save? How to Fix the U.S. Financial System. But it fits in a somewhat specialized niche. If you are new to the current crisis, it is not the first book you should read on the topic. For narrative framework, I'd recommend this or this, either followed by this. No: instead of overview, what Pozen offers is an analytical framework on virtually every important practical issue in finance, together with recommendations. In short, what we have here is the book that every business/finance professor wants needs. Not to assign to his students: nothing to vulgar as that. What you do with Pozen is stuff it in your top drawer and sneak a peek whenever you want to look brilliant. I can't think of anybody who has covered such a range of issues so efficiently or so well.

But it's not a simple miracle. Pozen brings a lot to the table: he's chairman of a major money manager. He's had a string of posts in the finance industry, with a strong minor in public policy (I assume that he is the same Robert Pozen who, back in a simpler time, co-authored a Ralph Nader report on the state of Delaware). So he has to be in command of a lot of technical detail that most professors don't know (he also authored a couple of academic textbooks, so there is some crossover). What comes closer to miraculous is his talent for exposition: there may be others who can command this kind of detail, but I don't know anybody else can make it march in serried ranks. Pozen has the presentational skills of a journalist (which he is not). In his current guise, it's a blessing.

What we have here, then, is a comprehensive aide-memoire, but Pozen goes it one better. At the end of each chapter he offers up a "summary"--some of them not a lot shorter or less detailed than the original, to serve as an aid to an aid. I wonder if he has a third version tucked away in his laptop somewhere--the superlong version, written before his publisher made him cut it down to a book.

I almost wrote that the book was "about the current crisis," but that's not quite right: Pozen covers a range of issues, and if they all seem to be related to the current crisis, it is more because of the reach of the crisis than the narrow relevance of the issues. So what we have here is not quite an encyclopaedia, but an impressively extensive review of so many of the issues that concern anybody who cares about finance.

With so many specific practical recommendations, it is hard to provide a useful summary but it is possible to note some patterns. Pozen is clearly a guy who likes markets but has seen enough of them to know that they don't just invent themselves. Virtually all of his solutions, including those that involve some kind of government intervention, seem pretty clearly directed at making markets function better.

In the current uproar, he is refreshingly unimpressed by some of the popular shibboleths. He seems to have no truck, for example with the "all-Jimmy-Carter's-fault" school of policy criticism, which argues that all our travail can be laid at the door of those who wanted to increae home ownership. In the case of FNMA and GNMA, for example, Pozen seems much more impressed by the pressure the mortgage-buyers experienced from the CEO of Countrywide Finance than anything they may have felt from Chris Dodd or Barney Frank. He's similarly unpersuaded by those who say it was all the fault of marke-to-market accounting. Pozen does his best to lay out the classic case for truth in disclosure; on the way he provides an admirable nontechnical introduction to the narrow accounting issues.

On the other hand, Pozen is no more impressed by the idea that it was all the fault of the repeal of Glass-Steagall. Pozen makes a fairly sophisticated argument here. He grants that commercial banks gained some new freedom after repeal. But he says that many of their goals they had already achieved interstitially years before outright repeal. And (we are getting close to the point now) some banks exercised their newer, broader powers; some did not. The kicker is that those who did use their broader lending powers appear to have got into no more--and perhaps less--trouble than their brethren who did not. I might add:there might be other reasons why repeal of Glass-Steagall was a bad idea, but if Pozen is right, then culpability for the late meltdown is not one of them.

This is so rich that it seems captious to ask more of it. Still, one's appetites are insatiable and every frontier is a horizon. For example, I wish he had used a bit more of his formidable power as an explainer to throw some light onto the process of securitization--to show why the core idea of securitization really is quite a good one, while the recent innovations are justs betrayals of its good name.

Similarly, although Pozen didn't pretend to write a big-picture book, I'd love to know how he feels in general about the "asymmetry" issue that Barry Ritholtz treats so well: to what extent, for example, does he think we can blame our troubles on the shift to corporate structure at the great investment bank, and the corollary institution of heads-I-win, tails-you-lose incentives. And if I am on the right track so far, why (in the name of all that is holy) did shareholders ever let them get away with it.

And just to show I kept my eyes open, let me offer one policy point that seems to me germane to his discussion, but which he didn't touch on. The issue is executive compensation. Pozen is justly (I think) skeptical of the capacity of government to solve the problem of compensation obscenities; the job will be done, if at all, by better structured boards. In general, Pozen favors incentive-based compensation--but much reformed and improved from the phony incentives on offer today. But here's what he overlooks: almost every serious incentive scheme keys executive earnings to stock value. The trouble with this is thar stock value is not asset value. And as against the assets, shareholders on a leveraged balance sheets have perverse incentives from the get-go. They are impelled by the structure of the enterprise to take value-reducing risks. I admit I am not a careful follower of the debate over executive comp, but I don't know of any serious player who pays any attention to this issue. Pozen is ideally positioned to do so; I wish he would.

So, two points off for incompleteness, but it still leaves him way ahead of the pack. Although there is a final irony here. This book is nothing if not "timely": completely up-to-date and apposite to our current concerns. The irony is that it will be out of date next week. So read it quickly, and enjoy.

Oh, but a word of caution: don't get the Kindle (unless, perhaps, you have one of those new giant jobbies, of which I suspect they have sold about two). This book has far too many charts and tables, unreadable in the tiny format. And right now in the mess on my desk I can't even find mine, but that is another problem.

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