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A review by ashrafulla
The Origin of Financial Crises: Central Banks, Credit Bubbles, and the Efficient Market Fallacy by George Cooper
4.0
This is a good book explaining a possible feedback mechanism that causes financial crises. Essentially expedience forces market participants to overlever during good periods and try to retract money during bad periods. This exacerbates the natural economic cycle so that peaks go higher (when borrowing money to invest) and troughs go lower (when pulling money out). As a result the drawdown is far wider than the normal economic cycle.
The author does a very good job of describing this mechanism as well as why it happens. He avoids for the most part the use of behavioral economics on purpose. The reason is to avoid people making the assumption that Shiller and Kahneman are required for this cycle-to-crisis transformation. You can use rational efficient market theory, an adherence to the flawed efficient market hypothesis and shorter-term political pressure to generate the cycle. You don't need a decision utility curve or a system 1/2 procedure because the arguments are all rational in the eyes of the actors.
I was a little bit disappointed in the author's proposed solution to the credit expansion of market participants. It amounted to telling everyone they are wrong rather than forcing them. If you believe the right answer is to force investors to have enough capital to take the bets they are taking, then it is not enough to remind them. You have to use an expanded law to force constant monitoring of credit. If you are free market, then what you want is for overleveraged firms to fail during the downturn so that those consequences are priced into the market. The notion of using words over actions seems academic more than influential.
Still, I recommend the book as a good way to learn how to describe the effect of credit policy on financial cycles.
The author does a very good job of describing this mechanism as well as why it happens. He avoids for the most part the use of behavioral economics on purpose. The reason is to avoid people making the assumption that Shiller and Kahneman are required for this cycle-to-crisis transformation. You can use rational efficient market theory, an adherence to the flawed efficient market hypothesis and shorter-term political pressure to generate the cycle. You don't need a decision utility curve or a system 1/2 procedure because the arguments are all rational in the eyes of the actors.
I was a little bit disappointed in the author's proposed solution to the credit expansion of market participants. It amounted to telling everyone they are wrong rather than forcing them. If you believe the right answer is to force investors to have enough capital to take the bets they are taking, then it is not enough to remind them. You have to use an expanded law to force constant monitoring of credit. If you are free market, then what you want is for overleveraged firms to fail during the downturn so that those consequences are priced into the market. The notion of using words over actions seems academic more than influential.
Still, I recommend the book as a good way to learn how to describe the effect of credit policy on financial cycles.