Slapped by the Invisible Hand: The Panic of 2007

Slapped by the Invisible Hand: The Panic of 2007

Slapped by the Invisible Hand: The Panic of 2007

Slapped by the Invisible Hand: The Panic of 2007


Originally written for a conference of the Federal Reserve, Gary Gorton's "The Panic of 2007" garnered enormous attention and is considered by many to be the most convincing take on the recent economic meltdown. Now, in Slapped by the Invisible Hand, Gorton builds upon this seminal work, explaining how the securitized-banking system, the nexus of financial markets and instruments unknown to most people, stands at the heart of the financial crisis.

Gorton shows that the Panic of 2007 was not so different from the Panics of 1907 or of 1893, except that, in 2007, most people had never heard of the markets that were involved, didn't know how they worked, or what their purposes were. Terms like subprime mortgage, asset-backed commercial paper conduit, structured investment vehicle, credit derivative, securitization, or repo market were meaningless. In this superb volume, Gorton makes all of this crystal clear. He shows that the securitized banking system is, in fact, a real banking system, allowing institutional investors and firms to make enormous, short-term deposits. But as any banking system, it was vulnerable to a panic. Indeed the events starting in August 2007 can best be understood not as a retail panic involving individuals, but as a wholesale panic involving institutions, where large financial firms "ran" on other financial firms, making the system insolvent.

An authority on banking panics, Gorton is the ideal person to explain the financial calamity of 2007. Indeed, as the crisis unfolded, he was working inside an institution that played a central role in the collapse. Thus, this book presents the unparalleled and invaluable perspective of a top scholar who was also a key insider.


I want to talk for a few minutes with the people of the United States
about banking—to talk with the comparatively few who understand the
mechanics of banking, but more particularly with the overwhelming
majority of you who use banks for the making of deposits and the draw
ing of checks.

—Franklin Roosevelt, first fireside chat, March 12, 1933

I am by no means an alarmist. I believe that our system, though curious
and peculiar, may be worked safely; but if we wish so to work it, we
must study it. We must not think we have an easy task when we have a
difficult task, or that we are living in a natural state when we are living
in an artificial one. Money will not manage itself, and Lombard Street
has a great deal of money to manage.

Walter Bagehot, Lombard Street: A Description of the
Money Market

WHEN THE PANIC OF 2007 BROKE OUT IN AUGUST OF THAT YEAR, I WAS IN a unique position to observe the events. For 25 years, my academic career—in the Federal Reserve System, at the Wharton School of the University of Pennsylvania, and at Yale School of Management—focused on banking, financial crises, and banking panics. My 1983 PhD dissertation was on the subject of banking panics. One paper from my thesis was the first (and, as far as I know, the only) econometric study of panics to this day. But, starting in 1996, I also consulted for AIG Financial Products, where I worked on structured credit, credit derivatives, and commodity futures. During the panic, AIG became a focal point of anger because of its sheer size and the extent of the resources needed to maintain the company as a going concern.

When I wrote my PhD thesis in the early 1980s about banking panics, I never dreamed that I would live through one. Who could possibly have imagined what . . .

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