Misunderstanding Financial Crises: Why We Don't See Them Coming

By Gary B. Gorton | Go to book overview

PREFACE

The effects of the financial catastrophe through which the country
had passed in the previous period were seen in legislation for
perhaps a decade, but then they were gradually forgotten. The
literature of this subject for fifty years had repeated the same
inferences, lessons, and warning; but all the doctrines of currency
have to be learned over again apparently every ten or fifteen years, if
indeed they were ever learned at all.

—William Graham Sumner, A History of Banking in the United States, 1896

William Graham Sumner (1840–1910), a Yale professor and expert on banking, was describing the half century prior to the U.S. Civil War. The next seventy or so years after the Civil War were marked by repeated financial crises until federal deposit insurance legislation was passed during the Great Depression, and could be described similarly. The global financial crisis of 2007–8 suggests that the lessons were probably never learned. What are the lessons?

One is that financial crises are inherent in the production of bank debt, which is used to conduct transactions, and, unless the government designs intelligent regulation, crises will continue. This is not understood. Prior to the financial crisis of 2007–8, economists thought that no such financial crisis would ever happen again in the United States. Economists thought that a crisis could not happen. Then the unthinkable happened; the inconceivable happened. How could economists, myself included, have been so wrong?

Economists misunderstand financial crises, what they are, why they occur, why we didn’t have one in the United States between 1934 and

-vii-

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Misunderstanding Financial Crises: Why We Don't See Them Coming
Table of contents

Table of contents

  • Title Page iii
  • Contents v
  • Preface vii
  • I- Introduction 3
  • II- Creating the Quiet Period 10
  • III- Financial Crises 29
  • IV- Liquidity and Secrets 45
  • V- Credit Booms and Manias 59
  • VI- The Timing of Crises 74
  • VII- Economic Theory without History 87
  • VIII- Debt during Crises 98
  • IX- The Quiet Period and Its End 125
  • X- Moral Hazard and Too-Big­ to-Fail 134
  • XL- Bank Capital 151
  • XII- Fat Cats, Crisis Costs, and the Paradox of Financial Crises 165
  • XIII- The Panic of 2007–8 182
  • XIV- The Theory and Practice of Seeing 200
  • Bibliographic Notes 213
  • Notes 239
  • References 247
  • Index 273
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