They Stumble Who Run Fast: Roubini and Mihm's Crisis Economics

By Selgin, George | Independent Review, Summer 2011 | Go to article overview

They Stumble Who Run Fast: Roubini and Mihm's Crisis Economics


Selgin, George, Independent Review


It takes only three paragraphs for Nouriel Roubini and Stephen Mihm, the authors of Crisis Economics: A Crash Course in the Future of Finance, to tell how Roubini stunned listeners at a September 2006 International Monetary Fund seminar by heralding a "once-in-a-lifetime" housing bust to be followed by a deep, long recession (Roubini and Mihm 2010, 1-2). Yet they may still deserve credit for modesty, for if one devoted Roubini watcher is to be believed, "Dr. Doom" actually predicted no fewer than "48 of the last 4 recessions" (comment on Elfenbein 2009).

Some quick fact-checking lends credence to our informant's otherwise incredible claim by showing that Roubini predicted a serious crash for 2004, then a severe slowdown for 2005, then a global reckoning for 2006, and finally a sharp recession for 2007. After the much-trumpeted crisis at last materialized (though not quite for the reasons Roubini had harped on), he declared that the S&P 500 would sink to 600, that oil would get stuck below $40 a barrel, and that a gold "bubble" was about to do what the housing one had done. To be sure, these things have not yet come to pass, but tomorrow is another day, and to succeed prophets need only mark when they hit and never mark when they miss.

If Roubini's marksmanship impresses you, you are perhaps bound to hang on every word of Crisis Economics, no matter what any less-than-divine reviewer says about it. If, on the other hand, that marksmanship puts you in mind of the accuracy of a stopped clock, you may hearken to the warning that although the book's assessment of the causes of the recent great housing boom and bust is for the most part sound and informative, some of its claims are highly misleading, if not simply false.

Roubini and Mihm start well enough by dismissing as red herrings various popular diagnoses of the crisis, including the "tired" argument that it was caused by "greed," with its far-fetched though implicit assumption "that the financiers of 2007 were greedier than the Gordon Gekko's of a generation ago" (pp. 31-32). They draw attention instead to changes in the structure of incentives "that channeled greed in new and dangerous directions" (p. 32). These changes included government policies aimed at increasing poorer (and riskier) persons' access to mortgages, the growing moral hazard connected with the "too big to fail" doctrine, and the Federal Reserve's post-2001 easy-money policy.

Regarding the last, Roubini and Mihm note how, in attempting to create a soft-landing from the dot.com crash, Alan Greenspan's Fed "muted the effects of one bubble's collapse by inflating an entirely new one" (p. 73). They are contemptuous, and rightly so, of Greenspan's policy of promising to rescue market participants from collapsing bubbles, while simultaneously promising to do nothing to prevent such bubbles from developing in the first place. This "Greenspan put," they observe, "created moral hazard on a grand scale, and Greenspan deserves blame for it" (p. 73). Furthermore, they recognize (as some analysts fail to do) that the Fed was only one of several central banks that contributed to what was in fact a multination housing boom (pp. 31, 126-28). Finally, they reject Ben Bernanke's attempt to blame the credit bubble on a "global savings glut," noting (among other things) that "the Fed helped to create the unsustainable boom that attracted (global) savings in the first place," in part by encouraging American homeowners to go on a home-equity-induced global spending spree (pp. 249-50).

Roubini and Mihm also offer trenchant criticisms of the Fed's response to the crisis. They note in particular how "in its rush to prop up the financial system," the Fed "rescued both illiquid and insolvent financial institutions," exposing taxpayers to risk with its "dodgy" schemes for purchasing toxic assets and helping to "sow the seeds of bigger bubbles and even more destructive crises" (pp. …

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