Johan Van Overtveldt “The Chicago School” (2007) Agate Publishing, Chicago

A former American President observed that: “The business of America is business”. In the 20th century, the business of business became money. Stocks and the stock market evolved from a mechanism to raise finance for business to the raison d’être of business. Industry’s focus shifted from providing goods and services to the stock price. Business leaders became obsessed with the price of their stock and pursued strategies that optimised the market value of the company sometimes to the detriment of the underlying business. Financial engineering replaced real engineering.

The Speculation Economy traces events between 1899 and 1919 outlining how the Modern Corporation and stock markets evolved. The thesis is developed through a detailed history of the legal, financial and economic events that allowed financiers such as J.P. Morgan, Rockefeller and other to collect companies and create large firms for the primary purpose of creating stock and selling it. The book explores how legal and financial manipulation lay at the heart of the process by which these businessmen and their acolytes made money. This was the road that ultimately led to the current financial crisis via the pit stops of junk bonds, Enron and Worldcom.

The Chicago School lies at the other end of the century and the speculation economy. The Graduate School of Business at the University of Chicago provided much of the financial economics that facilitated the triumph of finance. The work of pioneers – Harry Markowitz, William Sharpe, Merton Miller, Eugene Fama, Robert Merton, Myron Scholes and Fischer Black – helped separate the value of financial obligations (stocks) further from the real underlying businesses.

Markowitz’s work that underlies much of financial economics developed the proposition that the risks of specific corporations could be diversified away. Therefore, corporations should compensate their shareholders for the general market risk of stock or risky assets generally and the stock’s risk with respect to the broad market (the stocks ? – beta). The profound conclusion that underlies this logic is that the specifics of the business matter less and less and the overall stock market more and more. There are other ancillary effects such as changing the fundamental concept of risk. Derivatives, which are the logical extension of this line of reasoning, further extends the thesis allowing investors to trade in stock price movements without actually owning the stock.

While the financial economics portion of The Chicago School is perhaps the most interesting, the book also covers the other theoretical developments at the University including monetary analysis (Friedman), economics of industrial organisation and regulation (Coase, Stigler, Telser) and the economics of the law (Posner).

Both authors are academics with a deep and profound understanding of their subjects. The level of detail and analysis is consistently strong. The Speculation Economy and The Chicago School provide fascinating historical perspectives into the nature of finance and the evolution of financial markets in the 20th century.

The events unfolding today flow directly from the events and philosophies outlined in these two economic histories. As Mark Twain observed: “History does not repeat but it rhymes.”

Mark Zandi “Financial Shock – A 360’ Look at the Subprime Mortgage Implosion and How to Avoid the Next Financial Crisis” (2008, FT Press)

Paul Muolo and Mathew Padilla “Chain of Blame – How Wall Street Caused The Mortgage and Credit Crisis” (2008, John Wiley)

Robert F. Bruner and Sean D. Carr “The Panic of 1907 – Lessons from the Market’s Perfect Storm” (2008, John Wiley)

Some people are having a very good “credit crisis”. Financial journalists have found lots to write about. Publishers are flooding the market with books on the credit crisis. Financial publishing is akin to throwing jelly at a wall in the hope that some of it will stick, so the quality and focus of the books vary significantly.

In reviewing Charles Morris’ book, I must declare an interest. I know him, had a number of conversations with him and my “advance praise” appears on the jacket. That notwithstanding, once you get past sensational title Trillion Dollar Meltdown is an engaging and broad ranging discussion of the current credit crisis. The book’s thesis is that a number of factors – free market economics, loose monetary policies, fundamental economic imbalances and financial engineering – combined to create the current debt bubble. While it does not provide detail on many of the individual issues, it provides a useful “helicopter” view of the problem. Written in an easy to read, lucid and not overly technical style, it gives the reader a useful understanding of the issues on “this path to disaster”. The book is fortuitously timed as it was apparently in the works before the crisis commenced and its production was accelerated. The other books in comparison seem somewhat rushed and written to take advantage of events.

Financial Shock shares the sensational title but not the quite the broad perspective of Trillion Dollar Meltdown. Mark Zandi is “one of the world’s leading experts on credit markets” (everybody seems to be an expert in this subject these days!). The book’s strength is its detailed and clear view of the conditions that led to the build up of low quality housing debt in the US. The latter chapters appear rushed and smack of newspaper articles strung together. The analysis is adequate but not especially penetrating and provides a precis of events. The author’s unwillingness to discuss the role of rating agencies (Zandi is the Chief economist and founder of moody’seconomy.com, an independent subsidiary of Moody’s) robs the text of a key element of the causes of the crisis.

Both Trillion Dollar Meltdown and Financial Shock offer suggestions as to how the financial system can be improved to avoid the next financial crisis. The proposals are unexceptional but fail to address the powerful forces of self interest and self regulation that dominate the DNA of the financial superclasses. Many of the suggestions, such as derivatives clearing houses, have been doing the rounds for 20 years. Giuseppe di Lampedusa’s observation in his classic “The Leopard” sums up the position neatly: “everything must change so that everything can stay the same”.

Chain of Blame is more straightforward reportage focusing on the “story” and “characters” rather than “deep” analysis. Chain of Blame provides a well crafted, vivid portrait of the US sub-prime industry built around the characters of Angelo Mozilo (Countrywide) and Roland Arnall (Ameriquest). Reading the book gives you a very human portrait of the industry, its origins, development and ultimate demise. Unfortunately, there is limited analysis of the underlying forces that drove the rise and fall of this industry. The story itself is an old financial cliché of “rise and fall” and “ambition and greed”. For people unfamiliar with sub-prime lending practices (such as regulators and politicians) it may prove a welcome eye-opener.

Panic of 1907 is a straightforward re-telling of the 1907 stock market crash. The book is pitched as the use of history to help understand the present problems. In reality, the book is a straightforward record of the events of 1907. It retells the story of margin loans, “bear raids” (short selling) and the self serving heroics of J.P.Morgan in cobbling together a rescue package. The events of 1907 were pivotal in the creation of the Federal Reserve System that lies at the epicenter of the current crisis. The academic authors aim for a neutral prose that unfortunately leaches the inherent drama out of the story. The book also falls between two stools – for the novice it assumes knowledge of financial markets and for the more knowledgeable reader it lacks the depth of analysis beyond the facts that would have made the book interesting. Panic of 1907 does highlight the fact that the current crisis is far from unique and the same set of problems seems to recur in financial markets with ominous and disturbing regularity.

The Economist magazine wrote that: “…public credit depends on public confidence…The financial crisis in America is really a moral crisis, caused by the series of proofs …that the leading financiers who control banks, trust companies and industrial corporations are often imprudent, and not seldom dishonest. They have mismanaged…funds and used them freely for speculative purposes. Hence the alarm of depositors and a general collapse of credit…” The words appeared over 100 years ago on 2 November 1907 during the 1907 crash. They seem relevant today.

All four books provide useful information and sometimes insights into the current crisis. To varying degrees all are burdened by the fact that fast moving events are overtaking the text very rapidly. Mark Zandi’s ruminations that the crisis seems to be easing is an example of this problem.

The definitive history of the crisis is still waiting to be written. In the meantime, we can expect a constant stream of hors d’ouvres to whet our appetite. Publisher’s, it appears, are one of the few sectors of the economy enjoying the financial crisis.

© 2008 Satyajit Das All Rights reserved.

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall).