Book Review
by William A. Hayes
Financial Shock: A 360º Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis by Mark Zandi. FT Press. 2008.
Mark Zandi takes the reader step-by-step through the subprime crisis in Financial Shock. Like many of us, he foresaw problems coming out of these loans, but not the ultimate scale and impact. Starting with low quality mortgages, a financial virus spread across the global capital markets, threatening to shut it down. Now governments and central banks are pumping vast amounts of liquidity into these markets, which may itself create future massive problems that are not now evident.
There may never have been a financial crisis caused by so many different parts of the financial chain. It was started by a generation that became housing speculators, believing prices could only go up. Their speculation was fueled by eager real estate brokers and lenders who took their cut, and passed on the “made to destruct” loans. Asset securitization spread the virus along to all parts of the world. Global excess liquidity provided the funding. Derivatives creators devised myriad ways to spread it further. Central banks and regulators appear to have had little, if any sense of the risks in the new derivatives, and even applauded them. Fatally they were a generation behind what was going on. At its peak, just before the downward spiral, risk protection was priced at a minimal level. As the author concludes, “everyone assumed someone else was in control. No one was.”
Reading about the chain of folly, I was reminded of a statement by Bill Gross of Pimco in his November 2008 Investment Outlook. Gross said what is more important than IQ to measure intelligence is “CQ,” which is the Common Sense Quotient. We are being inundated with articles seeking to explain subprime and the financial crisis, but what is clear from Financial Shock is there was very little CQ in the financial markets, even in top management of some top firms, much less with the borrowers who had no idea of what they were signing up for.
After explaining how we got to this juncture, Zandi provides recommendations on how we can prevent future financial crises—maybe next time we’ll listen.
[PRINTER FRIENDLY VERSION]
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