Debt Spiral: How Credit Failed Capitalism

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9780615319124: Debt Spiral: How Credit Failed Capitalism

In clear and straightforward language, Debt Spiral tells the story of the financial crisis of 2007-2009 for non-expert readers. It is the first book to cover the many aspects of the history of the crisis. It focuses on public policy and the ways the U.S. Government s policies not only failed to prevent the crisis, but actually contributed to it.

Part I covers the history of the markets, the various types of banking institutions, and the governmental authorities. It covers mortgage lending, the ways in which the U.S. subsidizes mortgage lending, the Federal Reserve Board, the mechanics of securitization, the rating agencies, and the boom state conditions that set up the crisis.

Part II is the story of how the crisis unfolded in 2007-2008. It includes background sketches of the major firms that failed and a discussion of the difficulties that the Fed and Treasury faced in dealing with the crisis. It demonstrates that the U.S. Government was behind the curve and did not promptly take the actions that could have significantly reduced the eventual size of the problem.

Part III, called Taming the Debt Spiral, analyzes the events of 2007-2008 in the light of history. It includes a discussion of other writings in the field, which enables the reader to place the author's conclusions in the context of what other commentators are saying.

Excessive debt and financial leverage caused the crisis, as they have caused many financial crises in the past. Debt Spiral shows how this excessive debt and leverage are encouraged by U.S. Government policies and subsidies. Author Martin Lowy concludes that if Americans want to avoid recurrent booms and busts, the Government will have to stop subsidizing debt and, by encouraging debt, in effect encouraging excessive financial leverage throughout the economy.

Banks receive many of the subsidies that encourage debt. Some of these subsidies may have been appropriate in the past, but with 21st century technology, they are no longer needed. Eliminating these subsidies would be an important part of reforming the banking system.

Capitalism was not on trial, author Lowy concludes, but the crisis shows how the failure to regulate properly can lead to excesses. Competitive markets confer the benefits of capitalism, but competitive markets need government help to thrive. In particular, two natural tendencies of market participants have to be curbed: the tendency of competitors to collude; and the tendency of agents to pervert the market by acting in their own interests instead of the interests of the principals (and principles) they have agreed to represent. These are old problems, but many people who should have known better forgot about them.

Readers will enjoy a trip through the financial world with Martin Lowy as their guide.

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About the Author:

Martin Lowy, author of Debt Spiral and High Rollers, the acclaimed book on the S&L debacle, has worked in the banking field for over 40 years, as an adviser to banks, bank directors and regulators, as a senior bank officer, as a bank director, and as a commentator. Debt Spiral is his fifth book. His other books include Corporate Governance for Public Company Directors and the Practical Handbook for Bank Directors.

Mr. Lowy practiced corporate, securities and banking law in international law firms for twenty years before becoming a banker, economic commentator, and entrepreneur. He has served as Vice Chairman of a regional bank and as CEO of a high-tech startup.

Mr. Lowy not only knows the technical side of the banking and legal issues; he also has the practical experience of running private companies. He is an innovator and an independent thinker, and those characteristics make Debt Spiral the best book on the financial crisis.

Mr. Lowy is a graduate of Amherst College and Yale Law School, where he was Managing Editor of The Yale Law Journal.

Review:

Few thought it would ever happen again, but it has: a financial crisis so large and deep that it nearly brought the world economy to its knees. Since late 2007, the U.S. and global economies have suffered their largest downturns since the Great Depression, with bleak prospects for a rapid recovery.

How could something like this have happened? Wasn t our financial system supposed to be the most sophisticated in the world? Weren t we told that our banks were as well capitalized as they had been in a long time? Weren t the various automatic stabilizers and shock absorbers introduced since the Depression deposit insurance, social security, unemployment insurance, Medicare and Medicaid supposed to keep our economy from ever free-falling again?

Yes, yes, and yes but none of these facts were able to prevent the financial crisis and Great Recession of 2007-09. By now, if course, it is widely recognized that the rapid development and growth of the subprime mortgage market, and the widespread expectation of ever-rising residential real estate prices which it fueled, provided the spark for a major financial explosion when real estate prices in fact quit rising in late 2006. But the financial conflagration that followed would not have been possible without an extraordinary increase in credit, and thus leverage, throughout the financial system. As a result, when losses from securities backed by subprime debt began to mount, too many financial institutions banks included had too little capital to absorb the pain. National firefighters throughout the developed world, central banks, had to step in with unprecedented amounts of financial water cash to keep the financial firestorm from consuming the world economy.

If we are to have any chance of avoiding something like what has just happened from repeating, then we must first understand why why the subprime mortgage got out of control and why Americans and their financial institutions became too highly leveraged.

Martin Lowy comes to the task of providing answers with impressive credentials and much experience. For over 40 years he has studied and written about the nation s financial system, while providing legal counsel to many financial institutions. He has seen too many financial failures up close and personal. He never wants the nation to have to go through what it has experienced in these past few years.

He has brought this passion and experience to you, readers who want answers to the questions I have briefly posed here, and to many others he raises in these pages.

Many of Mr. Lowy s conclusions are controversial (even though they are neither far left nor far right) and I do not agree with all of them. But he is right to focus on countercyclical solutions and on creating competitive markets. He also is right to closely examine government subsidies for banks and housing to determine whether they are warranted.

But regardless of whether you will agree with Mr. Lowy s conclusions, his presentation of the history of this crisis should be read by anyone who wants to understand what happened. He writes clearly, with humor, and in a manner that ordinarily intelligent readers can understand and enjoy. He focuses on and explains the main points about what happened: (1) the changes in the mortgage market and the rise of the originate to sell model, (2) the pivotal role played by the rating agencies, and (3) the importance of the leverage in the banking system and financial system more generally in transforming a mortgage market event into a worldwide systemic crisis.

The financial world is a complicated place, even after the meltdown just experienced. It helps to have a guiding hand explain it to us. Martin Lowy is an excellent guide, and this is his and your guidebook. Robert E. Litan

Kauffman Foundation

Brookings Institution --Preface to Debt Spiral

"About this title" may belong to another edition of this title.

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