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Perspective on the Financial Crisis

From Financial Crisis to Global Recovery by Padma Desai (New York, USA: Columbia University Press), 2011; pp XVI + 254, $27.50.

BOOK REVIEW

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of banks and replacement of manage-

Perspective on the Financial Crisis

ment of banks was never explored, presumably as the author almost approvingly quotes US Senator Barney Frank’s Y V Reddy statement “You can’t go out and shoot

T
here has been a plethora of books on the global financial crisis. The value of another book on the subject is prima facie suspect, but Padma Desai’s book is an exception.

The book is unique in many respects. It provides a broader view than the others from several perspectives, and is not confined to the exclusive concerns of financial markets, economic theorists or policymakers. It gives a balanced view on policy actions and the current dilemmas confronted by the systemically most important countries, especially the United States (US). It also makes useful comparisons where appropriate, in parti cular between the experience with the Great Depression and the current financial crisis. The chapters of great i nterest for the global economy relate to the future of the dollar and of American capitalism. Desai as professor of comparative economic systems in Columbia University is well placed to share her deep knowledge and accumulated wisdom on these two critical questions within the overall context of her overview of both the current crisis and elements of recovery. Above all, the narrative is a mix of easy flow in a conversational style and impressive detail on current policies which is, at times, especially

From Financial Crisis to Global Recovery by Padma Desai (New York, USA: Columbia University Press), 2011; pp XVI + 254, $27.50.

in dealing with regulation, a bit of heavy reading. After going through the book, the reader will concede the claim made by the author in the Preface – “This book is different” (p 9).

Chapter 1 describes the origin of the financial crisis, essentially in terms of interactions between monetary and regulatory policies of the US, partly facilitated by flows of savings from outside, mainly China. This is followed by a detailed account of efforts at avoiding Great Depression 2.0. The narration reads like a play where none was a villain but everyone misjudged reality, and a catastrophe was avoided by swift and determined actions through a process described by the author as “timely but ironic show of generosity in favour of the bankers” (p 20). The cartoons provide a welcome addition to the essentially non-technical, but authentic account of events in the US. The domestic political economy factors and the external global financial architecture that may explain these events are available, to some extent, in the succeeding chapters. Obviously, the option of nationalisation

february 18, 2012

the bankers” and “But you have no option but to live with these people”, while recognising that “People are angry. They’re furious” (p 20).

Stress Tests

The next chapter titled “Banking Sector Stress Tests: United States versus European Union” provides a detailed account of the stress tests conducted, but there are three highlights of the analysis that warrant the attention of the reader. First, the contrast between the US and Europe in regard to the swiftness and quality of stress tests; second, the contrast between the hands-on role in management in regard to Chrysler and General Motors compared to the banks; and, third, the contrast between the approach of the US and the United Kingdom (UK) on exercising the option of nationalisation. The author holds that in her view nationalising the troubled US banks would have been “a colossal mistake” (p 26). An unexplored area in this regard is the teeth that the option of nationalisation would have given to stimulating and directing credit to the large domestic economy of the US. On the downside, nationalisation would have been the end of the position of the US as the ultimate upholder of the faith that governs capitalism and globalised

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Economic & Political Weekly

BOOK REVIEW

finance. In that sense, Desai may be right in her observations. Referring to the Federal Reserve’s Troubled Asset-Banked Loan Facility to encourage some types of lending and the US Treasury’s Public-Private Investment Program, the author rightly concludes that “the gambits were off the mark” (p 44).

Chapter 3 asks the question which, perhaps, still remains somewhat unanswered: “Is the US Economy on the Mend?”. The chapter details the policy dilemmas, policy initiatives, and policy outcomes in the threefold agenda that the US put for itself. These relate to assessing and relieving stress in Wall Street banks, the fiscal stimulus and monetary easing. The account is factual and objective, characterised by a full appreciation of the complexities in conduct of policy. There is a welcome mention of a poll of expectations of outcomes by economists, contrasted with the general public, and, not unsurprisingly, the current state of the US economy is closer to what the general public expected than what the economists had predicted. Desai spends the largest segment of the discussion on the problems and prospects of the real economy. Conceding that the threefold set of measures reflects “an encouraging record”, the author traces “the troubling features of the real economy that these policies were calculated to overcome” (p 47). The academic value of the chapter is e nhanced by the policy proposals that were considered but not implemented, such as a fee on big banks and the healthcare plan, as also by the description of political processes involved in the magnitude and composition of the fiscal stimulus. The concluding section which captures the author’s assessment of the US ends by eliminating the prospects of the recession but is cautionary on the prospects for the real economy. The author gets the whole picture right with the statement: “More than any

o ther consideration, the US employment rate would continue to figure as a strategic input in the policy decisions at the highest level (p 79).

Chapter 4 proceeds from an account of the US where the crisis originated, to the global economy to which it spread

Economic & Political Weekly

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february 18, 2012

through contagion, in particular to Europe, Asia, North and South America. The narration is brief in relation to the discussion of the US, but the regions and countries covered are appropriate. The sets of challenges for policy frameworks and outcomes are well articulated and the author’s considerable attention to the issues in regard to the Euro stands vindicated by subsequent events. Despite their resilience to the crisis, and significant contribution to the global r ecovery, Asian economies receive less attention in the narrative than others. The country ranking and analytical framework and assessment of recovery prospects (Figure 4.5 in p 107 and Section IX in p 108) are very informative, while comments on “financial globalisation” are music to this reviewer.

Chapter 5, “Hedge Funds and Derivatives, Credit Default Swaps and Rating Agencies”, sets for itself an ambitious agenda. It seeks to explain these to “an economics student who is a Wall Street outsider” (p 110). It largely succeeds in that effort given the complex issues that it seeks to address, such as problems posed by them for regulators, and the need to regulate them “selectively and prudently” (p 110). The explanation of some recent developments in policies relating to short-selling, high frequency trading, flash orders and dark pools, should be very informative to uninitiated economists.

Reforms in Regulation

The next chapter gives an exhaustive overview of the reforms in the regulation of the financial sector in the US and an account of regulatory proposals in the European Union (EU). These are interesting comparisons, though limited by the underlying diversity in challenges. For the EU, the priority is to address problems of excessive leverage in banks and lack of arrangements for coordination in regulation across the jurisdictions in the Union. In the US, the priority is to retain its supremacy as a major centre for globalised finance while restraining the unhealthy aspects of financial market innovations and the too large to fail banks, and enhancing consumer protection. The detailed treatment of the

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reforms in the US captures the market view, the regulators’ view and the political economy view, and is hence very valuable. The assessment of the new regulatory provisions by the author is somewhat brief and tentative for justifiable reasons. The value of the chapter lies in its excellent account of the competing considerations in regulatory r eform; complexities in the process of a rebalancing of the system from the d eficient present to one that is closer to the optimal, and the importance of a synchronised approach to changing regulation of institutions, instruments and incentives in markets as well as r egulatory structures to implement p ublic policy.

Assuming that the regulatory overhaul will move forward, the author is optimistic of the future “if the regulatory provisions relating to capital requirements by banks and transparent operations of derivatives are consistently and vigilantly applied” (p 172). The “if” in that statement is, indeed, a big “if”.

“The US Dollar’s Future as a Global Reserve Currency” is the theme of Chapter 7. It is an excellent, comprehensive and objective account of the origins and evolution of the recent debate on the US dollar as a reserve currency, consequent to the financial crisis in 2008. The analytical framework is provided through a succinct recall of contributions of Robert Triffin on the subject. The exchange rate policy of China, in particular during the years preceding the crisis, is placed within the overall macro-policy objectives of China, while noting that active debate was triggered by the statement by the governor of China’s central bank in 2009. The chapter details in a lucid manner the major contours of policy compulsions, voices and stances of the US and China in regard to the reserve currency. The reader will benefit immensely by the well-informed articulation of their respective positions. The author discounts the possibility of the renminbi becoming a reserve currency, though it is possible that it will be “an important currency for bilateral transactions” (p 186). At the same time, despite the support for use of Special Draw ing Right (SDR) in several countries, the

BOOK REVIEW

a uthor holds that “the SDR becoming an international reserve currency is neither likely nor desirable” (p 187). Recognising the infirmities of the current mone tary system, the author concludes “The responsibility for maintaining the dollar’s status as a reserve currency must r emain with the decision-makers in Washington rather than in Beijing” (p 191). There are several issues on this subject that are worth exploring further. What are the merits, demerits and feasibility of having a single country’s currency as a global currency, for the global economy? What are the advantages and limits to the exorbitant privilege enjoyed by a single country reserve currency and what are the concomitant services rendered by it such as those facilitating international payments? How can either binding rules or market discipline be incorporated in such a single country reserve currency? Will network externalities permit survival of several reserve currencies without any of them dominating?

The SDR may help diversification of risks emanating from the dominance of a single currency but does it eliminate the inherent infirmities of a currency of a country operating as a global reserve currency? Above all, how does the e xistence of a non-system in the internationally monetary framework, through the predominance of single currency, namely, the dollar, have an impact on the efficiency and stability of gloablisation of financial markets?

The first part of the chapter titled “The Great Depression and the Current Financial Crisis” is a succinct summary of the origins, symptoms, policies, institutional build-up, etc, in regard to both. This narrative leads to the more interesting observations on the differences in the origins of the crisis and impacts on the real economy, as also similarities and contrasts in policy responses. The chapter ends with a narration of the p olitical environment in the US now, u nder the leadership of President Barack Obama, compared to under Franklin Roosevelt. The author appears to believe that both the crisis and the solutions have been and have to be centred around the US.

Future of US Capitalism?

The concluding chapter is titled “The Future of American Capitalism”, and naturally the primary focus is on the US and not much on the lessons that could be drawn from other advanced economies or the emerging and developing countries that demonstrated impressive growth and resilience during the crisis. Further, the chapter proceeds on the assumption that rebalancing the market and regulation in the financial sector is the key to the future of American capitalism. The value of the narration lies in an incisive overview of Adam Smith’s market system, with special reference to the banking system. Similarly, Keynes’ view of the links between macroeconomic aspects and microeconomic decision-making, and his account of the role of markets and animal spirits are laid out clearly.

The author’s intention may be to provide the intellectual framework that should witness reforms of capitalism in America. Reforms will require rebalancing warranted by the crisis, between the state and the market, real and financial sectors, including leverage, short and long-term, and macro- and micro-aspects. The rest of the chapter is devoted to the features of and prospects for regulatory reform of the financial sector in the US. The success of the regulatory reform of which the author is optimistic is considered critical for preserving American corporate arrangements, and consequently the survival and success of American capitalism.

The book is a welcome and a valuable addition to the existing literature and should be of interest to academics, policymakers, market participants and interested laypersons. No wonder the book has received wholesome endorsements from a wide spectrum of eminent persons including George A Akerlof, Alan S Blinder and Nicholas Stern.

Y V Reddy (dryvr@gmail.com) is former governor of the Reserve Bank of India.

REVIEW OF RURAL AFFAIRS

January 28, 2012

Agrarian Transition and Emerging Challenges in Asian Agriculture: – P K Viswanathan, Gopal B Thapa,

A Critical Assessment Jayant K Routray, Mokbul M Ahmad Institutional and Policy Aspects of Punjab Agriculture: A Smallholder Perspective – Sukhpal Singh Khap Panchayats: A Socio-Historical Overview – Ajay Kumar Rural Water Access: Governance and Contestation in a Semi-Arid

Watershed in Udaipur, Rajasthan – N C Narayanan, Lalitha Kamath Panchayat Finances and the Need for Devolutions from the State Government – Anand Sahasranaman Temporary and Seasonal Migration: Regional Pattern,

Characteristics and Associated Factors – Kunal Keshri, R B Bhagat

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february 18, 2012 vol xlvii no 7

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