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The Origin of Financial Crises

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The Origin of Financial Crises

Central Banks, Credit Bubbles, and the Efficient Market Fallacy

Vintage Books,

15 min read
10 take-aways
Text available

What's inside?

If you wonder how the economy got so sour, consider this alternative to the failed “efficient market” hypothesis.

Editorial Rating

7

Qualities

  • Analytical
  • Overview
  • Concrete Examples

Recommendation

Analyst George Cooper’s book seems to prioritize passionate (although informed and understandable) advocacy over a strictly reportorial explanation of economic ideas. He clarifies his belief that much of the present fiscal misery flows from decades of unwarranted confidence in the “Efficient Market Hypothesis.” He offers the work of 1970s American economist Hyman Minsky, 19th century physicist James Clerk Maxwell and the inventor of fractal geometry Benoit Mandelbrot, to support his claim that experts could detect, govern and manage economic bubbles before they pop. He also recommends a dose of inflation plus governmental controls on credit creation to fix the economic system. He summarizes Minsky, uses Maxwell’s work on steam engine governors as a metaphor for managing credit creation and applies Mandelbrot’s observation of a memory effect to the economy. Even though his presentation of the efficient markets fallacy seems oversimplified in parts, his theory is interesting. getAbstract recommends Cooper’s background research on fiscal policy ideas, if not on every facet of fiscal events. The more government controls you favor, the more likely you are to be persuaded by his passion.

Summary

Binges Have Consequences

For the past decade or so, European and American businesses, governments and even private citizens have taken on debt at levels that only cosmic metaphors can describe. In 2008 and 2009, the vast credit bubble began to deflate with terrible dislocations worldwide. No one can predict how this will end, but governments are struggling mightily to keep their economies from imploding. The widespread nature of this problem flows from universal devotion to the “Efficient Market Hypothesis” (EMH), which states that if markets are left to work on their own they will reach equilibrium, and any attempt to control or shape them will only make them less efficient. Prices will rise and fall to signal availability, and to allocate resources to those who desire them the most and can use them best.

But, the markets are not efficient. For example, say that when a Picasso painting comes on the market, someone pays tens of millions of dollars for it. This inspires someone else to pay more than a hundred million for the next one. The efficient market hypothesis says that rising prices should lower demand, but – to the contrary – the demand for rare art rises as...

About the Author

Dr. George Cooper worked at Goldman Sachs, Deutsche Bank and J.P. Morgan, and is now a principal at Alignment Investors (a division of BlueCrest Capital Management, Ltd.). He is the author of Money, Blood and Revolution.

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