Fault Lines – Part One – The Financial Crisis Revisited

Fault Lines: How Hidden Fractures Still Threaten the World Economy by Raghuram G. Rajan (Princeton University Press, 2010)

As its title suggests, this book is a wake up call!

Its author, Raghuram G. Rajan (“Raj”) is an economist who challenged his community’s adoration of Alan Greenspan in the years before the Financial Crisis.

After the crisis “Raj” looked deeper into that crisis. He revealed the “fault lines” that nearly ten years after the Financial Crisis, still threaten us today.

 Fault Lines’ Questions

Raj Raghuram dared to ask “why’ questions about the Financial Crisis of 2007-2008, questions that most economists have not yet explained.

So why do we need a reminder about the Financial Crisis? Because we have not yet plumbed the depths of what happened in the first decade of this century.

This year, we’ve seen huge volatility in the stock market along with several growing indicators of possible trouble coming in the future.

The words “Fault Line” in the title of Raj’s book indicate that many of the causes of the Financial Crisis might be lurking under the surface of our so-called ‘great economy’ today.

Anyone who has been through an earthquake can recall how the earth often shakes after a large earthquake and then settles down. But then there’s another earthquake, one located at a different fault line.

In his Introduction to Fault Lines, Raj explains in plain English, in the clearest way I’ve ever seen it done, how “securitization” of loans by banks along with banks’ failure to monitor and label subprime loans accurately led to financial havoc all over the globe.

Raj then went on to the questions from the Financial Crisis that have been left unanswered:

• Why was foreign money used to finance subprime credit?
• Why couldn’t the U.S. export its way out of trouble like Germany and other countries?
• Why are poorer countries like China financing unsustainable consumption in richer countries like the U.S.
• Why did financial firms make loans to those who had no income, jobs or assets?
• And finally the question that echoes those readers of a fictional source from the early 1900’s, Upton Sinclair’s The Jungle: Why did the owners of the sausage factories eat their own products knowing that rat droppings were in it? 

In other words, why on earth did banks and financial firms buy their own securitized products when they knew those ‘assets’ were so risky?

Raghuram’s methodology

In future posts, I’ll give a short synopsis of what each Chapter of Fault Lines covers. For now, I’m just going to to tell you why I chose to go on the journey with Raj in search of answers to the questions about the Financial Crisis he raised in Fault Lines.

• For an economist, Raj is amazingly clear and easy to understand.
• He made accurate, although unpopular predictions, about the financial crisis through looking at chart patterns, a method I began using in 2007.
• Raj promised to explore multiple causes of the Financial Crisis without trying to come up with an over-simplified answer.
• I too am worried about the stock market. Are there things we don’t know about that are causing us to repeatedly come so close to a recession at the end of this decade?
• Raj has also noted the tremendous influence that politics now are having on economics.

In regard tot he last bullet point, I truly think these two fields, politics and economics, which once were united, need to be studied together again.

Political science as much as economics today is failing to bring us clarity when it comes to finding solutions to modern financial systems’ problems.

Lastly, I just love Raj’s metaphor of earthquake fault lines for the 2007 financial crisis!

Next time: “Fault Lines -Part Two – Who Should Read This Book?” I’ll look at the first five chapters in Raj’s 2010 book.