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Raghuram Rajan was one of the few economists who warned of the global financial crisis before it hit. Now, as the world struggles to recover, it's tempting to blame what happened on just a few greedy bankers who took irrational risks and left the rest of us to foot the bill. In Fault Lines, Rajan argues that serious flaws in the economy are also to blame, and warns that a potentially more devastating crisis awaits us if they aren't fixed.
Rajan shows how the individual choices that collectively brought about the economic meltdown--made by bankers, government officials, and ordinary homeowners--were rational responses to a flawed global financial order in which the incentives to take on risk are incredibly out of step with the dangers those risks pose. He traces the deepening fault lines in a world overly dependent on the indebted American consumer to power global economic growth and stave off global downturns. He exposes a system where America's growing inequality and thin social safety net create tremendous political pressure to encourage easy credit and keep job creation robust, no matter what the consequences to the economy's long-term health; and where the U.S. financial sector, with its skewed incentives, is the critical but unstable link between an overstimulated America and an underconsuming world.
In Fault Lines, Rajan demonstrates how unequal access to education and health care in the United States puts us all in deeper financial peril, even as the economic choices of countries like Germany, Japan, and China place an undue burden on America to get its policies right. He outlines the hard choices we need to make to ensure a more stable world economy and restore lasting prosperity.
- Sales Rank: #96610 in Books
- Brand: Brand: Princeton University Press
- Published on: 2010-05-24
- Original language: English
- Number of items: 1
- Dimensions: .93" h x 6.48" w x 9.32" l, 1.12 pounds
- Binding: Hardcover
- 272 pages
- Used Book in Good Condition
Review
- Raghuram G. Rajan, Winner of the 2013 Deutsche Bank Prize in Financial Economics, The Center for Financial Studies
- Winner of the 2010 Business Book of the Year Award, Financial Times and Goldman Sachs
- Winner of the 2011 Gold Medal in Finance/Investment/Economics, Independent Publisher Book Awards
- Winner of the 2010 PROSE Award in Economics, American Publishers Awards
- Winner of the 2010 Gold Medal Book of the Year Award in Business & Economics, ForeWord Reviews
- Finalist for the 2010 Paul A. Samuelson Award, TIAA-CREF
- One of strategy+business magazine's Best Business Books of the Year for 2010
- Best Crisis Book by an Economist and Named one of Bloomberg News's Thirty Business Books of the Year for 2010
- One of Financial Times's Books of the Year in Business & Economics, Nonfiction Round-Up for 2010
- Finalist for the 2010 Book of the Year Awards in Business and Economics, ForeWord Reviews
- Finalist for the 2011 Estoril Global Issues Distinguished Book Prize
"Like geological fault lines, the fissures in the world economic system are more hidden and widespread than many realize, he says. And they are potentially more destructive than other, more obvious culprits, like greedy bankers, sleepy regulators and irresponsible borrowers. Mr. Rajan . . . argues that the actions of these players (and others) unfolded on a larger world stage, that was (and is) subject to the imperatives of political economies. . . . [A] serious and thoughtful book."--New York Times
"In a new book . . . entitled Fault Lines, Rajan argues that the initial causes of the breakdown were stagnant wages and rising inequality. With the purchasing power of many middle-class households lagging behind the cost of living, there was an urgent demand for credit. The financial industry, with encouragement from the government, responded by supplying home-equity loans, subprime mortgages, and auto loans. . . . The side effects of unrestrained credit growth turned out to be devastating--a possibility most economists had failed to consider."--John Cassidy, New Yorker
"The book, published by Princeton University Press, saw off stiff competition from five others on the shortlist, to be chosen as 'the most compelling and enjoyable' business title of 2010. The final intense debate among the seven judges came down to a choice between Fault Lines and Too Big to Fail, Andrew Ross Sorkin's acclaimed minute-by-minute analysis of the collapse of Lehman Brothers. The book identifies the flaws that helped cripple the world financial system, prescribes potential remedies, but also warns that unless policymakers push through painful reforms, the world could be plunged into renewed turmoil."--Financial Times
"The left has figured out who to blame for the financial crisis: Greedy Wall Street bankers, especially at Goldman Sachs. The right has figured it out, too: It was government's fault, especially Fannie Mae and Freddie Mac. Raghuram Rajan of the University of Chicago's Booth School of Business says it's more complicated: Fault lines along the tectonic plates of the global economy pushed big government and big finance to a financial earthquake. To him, this was a Greek tragedy in which traders and bankers, congressmen and subprime borrowers all played their parts until the drama reached the inevitably painful end. (Mr. Rajan plays Cassandra, of course.) But just when you're about to cast him as a University of Chicago free-market stereotype, he surprises by identifying the widening gap between rich and poor as a big cause of the calamity."--David Wessel, Wall Street Journal
"[E]xcellent. . . . [Fault Lines] deserve[s] to be widely read in a time when the tendency to blame everything on catch-all terms like 'globalisation' is gaining ground."--Economist
"[C]onvincing."--Christopher Caldwell, New York Times Magazine
"Fault Lines is a must-read."--Nouriel Roubini, Forbes.com
"What if the financial crash of 2008 was really caused by income inequality? Not greedy bankers, not reckless homeowners, but the ever widening-gulf between the rich and the poor? And what if the lack of social services--like health care--made things much, much worse? This is the startling new theory from Raghuram Rajan. . . . [Fault Lines is] especially fascinating because it mixes free-market Chicago School economics with good-government ideas straight out of Obamaland."--John Richardson, Esquire.com
"A high-powered yet accessible analysis of the financial crisis and its aftermath, Fault Lines was awarded the FT/Goldman Sachs Business Book of the Year. Rajan . . . was one of the few who warned that the crisis was coming and his book fizzes with striking and thought-provoking ideas."--Financial Times (FT Critics Pick 2010)
"What caused the crisis? . . . There is an embarrassment of causes--especially embarrassing when you recall how few people saw where they might lead. Raghuram Rajan . . . was one of the few to sound an alarm before 2007. That gives his novel and sometimes surprising thesis added authority. He argues in his excellent new book that the roots of the calamity go wider and deeper still."--Clive Crook, Financial Times
"A thought-provoking new book. . . . [Rajan's] voice is worth listening to."--Martin Wolf, Financial Times
"Few people were able to foresee the recent economic downturn. Raghuram Rajan . . . was one of them. This makes his new book, Fault Lines, worthy of consideration amidst the rampant speculation about the causes of the financial crisis. . . . Fault Lines is valuable primarily for its clear explanation of unintended economic consequences from well-meaning government intervention."--Washington Times
"Rajan's writing is clear and direct."--James Pressley, Bloomberg News
"Former IMF chief economist Raghuram G. Rajan . . . in his new book, Fault Lines, brings together and explains the diverse failings that contributed to the crisis--the fault lines, as he puts it, that were exposed by the events of the past several years. Rajan then puts forward broad policy recommendations to ward off a future problem. . . . Rajan's book takes a comprehensive look at what got us into the crisis and offers an intriguing approach to avoiding another one."--Phillip Swagel, Finance & Development
"I devoured Raghuram Rajan's Fault Lines: How Hidden Fractures Still Threaten the World Economy in a very short span of time last night. It's brief, well-written, and extremely interesting. I would definitely recommend adding it to your financial crisis reading list."--Matthew Yglesias, Yglesias blog
"Rajan is worth reading not just because he was correct when few were but also because his writing is clear as a bell, even to nonspecialists."--Christopher Caldwell, Weekly Standard
"The proposed global reforms that [Rajan] lists in Fault Lines run the gamut from the prosaic to grandiose. Along with revamping Wall Street's pay system, he offers innovative ideas on building capital buffers into the global credit system, obviating much of the need for bailouts of companies deemed too big or too enmeshed in the financial system to fail."--Barron's
"Economists who can challenge their peers while remaining accessible to the general reader are rare, but Rajan belongs to this elite group. No short summary can do justice to this well-written, insightful, and nuanced study."--Choice
"In 2007, then-chief IMF economist Raghuram G. Rajan delivered a stark warning to the world's top bankers: financial markets were headed for doom. They laughed it off. In the wake of the collapse that followed, Rajan has written a new book, Fault Lines: How Hidden Fractures Still Threaten the World Economy, that warns the system is doomed to repeat its mistakes. Like many defenders of the market, Rajan urges us not to demonize the bankers. But it's this fiscal conservative's focus on inequality that makes him stand out from the pack. The growing wage gap, he argues, is a hidden driver of financial instability, putting constant pressure on politicians to enact short-term fixes."--Toronto Star
"The critics are wrong: Raghuram Rajan's analysis of the global financial crisis remains highly relevant and deserves to be widely read. . . . The breadth of Rajan's explanatory framework--which is presented cogently and concisely within 230 pages of text--marks this book apart from many others that tackle the same themes."--Mark Hannam, Prospect
"Dozens of experts have explored the reasons behind the ongoing global economic turmoil, and Raghuram Rajan provides his own elegant and thoughtful analysis in Fault Lines."--BizEd
"With Fault Lines, Rajan has made an original diagnosis of the credit crisis, one that goes much further than those of greedy bankers or wasteful mortgage giants such as Fannie Mae and Freddie Mac."--Christophe De Rijcke, De Tijd (translated from the Dutch by K.C.L.)
"A book that should be the default choice of discerning finance professionals when they enter the store the next time."--D. Murali, Business Line
"Rajan's Fault Lines is . . . expansive and policy-focused and clearly destined to become a must-read on any list of books on the recent global crisis."--Jahangir Aziz, Business Standard
"Insightful, educative and incredibly gripping, if you want just one book to understand the ongoing global financial crisis and the way forward, Fault Lines it is."--Gautam Chikermane, Hindustan Times
"Best Crisis Book by an Economist (2010)."--James Pressley, Bloomberg News
"Fault Lines has a strong claim to be the economics book that best caught the spirit of 2010. Raghuram Rajan's receipt of the Financial Times and Goldman Sachs annual business book award only confirmed his book's widespread popularity. It is not hard to see why so many people liked it. Fault Lines eschews hyperbole for a lucid and balanced account of the crisis."--Fund Strategy
"Rajan . . . comes up with original and important long-term remedies. . . . Rajan's book is a bold enterprise in three ways: firstly it aims to explain the US financial crisis by looking at deep, decade-long fractures in economies and societies; secondly it suggests well-known but radical solutions that few dare put forward; and finally it supplies innovative answers to practical questions. . . . [T]he book will please any reader looking for an inquiry into the deepest causes of the recession and a consistent account of government's errors of omission and commission."--Natacha Postel-Vinay, British Politics and Policy
"[Fault Lines]'s great strength is that it is a clearly written work of political economy, accessible to readers who do not have a PhD in economics or finance. Its objective is not to point fingers at the guilty, and it comes to some surprising conclusions."--Stewart Fleming, European Voice
"Fault Lines is a very well written and cogent book that provides a global perspective on the causes of the crisis, the dangers if the root causes of it are not addressed, possible solutions, and ideas for implementing them. . . . In sum, this book is a must read for analysts, academics, politicians, economists, and the like."--Emilia Garcia-Appendini, Financial Markets and Portfolio Management
From the Back Cover
"Fault Lines provides an excellent analysis of the lessons to be learned from the financial crisis, and the difficult choices that lie ahead. Of the many books written in the wake of our recent economic meltdown, this is the one that gets it right."--George A. Akerlof, coauthor of Animal Spirits and Identity Economics
"Amidst the welter of books about our financial crisis, Rajan's book stands out for several reasons: the author's intellectual distinction, his academic and real-world involvement in the problems of finance and the macroeconomy, his global perspective, his search for the roots of the financial crisis in America's growing economic inequality, and also his prescience. In 2005, Rajan foresaw the coming financial collapse--and was fiercely criticized for his insight."--Richard A. Posner, author of A Failure of Capitalism: The Crisis of '08 and the Descent into Depression
"Beautifully clear, cogent, and highly readable. This is the best book out there on the global imbalances that gave us the last financial crisis and might well give us the next one."--Kenneth S. Rogoff, coauthor of This Time Is Different: Eight Centuries of Financial Folly
About the Author
Raghuram G. Rajan is the Eric J. Gleacher Distinguished Service Professor of Finance at the University of Chicago Booth School of Business and former chief economist at the International Monetary Fund. He is the coauthor of "Saving Capitalism from the Capitalists: Unleashing the Power of Financial Markets to Create Wealth and Spread Opportunity" (Princeton).
Most helpful customer reviews
0 of 0 people found the following review helpful.
It’s easy to write a partisan manifesto outlining a left or ...
By Amazon Customer
In 2010 Raghuram Rajan set out to explain how structural instabilities in the global financial system led to the largest crisis in recent memory. With Fault Lines: How Hidden Fractures Still Threaten the World Economy he succeeded.
It’s easy to write a partisan manifesto outlining a left or right wing perspective of “what happened” in 2008 someone with no background in economics can understand and enjoy. It’s far trickier to write a balanced and accurate analysis for other economists. It’s comparatively impossible to write a balanced and accurate analysis someone with no background can both understand and find engaging. Rajan knocks it out of the park.
By using simple yet illustrative anecdotes and explanations (carefully chosen to illustrate the given phenomenon!) as stand-ins for complex economic theory, the current Governor of the Reserve Bank of India and former IMF Chief Economist morphs models into stories, and analysis into narrative as he brings to life the “fault lines” in the global financial system he famously warned of in 2005. Maligned at the time by many policymakers and academics, his speech proved prescient, and is now outlined for a broader audience to understand after the fact what he saw before.
Further, it illuminates how these factors are still generating risk in the financial sector today. With policymakers still too focused on basic factors (such as unemployment and inflation) in economic policy – instead of financial factors that exhibit highly dynamic and critical behavior – we are applying the wrong tools to the wrong target. This is exacerbated by the continued institutional misalignment of incentives in markets and political systems. Tying the present and past versions of these problems into a compelling narrative, Rajan explains how the same weaknesses culminating in the crisis of 2008 may strike again – then outlines both a set of fixes, and the roadblocks we should expect in their implementation.
Rajan proposes the interaction of an eclectic cocktail of factors ranging from economics and political science to psychology and education when constructing his explanation. The first of these is a credit expansion generated by the combination of inequality and short-term political incentives, while the rest of the book discusses factors that grew this expansion into vast imbalances then the largest crisis in recent memory.
Inequality has risen for decades. Accelerating technological development increased the need for high productivity workers above the capacity of an inadequate educational system to supply them, all while markets expanded due to Globalization. This led to an outsized portion of gains from growth to be accrued to these skilled workers at the upper end of the income distribution. With increased redistribution politically and financially costly, policymakers used a combination of populist measures aimed at expanding lending to the poor, and subtle arm-twisting of the closely tied financial sector to allow those left behind in income to “keep up” in consumption through increased (risky!) borrowing – especially for mortgages. Credit issuance was forced up and risk evaluations were forced down in a myopic attempt at placating the poor, distorting financial activity enough a tipping point was passed - tilting this initial expansion into a bubble, which fed on itself until large enough to tank the global financial sector.
International Trade and Financial flows – and therefore their role in the crisis - cannot be looked at in isolation. As developing countries became a larger part of the global economy, their export-led model required increased industrial country spending while generating excessive savings. The U.S. picked up the slack – partially through demand from the credit bubble, while developing countries searched for a safe place to park these savings – given domestic financial underdevelopment ruled out keeping it home. They found U.S. debt markets.
This insatiable appetite for safe U.S. debt by high-savings countries (emerging markets + Germany and Japan) was satisfied by turning these risky-mortgages into securities, as a misunderstanding of risk correlations in systemic events allowed them to be bundled and treated as “safe debt.” Flows into the U.S. from high foreign savings further eased already over-eased credit, increasing demand and strengthening the lethal combination of rising asset prices and falling risk assessments that builds into an irrational exuberance. Lowered risk brings inflows. Higher inflows increase asset (housing) values/credit issuance. Increased asset values and credit issuance often lowers risk evaluations through increased liquidity. Then lowered risk brings more inflows, and the cycle continues until it collapses.
This initial distortion may not have occurred were it not for idiosyncrasies within the U.S. political and economic system. Given the U.S.’s relatively weak safety net and cutthroat business environment, U.S. businesses and workers are (respectively) created/destroyed and hired/fired by the bundle relative to other countries. The result has been one of the world’s most flexible and innovative economic systems. In the recessions of the early 90s and 2000s this system sputtered, giving “jobless” recoveries to recessions. With the safety-net too weak to handle long-term unemployment (unlike European economies) the U.S. political system is highly sensitive to its presence. The Federal Reserve and Federal Government’s hands’ were forced.
A heavily stimulative monetary and fiscal response pushed interest rates down and deficits up. When financial markets have large credit growth or asset appreciation (present throughout this time), the resultant demand alone can encourage more risk-taking – begetting more credit growth, asset (housing) appreciation, and risk-taking that perpetuate the cycle. When outside factors such as large stimulus further increase demand, the vicious cycle accelerates. By dealing with unemployment instead of (well-masked) financial imbalances, policymakers piled on the growing bubble.
While mistakes by policymakers in generating, then failing to correct to, credit and asset imbalances bears the brunt of the blame in the early part of Rajan’s analysis, the financial sector itself is far from blameless. With earnings as the sole measure of professional success in the financial sector (unlike, say, teaching or engineering), maximizing self-worth, and therefore incentives (both monetary and non-monetary), purely centered on maximizing returns. This can be done by beating the market, or by taking on excessive risk then misevaluating it (knowingly or not) to masquerade as having beat the market. With risk related to large-scale movements manifesting rarely, it can be difficult to tell the two apart. Individual compensation mechanisms minimizing decision makers’ share in downside risk, and insufficient monitoring from deep-pocketed foreign investors made checks on reckless behavior minimal, and falling as the credit boom grew. After years of underrated systemic risk with losses pushed onto others, voices of moderation in the field were cast out as profit-killing pessimists. This culminated in mortgage companies pushing loans onto those completely unable to pay, which were bundled and sold as safe assets to investors unaware of their risk. The initial credit boom, already further inflated by other expansionary factors, was pushed beyond dangerous territory.
Given the linkage between financial markets and policy, it’s difficult to understand the behavior of financiers independent of the institutional structure they operated within. Low-rate policy put excessive pressure on financiers to generate returns by taking on high risk, while the implicit promise of bailouts from the government lowered the costs to doing so, eliminating the standard market mechanisms punishing those misevaluating risk. This combination acted as a taxpayer subsidy to the financial sector – money managers reaped the gains from risky investments knowing taxpayers were on the hook if the risk manifested. Corporate structure in the banking sector, misaligned to reward short-term benefits to shareholders over long-term benefits to society, exacerbated human fallibility associated with risk assessment by pushing incentives away from socially optimal behavior.
Reforming these incentives tops the list in Rajan’s proposed financial sector reforms. Human behavior is guided by incentives. Any attempt to change it must start there. Compensation structures focused on longer-term success, removing the implicit assumption of a bailout, and greater transparency of banks’ balance sheets will all increase the cost, thereby reducing the presence, of excessive risk-taking. One promising “in vogue” option – a new Federal Reserve policy tool to shift leverage or equity requirements counter-cyclically is left out. Absent this tool, monetary policy must acknowledge financial cycles then raise rates between recoveries – even at the cost of higher unemployment. Preventing institutions from becoming systemically important, while building buffers for when the system is stressed, requires avoiding government guarantees that drive excessive risk but still ensuring liquidity is available when needed – a difficult mechanism to design. Focusing on linkages, rather than institution size, and requiring the selling of instruments undertaking debt to equity conversions when stress thresholds are surpassed is a strong start.
If inequality resulting from an inadequate education system – and the use of credit to cover it up – sowed the seeds of the pre-crisis boom, expanding access to education must be part of the solution. This goes deeper than increasing funding to education. Most ills in modern society will not be solved with merely an increase in funding. Gaps between the richer and poorer of society begin early; children of poorer parents often fall behind both cognitively and socially due to a variety of socioeconomic factors. When these gaps grow, they often last a lifetime. Early childhood and low-income family targeted measures are essential. Increasing worker retraining and mobility (reducing barriers to relocation such as worker certification) while restructuring the safety net account for the need for lengthened (in a rule based system) benefits – but only in serious downturns – will reduce the anxiety that forces heavy stimulus and drives bubbles. Counter-intuitively, these expansions of benefits may then be likely to strengthen the government’s fiscal position by minimizing both the costly bust and fiscal response to it. Policy change of this nature though is easier said than done.
Higher hurdles stand in the way of international policy reform. Economists have always been aware the actions of countries are interconnected – in this case export-led high-savings countries flooded low-savings countries like the U.S. with liquidity, fueling credit booms then busts. However no mechanism exists to push net saving countries into increased spending to ease the burden of supplying global demand from industrial countries; indeed developing countries such as China and Vietnam argue a depreciated currency and export subsidies are necessary to grow in a world with built-in structural and first-mover advantages for industrial countries. Moderating capital flows presents even greater challenges; the integration of radically different financial cultures and institutions causes wires to cross with billions on the line. Investors seek to avoid this risk by using flighty short-term debt, allowing wild financial flows that generate these crises. Were a perfect solution available political actors are still hamstrung by domestic constituencies – at the cost of global financial stability. Pushing reforms constituents fear through a system from which entrenched interests benefit is a herculean task – and international institutions have little leverage. Rajan recounts his ill-fated pre-crisis series of globe trotting meetings to attempt just that as Chief Economist of the IMF.
Rajan illustrates how the complex interactions of politics and economics melded with institutional incentives and human nature to culminate in the Great Recession. By acknowledging the difficulty of policy reform amidst a nod to the validity of both partisan narratives, he avoids the blame game in favor of an even-keeled discussion of why the crisis happened with ideas to avoid the next. Fault Lines: How Hidden Fractures Still Threaten the World Economy deserves its award as the 2010 Financial Times/Goldman Sachs business book of the year.
0 of 0 people found the following review helpful.
Some excellent analysis, and some really shallow parts...
By Davis F. Taylor
I must confess, I stopped reading this book midway thru the 2nd chapter. Which is a pity, because there is much to recommend about Rajan's book, particularly his analysis of global capital flows and debt. And I was willing to overlook Rajan's predilections toward Chicago-school answers to the crisis. What made me stop reading was his facile approaches toward education and poverty in America. His analysis of the role of the supply and demand of educated workers would not pass college introductory economics (which I teach), and his assessment of the causes of poverty is a thinly veiled culture-of-poverty approach. I was hoping to use this book in an intermediate macroeconomics class (as the textbooks are embarrassingly short on the role of debt and the financial system in explaining the crisis), but I can't present and explain such facile material to students.
1 of 1 people found the following review helpful.
Analysis holds up well four years after publication
By MT57
I am working my way through every book about the financial crisis of 2007-09 and finally got around to this, although I was familiar from secondary sources with the first of his theses -- that the crisis was caused in part by pro-home-mortgage-indebtedness policies the federal government sponsored for decades, across multiple administrations, as a way to keep the middle class and working class content as globalization and other forces put downward pressure on their wages and salaries, a thesis supported by the recent book "House of Debt" which came out while I was reading this one. Having read a good deal of these books, I have developed my own views, which happen to coincide with Rajan's , not merely the aforementioned thesis regarding federal governmental distortion of housing finance, but the others developed in this book, specifically the role of other nations' economic policies leading them to keep a constant appetite for US debt instruments, and so I approached this favorably disposed, and I was not disappointed. This is quite an insightful and instructive book, and of course since it was published, the author has been appointed head of India's central bank, and also on record for having warned of excess risk in the financial system years before the crisis, so this is someone more than a mere academic whose views need to be taken seriously. Yet it is written in a very clear and non-technical manner. If it has any weakness, in fact, it is a little too non-technical, and a little too lacking in citations to supporting data (other books such as Guaranteed to Fail and House of Debt, however, contain supporting data. Toward the end he offers a fairly standard list of policy prescriptions (invest more in education, reduce consumption subsidies, reduce banking system risk, and so on), although my favorite was his call to finally fully privatize the GSE's, so that they are just E's, without the GS, which is long overdue.
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