Syndicalist philospher Georges Sorel writes about Social Myths which may or may not be true, but act on a class or a group as a spur to action. For early Christians it was the prospect of the imminent return of Christ and for Syndicalists it was the General Strike which would herald a Socialist revolution. He writes in his Letter to Halevy that "People who are living in this world of "myths," are secure from all refutation; this has led many to assert that Socialism is a kind of religion" (www.historyguide.org/europe/sorel.htm)
To this, Sorel could have added the Capitalists have their own myth, their own irrefutable doctrine that acts as a spur to action - that of a belief in the self-regulating nature of the markets in an environment free from regulatory interference. Now this may be true in the austere pages of economic textbooks, but generally such doctrines are underpinned by assumptions such as rational individuals making decisions based on perfect knowledge in a perfect market place. However, in reality, the rational individuals are characterised by greed and stupidity, knowledge is partial and monopolostic / monopsonistic powers hold sway over the marketplaces. The result is that markets in capitalist economies boom and crash as the tides ebb and flo and the Earth circles the sun.
However, in certain quarters there is a collective denial of the need for effective regulatory control of the excesses of the market - a quasi-religious belief in the face of all rational evidence that the markets were not only efficient but self-correcting - a denial, that is, until the Credit Crunch of 2007-9.
Now that the dust is settling on the Crunch, another mini-boom is underway - benign admittedly when compared with the excesses of expansion of Credit which characterised the early years of this century. This boom is in books from economics commentators, journalists and insiders all seeking to explain where it all went so horribly wrong, and point out what must be done to avoid repetition.
John Lanchester is an author who sought to understand for himself what was happening as the background to a novel, and discovered a more interesting story than the one he was writing. He takes a broad view and explains the concepts involved from first principles with wit, clarity and anger. If you don't know your CDSs from your CDOs then this is the place to start.
Gillian Tett of the Financial Times has consistently been the most readable and astute of the commentators on the crisis. In Fool's Gold, she looks at the origins of the crisis from the persective of the JPMorgan Investment Bank where Credit derivitives were first devised, but which missed out on the excesses of the boom as it stuck to its principles in risk management. This in turn has enabled it to become the world's leading investment bank as it emerges from the crash much stronger than its competitors.
Tett locates a fundamental problem as being how financial companies dealt with Super-Senior risk left over from the production of synthetic CDOs. Whilst JPMorgan continued to offset the Super-Senior risk, other companies as the Credit frezy set in retained this on their books or passed it on to undercapitalised monoline insurers or AIG. As a result, bankers at JPMorgan couldn't understand how other companies continued to make such strong returns, so they restricted their CDO pipeline thus limiting their exposure to the market.
The basic sound idea behind CDOs was that they allowed the dispersion of risk throughout the banking system. However, all the financial models which measured this dispersion were predicated on limited mortgage defaults in few localities. No-one had predicted systematic mortgage default across the country. But lax regulation - despite the unhappy memories of the Savings and Loans crisis in the 1980s - had allowed greed and stupidity to predominate. Mortgages were being sold to people who hadn't the abilty to repay them, but the sellers didn't care as their risk was being immediately sold on and rebundled by the banks within their mortgage-backed CDOs. However, when default rates started to hit 15%, then the concentration ratios started to change and Super-Senior dept was no longer impregnable. Tett tells the story with verve and clarity