Reading List: A History of Crises, Financial Madness and Failures


The world is teetering on the brink of a crisis that could turn out to be the most severe economic shock since the Great Depression and could lead to much more significant transformations than those that followed the global financial crisis. We have selected books devoted to crises, mostly taken from the reading lists of representatives of the NES community. These works are about the history of economic shocks, their causes and consequences, about everyone missing the new crisis thinking that "this time is different" but facing the same story over again.


History Lessons

The book by the World Bank's Chief Economist Carmen Reinhart and Harvard University Professor Kenneth Rogoff is called This Time Is Different: Eight Centuries of Financial Folly. They wrote a "guide" to the history of crises, collecting data on inflation, exchange rates, GDP, etc. of dozens of countries over hundreds of years. The book (recommended by NES Professor Oleg Shibanov) makes it clear that crises are almost inevitable, their causes are explicable, and getting out of a recession may take much longer than we think.

The main idea of the book – the typical expectation that "this time is different" – is best illustrated by an advertisement published on September 1, 1929, saying that today every investor has tools to obtain facts that, as far as humanly possible, can eliminate the damage from speculation and replace it with firm investment principles. This ad appeared two months before Black Tuesday, the stock market crash that became the starting point of the Great Depression.

In those days, no one believed that the market crash portends a catastrophe. The Wall Street Journal reported that the price dynamics of most stocks continued to show an upward trend, temporarily suspended due to technical revaluation. Those events are described in detail in the book The Great Crash 1929 by the American economist John Kenneth Galbraith. He recalls the history of financial "bubbles," describes how the US economy was moving towards the abyss and what could push it into crisis.

The same events are the subject of Lords of Finance: The Bankers Who Broke the World, a bestseller by the investment banker and writer Liaquat Ahamed (recommended by NES Professor Konstantin Egorov). Former Fed Chairman Ben Bernanke advised reading this book in order to better understand the global crisis. It is a story of the governors of the US, UK’s, French and German central banks, who tried to prevent the Great Depression a century ago.

At the start of the 21 century the world was again struck by the same blindness. When clouds began to pile up over the US economy in 2007 and early 2008, economists were often asked if another depression or even a deep recession was possible. Most of them responded instinctively with a decisive No, Nobel Prize winner Joseph Stiglitz recalls in his book Freefall: America, Free Markets, and the Sinking of the World Economy.

Meanwhile, Konstantin Egorov recommends reading about that crisis in the book by Ben Bernanke The Courage to Act: A Memoir of a Crisis and its Aftermath. He recalls how he first got into the Fed, and how at the very beginning of the crisis he opened a huge book with his job description and found there just one sentence with instructions on how to act in such a situation.

For those who prefer detective stories, Oleg Shibanov suggests a book by financial journalist Michael Lewis The Big Short: Inside the Doomsday Machine. Many people know it thanks to The Big Short movie.


Psychology Lessons

And yet, why did the authorities and financial market professionals overlook the crisis? After all, everything seemed to point to its imminence: a bubble in the real estate market, unsecured mortgages, an extremely complex and very opaque system of financial instruments, market overheating, and so on. Alan Blinder, a Professor at Princeton University and former Vice Chairman of the Federal Reserve, offers his answer to this question in the book After the Music Stopped (recommended by Konstantin Egorov). Everyone saw the risks, but they seemed like someone else's problem, he explains. Blinder tries to show how the system of responsibility transfer (“passing the buck”) appeared in the US, why it did not exist before and how we can prevent such a catastrophe in the future.

In their famous bestseller Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism (recommended by NES Professors Evgeny Yakovlev and Oleg Shibanov), two Nobel Prize winners George Akerlof and Robert Schiller raise  the question why no one noticed anything wrong before all the troubles – bank crashes, layoffs, foreclosures on mortgages – hit us all. In order to understand economics, one has to figure out how it is driven by irrationality, Akerlof and Shiller write, referring to the ideas of John Maynard Keynes.

The book is full of examples of irrational behavior of people and markets (you can also read Irrational Exuberance, another book by Schiller). Akerlof and Schiller point to a human being that was missing in the models used for forecasting at that time. The legendary Fed Governor Alan Greenspan, the man who is blamed by many for the global financial crisis, confirms this point in his book The Map and the Territory: Risk, Human Nature, and the Future of Forecasting.

Animal Spirits examines five manifestations of irrationality and their impact on the economy: trust, justice, abuse and dishonesty, monetary illusion and how our ideas about reality are intertwined with stories from our lives. The authors of the book are convinced that in quiet times, the state need not actively interfere in a free market economy, even though it is far from perfect. But everything changes when a crisis sets in: then the state must stabilize the economy and help it return to equilibrium. And if we manage to avoid serious recessions and blatant injustice, the market economy that helped billions of people achieve prosperity will continue to develop for the benefit of even more people, Shiller states in the preface.


Lessons from a Crisis

It is difficult to talk about crises without touching upon their causes. And yet, it is worth mentioning at least two books on the "crisis bookshelf" about how and why entire civilizations found themselves in crisis and even went extinct.

In the book Collapse: How Societies Choose to Fail or Succeed (recommended by NES Professor Gerhard Toews) Jared Diamond examines examples of civilizational collapses including the Maya cities, the disappearance of the Easter Island population and the Norse in Greenland, etc.

What could have led to crises described in the book and why did they turn into a collapse? Diamond identifies five main factors:

 – destruction of the environment;

 – climate change;

 – hostile neighbors;

 – reduction of support from friendly neighbors;

 – the reaction of society to problems, whether environmental, political or social.

The first four factors do not necessarily lead to catastrophic consequences if the society responds correctly to emerging problems. If it is not ready to realize them, it would collapse, not even noticing the inevitability of such an outcome. Diamond asks a student’s question about what the Easter Islander was thinking about when he chopped down the last palm tree. The answer is relevant for us even today.

Renowned economists Daron Acemoglu and James Robinson, the authors of the bestseller Why Nations Fail: The Origins of Power, Prosperity, and Poverty, offer their view on the fundamental causes of crises (recommended by Ruben Enikolopov). Acemoglu and Robinson consider political and economic institutions to be the main factors for societies’ prosperity, distress and even collapse. Institutions can be good and bad: inclusive institutions allow the whole society to enjoy the benefits of development, extractive institutions aim to provide rents for the elites. Countries with inclusive institutions thrive, while those with extractive ones languish and perish. Political institutions are the key to the emergence of proper economic institutions. To break away from the vicious circle of the extractive environment, the political regime needs to be changed. "That is the key to eliminating poverty and ultimately getting to prosperity". Economic growth will only occur if it is not blocked by those who are afraid of losing from it and losing the privileges on which their wealth and power are based, Acemoglu and Robinson write.


Forecasting Lessons

"But who wants to be foretold the weather? It is bad enough when it comes, without our having the misery of knowing about it beforehand" Three Men in a Boat by Jerome K. Jerome

Finally, we suggest books that answer the questions whether we can trust forecasts and why they fail to come true so often. In other words, why forecasts can promise growth and prosperity or a slight turbulence when the economy is speeding towards a crisis.

A Crisis of Beliefs (recommended by Oleg Shibanov), written by Bocconi University Professor Nicola Gennaioli and Harvard University Professor Andrei Shleifer, describes how we make mistakes, and what is even worse – how we believe in our delusions. The great strengths of the book are the suggested model of psychological perceptions and an attempt to offer a unified approach. Through psychology, the authors explain such phenomena as the financial crisis, credit cycles, errors in analysts' predictions, etc.

Expert Political Judgment (recommended by NES Professor Marat Salikhov), written by Philip Tetlock, a psychologist from the University of Pennsylvania, is also about forecasts. What does it take to assess the quality of a geopolitical forecast? Formalization. Tetlock conducts several studies and finds that experts’ ability to predict the future varies greatly. What explains these variations? Education, experience, political orientation – all these factors come up to be not so important. Meanwhile, cognitive style, a concept described in Isaiah Berlin's essay The Hedgehog and the Fox, appears to be the decisive factor. Some experts are foxes who rely on many different theories in their forecasts. Others are hedgehogs who strive to reduce everything to one overarching idea. Experts that are closer to foxes and not hedgehogs offer more accurate forecasts. Of course, the book is not limited to this observation alone: it describes many interesting patterns and examples. One such example is the collapse of the USSR: in 1988, very few experts were able to predict that the USSR would collapse in just a few years.

While Tetlock believes in ways to reliably predict the likelihood of important economic, social or political events, Mervyn King (former Governor of the Bank of England) and Sir John Kay (the first dean of Oxford’s Said Business School) think differently. In their book Radical Uncertainty, they warn against excessive trust in mathematical models, and suggest creating sustainable and flexible decision-making processes instead of relying on forecasts.