Surviving Large Losses: Financial Crises, the Middle Class, and the Development of Captial Markets (review)

This engaging small book is a scholarly popular book on financial crises. This apparent oxymoron is, in fact, a new genre of books started by Kindleberger and Krugman, in which economists attempt to communicate with the general public—that is, non-economists—about current and past affairs.¹ The book under review appears to be a broad survey based on a more scholarly book that the authors wrote about eighteenth-century French finance.²

Their account of financial crises is engaging but difficult to follow if you have not been a student of historical finance. The authors range over continents and centuries with the confidence that readers will follow their intellectual travels. They tend to focus on France and the United States, but their accounts range from the seventeenth to the twenty-first century, requiring knowledge and imagination from their readers. This is not to say that anyone is barred from understanding their argument, but this kind of historical survey cannot provide the background for any particular story that most historians would think necessary.

The book is organized around two “models” that are used for various purposes in the narratives—not formal models of behavioral relations among quantifiable variables but lists of factors or causes and generalizations of a simpler sort. The first model appears in Chapter 1 to help predict financial crises, and in the last chapter to predict the likelihood of good reforms. The three factors in this model are sensible government finance, as identified by not too much government debt; abundant information about financial affairs; and a large middle class. The corollary to it is that conditions that make financial crises more likely make constructive reforms less likely. Unruly governments are too predatory to avoid crises or to fix the financial system. The middle class loses the most from financial crises, but since it needs personal finance the most, it supports reform. Asymmetric information is the bane of all financial systems and needs to be minimized for financial health.

The second financial model is Marxist in origin—another oxymoron? It appears in the middle of the book to inquire more closely into the actions of governments. The three factors (in Marxist terms, classes) of this model are the poor (proletariat), the middle class (bourgeoisie), and the rich (capitalists). As in Karl Marx’s work, the dynamics of the model come when any two factors/classes get together. Depending on which two enforce their will on the third, the outcome is better or worse for the poor and middle class. As before, the existence of a large and powerful middle class or bourgeoisie makes for better outcomes. The paradox of most analyses of progress is that the middle class is both the engine of economic stability and growth and the beneficiary of economic stability and growth.

This book was written after the fiasco of Long Term Capital Management’s melt-down and the collapse of the dot-com bubble, but before the subprime mortgage crisis. How well does history inform the likely progress of this last financial crisis? The first thing to note is that the United States lacks two of the three factors making financial crises less likely and reforms more effective. The government today is more indebted than ever, and the information—apparently even to professionals—about the complex securities that were traded in the mortgage market in the last few years is scarce. Hence, this book would advise us not to be surprised if a financial crisis occurs or to be hopeful that effective and sober reforms will follow it.

This book will appeal to those who like financial affairs. The history is generally sound and the arguments sensible. The authors make a good case for the importance of history, and the lessons from this brief book are clearer than most.