Book Review: Fault Lines by Raghuram G Rajan

Raghuram G Rajan is the only economist who had predicted the global crash of 2007 - the subprime crisis - before it happened; At an event where the focus was on Alan Greenspan (http://en.wikipedia.org/wiki/Alan_Greenspan) Mr Rajan forecasted the crash - and was roundly criticized for this. In his paper "Has Financial Development Made The World Riskier?" the author pointed out skewed incentives in the financial sector, credit default swaps, and the increasing risk profile of banks and warned that the "interbank market could freeze up, and we could well have a full-blown financial crisis"

(Readers' can find any number of blogs and articles that analyse the contents of this book - all of them by qualified economists. I am not one; so my approach is to summarise the achievements of the author; the achievements garnered by the book; and lastly to give readers like me- sales / marketing professionals, students a reason to read the book with the objective of stoking interest in a book I regard as one of the most well-reasoned books I have ever read. One word of caution: if you are totally unaware of the subprime crisis, it would be better if you read The Monster - Michael W Hudson before this book)

Raghuram Rajan is the Eric J. Gleacher Distinguished Service Professor of Finance at the University of Chicago’s Booth School of Business. Dr. Rajan is also currently an economic advisor to the Prime Minister of India. Prior to resuming teaching in 2007, Dr. Rajan was the Economic Counselor and Director of Research (in plain English, the Chief Economist) at the International Monetary Fund (from 2003). Since then, he has chaired the Indian government’s Committee on Financial Sector Reforms, which submitted its report in September 2008.

(Eric J. Gleacher Distinguished Service Professor of Finance and the Charles M. Harper Faculty Fellow)

• Winner of the 2010 Financial Times and Goldman Sachs Business Book of the Year Award
• Gold Medal Winner of the 2011 Independent Publisher Book Awards in the Finance/Investment/Economics category
• Winner of the 2010 PROSE Award for Excellence in Economics, American Publishers Awards for Professional and Scholarly Excellence
• Gold Medal Winner of the 2010 ForeWord Reviews Book of the Year Awards in the Business & Economics Category
• Finalist for the 2010 TIAA-CREF Paul A. Samuelson Award
• Named one of the 2010 Best Business Books of the Year, strategy+business magazine
• Best Crisis Book by an Economist and Named one of the 2010 Top Thirty Business Books of the Year, Bloomberg News (bloomberg.com/news)
• Named as one of the 2010 Books of the Year in Nonfiction Round-Up in the Business & Economics list, Financial Times (FT.com)
• Finalist of the 2010 ForeWord Reviews Book of the Year Awards, Business and Economics Category
• Finalist, 2011 Estoril Global Issues Distinguished Book Prize

It is common to blame the big businesses for any and every financial crisis that takes place; whenever you go through one, the blame always goes to the big corporation - as if this corporation is a living entity who can think and act on its own. Second, there is always an undercurrent of suspicion that things were deliberately done... that every player was out to make a killing at any cost

And this is the attitude that this book seeks to change, it attempts to give the reader a wider perspective of the worldwide economic scenario and the forces that led to the meltdown without absolving anyone of any blame. It is not an attempt to protect any player; nor is the book overly critical or full of praise for any single person or entity. These value judgements have been left to the reader: it is merely an objective analysis of various forces that interacted as well as the several positions that were taken by the participants, It is this objective approach that, to my mind, makes this book such a praiseworthy book. It must have been tempting to do a post-mortem so to speak; instead the author has wisely chosen to analyse the situation dispassionately - and in the process give the readers an indepth perspective of the scenario

The author has highlighted how unbridled credit expansion; focus on affordable housing by the US government; global export-import imbalances; the lack of a safety net in terms of unemployment and social-health benefits; the pitfalls of foreign financing as opposed to internal savings and the various government responses like monetary stimulus etc interacted to create a full-blown crisis. What is most pertinent is that the book highlights how individual decisions taken with the right intentions all were rational responses to the situations as they lay at that point in time; how the presence of some deeper systemic problems led to the scenario. The part on FIs and their incentives dwells on how the inbuilt reward and incentive structures in firms lead a person to taking greater and greater risk - till it reaches a point of no-return. 

The book enables a person to get a clear picture of how unchecked risk-taking by organisations combined with a lack of safety nets for people and skewness in the reward structures interacted in a macroeconomic atmosphere where the government of the USA was focusing on housing for all. The presence of easy credit generated the liquidity which  put buying power in the hands of citizens - and export surpluses completed the picture, linking the global economy to what was essentially a local matter! The fear of loss of a job combined with the incentives for success to make higher risk-taking acceptable to people, affecting their decisions.  The propensity of people to cut corners is universal, and rather than berate anyone on this essentially human habit, the book has chosen to look at systemic flaws. With unchecked risk in an atmosphere where success carries tremendous rewards, the higher risk - higher reward finance fundamental meant that people increasingly took on higher and higher risk... the last straw was the belief of everyone in the system that the government would act as a bullwark in case of a major issue. 

The book is a must read for everyone and anyone in business, as it analyses rational responses and  systemic flaws, and stays away form a witch hunt.  It gives you a good understanding of international business, as well as the underlying forces and takes your mind to the big picture, teaching you to look at any situation from afar. However, I would recommend that readers' like me also read The Monster, which goes deeper into the specifics of this particular issue which will give you a clear idea as to what Mr Rajan is talking about. That will enable a fuller understanding of the specifics of the international situation.