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Book Review: Boom and Bust

Why are we always so surprised when a crisis strikes the economy? Bankers, investors and homeowners alike watched the stock market tumble in 2008 with wide eyes, as if it has never happened before—at least not like this.

In Boom & Bust: Financial Cycles and Human Prosperity, Alex J. Pollock, a resident fellow at the American Enterprise Institute, reminds readers there is nothing new under the sun in financial markets. Even when regulations are put into place, human beings continue to make the same mistakes. Rather than focusing on mathematical equations and economic forecasting, Pollock explains the cyclical nature of markets in terms of the behavioral nature of human beings:

“The general pattern of bubbles and crises thus does not change, because the underlying human nature that drives them does not change.”

In our personal lives, we can be prideful and over-confident at times; we speculate; we desire short-term rewards over long-term rewards; we fail to properly assess risk; we fear uncertainty; we cannot predict the future, and yet we try to control the outcomes. Human weaknesses as such can and must be directly applied to financial markets to better understand the cyclical nature of the economy. Because human beings inevitably fail, so do markets. As economist Allan H. Meltzer once said, “Capitalism without failure is like religion without sinit doesn’t work.”

Two major problems Pollock discusses in Boom & Bust are the attempt of the government to control human behavior through regulation and the false sense of safety regulation brings. In reference to financial regulation, Pollock illustrates:

“Whenever we try to engineer and control human behavior, those attempts at control themselves induce unexpected adaptations and reactions, in markets, but also in the behavior of regulators and politicians. Hence, every reform requires another reform to address the effects of the prior one- and on ad infinitum.”

The belief that each generation is more advanced or more invincible than the last is a common lie every generation tends to believe, and we are no different today. With detailed regulation and intricate economic regression models designed to predict the future market trends, many believed the United States’ economy was fairly bullet-proof in the early 2000s. Why did so many economists fail to predict the recession? Pollock claims ignorance in human behavior in financial history and heavy faith in mathematical models are the two major problems at the heart of the every economic disaster:

“Did the models show that what banks were counting as ‘profits’ was the result of exponentially increased risk? Did the models adequately take into account the cumulative human forces of optimism, gullibility, short-term focus, and assumption that current trends will last forever, group psychology, and increasing fraud? Did the models keep up with the rapid pace of change in the very behavior that the models were supposed to describe? Obviously they did not.”

Pollock provides practical solutions to ameliorate future economic crises while emphasizing the need to maintain freedom of financial risk-taking. He explains that though there will always be economic recessions, the overall trend of the U.S. economy has been upward growth, and without risk-taking there is no growth.

Boom and Bust provides insightful and easy-to-digest information useful for both the investment banker on Wall Street and the common man. Pollock successfully tackles big questions of the Great Recession by leaving behind confusing economic discussions about numbers and graphs and introducing a simpler conversation concerning human behavior and values.