14 July 2025

Multipliers

Recommendation

Everyone wants to elicit more from the people with whom they work (or live). Liz Wiseman and her colleague and primary contributor Greg McKeown show you how. They know you can draw more from people by making more of them – by multiplying their contributions. This book names the ways in which managers help others grow to become more than they thought they could be – or halt their growth and make them less than they wanted to be. Anchored in the research of the authors, as well as work from Carol Dweck and multiple-intelligences guru Daniel Goleman, this book will challenge you at every turn, adding value to your work and life. Readers with a natural distrust of dichotomies may question the ease with which the authors find a yang for every yin. For every “Challenger” there is a “Know-It-All.” For every “Investor” there is a “Micromanager.” Instead of being suspicious, think of these opposites as a continuum between those who “Multiply” and those who “Diminish” the talent around them. BooksInShort recommends that leaders at all levels follow the suggestion of K.R. Sridhar, CEO of Bloom Energy: “I have zero tolerance if someone does not run the experiment.” If even a single person reports to you, run the experiment. Read the book.

Take-Aways

  • Managers can increase or limit their employees’ growth.
  • “Diminishers” shut down the potential of others. They shrink the long-term possibilities of their enterprises.
  • “Multipliers” inspire boundless productivity from their workforce.
  • They require fewer resources to yield greater results.
  • “Talent Magnets” multiply by attracting and developing the best workers.
  • Some multiply by “Liberating,” creating space for mistakes and learning.
  • Some multiply by “Challenging,” inspiring groups to pursue “stretch” opportunities.
  • Some multiply by fostering “Debate,” broadcasting many voices and allowing more “fingerprints” to appear on final decisions.
  • Some multiply by “Investing,” sharing project ownership and growth opportunities.
  • To be a Multiplier, build onto your prominent strength, eliminate your biggest weakness and add layers of the core competencies – slowly but surely.

Summary

“The Multiplier Effect”

If you’ve worked with leaders who are “Diminishers,” you know it. When they run a meeting, they shine and others around them grow dim. This style of leadership isn’t just bad for a team – it’s bad for the entire organization.

Leaders who are “Multipliers” rapidly advance the capacity of their followers, increasing the intelligence of individuals and groups. Productivity and innovation follow.

“It isn’t just how intelligent your team members are; it is how much of that intelligence you can draw out and put to use.”

Research shows that Multipliers draw more effort, energy and achievement from employees. They don’t just access the best people have to offer; they “stretch” the best people have to offer.

Additionally, managers who are Multipliers make resources go further, stimulating a “new corporate logic: Utilize your workers to the fullest and you need not invest in ‘more resources’.”

“Multipliers generate belief – the belief that the impossible is actually possible.”

Answer these questions:

  • Do you view intelligence as something just a few people possess?
  • When you attend a meeting, do you listen only to those who contributed something in the past?

Answering no marks you as a potential Multiplier. Answering yes means you might be a Diminisher (even if you didn't imagine you were).

“Corporate environments and modern organizations are the perfect setup for diminishing leadership and have a certain built-in tyranny.”

The distinction matters. Multipliers and Diminishers may treat customers with the same level of care; they both might understand business at a high level. But they differ fundamentally in the ways they approach thinking, talent, challenges, decisions and ownership within their organizations.

Multiplier as “Talent Magnet”

Talent Magnets help people to grow and to prepare for bigger assignments – maybe even their next jobs. Preparing employees to leave your organization might seem counterintuitive, but Talent Magnets know that more talented employees will appear. They have created an environment that attracts them.

“A Talent Magnet creates a powerful force that attracts talent and then accelerates the growth of intelligence and capability.”

Because “Empire Builders” are Diminishers rather than Multipliers, they have a different relationship to talent. They can attract it, but they do nothing to improve talent once it reports for work. Instead, they build up their workforce to bolster their own agendas and images. Talent under their supervision goes unnoticed – they don’t nurture or promote it. People who work for Empire Builders lose their edge and have a difficult time finding their next opportunities.

“In their quest to assemble the finest talent, Talent Magnets are blind to organizational boundaries. They see the multiple forms of intelligence that exist everywhere.”

To avoid being a diminishing Empire Builder, follow the Talent Magnet’s approach:

  1. “Look for talent everywhere” – Talent Magnets know intelligence comes in many flavors and types; sample them all to deal most productively with the range of problems that beset most organizations.
  2. “Find people’s native genius” – Learn what skills come easily to your workers so you can identify contributions they can make without exhausting their time or energy.
  3. “Utilize people at their fullest” – Once you know an area in which people excel, give them an assignment that taps into it. Set them free to do their best work.
  4. “Remove the blockers” – When you are trying to build up talented people, eliminate anyone who stands in your way. Whatever they contribute, they are not worth the cost.

Multiplier as “Liberator”

Your work environment can limit your ability to share your best ideas. For example, “formal hierarchies” give more weight to the opinions of those on top. If you’re working your way up, compliance with the boss may feel like your only option, especially if you work for a “Tyrant.” These leaders specialize in “intimidation.” They want people to give their best, but they never create an environment where staffers can flourish. Instead, people shut down in the face of the stress that tyrants create.

“Diminishers tell you what they know; Multipliers help you learn what you need to know.”

Liberators, on the other hand, use “intensity” to encourage employees to think hard and do what’s best for the organization. Knowing that “comfort” and “pressure” are not mutually exclusive, leaders who are Liberators do things differently. First, they create a space where great work can transpire, and they resist the urge to use up all that space themselves. Since most organizations are hierarchies, high-ranking Liberators know their opinions wield disproportionate power. So they become “ferocious listeners,” trying constantly to discover other people’s best ideas. They want the best from their staff, but they know they only can obtain it if people have the “ability to focus on the real issues” and contribute fully, openly and honestly.

“Liberators get the best thinking from people by creating a rapid cycle between thinking, learning, and making and recovering from mistakes.”

Second, Liberators “demand people’s best work” and ask for it continuously. Third, they keep learning at the center of what they and their employees do. Mistakes happen and they know it. But people always should learn from their errors – and quickly. Multipliers who act as Liberators generate “rapid learning cycles” in the wake of errors, but Diminishers see only the need to reprimand.

Multiplier as “Challenger”

Working for a “Know-It-All” severely limits a team. When the team hits the edge of the Know-It-All’s knowledge or capabilities, its progress will stop. No one has room to grow in such an environment. Challengers, on the other hand, know how to push a team past its obvious limit. They sniff around for tasks and for opportunities that force people to rise to meet them. Three “practices” guide their behavior:

  1. They “seed” opportunities – Instead of telling people what to do, Challengers spark interest in projects. They don’t talk about problems; instead, they join people together to explore opportunities.
  2. They “lay down a challenge” – Challengers make employees excited to try rather than scared to fail. As a result, they find that people are capable of extraordinary things. Challengers help organizations succeed because they ask questions that are “so immense that people can’t answer them based on their current knowledge.” So, they must learn.
  3. They “generate belief” – Meeting a true challenge isn’t easy, but a Multiplier helps people believe they can find a way to “stretch themselves” to handle it. Additionally, these leaders encourage staffers to “co-create the plan.” This builds buy-in from the start.
“An unsafe environment yields only the safest ideas.”

To challenge others successfully, as a Multiplier would, get out of “answer mode” and boss mode. Be inquisitive. Ask probing questions. Make people think, so that you can move them forward with you – if others won’t follow, then you haven’t challenged them enough to multiply their capacities or their intelligence.

Multiplier as “Debate Maker”

Decisions are a crucial part of every enterprise. Multipliers know how to engage many perspectives and voices, making use of all the intelligence on the team. As Debate Makers, they are interested in accessing the “full brainpower of the organization.” Their polar opposites, “Decision Makers,” call people together not to seek input, but to announce their fiat decisions. They are interested in a small range of intelligence – their own and maybe that of a few key advisers.

“Diminishers give answers. Good leaders ask questions. Multipliers ask the really hard questions.”

When a big decision arrives, Multipliers who function as Debate Makers follow a general pattern to pull more intelligence from more people. First, they establish the ground for broad contributions by giving the decision a proper “frame.” They ask questions that might disrupt the group’s or organization’s typical suppositions. They confirm that the correct people are at the table. Then, they ensure that the participants have an opportunity to “examine the facts and confront reality,” and that their opinions are informed by the right data. Finally, they clarify the decision itself, confirming that everyone who comes to the table knows the reason the decision is important and the way they actually will decide.

“Becoming a Challenger starts with developing an overactive imagination and a serious case of curiosity.”

Once the ground is established, a Multiplier drives the debate, making people feel safe enough to contribute. A Multiplier makes it clear that the results matter. “Evidence” is important, but it must be rooted in fact, not feelings or subjective rationales. The Multiplier ensures that the group considers each member’s perspectives and assumptions. The Multiplier explains, “What will be done” with the team’s ideas. Will the team decide together? If so, how? If the team won’t decide, how does its contribution inform or change the potential decision? Multipliers are not afraid to decide on their own, and they are not solely interested in group agreement. They generate debate to bring the best ideas to the surface. Additionally, debates allow others to “put their fingerprints on the decision,” so they better understand it and are ready to carry it forward.

Multiplier as “Investor”

Diminishers believe that people won’t be able to figure things out without them. These “Micromanagers” jump in and take over at the first sign of a glitch. In contrast, Multipliers who act as Investors put other people in charge, and then invest in their success by teaching, coaching and supplying the needed resources. This enables their staff to work independently and to be held fully accountable for their work and results.

“Multipliers understand that their role is to invest, to teach and to coach, and they keep the accountability for the play with the players. By doing so, they create organizations that can win without them on the field.”

Along the way, Investors are not afraid to make you “stretch,” but they won’t hang you out to dry. They thrive – by helping you thrive – in the teaching mode. They don’t take a problem out of your hands to micromanage it. They want it in your hands – they want you to handle it well, be accountable and generate your best, most “complete” work. This is why they won’t take work back from you. They might give you feedback or coaching; they might even praise you. But they won’t “diminish” you by being overly involved or shielding you from the “natural consequences” of the work that you do or don’t do.

“Multipliers…want to leverage every ounce of intelligence and capability they can in making and executing sound decisions.”

It’s no wonder, then, that when a Micromanager leaves an organization, it falls apart.

When an Investor leaves, a “legacy” flourishes.

“Becoming a Multiplier”

Corporate culture can encourage a Diminisher. Often, either your boss is one or you are, and you’re just too busy to consider changing your mindset, your relationship to your colleagues or how you do your job. Fortunately, you can employ a few “lazy” methods to become a leader more closely aligned with the qualities of a Multiplier.

  1. “Work the extremes” – If you’re trying to be good at every positive leadership quality, stop. If you have a single, huge, glaring weakness, stop indulging that, too. Take the best thing that you do and do it better. Get rid of the worst thing that you do, or at least bring it into the range where it isn’t harmful.
  2. “Start with assumptions” – The ideas you assume to be true guide your actions. If you think everyone around you is unintelligent or incompetent, you will likely manage in ways that create a self-fulfilling prophecy. Practice the chief assumption Multipliers hold: “people are smart and will figure it out,” and watch how this belief proves itself true.
  3. Give yourself 30 days – To start behaving like a Multiplier, in any category, practice a new approach for 30 days. It will become a positive habit.
“It isn’t how much you know that matters. What matters is how much access you have to what other people know.”

This process will get you started. Adding layers over time and working with others on similar goals will move you from being a “genius” to being a “genius maker.”

That changes everything – for you and those around you.

About the Authors

Liz Wiseman, a former executive at Oracle, serves as president of the Wiseman Group, a consultancy where Greg McKeown is a partner.


Read summary...
Multipliers

Book Multipliers

How the Best Leaders Make Everyone Smarter

HarperBusiness,


 



14 July 2025

Everyone Communicates, Few Connect

Recommendation

To learn how to connect well with others, imitate a connection superstar: leadership development expert John C. Maxwell. When he posted a preliminary version of this book on his blog, 100,000 people viewed it, and many offered comments on how to make it better. Maxwell has sold more than 18 million books and his company has taught leadership skills to more than five million people. He offers this book’s simple principles and its very abundant quotations, anecdotes and stories to explain how to build relationships with other people in many settings. Without being preachy – though he is a preacher – he provides an intelligent, purposeful philosophy about connection. Maxwell’s sensible counsel – focus on others, help them, smile – is not earth shattering, but no one could dispute its basic verity. If the book sometimes seems just to skip merrily from one great story to another, that’s part of its charm – and it all adds up to advice that will improve your ability to link with other people. The trick is to put these examples into practice and Maxwell explains how to do that. BooksInShort recommends his book to all those who want to improve their public speaking skills and interpersonal connections.

Take-Aways

  • If people feel close to you, then they will speak well of you, trust you, go the extra mile for you and enjoy being with you.
  • To build a good rapport with others, focus on them, not on yourself.
  • To create meaningful bonds, show people you care for them, you want to help them and they can trust you. You must give support to earn it.
  • Try to link with people “visually, intellectually, emotionally” and “verbally.”
  • Be the first to initiate a relationship with individuals, groups and audiences.
  • People often find connecting difficult because they assume too much, act arrogantly, appear indifferent or exert too much control.
  • Use the “3S” communication strategy: “Keep it simple. Say it slowly. Have a smile.”
  • People will befriend you more readily when you share common bonds.
  • In public speaking, be brief, clear, relatable, engaging and direct. Repeat your most important points. Tell stories.
  • To inspire others to act, share what they “need to know,” show what they “need to see” and convey your passion about what they “need to feel.”

Summary

To Connect, You Must Communicate

How do you know when you’ve connected well with other people? They go out of their way for you. They speak favorably about you. They bond with you emotionally and communicate openly. They trust you. They exhibit positive energy toward you and enjoy being around you. Connecting meaningfully with others pays big dividends. People with warm connections face less conflict and enjoy their relationships more. However, forming such links with others requires cutting through the barrage of signals and messages that bombard everyone daily. That means becoming an effective communicator, a skill you can teach yourself – and you’ll be glad you learned it.

“Even if connecting with others isn’t something you’re good at today, you can learn how to do it and become better tomorrow.”

Warm connections depend on recognizing and acknowledging other people’s value. Take the focus off yourself and place it on others. Put your ego aside. Learn to work well with others. To connect with people, talk with them and center the conversation on their concerns, not yours. Try to build one-on-one relationships where some “90% of all connecting occurs.” Perfect your skills in this basic area. Then learn to connect with the members of groups and, finally, with people in an audience. This isn’t all easy, but it's essential.

“Connecting is the ability to identify with people and relate to them in a way that increases your influence with them.”

Consider how someone you are talking to would answer these questions about you:

  1. “Do you care for me?” – Demonstrate that you truly care about others. Stop fretting about your needs and pay attention to theirs.
  2. “Can you help me?” – Great salespeople live by this timeworn but true maxim: “Nobody wants to be sold, but everyone wants to be helped.” Instead of looking for people to help you, begin to help others.
  3. “Can I trust you?” – Love between people is vital, but trust is even more critical. You will never connect with anyone if you are untrustworthy.
“Connection always begins with a commitment to someone else.”

Your agenda is not important to other people, but your help promoting their agendas is. To get people on your side, quickly get on their side. Connecting is that simple, if you do it in a genuine, credible way. How you act is far more meaningful than what you say. In fact, words often have little to do with connecting. The impression you make depends, instead, on how much of yourself you reveal.

“People may hear your words, but they feel your attitude.”

Connecting positively has four components:

  1. “What people see: connecting visually” – What you look like is far more important than what you say. Dress nicely. Be well-groomed. Smile and use warm, likeable facial expressions. Stand up straight. Move with energy.
  2. “What people understand: connecting intellectually” – To connect well with others, relate authentic personal experiences they can share, feel and respect. Think of it this way: “When you find yourself, you find your audience.” Charles Laughton, a famous [mid-20th century] actor, once attended a Christmas party in London where the host asked everyone to recite a passage that represented the season. Laughton professionally recited Psalm 23 to warm applause. The next turn belonged to an elderly woman who was asleep in her chair in the corner. After her friends woke her up and told her what was going on, she sincerely, but quite unprofessionally, began to say the same psalm: “The Lord is my Shepherd, I shall not want...” When she finished, everyone was in tears. Why did her recitation provoke a stronger emotional reaction than the actor’s polished declamation? Laughton explained, “I know the psalm; she knows the Shepherd.”
  3. “What people feel: connecting emotionally” – Attitude makes one speaker more charismatic than the next. If you are caring and confident, people will be drawn to you.
  4. “What people hear: connect verbally” – Use positive words and use them well. Heed Mark Twain’s dictum: “The difference between the almost right word and the right word is really a large matter – it’s the difference between the lightning bug and the lightning.”

Expend the Energy to Connect

You need to exert genuine energy to connect with others. If you wait for them to move first, you will be alone. Instead of hoping for the perfect situation to arise for initiating a relationship, seize the moment. But don’t jump in; prepare what you’re going to do and say. Be patient and selfless.

“More than 90% of the impression we...convey has nothing to do with what we actually say.”

Apply the wisdom of Sam Walton’s “10-Foot Rule” to the people in your life. Walmart employees make this pledge based on Walton’s beliefs: “I solemnly promise and declare that every time a customer comes within 10 feet of me, I will smile, look him in the eye and greet him.” Spend your energy getting to know people, but don’t wear yourself thin. When you speak to an audience, the bigger it is, the more energy you must project. To communicate to a group of people, learn about them in advance. When you meet with them, introduce yourself to everyone. Understand that the group owns the meeting – not you. Tell people you appreciate them, whether you are dealing with one person, a small group or a large crowd. Make service your calling card.

“People don’t remember what we think is important; they remember what they think is important.”

Even if you are a compelling communicator, having solid relationships with respected people who can share their credibility with you is always a plus. That’s how U.S. television psychologist Dr. Phil McGraw became famous. He appeared on Oprah Winfrey’s talk show and she made it clear to her viewers that she thought well of him, so they, too, began to hold him in high regard. Of course, credibility doesn’t depend only on “who you know,” it also depends on “what you know” and what you achieve. Notable accomplishments draw acclaim and electrify connection.

Finding “Common Ground”

The best way to connect with others is to find common ground. To identify territory you share, learn more about the people you want to reach.

“The most called-upon prerequisite of a friend is an accessible ear.”

Unfortunately, some people find this difficult, often for one or more of these four reasons:

  1. “Assumption – I already know what others know, feel and want” – When you generalize, you often make errors. Don’t stereotype people and think that you have nothing to learn from them. Inevitably, human beings will surprise you.
  2. “Arrogance – I don’t need to know what others know, feel or want” – The core of building relationships is caring about others and trying to understand them.
  3. “Indifference – I don’t care to know what others know, feel or want” – People who feel this way focus only on themselves and can’t possibly connect with others. As comedian George Carlin quipped, “Scientists announced today that they had found a cure for apathy. However, they claim no one has shown the slightest bit of interest in it.”
  4. “Control – I don’t want others to know what I know, feel or want” – If you withhold yourself and your knowledge from your employees, expect morale to plunge. Heed author Jim Lundy’s “Subordinate’s Lament” about “the uninformed, working for the inaccessible...doing the impossible for the ungrateful.”
“Most people decide very quickly whether they will continue listening to you or simply ‘turn off’ and stop paying attention.”

Don’t make such mistakes. Spend time with others. Listen. Learn their interests; ask about their likes and dislikes. Show appreciation and demonstrate caring. Validate their feelings by telling them you often feel the same way. Show them that you are like them and that you’re on their side.

Using Clarity, Humor and a Smile

In The Power of Little Words, John Beckley writes, “The emphasis in education is rarely placed on communicating ideas simply and clearly...our schooling in English teaches us how to fog things up.” How true. Some people assume they must speak and write in a complicated fashion so that others will think they are intelligent and have something important to say. That is exactly backward. To communicate and connect, use easily understood thoughts and ideas. This sounds simpler than it is. As mathematician Blaise Pascal once admitted, “I have made this letter longer than usual because I lack the time to make it short.”

“Perhaps the most effective way to capture people’s interest and make the experience enjoyable when you talk is to include stories.”

To gain attention and regard, provide information and anecdotes that are funny, emotionally stirring, motivational or helpful. You want to make people laugh, tap into their feelings, inspire them and make their lives easier. To win others over, communicate with them according to the “3S strategy:

“I have a collection of laminated cards that contain the best stories I’ve found. When I pull out one of these cards [people] can be sure of four things: I will read them the card. It will be humorous. It will teach a point. And I will read it to them as if it is the first time I have ever read it.”

Keep it simple. Say it slowly. Have a smile.” Then follow these five guidelines:

  1. “Talk to people, not above them” – No one likes it when others are condescending.
  2. “Get to the point” – You have something to say, so say it.
  3. “Say it over and over and over and over again” – Otherwise, people will not recognize the value of what you want to communicate. Author Daniel Pink explains, “Three words are essential to connect with others: 1) brevity, 2) levity and 3) repetition.”
  4. “Say it clearly” – Don’t speak or write about something until you know your message. Your audience won’t take away what you tell them, but “what they understand.”
  5. “Say less” – No one ever wants a speaker to talk longer. Caught in a time jam as a speaker on a program that was already running late, author John C. Maxwell promised, “I’ll give my pizza speech. If I don’t deliver in less than 30 minutes, you don’t have to pay me.” And, he delivered.
“Cemetery communication: lots of people are out there, but nobody is listening.”

Engage listeners with lively “quotes, stories and illustrations.”

To energize your speeches:

  • “Take responsibility for your listeners” – The speaker and the writer are responsible for connecting with the audience. Historian and author Barbara Tuchman reminded herself of this daily by posting this question at her desk: “Will the reader turn the page?”
  • “Communicate in their world” – Be sure people can relate to your phrases and ideas.
  • “Capture people’s attention from the start” – And hold it. Avoid what presidential speechwriter Peggy Noonan calls “the hammock speech,” that is, a speech with “a nice strong tree holding it at one end...and at the other end...and in the middle, there is this nice soft section where we all fall asleep.”
  • “Activate your audience” – Ask questions, get people to engage with each other (they could all shake hands) and urge them to do something physical (“stand and stretch”).
  • “Say it so it sticks” – Offer vital information, original ideas, startling data and humor.
  • “Be visual” – Use gestures, props and engaging expressions to be interesting to watch.
  • “Tell stories” – Sharing great stories is the best way to hold people’s attention.
“As time goes by, the way people live outweighs the words they use.”

Another way to connect positively with people is to motivate them. Use the “Inspiration Equation” to stir them to take meaningful action.

This formula has three elements:

  1. “What people need to know” – This is crucial. Show others that you are on their side and care about them, that they matter to you and that you expect big things from them.
  2. “What people need to see” – Demonstrate your conviction, character and credibility.
  3. “What people need to feel” – Be confident and passionate about your subject. Demonstrate your gratitude for having the privilege of speaking to your audience.

“You Are Your Message”

When you first start to build a connection with people, either in a one-on-one relationship or in a group, how you communicate makes all the difference. Once they know you, credibility will become the most vital factor in maintaining your bonds with them. When Senator Barack Obama campaigned in 2008, everyone could see that he was a strong communicator who had the ability to connect with people across the United States. As president, his credibility as a national leader is far more important than his communication skills. The same is true of you: Once you establish a connection, you must maintain people’s trust. The best way to ensure that others find you trustworthy is to connect with yourself, learn to rely on yourself and be comfortable with caring about yourself. Others will not like you if you do not like yourself. Be accountable for your actions. Always “live what you communicate.”

About the Author

John C. Maxwell is an evangelical Christian pastor, speaker and author, who has sold more than 18 million books in more than 50 languages. He is the author of Developing the Leader Within You and The 21 Irrefutable Laws of Leadership, among many other books.


Read summary...
Everyone Communicates, Few Connect

Book Everyone Communicates, Few Connect

What the Most Effective People Do Differently

HarperCollins Leadership,


 



14 July 2025

How Markets Fail

Recommendation

Adam Smith laid the intellectual foundation for free enterprise in his widely hailed 1776 book, The Wealth of Nations, but he also supported tight regulation of banks to suppress speculation and stabilize credit, a message most modern-day free market advocates have overlooked. Journalist John Cassidy’s thorough review of the events leading up to the 2008 financial crisis underscores how strict application of “utopian economics” can lead to disaster. He makes a strong argument for incorporating “reality economics” into the US’s supervision of the financial system. BooksInShort recommends this weighty book to readers with a background in finance and to those interested in how free markets can coexist – and stabilize – with judicious government oversight.

Take-Aways

  • The boom-and-bust financial sector of the economy defies the theories of free markets and market equilibrium.
  • Recent events challenge the belief that unrestricted markets tend toward stability.
  • Economist Adam Smith extolled free enterprise but encouraged bank regulation.
  • Increases in the prices of financial assets compound, rather than reduce, public demand for them.
  • “Rational irrationality” reigns when individual incentives undermine a group’s best interests. For instance, it explains why investors withdraw their deposits in a bank run.
  • The financial crisis of 2008 upended the notion that removing regulatory restraints – like Glass-Steagall – from financial institutions is socially beneficial.
  • Deregulation encouraged commercial and investment banks to amass riskier assets.
  • Private credit-rating agencies have replaced government agencies as bank monitors.
  • Former US Federal Reserve chairman Alan Greenspan backed financially destabilizing public policies.
  • The Fed should ensure financial stability, not just stable prices and labor demand.

Summary

Theory and Reality in the Financial Industry

Few government regulators foresaw the financial crisis that peaked in 2008 when investment bank Lehman Brothers filed for bankruptcy. The Lehman insolvency panicked banks around the world, withered their willingness to lend and deepened an economic recession that was already underway. The financial crisis surprised even powerful central bankers: Neither former US Federal Reserve Board chairman Alan Greenspan nor Ben Bernanke, who succeeded Greenspan in 2006, predicted the collapse in home prices that led to the “Great Crunch” in credit availability.

“Once a bubble begins, free markets can no longer be relied on to allocate resources sensibly or efficiently.”

By 2008, a sharp increase in mortgage loan defaults had popped a massive bubble of inflated US home prices, undoing widespread faith that the value of residential real estate could only rise. Lehman and many other financial institutions got into trouble because they had purchased too many securities bundled with subprime mortgages that were in default. Overnight lending between banks plunged because financial executives were uncertain about other institutions’ exposure to the mortgage mess. These financiers lacked a clear idea of the worth of their own subprime mortgage securities, let alone those belonging to other banks.

“The notion of financial markets as rational and self-correcting mechanisms is an invention of the last 40 years.”

Credit availability gradually improved after the government intervened, recapitalizing and restructuring many of the US’s largest financial institutions and thus stabilizing the financial environment and preventing the 2008 crisis from becoming a full-blown catastrophe. The turmoil seemed to have been unpredictable – largely because it contradicted conventional views of the economy. In mainstream economic theory, buyers and sellers who face few transaction obstacles compose a “free market.” They make decisions in a theoretical commercial environment free of government interference, the burden of missing data and the risk of exogenous threats. The theoretical free market constantly heads toward equilibrium – a virtuous model of efficiency that uses price increases and decreases to adjust the supply of anything to suit the public’s appetite for it until supply equals demand.

“Just because central planning failed, it doesn’t necessarily follow that markets always get things right.”

However, the boom-and-bust financial sector of the economy defies the theory of market equilibrium. For example, while the theory holds that a price increase tends to cut the sales of any good or service, a rise in the price of a financial asset may actually increase the number of investors who want to buy it, further inflating the price. This particular proclivity toward disequilibrium is a “herding” response, one of the everyday realities of financial markets that classic economic theory fails to capture. The problem is more than just academic. The common belief that all markets, including financial ones, tend toward a state of equilibrium has resulted in misguided public policy. Indeed, a major cause of the 2008 crisis was the multiphased deregulation of the US financial industry that began in the second half of the 20th century, when the free market doctrine became widely accepted.

The Invisible Hand of Speculation

Scottish economist Adam Smith was one of history’s most influential promoters of the free market doctrine. In his acclaimed book on capitalism, The Wealth of Nations, published in 1776, Smith memorably compared the dynamic of an open, unplanned economy to a benevolent “invisible hand” that moves markets toward states of equilibrium, adjusting supply and demand through price changes. But Smith was wary of speculative excesses in financial markets, and he advocated limits to banks’ freedom. Some of Smith’s modern-day supporters who have used his insights as a pretext for deregulation overlooked his concern about the risk of lax banking regulation. He advocated government intervention to deter financial frauds and panics.

“The proper role of statistical models is as a useful adjunct to an overall strategy of controlling risk, not as a substitute for one.”

Smith believed that banning banks from issuing interest-bearing notes to “speculative lenders” would halt recurring gaps in credit availability. While he also wrote that such a ban could be considered “a violation of natural liberty,” he added, “but these exertions of the natural liberty of a few individuals...might endanger the security of the whole society.”

Setting the Financial Industry Loose

As the 20th century progressed, lawmakers deregulated banks and other types of financial institutions and thus relaxed the US government’s grip on the banking system. But proponents of free markets underestimated the destabilizing potential of setting the financial industry loose.

“In the best 19th-century tradition, the housing bubble and the subprime craze would be allowed to run their course.”

The 1980 enactment of the Depository Institutions Deregulation and Monetary Control Act removed regulatory caps on the interest rates that banks could pay depositors. The law injected free market competition into the market for bank deposits, but it also motivated banks to put money into loans and other assets with higher returns, which meant taking greater risks. In 1999, federal lawmakers repealed the 1933 Glass-Steagall Act, which had prevented deposit-taking banks from engaging in investment activities such as selling bonds, stocks and other securities. Even though housing prices hit a long-term peak in 2006, financial deregulation continued apace. The US Congress passed the Financial Services Regulatory Relief Act of 2006, lowering banks’ minimum capital requirements.

“There is now a wealth of evidence from all around the world that the existence of deposit insurance encourages banks to take bigger risks and raises the probability of financial crises occurring.”

Over the two decades prior to 2000, the US and many other countries also started requiring banks to adjust their capital based on the credit ratings of the securities they owned. As a result of these public policy changes, the three major credit rating agencies Fitch, Moody’s, and Standard & Poor’s replaced government regulators as the leading examiners of banks and their balance sheets. But because these three agencies get their income from the debt issuers they rate, the agencies’ efforts to please their clients can reduce the reliability of their ratings. Allowing issuers of debt securities to pay for credit ratings causes “inherent conflicts of interest.”

“One of the key assumptions of the free market model is that everybody has all the information they need to make the right decisions.”

Unfettered product innovation, which usually benefits society, proved disastrous in the mortgage business. New, riskier types of mortgage loans to subprime borrowers were among the leading culprits in the 2008 financial crisis and its recessionary aftermath. Lenders made “stated-income” mortgage loans based on borrowers’ unverified statements about their personal income. Another risk-filled innovation – the “option ARM,” an adjustable-rate mortgage – gave borrowers the choice to pay only part of the interest on their loans, thereby inflating their principal balances.

“During a speculative bubble, the laws of supply and demand don’t get repealed, but they do get suspended.”

The intrinsic risks in option ARMs and stated-income loans, also known as “liar loans,” did not deter lenders, because investment banking firms had developed a vast secondary market for such packages. Instead of holding these dubious loans, lenders sold them to investment firms. Wall Street packaged the loans as interest-bearing securities and resold them to American and global investors, usually after obtaining a top credit rating for each issue from the rating agencies. Unfortunately, the long upward trend in housing prices apparently blinded the agencies to the possibility of a national collapse in residential real estate. Prior downturns in the US housing market had been confined to individual regions, but the drop that began in 2006 was national; risky mortgage practices had spread across the country, not just to a cluster of states.

The Greenspan Effect

Alan Greenspan did more than any other individual to create the conditions for “letting the hogs run wild.” As Fed chairman from 1987 to 2006, Greenspan encouraged a borrowing binge by keeping interest rates very low – below 2.5% – in the final years of his tenure. In addition, he long championed a laissez-faire environment of slack regulatory oversight. In 1999, for example, Greenspan criticized the Glass-Steagall Act and its wall between commercial and investment banking as an “archaic” regulatory arrangement that blocked financial services from operating in a free market. Greenspan believed that, compared to government agencies, banks could do a better job of assessing each other’s solvency because they conduct so many open-market transactions with one another. By the time Ben Bernanke succeeded him, Greenspan had presided over a massive accumulation of debt. Together, low interest rates and financial deregulation did more to expand credit availability than either development could have done alone. In 2006, total US indebtedness was almost four times the country’s GDP.

Game Theory and “Rational Irrationality”

Empirical research says stock prices exhibit momentum, tending to move in the same direction, up or down, over short time periods. Many investors decide to invest or divest based on stocks’ momentum, buying them as they appreciate and selling them as prices fall. This “rational herd behavior” happens because momentum often is a reliable short-term indicator of stock price direction. Yet this phenomenon pokes holes in the “efficient market hypothesis,” the free market theory that says stock prices are always and only a reflection of all the known information about those publicly traded securities.

“Wall Street and Main Street, for all their mutual suspicion, are locked in a symbiotic embrace.”

Herd behavior among investors also can distort price signals. For example, the 129% increase in average US home prices from 1996 to 2006 indicated a demand for residential real estate greater than population or income growth. Before the long-held myth of perpetual property appreciation finally faded, it helped to sustain a massive market failure in which banks made mortgage loans to borrowers who were unable to repay, construction companies built homes no one wanted to buy and investment firms peddled mortgage securities no one could resell.

“A new way of thinking about economics has to be articulated as a replacement for utopian economics – an economic philosophy that acknowledges the usefulness of markets but also their limitations.”

Game theory may elucidate economic phenomena that the free market doctrine cannot explain. Consider the game that depositors must play if they suspect their bank is nearly insolvent. They may want to withdraw their money, but if all of them do so at the same time, the bank will fail. If all of them leave their deposits untouched, the bank will remain solvent. But the self-interest of each depositor dictates withdrawal, so a fatal run on the bank is the most likely outcome. In this rational irrationality, individuals sometimes make logical decisions that serve their self-interest but produce disastrous results for the group as a whole. The prevalence of rational irrationality is an element of “reality-based economics” that conflicts with free market “utopian economics.”

“The idealized free market is a fiction, an invention: It never existed, and it never will exist.”

Rational irrationality helps illustrate how the investment bank Bear Stearns folded in early 2008. Counterparties that lent to the firm accepted risky mortgage securities as collateral. But once lenders began to have doubts about the value of Bear’s securities, so many of them withdrew funding from Bear at the same time that they forced the investment banking firm into a government-assisted merger with JPMorgan Chase in March 2008.

A Need for Tighter Financial Regulation

Regulatory intervention in March 2008 kept the financial problems at Bear Stearns from spreading rapidly to the rest of the economy. The Fed made a $13 billion loan to Bear through JPMorgan Chase by invoking its seldom-used authority to lend money to any type of business “under unusual and exigent circumstances.” Bear had borrowed heavily from money market mutual funds, so the unimpeded collapse of the investment firm could have caused the failure of many such funds, thus harming countless individual investors.

“The proper role of the financial sector is to support innovation and enterprise elsewhere in the economy. But during the past 20 years, it has grown into Frankenstein’s monster, lumbering around and causing chaos.”

Yet only six months later, the Fed and the US Treasury handled similar problems at Lehman very differently. Rather than save Lehman from insolvency, regulatory authorities allowed the market to determine its fate. After free market forces led Lehman into bankruptcy and spawned a global slump in lending, US regulators changed course and intervened to rescue AIG. They publicly promised that the government would prevent any systemically important financial institution from failing.

“It is essential to put Wall Street in its place and to confront utopian economics with reality-based economics.”

Critics assail this “too big to fail” policy as an assault on the free market doctrine. But this type of government procedure is justified; constraining financiers’ speculative impulses warrants further regulatory intervention in the financial services industry. For example, a new regulatory regime could revive the market for mortgage-backed securities, but lenders that sell loans into the secondary market would have to keep on their books a large portion of the mortgages they originate to maintain the integrity of their loan portfolios.

Lawmakers also should expand the Fed’s “dual mandate” – to strive for “maximum sustainable employment and price stability” – to encompass a third objective: “preservation of financial stability.” Without significant regulatory reforms, rational irrationality will continue to create calamities in the financial sector that spill into the rest of the economy.

About the Author

John Cassidy is a British-American journalist and author. He writes for The New Yorker and contributes to The New York Review of Books. He is the author of Dot.con: How America Lost Its Mind and Money in the Internet Era.


Read summary...
How Markets Fail

Book How Markets Fail

The Logic of Economic Calamities

Penguin,


 




All Articles
Load More