What Caused the Financial Crisis presents the most comprehensive account I have seen of the regulations that, when considered as a whole, have incentivized unprecedented self-delusion and risk-taking in the subprime mortgage market. To put it in a manner that financial advisors will understand, the book shows that the policies and regulations greatly increased the Sharpe ratio of the financial industry – they increased the return for taking risk.

The book is a collection of essays on the financial crisis edited by Jeffrey Friedman, a visiting scholar in the Department of Government at the University of Texas at Austin. It is a republication of the June 2009 issue of Critical Review, a scholarly journal Friedman edits. Most of it is not particularly easy reading; but thankfully it’s not in the impenetrable prose and dense mathematics you see in many scholarly economics journals these days. Because so many of its essayists are economists – 17 of 20 have economics PhDs – and because readers would be largely economists too, the book at times reads like a private post-mortem among players who lost a game.

Many books have been written about the financial crisis since 2008. This book, with a 2011 publication date, is only one of the most recent, and yet its editor boasts that it is “the first collection of scholarly essays devoted entirely to the question of what caused the financial crisis of 2008.” This smacked of academic arrogance to me – as if no previous work had been scholarly?

Nevertheless, I’m inclined to agree – in a specific, limited way – with its editor’s assessment that this volume “brings us much closer to a comprehensive answer” to its central question.

Don’t expect to find in this book reconstructed boardroom palaver or office, restaurant, phone or email chats between CEOs or between CEOs and their top executives. It’s not “The Big Short;” its not that kind of book at all. And Friedman made a point of steering his authors away from anything approaching policy advocacy – its intent is retrospective. But none of this means that the book steers clear of controversy, dissent and criticism – far from it, as we’ll soon see.

The fluid dynamics interpretation of history

The style guidelines do somehow result, however, in many of the essays taking a peculiar view of the interpretation of history. Let’s call it the “fluid dynamics” approach.

In fluid dynamics one specifies the containers, conduits, sources and receptacles. Then based on these, and the influxes, and the physical nature of the fluid or gas, one can calculate the pressures and flows.

The fluid is, in short, expected to obey aggregate physical laws, even though each individual molecule may be going this way or that at any moment. For example one can predict the pressure exerted in aggregate on a containing vessel, even though almost half the molecules in the vicinity of the containing walls are not exerting any pressure on it at all.

For many of the essayists in “What Caused the Financial Crisis”, regulations and government policy –motivated by economic theory or politics – constitute the containing structure, while all other economic actors (for example bankers, and even ratings agencies) are the fluid. The fluid only does what it must do given its containers and conduits. Hence, if something goes wrong, it is by implication the fault of the containing structures.