Economic & Market Myths

• The 2008 crisis made it clear that

some of our assumptions about

economics and the markets are wrong.

• Crises are always a test of what we

know.

• It’s time for journalists to start writing

about our misunderstandings.

Markets are Efficient-Not!

• Information was not a variable in

classical econometrics.

• Assumption: Information spreads

uniformly to market players.

• If true, we’d be out of a job!

• Game theory, decision-making theory

make information a financial variable.

• See work of John Nash (Nobel winner),

Mandelbrot on fractal behavior.

Markets Are Rational-Not!

• Daniel Kahneman, Vernon Smith, 2002

Nobel Prize.

• Even with complete info, humans take

shortcuts, make bad assumptions.

• “It’s different this time.”

• Housing prices will rise forever!

• See patterns where none exists.

• Game theory applied here, too.

Self-Regulation Works-Not!

• Rollback of key laws helped crisis occur.

• Until 1999, U.S. banks restricted in their

ability to speculate in markets.

• Glass-Steagall suspended.

• Derivatives deregulated.

• Basel rules of BIS: a disaster so far?

• Ratings agencies: a joke.

• How to regulate without killing

innovation?

Formulas Can Set Values-Not!

• Long-Term Credit Management failure.

• Myron Scholes & Robert Merton.

• Nobel Prize for derivative valuation.

• Lost $4.8 billion in 1998, saved by Fed.

• No market, no good valuation.

• Current ABS, swaps, etc.: no market.

• Buffett: “If you want to know what.

something’s worth, sell a piece of it.”

Economies Can Be Guided-Not!

• Greenspan on current crisis: I was

wrong.

• Central banks try to smooth cycles.

• The cycle seems to always reimpose

itself, as now.

• Too many variables.

• No global regulators-nations at odds.

• Current protectionist problems.

Assets Uncorrelated-Not!

• Modern portfolio theory: reduce risk by

having uncorrelated assets.

• Mix of stocks, bonds, commodities, etc.

• Sometimes everything moves together.

• Gold and dollar tracked each other.

• Treasurys and gold tracked.

• Gold and oil delinked.

• See William Sharpe, Stanford economist.

Spread Risk, Reduce It-Not!

• CDOs spread debt risk among thousands

of buyers. Supposed to cut risk.

• Hasn’t worked.

• No one can tell what’s inside them.

• Rating agency formulas useless.

• Buyer’s strike closes down market.

• Spreading risk did not affect collapse

of these instruments.

“Buy and Hold” Works-Not!

• “Secular uptrend” is REALLY long-term.

• 10 years of gains wiped out.

• Traders, short-sellers, market timers

have lower losses, some gains.

• Mutual fund (unit trust) managers have

failed their clients.

• Long term works only if you never die!

• What will replace this strategy?

Economics Gets All Costs-Not!

• “Mechanism design theory.”

• Externalities: not in the equation.

• Tribal people, laid-off workers,

carbon emissions.

• Supply, demand & those who get

screwed out of the equation.

• See Hurwicz, Maskin, Meyerson, 2007

Nobel Prize.

Capitalism=Democracy-Not!

• Noncapitalist countries have had fastest

growth rates for years.

• Singapore, China are stark examples.

• Commission on Growth & Development.

• High growth: credible government, high

savings rate, played into world economy,

stability, flexible home markets.

• Most not democracies; China is model?

Euro Crisis: More of Same

• Greece: Failure to observe Euro rules,

low economic output, low exports.

• Spain: Real estate bust, weak banks.

• Italy: Huge debt, inadequate revenue.

• Continuation of 2008 crisis.

• QE everywhere.

• Governments resist fiscal measures.

• Rest of world beginning to falter?

Let’s Report It

• Much of our reporting has latent, untrue

assumptions.

• Challenge sources on markets.

• Reinforce uncertainty—the real state of

things

• Report, write what you don’t understand.