Robert Shiller

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Capital Ideas Evolving by Peter L. Bernstein

Albert Einstein, algorithmic trading, Andrei Shleifer, asset allocation, business cycle, buy and hold, buy low sell high, capital asset pricing model, commodity trading advisor, computerized trading, creative destruction, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, diversification, diversified portfolio, endowment effect, equity premium, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, high net worth, hiring and firing, index fund, invisible hand, Isaac Newton, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Arrow, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, market bubble, mental accounting, money market fund, Myron Scholes, paper trading, passive investing, Paul Samuelson, price anchoring, price stability, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, statistical model, survivorship bias, systematic trading, technology bubble, The Wealth of Nations by Adam Smith, transaction costs, yield curve, Yogi Berra, zero-sum game

Certainty in responses to questions does not exist. Leibniz’s admonition—“but only for the most part”—and Lo’s interjection of “but not necessarily”—explains why there is such a thing as risk in the first place. Without that qualification, everything would be predictable, and change would be impossible in a world where every event is identical to some previous event.2 bern_c06.qxd 3/23/07 9:03 AM Page 65 6 Robert Shiller The People’s Risk Manager rofessor Robert Shiller of the Cowles Foundation at Yale looks much too young to have earned his Ph.D. at MIT over thirty years ago, while working with Paul Samuelson and Franco Modigliani. During those thirty years, he has managed to publish over 200 papers and five books, including the worldwide best seller, Irrational Exuberance. All of this mountain of material is about finance. “Finance is like the lifeblood of the economy,” he points out.

HG173.B473 2007 658.15—dc22 2006102237 Printed in the United States of America. 10 9 8 7 6 5 4 3 2 1 bern_a01ffirs.qxd 3/23/07 11:19 AM Page v For Barbara With love, gratitude, and cheers bern_a01ffirs.qxd 3/23/07 11:19 AM Page vi bern_a02ftoc.qxd 3/23/07 8:42 AM Page vii Contents Preface A Note on Usage ix xxii PART I: THE BEHAVIORAL ATTACK 1. Who Could Design a Brain . . . 2. The Strange Paradox of Behavioral Finance: “Neoclassical Theory Is a Theory of Sharks” 3 19 PART II: THE THEORETICIANS 3. Paul A. Samuelson: The Worldly Philosopher 37 The Institutionalists 4. Robert C. Merton: “Risk Is Not an Add-On” 5. Andrew Lo: “The Only Part of Economics That Really Works” 6. Robert Shiller: The People’s Risk Manager 47 58 65 The Engineers 7. Bill Sharpe: “It’s Dangerous to Think of Risk as a Number” vii 91 bern_a02ftoc.qxd 3/23/07 8:42 AM Page viii viii CONTENTS 8. Harry Markowitz: “You Have a Little World” 9. Myron Scholes: “Omega Has a Nice Ring to It” 100 110 PART III: THE PRACTITIONERS 10. Barclays Global Investors: “It Was an Evangelical Undertaking” 11. The Yale Endowment Fund: Uninstitutional Behavior 12.

. † All material in quotation marks is from an interview, unless otherwise indicated. bern_c03.qxd 3/23/07 9:01 AM Page 39 Paul A. Samuelson 39 Ever the economist, Samuelson has mixed feelings about Behavioral Finance, which he wryly def ined to me as “the study of people not doing the most rational thing as judged by assistant professors of f inance.” Nevertheless, Samuelson’s connection with Behavioral Finance is far from casual. As Robert Shiller of Yale has pointed out in a recent paper, “This is a good occasion to recall that [Samuelson] was in an important sense one of the originators of the canonical intertemporal model that underlies much of the theory of neoclassical f inance, but also, at the same time, anticipated a good deal of the progress of behavioral f inance. This means that both maximizing f inance and behavioral f inance were born together, are sisters.”2 As an example, Shiller cites Samuelson’s classic paper published in 1937, “A Note on Measurement of Utility,” in which Samuelson argues that people are not time-consistent.3 Aware of that weak point, they often try to control themselves with decisions designed to bind their future, such as the “behavior of men who make irrevocable trusts, in taking out life insurance as a compulsory savings measure.”* Samuelson admires Kahneman but considers much of the work in the area as “a lot of noise.”


pages: 1,088 words: 228,743

Expected Returns: An Investor's Guide to Harvesting Market Rewards by Antti Ilmanen

Andrei Shleifer, asset allocation, asset-backed security, availability heuristic, backtesting, balance sheet recession, bank run, banking crisis, barriers to entry, Bernie Madoff, Black Swan, Bretton Woods, business cycle, buy and hold, buy low sell high, capital asset pricing model, capital controls, Carmen Reinhart, central bank independence, collateralized debt obligation, commoditize, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, deglobalization, delta neutral, demand response, discounted cash flows, disintermediation, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, framing effect, frictionless, frictionless market, G4S, George Akerlof, global reserve currency, Google Earth, high net worth, hindsight bias, Hyman Minsky, implied volatility, income inequality, incomplete markets, index fund, inflation targeting, information asymmetry, interest rate swap, invisible hand, Kenneth Rogoff, laissez-faire capitalism, law of one price, London Interbank Offered Rate, Long Term Capital Management, loss aversion, margin call, market bubble, market clearing, market friction, market fundamentalism, market microstructure, mental accounting, merger arbitrage, mittelstand, moral hazard, Myron Scholes, negative equity, New Journalism, oil shock, p-value, passive investing, Paul Samuelson, performance metric, Ponzi scheme, prediction markets, price anchoring, price stability, principal–agent problem, private sector deleveraging, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Robert Shiller, Robert Shiller, savings glut, selection bias, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stochastic volatility, stocks for the long run, survivorship bias, systematic trading, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs, tulip mania, value at risk, volatility arbitrage, volatility smile, working-age population, Y2K, yield curve, zero-coupon bond, zero-sum game

Campbell, John Y.; Andrew W. Lo; and A. Craig MacKinlay (1997), The Econometrics of Financial Markets, Princeton, NJ: Princeton University Press. Campbell, John Y.; and Robert J. Shiller (1988), “Stock prices, earnings and expected dividends,” Journal of Finance 43(3), 661–676. Campbell, John Y.; and Robert J. Shiller (1991), “Yield spreads and interest rate movements: A bird’s eye view,” Review of Economic Studies 58, 495–514. Campbell, John Y.; and Robert J. Shiller (1998), “Valuation ratios and the long-run stock market outlook,” Journal of Portfolio Management 24(2), 11–26. Campbell, John Y.; Robert J. Shiller; and Luis M. Viceira (2009), “Understanding inflation-indexed bond markets,” Brookings Papers on Economic Activity (Spring), 79–120. Campbell, John Y.; Adi Sunderam; and Luis M.

Earlier data estimates are available for U.S. house prices but not for commercial real estate. The best known series is the composite real house price series since 1890 that Robert Shiller and Karl Case created from various data sources (see Figure 11.3). Shiller’s result has been summarized as saying that house prices barely kept up with inflation, except for the bubble runup. This finding is surprising but consistent with other evidence that Manhattan (Amsterdam) land in a great location barely maintained its real value over 100 (400) years. Figure 11.3. Real house prices estimated by Robert Shiller, 1890–2010. Source: Robert Shiller’s website. Net real house price appreciation (HPA) was minimal over the 120-year window (0.3% per annum) but there were two big rallies—the late 1940s (due to the postwar return of soldiers) and the early 2000s—and two big falls—a real fall during the 1910s inflation and the recent crunch.

These relations normalized so much during the year that by early 2010 no glaring market opportunities were evident. There are of course many other ways to predict asset returns—to be discussed in Sections 8.6, 9.6, and 24.4—but the contrarian approach shows promise and at least seems to do better than extrapolating long-run past returns. For an example popularized by Robert Shiller and John Campbell, Figure 2.8 shows how well smoothed earningsFigure 2.8. Valuation ratios have been good predictors of subsequent multi-year equity market return. Sources: Robert Shiller’s website, Kenneth French’s website. yields (the inverse of the P/E ratio, with 10-year average trailing earnings used instead of current year earnings, adjusted for inflation) have been able to predict subsequent multi-year equity market returns [5]. 2.4 NOTES [1] The venture capital (VC) asset class shows the highest average returns, perhaps partly reflecting various biases.


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Irrational Exuberance: With a New Preface by the Author by Robert J. Shiller

Andrei Shleifer, asset allocation, banking crisis, Benoit Mandelbrot, business cycle, buy and hold, computer age, correlation does not imply causation, Daniel Kahneman / Amos Tversky, demographic transition, diversification, diversified portfolio, equity premium, Everybody Ought to Be Rich, experimental subject, hindsight bias, income per capita, index fund, Intergovernmental Panel on Climate Change (IPCC), Joseph Schumpeter, Long Term Capital Management, loss aversion, mandelbrot fractal, market bubble, market design, market fundamentalism, Mexican peso crisis / tequila crisis, Milgram experiment, money market fund, moral hazard, new economy, open economy, pattern recognition, Ponzi scheme, price anchoring, random walk, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, Small Order Execution System, spice trade, statistical model, stocks for the long run, survivorship bias, the market place, Tobin tax, transaction costs, tulip mania, urban decay, Y2K

Michael Brennan, “Stripping the S&P 500,” Financial Analysts’ Journal, 54(1) (1998): 14. 29. Robert Shiller, Macro Markets: Creating Institutions for Managing Society’s Largest Economic Risks (Oxford: Oxford University Press, 1993). I have been working with my colleague Allan Weiss and others at my firm, Case Shiller Weiss, Inc., to develop certain of these new markets. See Karl E. Case, Robert J. Shiller, and Allan N. Weiss, “Index-Based Futures and Options Trading in Real Estate,” Journal of Portfolio Management, 19(2) (1993): 83–92; Robert J. Shiller and Allan N. N O TE S TO PAG E S 230–232 267 Weiss, “Home Equity Insurance,” Journal of Real Estate Finance and Economics, 19 (1999): 21–47; and Robert J. Shiller and Allan N. Weiss, “Moral Hazard in Home Equity Conversion,” forthcoming in Real Estate Economics (2000). 30.

Irrational Exuberance This page intentionally left blank Irrational Exuberance Robert J. Shiller Princeton University Press Princeton, New Jersey Copyright © 2000 Robert J. Shiller Published by Princeton University Press, 41 William Street, Princeton, New Jersey 08540 In the United Kingdom: Princeton University Press, Chichester, West Sussex All Rights Reserved Library of Congress Cataloging-in-Publication Data Shiller, Robert J. Irrational exuberance / Robert J. Shiller. p. cm. Includes bibliographical references and index. ISBN 0-691-05062-7 (cloth : alk. paper) 1. Stocks—United States. 2. Stock exchanges—United States. 3. Stocks—Prices—United States. 4. Risk. 5. Dow Jones industrial average. I. Title. HG4910.S457 2000 332.63'222'0973—dc21 99-088869 This book has been composed in Adobe Palatino and Berkeley Old Style Book and Black by Princeton Editorial Associates, Inc., Scottsdale, Arizona, and Roosevelt, New Jersey The paper used in this publication meets the requirements of ANSI/NISO Z39.48-1992 (R1997) (Permanence of Paper) http://pup.princeton.edu Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 To Ben and Derek This page intentionally left blank Contents List of Figures and Tables Preface Acknowledgments One ix xi xix The Stock Market Level in Historical Perspective 3 Part One Structural Factors Two Three Precipitating Factors: The Internet, the Baby Boom, and Other Events Amplification Mechanisms: Naturally Occurring Ponzi Processes 17 44 Part Two Cultural Factors Four Five Six The News Media New Era Economic Thinking New Eras and Bubbles around the World vii 71 96 118 viii C ONT ENTS Part Three Psychological Factors Seven Eight Psychological Anchors for the Market Herd Behavior and Epidemics 135 148 Part Four Attempts to Rationalize Exuberance Nine Ten Efficient Markets, Random Walks, and Bubbles Investor Learning—and Unlearning 171 191 Part Five A Call to Action Eleven Speculative Volatility in a Free Society Notes References Index 235 269 283 203 Figures and Tables Figures 1.1 1.2 1.3 9.1 Stock Prices and Earnings, 1871–2000 Price-Earnings Ratio, 1881–2000 Price-Earnings Ratio as Predictor of Ten-Year Returns Stock Price and Dividend Present Value, 1871–2000 6 8 11 186 Tables 6.1 6.2 6.3 6.4 Largest Recent One-Year Real Stock Price Index Increases Largest Recent One-Year Real Stock Price Index Decreases Largest Recent Five-Year Real Stock Price Index Increases Largest Recent Five-Year Real Stock Price Index Decreases ix 119 120 121 122 This page intentionally left blank Preface T his book is a broad study, drawing on a wide range of published research and historical evidence, of the enormous recent stock market boom.

Campbell, John Y., Andrew Lo, and Craig Mackinlay. The Econometrics of Financial Markets. Princeton, N.J.: Princeton University Press, 1997. Campbell, John Y., and Robert J. Shiller. “The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors.” Review of Financial Studies, 1 (1988): 195–228. ———. “Valuation Ratios and the Long-Run Stock Market Outlook.” Journal of Portfolio Management, 24 (1998): 11–26. 272 R EFER ENC ES Case, Karl E., Jr., and Robert J. Shiller. “The Behavior of Home Buyers in Boom and Post-Boom Markets.” New England Economic Review, November-December 1988, pp. 29–46. Case, Karl E., Robert J. Shiller, and Allan N. Weiss. “Index-Based Futures and Options Trading in Real Estate.” Journal of Portfolio Management, 19(2) (1993): 83–92. Chevalier, Judith, and Glenn Ellison.


pages: 461 words: 128,421

The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street by Justin Fox

activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, bank run, beat the dealer, Benoit Mandelbrot, Black-Scholes formula, Bretton Woods, Brownian motion, business cycle, buy and hold, capital asset pricing model, card file, Cass Sunstein, collateralized debt obligation, complexity theory, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, discovery of the americas, diversification, diversified portfolio, Edward Glaeser, Edward Thorp, endowment effect, Eugene Fama: efficient market hypothesis, experimental economics, financial innovation, Financial Instability Hypothesis, fixed income, floating exchange rates, George Akerlof, Henri Poincaré, Hyman Minsky, implied volatility, impulse control, index arbitrage, index card, index fund, information asymmetry, invisible hand, Isaac Newton, John Meriwether, John Nash: game theory, John von Neumann, joint-stock company, Joseph Schumpeter, Kenneth Arrow, libertarian paternalism, linear programming, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, market bubble, market design, Myron Scholes, New Journalism, Nikolai Kondratiev, Paul Lévy, Paul Samuelson, pension reform, performance metric, Ponzi scheme, prediction markets, pushing on a string, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Richard Thaler, risk/return, road to serfdom, Robert Bork, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, shareholder value, Sharpe ratio, short selling, side project, Silicon Valley, Social Responsibility of Business Is to Increase Its Profits, South Sea Bubble, statistical model, stocks for the long run, The Chicago School, The Myth of the Rational Market, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, Thomas L Friedman, Thorstein Veblen, Tobin tax, transaction costs, tulip mania, value at risk, Vanguard fund, Vilfredo Pareto, volatility smile, Yogi Berra

Siegel, Stocks for the Long Run, 2nd ed. (New York: McGraw-Hill, 1998), 45. 13. Pablo Galarza, “It’s Still Stocks for the Long Run,” Money, Dec. 2004. 14. Robert J. Shiller, “Price-Earnings Ratios as Forecasters of Returns: The Stock Market Outlook in 1996,” paper posted on Shiller’s Web site, July 21, 1996, www.econ.yale.edu/%7Eshiller/data/peratio.html. The original paper was John Y. Campbell and Robert J. Shiller, “Stock Prices, Earnings, and Expected Dividends,” Journal of Finance (July 1988): 661–76. 15. Alan Greenspan, The Age of Turbulence (New York: Penguin, 2007), 176–79. 16. J. Bradford DeLong and Konstantin Magin, “Contrary to Robert Shiller’s Predictions, Stock Market Investors Made Much Money in the Past Decade: What Does This Tell Us?” Economists’ Voice (July 2006). 17. “Volatility in U.S. and Japanese Stock Markets: Selections from the First Annual Symposium on Global Financial Markets,” Journal of Applied Corporate Finance, Spring 1992: 4–35.

Arjo Klamer, Conversations with Economists: New Classical Opponents and Their Opponents Speak Out on the Current Controversy in Macroeconomics (Totowa, N.J.: Rowman & Allanheld Publishers, 1984), 223. 14. This work is described in chapter 13, “Bond Market Volatility: An Introductory Survey,” of Robert J. Shiller, Market Volatility (Cambridge, Mass.: MIT Press, 1989), 219–36. The best known of his papers on the subject was “The Volatility of Long-Term Interest Rates and Expectations Models of the Term Structure,” Journal of Political Economy (Dec. 1979): 1190–219. Reprinted in Shiller, Market Volatility, 256–87. 15. Robert J. Shiller, “Do Stock Prices Move Too Much to Be Justified by Subsequent Changes in Dividends?” American Economic Review (June 1981): 421–35. Reprinted in Shiller, Market Volatility, 105–30. Two Federal Reserve Board economists published a similar study with similar results—based on reported earnings rather than dividends—the same year.

That was a statement with which most economists of his generation, including Paul Samuelson and even Milton Friedman, would agree. None of these men devoted any of their serious scholarly work to fleshing out these ideas about financial market error. THAT WOULD BE THEIR STUDENTS’ job. While Joe Stiglitz led the way in looking for theoretical flaws in the perfect market worldview, another product of Samuelson and Modigliani’s MIT was to take on the efficient market hypothesis where it counted—in the data. Robert Shiller, who got his doctorate from MIT in 1972, was a sophisticated statistician and a crack computer programmer. He combined those skills with a seemingly naive eagerness to apply them to questions so simple that they could seem childlike, brazen, or even downright lunkheaded. In his dissertation and his early work as a professor at the University of Pennsylvania, Shiller focused on whether real-world interest rates behaved in accordance with the theory of rational expectations.


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Stocks for the Long Run 5/E: the Definitive Guide to Financial Market Returns & Long-Term Investment Strategies by Jeremy Siegel

Asian financial crisis, asset allocation, backtesting, banking crisis, Black-Scholes formula, break the buck, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, capital asset pricing model, carried interest, central bank independence, cognitive dissonance, compound rate of return, computer age, computerized trading, corporate governance, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, Deng Xiaoping, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, Eugene Fama: efficient market hypothesis, eurozone crisis, Everybody Ought to Be Rich, Financial Instability Hypothesis, fixed income, Flash crash, forward guidance, fundamental attribution error, housing crisis, Hyman Minsky, implied volatility, income inequality, index arbitrage, index fund, indoor plumbing, inflation targeting, invention of the printing press, Isaac Newton, joint-stock company, London Interbank Offered Rate, Long Term Capital Management, loss aversion, market bubble, mental accounting, money market fund, mortgage debt, Myron Scholes, new economy, Northern Rock, oil shock, passive investing, Paul Samuelson, Peter Thiel, Ponzi scheme, prediction markets, price anchoring, price stability, purchasing power parity, quantitative easing, random walk, Richard Thaler, risk tolerance, risk/return, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, stocks for the long run, survivorship bias, technology bubble, The Great Moderation, the payments system, The Wisdom of Crowds, transaction costs, tulip mania, Tyler Cowen: Great Stagnation, Vanguard fund

The earnings yield may differ from the commonly cited ROE, or return on equity, which usually measures the ratio of profits to the book value of equity rather than its market value. 7. In 2013 Robert Shiller was awarded the Nobel Prize in Economics in part because of his work on stock market volatility and behavioral finance. 8. J. Y. Campbell and R. J. Shiller, “Valuation Ratios and the Long-Run Stock Market Outlook,” Journal of Portfolio Management, Winter 1998, pp. 11-26. Their earlier paper was Campbell and Shiller, “Stock Prices, Earnings and Expected Dividends,” Journal of Finance, vol. 43, no. 3 (July 1988), pp. 661-676. Robert Shiller posted a paper, “Price Earnings Ratios as Forecasters of Returns: The Stock Market Outlook in 1996,” on his website on July 21, 1996, which served as the basis for his presentation to the Federal Reserve. 9.

Until 2003, the VIX was based on the S&P 100 (the largest 100 stocks in the S&P 500 Index). 15. John Maynard Keynes, The General Theory of Employment, Interest, and Money, First Harbinger Edition, New York: Harcourt, Brace & World, 1965, p. 157. (This book was originally published in 1936 by Macmillan & Co.) 16. Robert Shiller, Market Volatility, Cambridge, MA: MIT Press, 1989. The seminal article that spawned the excess volatility literature was “Do Stock Prices Move Too Much to Be Justified by Subsequent Changes in Dividends?,” American Economic Review, vol. 71 (1981), pp. 421-435 17. Robert Shiller was awarded the 2013 Nobel Prize in Economics in part for this research on market volatility. 18. Memorandum from Dean Witter, May 6, 1932. 19. Keynes, The General Theory, p. 149. Chapter 20 1. Benjamin Graham and David Dodd, Security Analysis, New York: McGraw-Hill, 1934, p. 618. 2.

David Dreman, Contrarian Investment Strategies: The Next Generation, New York: Simon & Schuster, 1998. 2. Frank J. Williams, If You Must Speculate, Learn the Rules, Burlington, VT: Freiser Press, 1930. 3. Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica, vol. 47, no. 2 (March 1979). 4. Robert Shiller, “Stock Prices and Social Dynamics,” Brookings Papers on Economic Activity, Washington, DC: Brookings Institution, 1984. 5. Robert Shiller, “Do Stock Prices Move Too Much to Be Justified by Subsequent Movements in Dividends?” American Economic Review, vol. 71, no. 3 (1981), pp. 421-436. See Chapter 19 for further discussion. 6. Solomon Asch, Social Psychology, Englewood Cliffs, NJ: Prentice Hall, 1952. 7. Morton Deutsch and Harold B. Gerard, “A Study of Normative and Informational Social Influences upon Individual Judgment,” Journal of Abnormal and Social Psychology, vol. 51 (1955), pp. 629-636. 8.


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Never Let a Serious Crisis Go to Waste: How Neoliberalism Survived the Financial Meltdown by Philip Mirowski

"Robert Solow", Alvin Roth, Andrei Shleifer, asset-backed security, bank run, barriers to entry, Basel III, Berlin Wall, Bernie Madoff, Bernie Sanders, Black Swan, blue-collar work, Bretton Woods, Brownian motion, business cycle, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, complexity theory, constrained optimization, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, dark matter, David Brooks, David Graeber, debt deflation, deindustrialization, do-ocracy, Edward Glaeser, Eugene Fama: efficient market hypothesis, experimental economics, facts on the ground, Fall of the Berlin Wall, financial deregulation, financial innovation, Flash crash, full employment, George Akerlof, Goldman Sachs: Vampire Squid, Hernando de Soto, housing crisis, Hyman Minsky, illegal immigration, income inequality, incomplete markets, information asymmetry, invisible hand, Jean Tirole, joint-stock company, Kenneth Arrow, Kenneth Rogoff, Kickstarter, knowledge economy, l'esprit de l'escalier, labor-force participation, liberal capitalism, liquidity trap, loose coupling, manufacturing employment, market clearing, market design, market fundamentalism, Martin Wolf, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Naomi Klein, Nash equilibrium, night-watchman state, Northern Rock, Occupy movement, offshore financial centre, oil shock, Pareto efficiency, Paul Samuelson, payday loans, Philip Mirowski, Ponzi scheme, precariat, prediction markets, price mechanism, profit motive, quantitative easing, race to the bottom, random walk, rent-seeking, Richard Thaler, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, savings glut, school choice, sealed-bid auction, Silicon Valley, South Sea Bubble, Steven Levy, technoutopianism, The Chicago School, The Great Moderation, the map is not the territory, The Myth of the Rational Market, the scientific method, The Wisdom of Crowds, theory of mind, Thomas Kuhn: the structure of scientific revolutions, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, Vilfredo Pareto, War on Poverty, Washington Consensus, We are the 99%, working poor

Once the crisis hit, journalists predictably turned to accusing Wall Street of behaving irrationally (in the looser vernacular meaning), and economists of investing too much credence in the rationality of their agents. Two best-selling books were especially effective in broadcasting this line: John Cassidy’s How Markets Fail and Justin Fox’s Myth of the Rational Market. Some economists who had been strong advocates of behavioral approaches prior to the crash, such as Robert Shiller and Robert Frank, leaped in with op-eds essentially blaming the entire crisis on native cognitive weaknesses of market participants.37 This line became entrenched with the appearance of George Akerlof and Robert Shiller’s Animal Spirits: displaying an utter contempt for the history of economic thought, they “reduced” the message of Keynes’s General Theory to the proposition that people get a little irrational from time to time, and thus push the system away from full neoclassical general equilibrium.38 They wrote: The idea that economic crises, like the current financial and housing crisis, are mainly caused by changing thought patterns goes against standard economic thinking.

“The Discursive Management of Financial Risk Scandals,” Qualitative Sociology 35 (2012): 251–70. Akerlof, George, and Rachel Kranton. Identity Economics (Princeton: Princeton University Press, 2010). Akerlof, George, and Paul Romer. “Looting: The Economic Underworld of Bankruptcy for Profit,” Brookings Papers on Economic Activity no. 2 (1993): 1–73. Akerlof, George, and Robert Shiller. Animal Spirits (Princeton: Princeton University Press, 2009). Akerlof, George, and Robert Shiller. “Disputations: Our New Theory of Macroeconomics,” New Republic (2009), www.tnr.com/article/books-and-arts/disputations-our-new-theory-macroeconomics. Akerlof, George, and Joseph Stiglitz. “Let a Hundred Theories Bloom” (2009), www.project-synciate.org. Alterman, Eric. “The Professors, the Press, the Think Tanks—and Their Problems,” Academe, May-June, 2011.

Treasury on part of its debt—then it was a snap to get 162 economists, including two Nobel winners, to sign a statement denying that proposition.74 Or take that larger and more contentious issue, the question of whether there was a bubble in housing prices by 2006, and why so few economists were willing to sound the alarm. There is retrospective evidence that a few prominent economists had warned the New York Fed of a housing bubble as early as 2004; in response to one such presentation, Timothy Geithner removed Robert Shiller from the Fed advisory board.75 But the orthodox profession seems loathe to ever admit knowledge is actively policed and purged according to a preset script. After the fact, some economists at the Boston Fed decided that, because one would encounter a range of opinions on that issue before the crisis, there is no justification in blaming the profession for missing the disaster. They wrote: “Economic theory provides little guidance as to what should be the ‘correct’ level of asset prices—including housing prices . . .


Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies by Jeremy J. Siegel

addicted to oil, asset allocation, backtesting, Black-Scholes formula, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, capital asset pricing model, cognitive dissonance, compound rate of return, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, Eugene Fama: efficient market hypothesis, Everybody Ought to Be Rich, fixed income, German hyperinflation, implied volatility, index arbitrage, index fund, Isaac Newton, joint-stock company, Long Term Capital Management, loss aversion, market bubble, mental accounting, Myron Scholes, new economy, oil shock, passive investing, Paul Samuelson, popular capitalism, prediction markets, price anchoring, price stability, purchasing power parity, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, stocks for the long run, survivorship bias, technology bubble, The Great Moderation, The Wisdom of Crowds, transaction costs, tulip mania, Vanguard fund

It appears suddenly as a new name for our hopes and for economic progress due to recent technological advances, notably the Internet, and for our reasons to think that the future growth prospects are ever so brilliant. ROBERT SHILLER, 20011 What are the most important macrotrends in the economy that influence future stock market returns? Economic growth immediately comes to mind. But economic growth has nowhere near as big an impact on stock returns as most investors believe. However, other important trends do have a positive impact on stock valuation: the stability of the overall economy, the reduction in transactions costs, and the change in taxes on stock market income. 1 Robert Shiller, Irrational Exuberance, New York: First Broadway Books, 2001, Afterword to the paperback edition, p. 249. 123 Copyright © 2008, 2002, 1998, 1994 by Jeremy J. Siegel.

He conducted a famous experiment where subjects were presented with four lines and asked to pick the two that were the same length. The right answer was obvious, but when confederates of Dr. Asch presented conflicting views, the subjects often gave the incorrect answer.6 3 Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision under Risk,” Econometrica, vol. 47, no. 2 (March 1979). 4 Robert Shiller, “Stock Prices and Social Dynamics,” Brookings Papers on Economic Activity, Washington, D.C.: Brookings Institution, 1984. 5 Robert Shiller, “Do Stock Prices Move Too Much to Be Justified by Subsequent Movements in Dividends?” American Economic Review, vol. 71, no. 3 (1981), pp. 421–436. See Chapter 16 for further discussion. 6 Solomon Asch, Social Psychology, Englewood Cliffs, N.J.: Prentice Hall, 1952. 324 PART 4 Stock Fluctuations in the Short Run Follow-up experiments confirmed that it was not social pressure that led the subjects to act against their own best judgment but their disbelief that a large group of people could be wrong.7 Dave: Exactly, so many were hyping these stocks that I felt there had to be something there.

Although in 1929 this was certainly not as good as putting money gradually in the market, even this plan beat investment in Treasury bills after 20 years. 5 A brief description of the early stock market is found in Appendix 1 at the end of this chapter. The stock price data during this period are taken from Schwert (1990), and I have added my own dividend series. G. William Schwert, “Indexes of United States Stock Prices from 1802 to 1987,” Journal of Business, vol. 63 (July 1990), pp. 399–426. 6 The stock series used in this period are taken from the Cowles indexes as reprinted in Robert Shiller, Market Volatility, Cambridge: MIT Press, 1989. The Cowles indexes are capitalizationweighted indexes of all New York Stock Exchange stocks, and they include dividends. 7 The data from the third period are taken from the Center for Research in Security Prices (CRSP) capitalization-weighted indexes of all New York stocks, and starting in 1962, they include American and Nasdaq stocks. 6 PART 1 The Verdict of History FIGURE 1–1 Total Nominal Return Indexes, 1802 through December 2006 It can be easily seen that the total return on equities dominates all other assets.


pages: 297 words: 91,141

Market Sense and Nonsense by Jack D. Schwager

3Com Palm IPO, asset allocation, Bernie Madoff, Brownian motion, buy and hold, collateralized debt obligation, commodity trading advisor, computerized trading, conceptual framework, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, fixed income, high net worth, implied volatility, index arbitrage, index fund, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, market fundamentalism, merger arbitrage, negative equity, pattern recognition, performance metric, pets.com, Ponzi scheme, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, selection bias, Sharpe ratio, short selling, statistical arbitrage, statistical model, survivorship bias, transaction costs, two-sided market, value at risk, yield curve

For over a century since the starting year of the Case-Shiller Home Price Index, the inflation-adjusted index level fluctuated in a range of approximately 70 to 130. At the peak of the 2003–2006 housing bubble, the index more than doubled its long-term median level (see Figure 2.5). Figure 2.5 Case-Shiller National Home Price Index, Inflation-Adjusted Source: www.multpl.com/case-shiller-home-price-index-inflation-adjusted/; underlying data: Robert Shiller and Standard & Poor’s. The extremes of the housing bubble were fueled by excesses in subprime mortgage lending in which loans were made to borrowers with poor credit, requiring little or no money down and in its later phases no verification of income or assets. The competition among mortgage lenders to find new borrowers seemed like a race to issue the poorest-quality mortgages possible, and in terms of both market share and excesses, Countrywide seemed to be the clear winner in this dubious contest.

The average return in years following lowest-quartile five-year returns was almost exactly double that of years following highest-quartile five-year returns (18.7 percent versus 9.4 percent). These results are summarized in Figure 3.2. The consistent superior performance of years following low-quartile return periods versus years following high-quartile return periods is clearly evident. Figure 3.2 S&P Returns, Including Dividends: Comparison of Years Following Highest- and Lowest-Quartile Performance, 1872–2011 Data source: Moneychimp.com, which is based on Robert Shiller’s data and Yahoo!. Prior to 1926 (first year of S&P index), data is based on Cowles stock index data. There is always a trade-off between more data and more relevant data. It can reasonably be argued that by going back as far as the 1870s, we included a period of history that is not representative of the current market. We therefore repeated the exact same analysis for the years 1950 forward.

Once again, years following low-quartile return periods significantly outperformed years following high-quartile periods, with the difference being 6 percent for the one-year period and nearly 4 percent for the three-year period. Figure 3.3 S&P Returns, Including Dividends: Comparison of Years Following Highest- and Lowest-Quartile Performance, 1950–2011 Data source: Moneychimp.com, which is based on Robert Shiller’s data and Yahoo!. The lesson is that the best prospective years for realizing above-average equity returns are those that follow low-return periods. Years following high-return periods, which are the times most people are inclined to invest, tend to do slightly worse than average on balance. Implications of High- and Low-Return Periods on Longer-Term Investment Horizons In the prior section, we examined the performance of the S&P in the single years following highest-return periods.


pages: 249 words: 66,383

House of Debt: How They (And You) Caused the Great Recession, and How We Can Prevent It From Happening Again by Atif Mian, Amir Sufi

"Robert Solow", Andrei Shleifer, asset-backed security, balance sheet recession, bank run, banking crisis, Ben Bernanke: helicopter money, break the buck, business cycle, Carmen Reinhart, collapse of Lehman Brothers, creative destruction, debt deflation, Edward Glaeser, en.wikipedia.org, financial innovation, full employment, high net worth, Home mortgage interest deduction, housing crisis, Joseph Schumpeter, Kenneth Rogoff, Kickstarter, liquidity trap, Long Term Capital Management, market bubble, Martin Wolf, money market fund, moral hazard, mortgage debt, negative equity, paradox of thrift, quantitative easing, Robert Shiller, Robert Shiller, school choice, shareholder value, the payments system, the scientific method, tulip mania, young professional, zero-sum game

See Charley Stone, Carl Van Horn, and Cliff Zukin, “Chasing the American Dream: Recent College Graduates and the Great Recession,” in Work Trends: Americans’ Attitudes about Work, Employers, and Government (Rutgers University, May 2012), http://media.philly.com/documents/20120510_Chasing_American_Dream.pdf; and Meta Brown and Sydnee Caldwell, “Young Student Loan Borrowers Retreat from Housing and Auto Markets,” Federal Reserve Bank of New York Liberty Street Economics Blog, April 17, 2013, http://libertystreeteconomics.newyorkfed.org/2013/04/young-student-loan-borrowers-retreat-from-housing-and-auto-markets.html. 6. Martin and Lehren, “A Generation Hobbled.” 7. Bernard, “In Grim Job Market.” 8. We have been influenced heavily by the work of Robert Shiller for many of the ideas in this chapter. He has been a strong advocate for financial contracts that more equally share risk in the context of household and sovereign debt. See, for example, Stefano Athanasoulis, Robert Shiller, and Eric van Wincoop, “Macro Markets and Financial Security,” FRBNY Economic Policy Review, April 2009. Kenneth Rogoff has also advocated more equity-like instruments in the context of sovereign debt. See Kenneth Rogoff, “Global Imbalances without Tears,” Project Syndicate, March 1, 2011, http://www.project-syndicate.org/commentary/global-imbalances-without-tears.

Yet the authors found something remarkable—an outcome that has been repeated many times by various researchers since. Stock prices in Smith’s experiment fluctuated wildly, with prices at times deviating two to three times away from their fundamental value. Of the twenty-two experiments conducted, fourteen saw a stock market “characterized by a price bubble measured relative to dividend value.” The results bore an uncanny resemblance to the “excess volatility” phenomena first documented by Robert Shiller in 1981 for the U.S. stock market.4 In his seminal paper that led to the creation of the field of behavioral finance, Shiller showed that stock prices moved too much to be justified by the subsequent movement in their dividends. This phenomenon was later succinctly summarized by Jeffrey Pontiff in 1997 when he demonstrated that closed-end mutual funds were significantly more volatile than the market value of the underlying securities.5 Closed-end mutual funds hold stocks and bonds like regular “open-ended” mutual funds.

A country with debt written in its own currency can reduce the real value of the interest payments by inflating, but countries that had adopted the euro did not have such an option. One proposal is for countries to leave the euro and revert to their own currency. However, given that leaving the euro would lead to default on all euro-denominated debt, an exit could destroy an economy. In a world of more flexible sovereign financing, such a dramatic course of action would be unnecessary. Mark Kamstra and Robert Shiller have proposed sovereign bonds where the coupon payment—the regular payment that countries make to investors—is linked to the nominal GDP of the country.22 Such a bond is more equity-like because the investor experiences profits that vary with the fortune of the country, much like an equity holder receives higher or lower dividends depending on earnings of a corporation. In the case of Spain, such financing would act as an automatic stabilizer: that is, payments on the bonds would immediately fall when the Spanish economy collapsed, providing some relief to Spaniards.


pages: 416 words: 118,592

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing by Burton G. Malkiel

accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, backtesting, beat the dealer, Bernie Madoff, BRICs, butter production in bangladesh, buy and hold, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dogs of the Dow, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, money market fund, mortgage tax deduction, new economy, Own Your Own Home, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, stocks for the long run, survivorship bias, The Myth of the Rational Market, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond

All the smart investor has to do is to beat the gun—get in at the very beginning. This theory might less charitably be called the “greater fool” theory. It’s perfectly all right to pay three times what something is worth as long as later on you can find some innocent to pay five times what it’s worth. The castle-in-the-air theory has many advocates, in both the financial and the academic communities. Robert Shiller, in his best-selling book Irrational Exuberance, argues that the mania in Internet and high-tech stocks during the late 1990s can be explained only in terms of mass psychology. At universities, so-called behavioral theories of the stock market, stressing crowd psychology, gained favor during the early 2000s at leading economics departments and business schools across the developed world. The psychologist Daniel Kahneman won the Nobel Prize in Economics in 2002 for his seminal contributions to the field of “behavioral finance.”

THE INTERNET BUBBLE Most bubbles have been associated with some new technology (as in the tronics and biotech booms) or with some new business opportunity (as when the opening of profitable new trade opportunities spawned the South Sea Bubble). The Internet was associated with both: it represented a new technology, and it offered new business opportunities that promised to revolutionize the way we obtain information and purchase goods and services. The promise of the Internet spawned the largest creation and largest destruction of stock market wealth of all time. Robert Shiller, in his book Irrational Exuberance, describes bubbles in terms of “positive feedback loops.” A bubble starts when any group of stocks, in this case those associated with the excitement of the Internet, begin to rise. The updraft encourages more people to buy the stocks, which causes more TV and print coverage, which causes even more people to buy, which creates big profits for early Internet stockholders.

Investors then began to purchase common stocks for no other reason than that prices were rising and other people were making money, even if the price increases could not be justifiable by fundamental reasons such as the growth of earnings and dividends. As the economic historian Charles Kindleberger has stated, “There is nothing so disturbing to one’s well-being and judgment as to see a friend get rich.” And as Robert Shiller, author of the best-selling Irrational Exuberance, has noted, the process feeds on itself in a “positive feedback loop.” The initial price rise encourages more people to buy, which in turn produces greater profits and induces a larger and larger group of participants. The phenomenon is another example of the Ponzi scheme that I described in chapter 4, in connection with the Internet bubble.


pages: 422 words: 113,830

Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism by Kevin Phillips

algorithmic trading, asset-backed security, bank run, banking crisis, Bernie Madoff, Black Swan, Bretton Woods, BRICs, British Empire, business cycle, buy and hold, collateralized debt obligation, computer age, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency peg, diversification, Doha Development Round, energy security, financial deregulation, financial innovation, fixed income, Francis Fukuyama: the end of history, George Gilder, housing crisis, Hyman Minsky, imperial preference, income inequality, index arbitrage, index fund, interest rate derivative, interest rate swap, Joseph Schumpeter, Kenneth Rogoff, large denomination, Long Term Capital Management, market bubble, Martin Wolf, Menlo Park, mobile money, money market fund, Monroe Doctrine, moral hazard, mortgage debt, Myron Scholes, new economy, oil shale / tar sands, oil shock, old-boy network, peak oil, plutocrats, Plutocrats, Ponzi scheme, profit maximization, Renaissance Technologies, reserve currency, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, Satyajit Das, shareholder value, short selling, sovereign wealth fund, The Chicago School, Thomas Malthus, too big to fail, trade route

Moody’s Economy.com estimated that the total for 2007 would reach 1.7 million, up from 1.26 million in 2006, through a “self-reinforcing downward cycle” of falling home prices, loan defaults, and credit tightenings.9 The public-relations-minded National Association of Realtors was slow to accept the inevitability of an outright decline—it finally did so in late summer—because year-over-year slippage would mark the NAR index’s first anual downturn of home prices since its launch in 1950. But outside measurement-takers had less compunction. The relatively new S&P/Case-Shiller Home Price Index, monitoring home prices in twenty major metropolitan areas, reported a 3.4 percent decline between June 2006 and June 2007.10 More scarily, Robert Shiller, the Yale economist who made his name predicting the fate of the technology stock bubble, pictured housing’s downfall in comparable terms. He told a late-August conference that home prices in some cities might fall by as much as half if the gathering bust could not be contained.11 If so, losses by U.S. homeowners could reach $10 trillion, more than the $7 trillion lost in the 2000-2002 stock market bust led by the decline of the technology-heavy NASDAQ index.

The second two weeks of August were the nadir, culminating in frozen commercial paper markets, stricken interbank lending, and a week of intense stock market gyrations and volatility between August 13 and 17. Finally, the thirty-first day of a painful month concluded with a much-publicized conference in Jackson Hole, Wyoming, the majestic onetime fur trappers’ rendezvous, the twenty-ninth in an annual series underwritten by the Federal Reserve Bank of Kansas City. This assemblage neatly book-ended the month’s surprises as participants came away from speeches—by Harvard’s Martin Feldstein, Robert Shiller the home-price Cassandra, German central bank chief Axel Weber, and others—convinced that a rougher endgame than they had hoped for was likely. “I came to Jackson Hole thinking there would be no recession,” said Susan Wachter, a professor of real estate at Pennsylvania’s Wharton School, “but I’m leaving thinking we could well have one.”29 When those events pass into the history books, the more detailed accounts will surely confect some of those unexpected German state bank casualties, fearful New York Stock Exchange openings, extraordinary final-hour Dow surges (possibly Washington-orchestrated), mortgage-lender death spirals, $700 billion of central bank liquidity injections, Venezuelan and Iranian rants, eerie “Hindenburg Omen” fulfillments, a hedge fund disgraces, and trillion-dollar meltdowns into the sort of breathless You Are There chronicles that have offered insider-type postmortems on previous notable financial crises.

Several market watchers, however, took a deeper breath and reminded their audiences that 1987 had led into the 1990-91 downturns, and that interest-rate cuts hastily provided in 1998 had wound up feeding the speculative bubble and eventual market debacle of 2000-2002. Treasury Secretary Paulson told a financial audience that he thought the 2007 crisis would last longer than individual shocks like those of 1987 and the 1990s. And some representatives of the most pessimistic school—Robert Shiller and other housing-crash worriers—outlined the case for a much more powerful downturn. This book does not predict, or select among, any of these outcomes. This is too early a stage. It does, however, take note of the variety of scenarios laid out, most relevant to the circumstances and problems described in these pages. Time will tell, but 2008 being an election year, politicians will also have a voice, and chapter 6 looks at how changes in the dynasties, party alignments, and interest-group access to U.S. politics have already laid new foundations.


pages: 500 words: 145,005

Misbehaving: The Making of Behavioral Economics by Richard H. Thaler

"Robert Solow", 3Com Palm IPO, Albert Einstein, Alvin Roth, Amazon Mechanical Turk, Andrei Shleifer, Apple's 1984 Super Bowl advert, Atul Gawande, Berlin Wall, Bernie Madoff, Black-Scholes formula, business cycle, capital asset pricing model, Cass Sunstein, Checklist Manifesto, choice architecture, clean water, cognitive dissonance, conceptual framework, constrained optimization, Daniel Kahneman / Amos Tversky, delayed gratification, diversification, diversified portfolio, Edward Glaeser, endowment effect, equity premium, Eugene Fama: efficient market hypothesis, experimental economics, Fall of the Berlin Wall, George Akerlof, hindsight bias, Home mortgage interest deduction, impulse control, index fund, information asymmetry, invisible hand, Jean Tirole, John Nash: game theory, John von Neumann, Kenneth Arrow, Kickstarter, late fees, law of one price, libertarian paternalism, Long Term Capital Management, loss aversion, market clearing, Mason jar, mental accounting, meta analysis, meta-analysis, money market fund, More Guns, Less Crime, mortgage debt, Myron Scholes, Nash equilibrium, Nate Silver, New Journalism, nudge unit, Paul Samuelson, payday loans, Ponzi scheme, presumed consent, pre–internet, principal–agent problem, prisoner's dilemma, profit maximization, random walk, randomized controlled trial, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, Silicon Valley, South Sea Bubble, Stanford marshmallow experiment, statistical model, Steve Jobs, Supply of New York City Cabdrivers, technology bubble, The Chicago School, The Myth of the Rational Market, The Signal and the Noise by Nate Silver, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, transaction costs, ultimatum game, Vilfredo Pareto, Walter Mischel, zero-sum game

“Raising the Stakes in the Ultimatum Game: Experimental Evidence from Indonesia.” Economic Inquiry 37, no. 1: 47–59. Carlson, Nicolas. 2014. “What Happened When Marissa Mayer Tried to Be Steve Jobs.” New York Times Magazine, December 17. Available at: http://www.nytimes.com/2014/12/21/magazine/what-happened-when-marissa-mayer-tried-to-be-steve-jobs.html. Case, Karl E., and Robert J. Shiller. 2003. “Is There a Bubble in the Housing Market?” Brookings Papers on Economic Activity, no. 2: 299–362. Case, Karl E., Robert J. Shiller, and Anne Thompson. 2012. “What Have They been Thinking? Home Buyer Behavior in Hot and Cold Markets.” Working Paper 18400, National Bureau of Economic Research. Chang, Tom Y., Samuel M. Hartzmark, David H. Solomon, and Eugene F. Soltes. 2014. “Being Surprised by the Unsurprising: Earnings Seasonality and Stock Returns.”

At the end we arrive in London, at Number 10 Downing Street, where a new set of exciting challenges and opportunities is emerging. My only advice for reading the book is stop reading when it is no longer fun. To do otherwise, well, that would be just misbehaving. ________________ * One economist who did warn us about the alarming rate of increase in housing prices was my fellow behavioral economist Robert Shiller. 2 The Endowment Effect I began to have deviant thoughts about economic theory while I was a graduate student in the economics department at the University of Rochester, located in upstate New York. Although I had misgivings about some of the material presented in my classes, I was never quite sure whether the problem was in the theory or in my flawed understanding of the subject matter.

I, for one, had trouble keeping track of which side of the case Miller was arguing. Miller’s talk came in the afternoon session of the last day, chaired by Eugene Fama, another Chicago faculty member and a strong defender of the rational point of view. The other speaker during that session was Allan Kleidon, who like Miller was not so much presenting new research of his own, but rather attacking a paper by Robert Shiller that we will discuss in detail in chapter 24. Shiller was given the role of discussant, along with two efficient market defenders, Richard Roll and Steve Ross. Shefrin and Statman could only heckle from the audience. Clearly, during this part of the program the deck was stacked. Chalk it up to home field advantage. Shiller was thrust into the unusual role of discussing a paper that critiqued his own work without having the chance to present his original research in any detail.


pages: 430 words: 109,064

13 Bankers: The Wall Street Takeover and the Next Financial Meltdown by Simon Johnson, James Kwak

American ideology, Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, banking crisis, Bernie Madoff, Bonfire of the Vanities, bonus culture, break the buck, business cycle, buy and hold, capital controls, Carmen Reinhart, central bank independence, Charles Lindbergh, collapse of Lehman Brothers, collateralized debt obligation, commoditize, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Edward Glaeser, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, financial intermediation, financial repression, fixed income, George Akerlof, Gordon Gekko, greed is good, Home mortgage interest deduction, Hyman Minsky, income per capita, information asymmetry, interest rate derivative, interest rate swap, Kenneth Rogoff, laissez-faire capitalism, late fees, light touch regulation, Long Term Capital Management, market bubble, market fundamentalism, Martin Wolf, money market fund, moral hazard, mortgage tax deduction, Myron Scholes, Paul Samuelson, Ponzi scheme, price stability, profit maximization, race to the bottom, regulatory arbitrage, rent-seeking, Robert Bork, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, Satyajit Das, sovereign wealth fund, The Myth of the Rational Market, too big to fail, transaction costs, value at risk, yield curve

Bagli, “Sam Zell’s Empire, Underwater in a Big Way,” The New York Times, February 6, 2009, available at http://www.nytimes.com/2009/02/07/business/07properties.html. 21. Terry Pristin, “Risky Real Estate Deals Helped Doom Lehman,” The New York Times, September 16, 2008, available at http://www.nytimes.com/2008/09/17/realestate/commercial/17real.html. 22. See Robert J. Shiller, The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to Do About It (Princeton: Princeton University Press, 2008), 30–34. Data for Figure 5-1 are from Robert Shiller, available at http://www.econ.yale.edu/~shiller/data.htm and used with his permission. Shiller’s historical housing data series was first used in Robert Shiller, Irrational Exuberance (Princeton: Princeton University Press, 2000) and later in Shiller, The Subprime Solution, supra. 23. Press Release, Citigroup, “Citi Finalizes SIV Wind-down by Agreeing to Purchase All Remaining Assets,” November 19, 2008, available at http://www.citibank.com/citi/press/2008/081119a.htm. 24.

Increased Wall Street demand for mortgages (to feed the securitization pipeline) funneled cheap money to mortgage lenders, who sent their sales forces out onto the streets in search of more borrowers; by the early 2000s, many prime borrowers had already refinanced to take advantage of low rates, and so subprime lending became a larger and larger share of the market. And the cycle continued. Figure 5-1: Real U.S. Housing Prices, 1890–2009 Source: Robert Shiller, Historical Housing Market Series. Used by permission of Mr. Shiller. Data were originally used in Robert Shiller, Irrational Exuberance (Princeton: Princeton University Press, 2000). Ordinarily, the instinct for financial self-preservation should prevent lenders from making too many risky loans. The magic of securitization relieved lenders of this risk, however, leaving them free to originate as many new mortgages as they could. Because mortgages were divided up among a large array of investors, neither the mortgage lender nor the investment bank managing the securitization retained the risk of default.

The basic belief was that if a financial transaction was taking place, it was a good thing. This belief reflects a general economic principle; given perfectly rational actors with perfect information and no externalities, all transactions should be beneficial for both parties. But few economists ever believed that these assumptions actually held in the real world. And over the next few decades, dozens of leading economists such as Joseph Stiglitz, Robert Shiller, and Larry Summers set about knocking holes in the Efficient Market Hypothesis.44 Brad DeLong, Andrei Shleifer, Summers, and Robert Waldmann created a model showing that “noise trading can lead to a large divergence between market prices and fundamental values.”45 Even Fischer Black (of Black-Scholes fame) agreed. At the 1985 meeting of the American Finance Association, he argued that it was impossible to differentiate between noise and information, and hence impossible to determine who was a noise trader and who was an information trader.


pages: 482 words: 121,672

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing (Eleventh Edition) by Burton G. Malkiel

accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, beat the dealer, Bernie Madoff, bitcoin, butter production in bangladesh, buttonwood tree, buy and hold, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, Detroit bankruptcy, diversification, diversified portfolio, dogs of the Dow, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, financial repression, fixed income, framing effect, George Santayana, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, money market fund, mortgage tax deduction, new economy, Own Your Own Home, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, stocks for the long run, survivorship bias, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond, zero-sum game

All the smart investor has to do is to beat the gun—get in at the very beginning. This theory might less charitably be called the “greater fool” theory. It’s perfectly all right to pay three times what something is worth as long as later on you can find some innocent to pay five times what it’s worth. The castle-in-the-air theory has many advocates, in both the financial and the academic communities. The Nobel laureate Robert Shiller, in his book Irrational Exuberance, argues that the mania in Internet and high-tech stocks during the late 1990s can be explained only in terms of mass psychology. At universities, so-called behavioral theories of the stock market, stressing crowd psychology, gained favor during the early 2000s at leading economics departments and business schools across the developed world. The psychologist Daniel Kahneman won the Nobel Prize in Economics in 2002 for his seminal contributions to the field of “behavioral finance.”

THE INTERNET BUBBLE Most bubbles have been associated with some new technology (as in the tronics and biotech booms) or with some new business opportunity (as when the opening of profitable new trade opportunities spawned the South Sea Bubble). The Internet was associated with both: it represented a new technology, and it offered new business opportunities that promised to revolutionize the way we obtain information and purchase goods and services. The promise of the Internet spawned the largest creation and largest destruction of stock market wealth of all time. Robert Shiller, in his book Irrational Exuberance, describes bubbles in terms of “positive feedback loops.” A bubble starts when any group of stocks, in this case those associated with the excitement of the Internet, begin to rise. The updraft encourages more people to buy the stocks, which causes more TV and print coverage, which causes even more people to buy, which creates big profits for early Internet stockholders.

Investors then began to purchase common stocks for no other reason than that prices were rising and other people were making money, even if the price increases could not be justifiable by fundamental reasons such as the growth of earnings and dividends. As the economic historian Charles Kindleberger has stated, “There is nothing so disturbing to one’s well-being and judgment as to see a friend get rich.” And as Robert Shiller, author of the best-selling Irrational Exuberance, has noted, the process feeds on itself in a “positive feedback loop.” The initial price rise encourages more people to buy, which in turn produces greater profits and induces a larger and larger group of participants. The phenomenon is another example of the Ponzi scheme that I described in chapter 4, in connection with the Internet bubble.


pages: 288 words: 16,556

Finance and the Good Society by Robert J. Shiller

Alvin Roth, bank run, banking crisis, barriers to entry, Bernie Madoff, buy and hold, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, cognitive dissonance, collateralized debt obligation, collective bargaining, computer age, corporate governance, Daniel Kahneman / Amos Tversky, Deng Xiaoping, diversification, diversified portfolio, Donald Trump, Edward Glaeser, eurozone crisis, experimental economics, financial innovation, financial thriller, fixed income, full employment, fundamental attribution error, George Akerlof, income inequality, information asymmetry, invisible hand, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, land reform, loss aversion, Louis Bachelier, Mahatma Gandhi, Mark Zuckerberg, market bubble, market design, means of production, microcredit, moral hazard, mortgage debt, Myron Scholes, Nelson Mandela, Occupy movement, passive investing, Ponzi scheme, prediction markets, profit maximization, quantitative easing, random walk, regulatory arbitrage, Richard Thaler, Right to Buy, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, selection bias, self-driving car, shareholder value, Sharpe ratio, short selling, Simon Kuznets, Skype, Steven Pinker, telemarketer, Thales and the olive presses, Thales of Miletus, The Market for Lemons, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, Vanguard fund, young professional, zero-sum game, Zipcar

Finance and the Good Society Finance and the Good Society _______________ Robert J. Shiller With a new preface by the author Princeton University Press Princeton and Oxford Robert J. Shiller is the Arthur M. Okun Professor of Economics at the Cowles Foundation for Research in Economics and professor of nance at the International Center for Finance, Yale University. He is a research associate at the National Bureau of Economic Research in Cambridge, Massachusetts. He is also the co-creator of the Standard & Poor’s / CaseShiller Home Price Indices, and he serves on the index committee for these indices at Standard & Poor’s, New York. At the CME Group in Chicago he is a member of the Competitive Markets Advisory Council. He is currently engaged in the joint analysis and development of exchange-traded notes with Barclays Capital in London.

Burman, Leonard, Robert Shiller, Gregory Leiserson, and Je rey Rohaly. 2007. “The Rising Tide Tax System: Indexing the Tax System for Changes in Inequality.” Unpublished paper, Department of Economics, Syracuse University, http://www.newfinancialorder.com/burman-nyu-030807.pdf. Bush, Vannevar. 1945. Science: The Endless Frontier. Washington, DC: U.S. Government Printing Office. Cabré, Anna, and Juan Antonio Módenes. 2004. “Homeownership and Social Inequality in Spain.” In Home Ownership and Social Inequality in a Comparative Perspective, 233– 54. Stanford, CA: Stanford University Press. Calhoun, Craig. 2012. “Shared Responsibility.” In Jacob Hacker and Ann O’Leary, eds., Shared Responsibilities, Shared Values, 8–16. New York: Oxford University Press. Campbell, John Y., and Robert J. Shiller. 1988a. “The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors.”

New York: Longmans, Green. Esterbrook, Frank H., and Daniel R. Fischel. 1985. “Limited Liability and the Corporation.” University of Chicago Law Review 52(1):89–117. Fabozzi, Frank J., and Franco Modigliani. 1992. Mortgage and Mortgage-Backed Securities Markets. Cambridge, MA: Harvard Business School Press. Fabozzi, Frank J., Robert J. Shiller, and Radu Tunaru. 2010. “Hedging Real-Estate Risk.” Journal of Portfolio Management, Special Real Estate Issue 35(5):92–103. Fair, Ray C., and Robert J. Shiller. 1990. “Comparing Information in Forecasts from Econometric Models.” American Economic Review 80(3):375–89. Falke, Armin. 2004. “Charitable Giving as a Gift Exchange: Evidence from a Field Experiment.” IZA Discussion Paper 1148. University of Bonn. Fama, Eugene F. 1965. “Random Walks in Stock Market Prices.” Financial Analysts Journal 21(5):55–59.


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Toward Rational Exuberance: The Evolution of the Modern Stock Market by B. Mark Smith

bank run, banking crisis, business climate, business cycle, buy and hold, capital asset pricing model, compound rate of return, computerized trading, credit crunch, cuban missile crisis, discounted cash flows, diversified portfolio, Donald Trump, Eugene Fama: efficient market hypothesis, financial independence, financial innovation, fixed income, full employment, income inequality, index arbitrage, index fund, joint-stock company, locking in a profit, Long Term Capital Management, Louis Bachelier, margin call, market clearing, merger arbitrage, money market fund, Myron Scholes, Paul Samuelson, price stability, random walk, Richard Thaler, risk tolerance, Robert Bork, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, stocks for the long run, the market place, transaction costs

Since no news development can be identified that could so decisively have changed investor expectations over so short a time span, it seemed intuitively obvious that the overall market must have been badly mispriced, either before or after the crash. This is the essence of the case made by critics of the efficient market hypothesis. It is based on the same reasoning employed by the economist Robert Shiller, who, as discussed in chapter 13, found that stock prices have been far more volatile over time than can be justified by changes in underlying fundamentals. After the 1987 crash, Robert Shiller wrote scathingly that “[the] efficient market hypothesis is the most remarkable error in the history of economic theory. This is just another nail in its coffin.”17 Harvard professor Lawrence Summers, later to be treasury secretary, agreed, noting, “If anyone did seriously believe that price movements are determined by changes in information about economic fundamentals, they got to be disabused of that notion by Monday’s 500-point movement.”18 The reasoning of Shiller and Summers has been expanded on by other scholars, who seek to replace the efficient market theory with what can best be called “behavioral” explanations of market movements.

Studies were published that isolated a “day of the week” effect, showing that stock prices tended to act differently on different days of the week. A 1977 analysis of low P/E stocks found that those stocks tended to perform better than did other stocks, implying that they were not efficiently priced.11 But the most crucial blow to the notion that markets were perfectly efficient was struck by Yale professor Robert Shiller. Shiller studied the aggregate dividends and earnings of the S&P 500 between 1871 and 1979 and concluded that the value of the market as measured by the index fluctuated far more than could be explained by changes in subsequent cash flows (dividends) to investors.12 According to the efficient market theory, the market should adjust instantaneously to new pieces of information pertinent to particular companies or to the overall market.

As Lynch put it, the heavily quantitative, theoretical analysis he was exposed to at Wharton “taught me that the things I saw happening at Fidelity couldn’t really be happening.”3 He went on to say, “It’s hard to support the popular academic theory that the market is [efficient] when you know somebody who just made a twentyfold profit in Kentucky Fried Chicken, and furthermore, who explained in advance why the stock was going to rise.”4 Lynch was also troubled by the seeming inconsistency between the idea of market efficiency and the fact that stock prices appeared to move around more than they should. (In this sense, he intuitively grasped the more rigorous argument made by economist Robert Shiller, cited in chapter 13, that stock prices are far more volatile than they should be if the market were truly efficient.) As his graduation from Wharton neared, Lynch made one additional, and very important, observation. He noticed that Wharton professors were not paid nearly as much as Fidelity managers and analysts. Lynch therefore decided to “cast [his] lot” with Fidelity, forswearing academia for the real world.5 After a short apprenticeship as an analyst, he was given control of the Fidelity Magellan Fund, then totalling approximately $20 million in assets.


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I.O.U.: Why Everyone Owes Everyone and No One Can Pay by John Lanchester

asset-backed security, bank run, banking crisis, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black-Scholes formula, Blythe Masters, Celtic Tiger, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, diversified portfolio, double entry bookkeeping, Exxon Valdez, Fall of the Berlin Wall, financial deregulation, financial innovation, fixed income, George Akerlof, greed is good, hedonic treadmill, hindsight bias, housing crisis, Hyman Minsky, intangible asset, interest rate swap, invisible hand, Jane Jacobs, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, Kickstarter, laissez-faire capitalism, light touch regulation, liquidity trap, Long Term Capital Management, loss aversion, Martin Wolf, money market fund, mortgage debt, mortgage tax deduction, mutually assured destruction, Myron Scholes, negative equity, new economy, Nick Leeson, Norman Mailer, Northern Rock, Own Your Own Home, Ponzi scheme, quantitative easing, reserve currency, Right to Buy, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, South Sea Bubble, statistical model, The Great Moderation, the payments system, too big to fail, tulip mania, value at risk

Except that the asshole was right: Enron’s accounting was so corrupt that when the nature of the frauds came out, the share price crashed from $90 to nothing, Skilling went to jail for twenty-four years, the auditor Arthur Andersen (one of the world’s five biggest accountancy firms) was put out of business, many employees lost their life savings, and many investors’ sentiments turned sharply against the stock market, since if a much-admired, much-analyzed blue-chip investment such as Enron could turn out to be worth nothing, whose accounts could you trust?* The economist Robert Shiller regularly sends out a questionnaire to investors, and the response in 2001, after the Enron crash, was that “Investors told us in no uncertain terms that the accounting scandals were a major factor in their withdrawal from the stock market.” As a result of the dot-com crash and the Enron implosion, the early years of the new millennium were a time when the money which chases the new idea, the go-go idea, had turned its attention away from the stock market.

Just to repeat the basic point: a 20 percent drop in U.S. home prices, not on the face of it an extraordinarily unlikely thing, was enough to cause a global banking crisis that nearly destroyed the entire system, followed by a global recession verging on depression. So why didn’t more economists seem aware of that possibility? Has the profession really drifted that far away from the real world? The short answer is that with some stellar exceptions—Robert Shiller, Nouriel Roubini, Paul Krugman, and John Kay conspicuous among them—yes, it has. The profession’s preference for textbook-perfect academic models of phenomena led to it being AWOL during the biggest economic crisis since the 1930s. A profession whose job it is to make sense of economic phenomena collectively failed. In the words of an American university provost, “I have an entire department of economists who can provide a brilliant ex post facto explanation of what happened—and not a single one of them saw it coming in advance.”

I would like to thank The Atlantic for permission to quote Simon Johnson’s article “The Quiet Coup,” and the Nobel Foundation for permission to quote Daniel Kahneman’s Biography. SOURCES This is a list both of sources and of suggestions for further reading. These are all books from which I have learnt a great deal. Ahamed, Liaquat. Lords of Finance: The Bankers Who Broke the World. Penguin Press, New York, 2009. Akerlof, George, and Robert Shiller. Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism. Princeton, Princeton, 2009. Bernstein, Peter. Against the Gods: The Remarkable Story of Risk. Wiley, New York, 1998. Bitner, Richard. Confessions of a Subprime Lender: An Insider’s Tale of Greed, Fraud, and Ignorance. Wiley, New York, 2008. Buchan, James. Frozen Desire. Picador, London, 1996.


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Smart Money: How High-Stakes Financial Innovation Is Reshaping Our WorldÑFor the Better by Andrew Palmer

Affordable Care Act / Obamacare, algorithmic trading, Andrei Shleifer, asset-backed security, availability heuristic, bank run, banking crisis, Black-Scholes formula, bonus culture, break the buck, Bretton Woods, call centre, Carmen Reinhart, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Graeber, diversification, diversified portfolio, Edmond Halley, Edward Glaeser, endogenous growth, Eugene Fama: efficient market hypothesis, eurozone crisis, family office, financial deregulation, financial innovation, fixed income, Flash crash, Google Glasses, Gordon Gekko, high net worth, housing crisis, Hyman Minsky, implied volatility, income inequality, index fund, information asymmetry, Innovator's Dilemma, interest rate swap, Kenneth Rogoff, Kickstarter, late fees, London Interbank Offered Rate, Long Term Capital Management, longitudinal study, loss aversion, margin call, Mark Zuckerberg, McMansion, money market fund, mortgage debt, mortgage tax deduction, Myron Scholes, negative equity, Network effects, Northern Rock, obamacare, payday loans, peer-to-peer lending, Peter Thiel, principal–agent problem, profit maximization, quantitative trading / quantitative finance, railway mania, randomized controlled trial, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, short selling, Silicon Valley, Silicon Valley startup, Skype, South Sea Bubble, sovereign wealth fund, statistical model, Thales of Miletus, transaction costs, Tunguska event, unbanked and underbanked, underbanked, Vanguard fund, web application

Paul Volcker, one former chairman of the Federal Reserve whose postcrisis reputation remains intact, has implied that no financial innovation of the past twenty-five years matches up to the automatic teller machine in terms of usefulness. Paul Krugman, a Nobel Prize–winning economist-cum-polemicist, has written that it is hard to think of any major recent financial breakthroughs that aided society.3 A conference held by the Economist in New York in late 2013 debated whether talented graduates should head to Google or Goldman Sachs. Vivek Wadhwa, a serial entrepreneur, spoke up for Google; Robert Shiller, another Nobel Prize–winning economist, argued for Goldman. Wadhwa had the easier task. “Would you rather have your children engineering the financial system creating more problems for us or having a chance of saving the world?” he asked. Even an audience of Economist readers in New York was pretty clear about its choice, plumping heavily for Mountain View over Wall Street. Yet Shiller’s arguments are the more powerful.

My hope, by the end of this book, is that such a prospect sounds less disturbing than it may have at the start. When the figures come out on the proportion of graduates going into the financial services industry, the usual reaction is to assume that other industries simply must be more productive outlets for our brightest young people. But are other sectors really more useful? In his book Finance and the Good Society, Robert Shiller cites a statistic showing that 19.7 percent of America’s labor force in 2002 was engaged in some form of guarding activity.1 That doesn’t scream social utility. Financial innovation has made enormous contributions to society in the past, and it is primed to do so again. Indeed, the crisis of 2007–2008 has made it more likely that finance will be both creative and constructive. Financial entrepreneurs have the opportunity to rethink an industry that is more constrained, cautious, and cost conscious than before.

Richard Sylla, “A Historical Primer on the Business of Credit Ratings” (paper prepared for a conference of the World Bank, Washington, DC, March 2001). 17. Andrew Odlyzko, “Collective Hallucinations and Inefficient Markets: The British Railway Mania of the 1840s,” SSRN Electronic Journal (2010). 18. Peter Tufano, “Business Failure, Judicial Intervention and Financial Innovation: Restructuring US Railroads in the Nineteenth Century,” Business History Review (1997). 19. Robert Shiller, “The Invention of Inflation-Indexed Bonds in America” (NBER Working Paper 10183, December 2003). For a more comprehensive history, see Franklin Allen and Douglas Gale, Financial Innovation and Risk Sharing (Cambridge, MA: MIT Press, 1994). 20. Sometimes, they are more important. As policy makers try to find a way to avoid bailing out banks in a future financial crisis, one answer is a new security issued by banks called “contingent convertible” bonds, or CoCos for short.


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How Markets Fail: The Logic of Economic Calamities by John Cassidy

"Robert Solow", Albert Einstein, Andrei Shleifer, anti-communist, asset allocation, asset-backed security, availability heuristic, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Black-Scholes formula, Blythe Masters, Bretton Woods, British Empire, business cycle, capital asset pricing model, centralized clearinghouse, collateralized debt obligation, Columbine, conceptual framework, Corn Laws, corporate raider, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Daniel Kahneman / Amos Tversky, debt deflation, different worldview, diversification, Elliott wave, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, George Akerlof, global supply chain, Gunnar Myrdal, Haight Ashbury, hiring and firing, Hyman Minsky, income per capita, incomplete markets, index fund, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, John Nash: game theory, John von Neumann, Joseph Schumpeter, Kenneth Arrow, Kickstarter, laissez-faire capitalism, Landlord’s Game, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, Mikhail Gorbachev, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Myron Scholes, Naomi Klein, negative equity, Network effects, Nick Leeson, Northern Rock, paradox of thrift, Pareto efficiency, Paul Samuelson, Ponzi scheme, price discrimination, price stability, principal–agent problem, profit maximization, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, RAND corporation, random walk, Renaissance Technologies, rent control, Richard Thaler, risk tolerance, risk-adjusted returns, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, technology bubble, The Chicago School, The Great Moderation, The Market for Lemons, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, unorthodox policies, value at risk, Vanguard fund, Vilfredo Pareto, wealth creators, zero-sum game

Contrary to some accounts, the boom didn’t begin in 2003 or 2004. Robert Shiller has put together a chart that shows inflation-adjusted U.S. home prices going back to 1890. (See Figure 18.1.) It clearly demonstrates that prices started to appreciate at an unprecedented rate in the mid-1990s. In many individual cities, the increases were even more dramatic than Shiller’s chart suggests. In the four-year period between December 1998 and December 2002 alone, house prices jumped by almost 70 percent in San Francisco and Boston, and by about 50 percent in Los Angeles, Miami, and Washington, D.C. (These figures and those that follow are not adjusted for inflation. They come from the S&P/Case-Shiller Home Price Indices, which the same Robert Shiller helped to develop.) FIGURE 18.1: HOUSE PRICES 1890–2008, along with Building Costs, Population, and Long-Term Government Bond Interest Rates, annual 1890–2008 (Source: Robert J.

HOW MARKETS FAIL THE LOGIC OF ECONOMIC CALAMITIES JOHN CASSIDY FARRAR, STRAUS AND GIROUX • NEW YORK Farrar, Straus and Giroux 18 West 18th Street, New York 10011 Copyright © 2009 by John Cassidy All rights reserved First edition, 2009 Grateful acknowledgment is made for permission to reprint material from Irrational Exuberance, Second Edition, by Robert J. Shiller, copyright © 2005 by Princeton University Press. Reprinted by permission of Princeton University Press. Library of Congress Cataloging-in-Publication Data Cassidy, John, 1963– How markets fail : the logic of economic calamities / John Cassidy. p. cm. Includes bibliographical references and index. eISBN: 978-1-429-99069-1 Date of eBook conversion: 07/17/2010 1. Financial crises. 2. Stock exchanges. 3.

Between 2003 and 2006, as the rise in house prices accelerated, many expressions of concern appeared in the media. In June 2005, The Economist said, “The worldwide rise in house prices is the biggest bubble in history. Prepare for the economic pain when it pops.” In the United States, the ratio of home prices to rents was at a historic high, the newsweekly noted, with prices rising at an annual rate of more than 20 percent in some parts of the country. The same month, Robert Shiller, a well-known Yale economist who wrote the 2000 bestseller Irrational Exuberance, told Barron’s, “The home-price bubble feels like the stock-market mania in the fall of 1999.” One reason these warnings went unheeded was denial. When the price of an asset is going up by 20 or 30 percent a year, nobody who owns it, or trades it, likes to be told their newfound wealth is illusory. But it wasn’t just real estate agents and condo flippers who were insisting that the rise in prices wouldn’t be reversed: many economists who specialized in real estate agreed with them.


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Anatomy of the Bear: Lessons From Wall Street's Four Great Bottoms by Russell Napier

Albert Einstein, asset allocation, banking crisis, Bretton Woods, business cycle, buy and hold, collective bargaining, Columbine, cuban missile crisis, desegregation, diversified portfolio, floating exchange rates, Fractional reserve banking, full employment, hindsight bias, Kickstarter, Long Term Capital Management, market bubble, mortgage tax deduction, Myron Scholes, new economy, oil shock, price stability, reserve currency, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, short selling, stocks for the long run, yield curve, Yogi Berra

Regan, For The Record: From Wall Street to Washington (Hutchison, 1988) Jeremy J. Siegel, Stocks For The Long Run: The Definitive Guide to Financial Market Returns and Long-Term Investment Strategies (McGraw-Hill, 3rd Ed., 2002) Mark Singer, Funny Money (Alfred A. Knopf, 1985) Robert Shaplen, Kreuger, Genius and Swindler (Alfred A Knopf, 1960) Robert J. Shiller, Irrational Exuberance (Princeton University Press, 2000) Robert J. Shiller, Market Volatility (MIT Press, 2001) Robert J. Shiller and Stanley B. Resor, www.econ.yale.edu/~shiller/data.htm Andrew Smithers and Stephen Wright, Valuing Wall Street: Protecting Wealth in Turbulent Markets (McGraw-Hill, 2000) Robert Sobel, Panic on Wall Street: A History of America’s Financial Disaster’s (Macmillan, 1968) Robert Sobel, The Great Bull Market - Wall Street in the 1920s (W.

Figure 54 provides the series of earnings from 1916-29 and indicates the volatility of earnings over the period. FIGURE 54. EARNINGS OF S&P COMPOSITE STOCK PRICE INDEX (INDEX, 1929=100) Source: Robert J. Shiller, Market Volatility The data shows the difficulty in assessing the level of profit growth of listed companies during the 1920s. It is clear the huge war-profit year of 1916 and the deflationary year of 1921 are not good starting points for launching any comparison with 1929. In order to cope with such problems throughout this book we refer to the cyclically adjusted earnings as providing the best guide to the underlying earnings power of listed companies. The chosen cyclical adjustment is to compute a ten-year rolling average earnings figure as recommended by Professor Robert Shiller in his book Irrational Exuberance. However, even this approach to calculating normal earnings is complicated in this particular period due to the exceptionally high levels of profit earned from 1915-17.

In Valuing Wall Street, they subject the most common valuation measures to various tests, importantly the reliability of those measures relative to subsequent returns as indicated by “hindsight value”. What we find is there were measures of value available to investors at the time that showed equities to be very cheap in 1921, 1932, 1949 and 1982. While accepting the usefulness of the cyclically adjusted PE - the chosen measure of value of Yale’s Robert Shiller - Smithers and Wright found that the q ratio has been a particularly accurate indicator of superior future returns. Given its usefulness, at least over the long term, we will use the q ratio to assess how equity valuations have altered over different periods. The q ratio is effectively a measure of the stock-market valuation of a company relative to the replacement value of its assets. In this book, a statement such as ‘equities were trading below fair value’ simply means the prevailing q ratio was below the geometric mean of the ratio.


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Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism by George A. Akerlof, Robert J. Shiller

"Robert Solow", affirmative action, Andrei Shleifer, asset-backed security, bank run, banking crisis, business cycle, buy and hold, collateralized debt obligation, conceptual framework, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, Deng Xiaoping, Donald Trump, Edward Glaeser, en.wikipedia.org, experimental subject, financial innovation, full employment, George Akerlof, George Santayana, housing crisis, Hyman Minsky, income per capita, inflation targeting, invisible hand, Isaac Newton, Jane Jacobs, Jean Tirole, job satisfaction, Joseph Schumpeter, Long Term Capital Management, loss aversion, market bubble, market clearing, mental accounting, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Myron Scholes, new economy, New Urbanism, Paul Samuelson, plutocrats, Plutocrats, price stability, profit maximization, purchasing power parity, random walk, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, South Sea Bubble, The Chicago School, The Death and Life of Great American Cities, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, working-age population, Y2K, Yom Kippur War

Animal Spirits Animal Spirits HOW HUMAN PSYCHOLOGY DRIVES THE ECONOMY, AND WHY IT MATTERS FOR GLOBAL CAPITALISM With a new preface by the authors GEORGE A. AKERLOF AND ROBERT J. SHILLER Princeton University Press • PRINCETON AND OXFORD George Akerlof is the Daniel E. Koshland Sr. Distinguished Professor of Economics at the University of California at Berkeley; co-director of the Program on Social Interactions, Identity and Well-Being of the Canadian Institute for Advanced Research; and a member of the board of directors of the National Bureau of Economic Research. Robert Shiller is the Arthur M. Okun Professor of Economics at the Cowles Foundation for Research in Economics and Professor of Finance at the International Center for Finance, Yale University; research associate at the National Bureau of Economic Research; and co-founder and principal of two U.S. firms that are in the business of issuing securities: MacroMarkets LLC and Macro Financial LLC.

We are very grateful for the invaluable help we have received from our research assistants Santosh Anagol, Paul Chen, Stephanie Finnel, Diego Garaycochea, Joshua Hausman, Jessica Jeffers, Mark Schneider, Hasan Seyhan, Ronit Walny, and Andy Di Wu, as well as from Carol Copeland, a most loyal administrative assistant. We are grateful for many comments offered by students in Robert Shiller’s Economics 527/Law 20083/Management 565 course, part of the macroeconomics sequence at Yale University, in which, over the course of five consecutive years, succeeding drafts of this book were used as a textbook. Robert’s wife, Virginia Shiller, a clinical psychologist, has been influential in impressing upon her husband the significance for economics of various principles of human psychology and has helped temper his technical impulses to make sure there is always a connection to economic reality. We both have sons who are emerging scholars and who have offered comments on the book.

Copyright © 2009 Princeton University Press Requests for permission to reproduce material from this work should be sent to Permissions, Princeton University Press Published by Princeton University Press, 41 William Street, Princeton, New Jersey 08540 In the United Kingdom: Princeton University Press, 6 Oxford Street, Woodstock, Oxfordshire OX20 1TW press.princeton.edu All Rights Reserved Ninth printing, and first paperback printing, with a new preface by the authors, 2010 Paperback ISBN: 978-0-691-14592-1 The Library of Congress has cataloged the cloth edition of this book as follows Akerlof, George A., 1940– Animal spirits : how human psychology drives the economy, and why it matters for global capitalism / George A. Akerlof and Robert J. Shiller. p. cm. ISBN 978-0-691-14233-3 (hardcover : alk. paper) 1. Economics—Psychological aspects. 2. Finance—Psychological aspects. 3. Capitalism. 4. Globalization. I. Shiller, Robert J. II. Title. HB74.P8A494 2009 330.12′2019—dc22 2008052649 British Library Cataloging-in-Publication Data is available This book has been composed in Adobe Galliard and Formata by Princeton Editorial Associates, Inc., Scottsdale, Arizona Printed on acid-free paper. ∞ Printed in the United States of America 10 9 Contents * * * Preface to the Paperback Edition Preface Acknowledgments INTRODUCTION Part One: Animal Spirits ONE Confidence and Its Multipliers TWO Fairness THREE Corruption and Bad Faith FOUR Money Illusion FIVE Stories Part Two: Eight Questions and Their Answers SIX Why Do Economies Fall into Depression?


Global Financial Crisis by Noah Berlatsky

accounting loophole / creative accounting, asset-backed security, banking crisis, Bretton Woods, capital controls, Celtic Tiger, centre right, circulation of elites, collapse of Lehman Brothers, collateralized debt obligation, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, deindustrialization, Doha Development Round, energy security, eurozone crisis, financial innovation, Food sovereignty, George Akerlof, God and Mammon, Gordon Gekko, housing crisis, illegal immigration, income inequality, market bubble, market fundamentalism, mass immigration, moral hazard, new economy, Northern Rock, purchasing power parity, quantitative easing, race to the bottom, regulatory arbitrage, reserve currency, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, South China Sea, structural adjustment programs, too big to fail, trade liberalization, transfer pricing, working poor

In order to make finance safe for our children, we need better laws and regulations. This is hard to accomplish, however, and it’s never enough. Unless people—at least most people—are willing to do what is right because it is right, our laws will be objects of mockery and abuse. First we need a change of heart. Perhaps we’ll then get the laws right too. 31 3 Viewpoint “Boom Thinking” Caused the Crisis Robert J. Shiller Robert J. Shiller is a professor of economics at Yale University and an economics columnist for the New York Times. In the following viewpoint, Shiller says that the boom in mortgage lending was fueled by a belief that housing prices would rise indefinitely. Shiller calls this belief a “social contagion”—an epidemic of a certain kind of thinking. Since people believe prices will go up, they spend more money, pushing prices further up, and convincing others to spend.

Policies for the Crisis Jenny Booth 22 China and Russia accuse the United States and its financial institutions and regulators of irresponsibly pursuing profit and ignoring economic danger signs. To meet the crisis, they called for greater global cooperation. 2. The Greed of Financial Institutions Caused the Crisis Oskari Juurikkala 27 Financial institutions wanted large profits, therefore they hid the risks they were taking from regulators. Better regulations are important, but businesspeople need to be more responsible and less greedy. 3. “Boom Thinking” Caused the Crisis Robert J. Shiller 32 Boom thinking is a kind of social contagion; once a commodity starts rising in price, people convince themselves and then each other that the price will keep going up. This happened in the United States with home prices, which rose to unsustainable levels. 4. The Weakness of Banking Regulations Caused the Crisis Vince Cable Some British banks have grown too big to fail, and perhaps too big for regulators to handle.

Since people believe prices will go up, they spend more money, pushing prices further up, and convincing others to spend. Regulators and experts also tend to be caught up in the enthusiasm, creating a speculative bubble that can have complicated and disastrous effects. As you read, consider the following questions: 1. Between 1997 and 2005, how much did homeownership rates in the United States increase, according to the U.S. Census? 2. According to Robert J. Shiller, with whom did Alan Greenspan have an overly strong ideological alignment? 3. What was the federal funds rate between mid-2003 and mid-2004? This text has been suppressed due to author restrictions. 32 Causes of the Global Financial Crisis This text has been suppressed due to author restrictions. 33 The Global Financial Crisis This text has been suppressed due to author restrictions. 34 Causes of the Global Financial Crisis This text has been suppressed due to author restrictions. 35 The Global Financial Crisis This text has been suppressed due to author restrictions. 36 Causes of the Global Financial Crisis U.S.


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The Unbanking of America: How the New Middle Class Survives by Lisa Servon

Affordable Care Act / Obamacare, Airbnb, basic income, Build a better mousetrap, business cycle, Cass Sunstein, choice architecture, creative destruction, Credit Default Swap, employer provided health coverage, financial exclusion, financial independence, financial innovation, gender pay gap, George Akerlof, gig economy, income inequality, informal economy, Jane Jacobs, Joseph Schumpeter, late fees, Lyft, M-Pesa, medical bankruptcy, microcredit, Occupy movement, payday loans, peer-to-peer lending, precariat, Ralph Nader, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, sharing economy, too big to fail, transaction costs, unbanked and underbanked, underbanked, universal basic income, Unsafe at Any Speed, We are the 99%, white flight, working poor, Zipcar

White, “Why Banks Love Debit Cards Again,” Time, March 28, 2013. http://business.time.com/2013/03/28/why-banks-love-debit-cards-again/ Despite these two huge suits: Pew Charitable Trusts, “Checks and Balances,” p. 3. 34 “have lost an essential tool”: Jessica Silver-Greenberg and Robert Gebeloff, “Arbitration Everywhere: Stacking the Deck of Justice,” New York Times, DealBook blog, October 31, 2015. http://www.nytimes.com/2015/11/01/business/dealbook/arbitration-everywhere-stacking-the-deck-of-justice.html “they tend to do them”: Ibid. George Akerlof and Robert Shiller: George A. Akerlof and Robert Shiller, Phishing for Phools: The Economics of Manipulation and Deception (Prince­ton, NJ: Princeton University Press), p. xi. 36 made it a common catchphrase: Renee Haltom, “Failure of Continental Illinois,” Federal Reserve History, November 22, 2013. http://www.federalreservehistory.org/Events/DetailView/47 37 “other people’s money”: Other People’s Money is the title of Louis Brandeis’s 1914 treatise.

Hackett links this shift to companies’ fear that lawsuits will force them to “abandon lucrative billing practices. . . . When banks make mistakes or do bad things,” Hackett says, “they tend to do them many times and to many people.” Banks are not the only type of business to engage in practices that aren’t in the best interest of consumers. In their book Phishing for Phools, the Nobel Prize–winning economists George Akerlof and Robert Shiller argue that the free market is set up to reward tricksters. Business people, they say, are under pressure to compete and to make the most profit possible. This environment leads them to engage in manipulation and deception. “The economic system,” Akerloff and Shiller write, “is filled with trickery.” Manipulation and deception, from opaque fees to unethical debt-collection practices, run through the entire consumer financial-services system.

Research from other industries suggests that eliminating this uncertainty, which the sandbox would do, can reduce by one-third the time needed to develop and introduce a new product, which also contributes to reduced cost to the developer. potential to improve consumers’: Ibid. to manage regulatory risk: Ibid. Paul Krugman argued: Paul Krugman, “Making Banking Boring,” New York Times, April 9, 2009. http://www.nytimes.com/2009/04/10/opinion/10krugman.html?_r=0 Bibliography Akasha, Nan. “Money Archetypes and Guilt and Shame.” Nan Akasha blog, May 29, 2012. Akerlof, George A., and Robert Shiller. Phishing for Phools: The Economics of Manipulation and Deception. Princeton, NJ: Princeton University Press, 2015. Ardener, Shirley. “Microcredit, Money Transfers, Women, and the Cameroon Diaspora.” Afrika Focus, vol. 23, no. 2 (2010): 11–24. Arnett, Jeffrey J., and Joseph Schwab. “The Clark University Poll of Parents of Emerging Adults.” Worcester, MA: Clark University, September 2013. Associated Press.


pages: 363 words: 28,546

Portfolio Design: A Modern Approach to Asset Allocation by R. Marston

asset allocation, Bretton Woods, business cycle, capital asset pricing model, capital controls, carried interest, commodity trading advisor, correlation coefficient, diversification, diversified portfolio, equity premium, Eugene Fama: efficient market hypothesis, family office, financial innovation, fixed income, German hyperinflation, high net worth, hiring and firing, housing crisis, income per capita, index fund, inventory management, Long Term Capital Management, mortgage debt, passive investing, purchasing power parity, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Sharpe ratio, Silicon Valley, stocks for the long run, superstar cities, survivorship bias, transaction costs, Vanguard fund

Stocks Long-Term Treasury Return Jul 53–May 54 Aug 57–Apr 58 Apr 60–Feb 61 Dec 69–Nov 70 Nov 73–Mar 75 Jul 81–Nov 82 Jul 90–Mar 91 Mar 01–Nov 01 Dec 07–Jun 09 Jan 53–Sept 53 Jul 56–Dec 57 Jul 59–Oct 60 Dec 68–Jun 70 Jan 73–Dec 74 Nov 80–Jul 82 Jun 90–Oct 90 Aug 00–Feb 03 Oct 07–Mar 09 −8.0% −14.3% −8.0% −26.3% −36.2% −16.6% −14.1% −42.5% −46.6% 1.2% 2.9% 8.9% −4.6% 6.6% 17.8% 0.1% 32.3% 23.4% The market peak and trough are determined by the monthly average of daily prices for the S&P 500 index. The S&P data is from Robert Shiller’s web site, http://www.econ.yale.edu/∼shiller/data.htm. The returns for large-cap U.S. stocks and Treasury bonds are from the 2010 SBBI Classic Yearbook (© Morningstar). The large-cap stock returns include dividends. by Standard & Poor’s (via the Zephyr StyleADVISOR database) is used instead. For this reason, the large-cap U.S. stock index will be referred to as the “S&P 500 index” even though it is the SBBI Large-Company Stock series from 1957 to 1973 and a narrower index prior to 1957.

Equities always rise as the economy recovers. Let’s study past recessions. In every recession, equities will be traced from their trough during the recession over the 12 months succeeding the trough. Table 1.5 lists dates for the nine recessions since 1951 including the second half of the double-dip recession(s) of 1980–82. The market trough is determined by the lowest monthly average of daily prices for the S&P 500 price index from Robert Shiller’s web site, http://www.econ.yale.edu/∼shiller/data.htm. The S&P 500 gain is based on P1: OTA/XYZ P2: ABC c01 JWBT412-Marston December 20, 2010 16:58 Printer: Courier Westford 14 PORTFOLIO DESIGN TABLE 1.5 S&P 500 Rallies After Recessions, 1951–2010 Recession months (NBER dating) Jul 53–May 54 Aug 57–Apr 58 Apr 60–Feb 61 Dec 69–Nov 70 Nov 73–Mar 75 Jul 81–Nov 82 Jul 90–Mar 91 Mar 01–Nov 01 Dec 07–Jun 09 Market Bottom Gain in first 12 months Sept 53 Dec 57 Oct 60 Jun 70 Dec 74 Jul 82 Oct 90 Feb 03 Mar 09 46.0% 43.4% 32.6% 41.9% 37.3% 59.3% 33.5% 38.5% 49.8% the total return on the S&P (including dividends) from the 2010 SBBI Classic Yearbook (©Morningstar).

Figure 2.5 shows the variation in P-E ratios for the S&P 500 index since 1951 as measured using the same methodology as P1: OTA/XYZ P2: ABC c02 JWBT412-Marston December 20, 2010 16:59 Printer: Courier Westford 32 PORTFOLIO DESIGN 50 40 30 20 10 0 1951 1961 1971 1981 1991 2001 FIGURE 2.5 Price-Earnings Ratios for S&P 500, 1951–2009 (Current Real Price Relative to 10-Year Average Real Earnings) Data Source: www.econ.yale.edu/∼Shiller described in Shiller (2000). Robert Shiller in his book, Irrational Exuberance (2000).12 Shiller compares the S&P 500 index for a given year with the average reported earnings of the S&P companies over the previous 10 years. Both series are expressed in real terms using the CPI. The rise in P-Es during the 1990s, in particular, introduced an upward trend into the average real return on equity. Since P-Es remained relatively high (at least prior to the financial crisis), average historical returns that include the recent period may overestimate future returns.


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The Wisdom of Crowds by James Surowiecki

AltaVista, Andrei Shleifer, asset allocation, Cass Sunstein, coronavirus, Daniel Kahneman / Amos Tversky, experimental economics, Frederick Winslow Taylor, George Akerlof, Howard Rheingold, I think there is a world market for maybe five computers, interchangeable parts, Jeff Bezos, John Meriwether, Joseph Schumpeter, knowledge economy, lone genius, Long Term Capital Management, market bubble, market clearing, market design, Monkeys Reject Unequal Pay, moral hazard, Myron Scholes, new economy, offshore financial centre, Picturephone, prediction markets, profit maximization, Richard Feynman, Richard Feynman: Challenger O-ring, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, The Nature of the Firm, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Toyota Production System, transaction costs, ultimatum game, Yogi Berra, zero-sum game

In Gladwell’s world, some people are far more influential than others, and cascades (he writes of them as epidemics) move via social ties, rather than being a simple matter of anonymous strangers observing each other’s behavior. People are still looking for information, but they believe that the ones who have it are the mavens, connectors, and salesmen (each of whom has a different kind of information). Do cascades exist? Without a doubt. They are less ubiquitous than the restaurant-going model suggests, since, as Yale economist Robert Shiller has suggested, people don’t usually make decisions in sequence. “In most cases,” Shiller writes, “many people independently choose their action based on their own signals, without observing the actions of others.” But there are plenty of occasions when people do closely observe the actions of others before making their own decisions. In those cases, cascades are possible, even likely. That is not always a bad thing.

That’s especially true when you consider that most investors are trying to evaluate only a small number of stocks, while the market has to come up with prices for more than five thousand of them. The fact that the market is, even under those conditions, smarter than almost all investors is telling. Even so, financial markets are decidedly imperfect at tapping into the collective wisdom, especially relative to other methods of doing so. The economist Robert Shiller, for instance, has shown convincingly that stock prices jump around a lot more than is justified by changes in the true values of companies. That’s very different from the NFL betting market or the IEM or even racetrack betting, where the swings in opinion are significantly milder and the crowd only rarely pulls a U-turn. Part of the reason for this is, again, that predicting twenty years of a company’s future is infinitely harder, and far more uncertain, than predicting who’s going to win on Sunday or even who’ll be elected in November.

abstract_id=267770; and Suzanne Lohmann, “The Dynamics of Informational Cascades: The Monday Demonstrations in Leipzig, East Germany, 1989–91,” World Politics 47 (1994): 42–101. A rigorous model of cascades and the way networks function is in Duncan Watts, Six Degrees (New York: Norton, 2002). A remarkably rich and human picture of how cascades work in the real world can be found in Malcolm Gladwell, The Tipping Point (New York: Little, Brown, 2000). Robert Shiller, “Conversation, Information, and Herd Behavior,” American Economic Review 85 (1995): 181–85. While Shiller is skeptical of the ubiquity of cascades, in this paper he nonetheless emphasizes the importance of social influence, as a way of explaining herding behavior. A longer account of William Sellers’s campaign to standardize the screw can be found in James Surowiecki, “Turn of the Century,” Wired 10.01 (January 2002), http://www.wired.com/wired/archive/10.01/standards_pr.html.


pages: 355 words: 92,571

Capitalism: Money, Morals and Markets by John Plender

activist fund / activist shareholder / activist investor, Andrei Shleifer, asset-backed security, bank run, Berlin Wall, Big bang: deregulation of the City of London, Black Swan, bonus culture, Bretton Woods, business climate, business cycle, Capital in the Twenty-First Century by Thomas Piketty, central bank independence, collapse of Lehman Brothers, collective bargaining, computer age, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, discovery of the americas, diversification, Eugene Fama: efficient market hypothesis, eurozone crisis, failed state, Fall of the Berlin Wall, fiat currency, financial innovation, financial intermediation, Fractional reserve banking, full employment, God and Mammon, Gordon Gekko, greed is good, Hyman Minsky, income inequality, inflation targeting, information asymmetry, invention of the wheel, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, joint-stock company, Joseph Schumpeter, labour market flexibility, liberal capitalism, light touch regulation, London Interbank Offered Rate, London Whale, Long Term Capital Management, manufacturing employment, Mark Zuckerberg, market bubble, market fundamentalism, mass immigration, means of production, Menlo Park, money market fund, moral hazard, moveable type in China, Myron Scholes, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, paradox of thrift, Paul Samuelson, plutocrats, Plutocrats, price stability, principal–agent problem, profit motive, quantitative easing, railway mania, regulatory arbitrage, Richard Thaler, rising living standards, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, shareholder value, short selling, Silicon Valley, South Sea Bubble, spice trade, Steve Jobs, technology bubble, The Chicago School, The Great Moderation, the map is not the territory, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, too big to fail, tulip mania, Upton Sinclair, Veblen good, We are the 99%, Wolfgang Streeck, zero-sum game

The point is underlined by the brilliant quote from Daniel Defoe with which Charles Mackay begins his book: Some in clandestine companies combine; Erect new stocks to trade beyond the line; With air and empty names beguile the town, And raise new credits first, then cry ’em down; Divide the empty nothing into shares, And set the crowd together by the ears.80 Missing from the work of efficient market theorists are the insights of behavioural finance, which brings the disciplines of psychology and sociology to the analysis of behaviour in financial markets. In discussing bubbles, economists such as Robert Shiller and Richard Thaler posit a feedback theory. When prices rise fast, the profits made by investors attract public attention, promoting word-of-mouth enthusiasm and encouraging expectations of further price rises. Commentators fuel the boom with rationalisations such as the idea that the economy has reached a new era of permanently higher returns. If the feedback is not interrupted, the result is a bubble.

Having made an initial 100 per cent profit of £7,000 on his shares in the South Sea Company, he was unlucky enough to go back into the market close to the top and lost £20,000, equivalent to £2.5 million in today’s money. A rueful Newton clearly grasped the logic of behavioural finance when he famously remarked: ‘I can calculate the motions of the heavenly bodies, but not the madness of people.’ Part of the psychology, as Robert Shiller points out, is that news of the profits of others leads people to a sense of futility in doing their relatively unrewarding day-to-day work and to a growing sense of envy. For many, including Pope, the stock market also appeared to hold the answer to their immediate financial problems. Dickens understood all this well. At the start of Nicholas Nickleby, which was written with the financial mania of 1825–26 in mind, he expertly catches the feel of how ordinary people can be swept along by the speculative tide: As for Nicholas, he lived a single man on the patrimonial estate until he grew tired of living alone, and then he took to wife the daughter of a neighbouring gentleman with a dower of one thousand pounds.

Like Alan Greenspan in revisionist mode, he claims that most bubbles are 20/20 hindsight: Now, after the fact you always find people who said before the fact that prices are too high. People are always saying that prices are too high. When they turn out to be right, we anoint them. When they turn out to be wrong, we ignore them. They are typically right and wrong about half the time. Meantime, Queen Elizabeth II famously asked at the London School of Economics why no one had predicted the crisis. But many had. Among leading economists Robert Shiller and Raghuram Rajan, a former chief economist at the International Monetary Fund who subsequently became governor of the Indian central bank, had given due warning, as had Nouriel Roubini of New York University’s Stern School of Business. And numerous fund managers have a consistently good record in identifying bubbles. Jeremy Grantham of the US fund management group GMO, to take just one example, has an impeccable history on this score and argues that they are, in fact, easy to identify.


pages: 515 words: 132,295

Makers and Takers: The Rise of Finance and the Fall of American Business by Rana Foroohar

accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, additive manufacturing, Airbnb, algorithmic trading, Alvin Roth, Asian financial crisis, asset allocation, bank run, Basel III, bonus culture, Bretton Woods, British Empire, business cycle, buy and hold, call centre, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, centralized clearinghouse, clean water, collateralized debt obligation, commoditize, computerized trading, corporate governance, corporate raider, corporate social responsibility, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, crowdsourcing, David Graeber, deskilling, Detroit bankruptcy, diversification, Double Irish / Dutch Sandwich, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial deregulation, financial intermediation, Frederick Winslow Taylor, George Akerlof, gig economy, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, High speed trading, Home mortgage interest deduction, housing crisis, Howard Rheingold, Hyman Minsky, income inequality, index fund, information asymmetry, interest rate derivative, interest rate swap, Internet of things, invisible hand, John Markoff, joint-stock company, joint-stock limited liability company, Kenneth Rogoff, Kickstarter, knowledge economy, labor-force participation, London Whale, Long Term Capital Management, manufacturing employment, market design, Martin Wolf, money market fund, moral hazard, mortgage debt, mortgage tax deduction, new economy, non-tariff barriers, offshore financial centre, oil shock, passive investing, Paul Samuelson, pensions crisis, Ponzi scheme, principal–agent problem, quantitative easing, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, Rana Plaza, RAND corporation, random walk, rent control, Robert Shiller, Robert Shiller, Ronald Reagan, Satyajit Das, Second Machine Age, shareholder value, sharing economy, Silicon Valley, Silicon Valley startup, Snapchat, Social Responsibility of Business Is to Increase Its Profits, sovereign wealth fund, Steve Jobs, technology bubble, The Chicago School, the new new thing, The Spirit Level, The Wealth of Nations by Adam Smith, Tim Cook: Apple, Tobin tax, too big to fail, trickle-down economics, Tyler Cowen: Great Stagnation, Vanguard fund, zero-sum game

Consider the Commodity Futures Trading Commission (CFTC), which has about the same staff size today as it did in the 1990s, despite the fact that the swaps market it oversees has ballooned to more than $400 trillion.68 It’s not easy for regulators on five-figure salaries, with modest research budgets and enforcement assets, to stay ahead of the algorithmic misdeeds of traders making seven figures. And that’s a shame, because a 2015 survey of hundreds of high-level financial professionals found that more than a third had witnessed instances of malfeasance at their own firms and 38 percent disagreed that the industry puts a client’s best interests first.69 THE THEATER OF FINANCIALIZATION Of course, there are other theories about why financialization occurs. Nobel Prize winner Robert Shiller has described the “irrational exuberance” that he believes is a natural human tendency. The fact that we go repeatedly from boom to bust throughout history, moving like lemmings toward the New New Thing—be it tulips or collateralized debt obligations (CDOs)—points to the idea that there are strong psychological forces at work. (The neuroscience of traders’ brains, which respond to deal making similarly to how addicts’ brains respond to cocaine, is in itself a fascinating area of scholarly inquiry.)70 Other academics, like University of Michigan scholar Gerald Davis, focus on the importance of new management theories such as our notion of shareholder value that puts the investor before everyone and everything else in society, including customers, employees, and the public good.71 The changes in the financial system have gone hand in hand with changes in business culture.

As Friedman famously said back in 1970, “the social responsibility of business is to increase its profits.”33 This went hand in hand with another idea, which was that the share price of a firm always perfectly reflected all known information, and thus stock prices were the best overall measure of corporate value. This idea, known as the “efficient-market hypothesis,” eventually won its creator, another Friedman disciple and Chicago academic, Eugene Fama, the Nobel Prize. Ironically, Fama won it jointly in 2013 with Robert Shiller, a Yale economist whose work basically said the opposite—that markets, and asset values, were influenced by a variety of things (emotions, biases, bad habits, and pure chance) that had little to do with efficiency, and that they didn’t always work well, or predictably.34 The joint prize to the two men, one representing the past and the other the future, expresses as well as anything the existential crisis that has beset the economics profession.

It’s a stark statement about who has profited, and who hasn’t, from the housing recovery.8 The federal government is still underwriting most new mortgages in one way or another, via a multitude of state-sponsored programs and federally backed bonds. If a healthy housing market is one that is stable, affordable, inclusive, and not primarily dependent on government life support, then “we’re a long way from there,” says Yale professor and housing expert Robert Shiller. How to create a truly healthy housing market is a question that matters to everyone, not just those of us who can’t afford homes. American consumers spend $2 trillion a year on housing, which triggers billions of dollars of additional spending in related industries like consumer goods, telecommunications and technology, automotives, construction, retail banking, etc. Research shows that rising housing wealth is much more likely to spur consumer spending than rising stock wealth is.


pages: 198 words: 53,264

Big Mistakes: The Best Investors and Their Worst Investments by Michael Batnick

activist fund / activist shareholder / activist investor, Airbnb, Albert Einstein, asset allocation, bitcoin, Bretton Woods, buy and hold, buy low sell high, cognitive bias, cognitive dissonance, Credit Default Swap, cryptocurrency, Daniel Kahneman / Amos Tversky, endowment effect, financial innovation, fixed income, hindsight bias, index fund, invention of the wheel, Isaac Newton, John Meriwether, Kickstarter, Long Term Capital Management, loss aversion, mega-rich, merger arbitrage, Myron Scholes, Paul Samuelson, quantitative easing, Renaissance Technologies, Richard Thaler, Robert Shiller, Robert Shiller, Snapchat, Stephen Hawking, Steve Jobs, Steve Wozniak, stocks for the long run, transcontinental railway, value at risk, Vanguard fund, Y Combinator

In other words, to go back to the example of the gambler who was tossing a mental coin between two teams, had the gambler been asked if they would like to change their mind, it's highly unlikely they would say yes. Confidence grows exponentially once you've decided on something you were previously unsure about. Overconfidence is so ingrained in our DNA that even if we're aware of it, shielding ourselves from it becomes supremely difficult. Robert Shiller has written, “Our satisfaction with our views of the world is part of our self‐esteem.”2 This applies to everyone, but especially to people in the financial business. David Dreman shows how overconfident financial analysts are in his book, Contrarian Investment Strategies: Analysts were asked for their high and low estimates of the price of a stock. The high estimate was to be the number they were 95 percent sure the actual price would fall below; the low estimate was the price they were 95 percent sure the stock would remain above.

Making decisions ahead of time, especially decisions that involve admitting defeat, can help conquer one of the biggest hurdles investors face; looking in the mirror and seeing an ability that we just do not possess. Notes 1. Daniel Kahneman, Jack L. Knetsch, and Richard H. Thaler, “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias,” Journal of Economic Perspectives 5, no. 1 (Winter 1991): 193–206. 2. Robert Shiller, Irrational Exuberance (Princeton, NJ: Princeton University Press, 2000), 60. 3. David Dreman, Contrarian Investment Strategies: The Psychological Edge (New York: Free Press, 2012), 176. 4. Roger Lowenstein, Buffett (New York: Random House, 2008), 62. 5. Ibid., 93. 6. Warren Buffett, Partnership Letter, October 9, 1967. 7. Warren Buffett, 2016 Berkshire Hathaway annual letter, February 25, 2017. 8.

Anthony Bianco, “The Warren Buffett You Don't Know,” Bloomberg.com, July 5, 1999. 22. Warren Buffett, 1999 Berkshire Hathaway annual letter, March 1, 2000. 23. Warren Buffett, 2000 Berkshire Hathaway annual letter, February 28, 2001. 24. Warren Buffett, 2014 Berkshire Hathaway annual letter, February 25, 2015. CHAPTER 9 Bill Ackman Get Of Your Soapbox Our satisfaction with our views of the world is part of our self esteem and personal identity. —Robert Shiller I once saw the Nobel Prize–winning psychologist Daniel Kahneman say, “Ideas are part of who we are. They become like possessions. Especially publicly. I mean, flip flopping is a bad word. I love changing my mind!” This attitude stands in stark contrast to most investors, who loathe to do few things more than kill a previously held belief. Our inability to process information that challenges our ego is one of the biggest reasons why so many investors fail to capture market returns.


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Phishing for Phools: The Economics of Manipulation and Deception by George A. Akerlof, Robert J. Shiller, Stanley B Resor Professor Of Economics Robert J Shiller

"Robert Solow", Andrei Shleifer, asset-backed security, Bernie Madoff, business cycle, Capital in the Twenty-First Century by Thomas Piketty, collapse of Lehman Brothers, corporate raider, Credit Default Swap, Daniel Kahneman / Amos Tversky, dark matter, David Brooks, desegregation, en.wikipedia.org, endowment effect, equity premium, financial intermediation, financial thriller, fixed income, full employment, George Akerlof, greed is good, income per capita, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, Kenneth Arrow, Kenneth Rogoff, late fees, loss aversion, market bubble, Menlo Park, mental accounting, Milgram experiment, money market fund, moral hazard, new economy, Pareto efficiency, Paul Samuelson, payday loans, Ponzi scheme, profit motive, publication bias, Ralph Nader, randomized controlled trial, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, short selling, Silicon Valley, the new new thing, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, theory of mind, Thorstein Veblen, too big to fail, transaction costs, Unsafe at Any Speed, Upton Sinclair, Vanguard fund, Vilfredo Pareto, wage slave

Agarwal, Driscoll, Gabaix, and Laibson, “The Age of Reason: Financial Decisions over the Life Cycle and Implications for Regulation,” Brookings Papers on Economic Activity (Fall 2009): 51–101. 13. But, of course, if Lightning could speak, as the parent of every two-year-old well knows, the taste would no longer be shrouded. 14. See, for example, Robert J. Shiller, “Do Stock Prices Move Too Much to Be Justified by Subsequent Changes in Dividends?” American Economic Review 71, no. 3 (June 1981): 421–36; and John Y. Campbell and Robert J. Shiller, “Cointegration and Tests of Present Value Models,” Journal of Political Economy 95, no. 5 (October 1987): 1062–88. 15. J. Bradford De Long, Andrei Shleifer, Lawrence H. Summers, and Robert J. Waldmann, “Noise Trader Risk in Financial Markets,” Journal of Political Economy 98, no. 4 (August 1990): 703–38. 16.

Phishing for Phools Phishing for Phools THE ECONOMICS OF MANIPULATION AND DECEPTION GEORGE A. AKERLOF AND ROBERT J. SHILLER Princeton University Press • PRINCETON AND OXFORD Copyright © 2015 by Princeton University Press Published by Princeton University Press, 41 William Street, Princeton, New Jersey 08540 In the United Kingdom: Princeton University Press, 6 Oxford Street, Woodstock, Oxfordshire OX20 1TW press.princeton.edu Jacket illustration © Edward Koren. Jacket design by Jason Alejandro. “(How Much Is That) Doggie in the Window?” Written by Bob Merrill. Copyright © 1953, 1981 Golden Bell Songs. Used by permission. All Rights Reserved ISBN 978-0-691-16831-9 British Library Cataloging-in-Publication Data is available This book has been composed in Adobe Galliard and Formata by Princeton Editorial Associates Inc., Scottsdale, Arizona Printed on acid-free paper. ∞ Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 CONTENTS PREFACE vii INTRODUCTION Expect to Be Manipulated: Phishing Equilibrium 1 PART ONE Unpaid Bills and Financial Crash CHAPTER ONE Temptation Strews Our Path 15 CHAPTER TWO Reputation Mining and Financial Crisis 23 PART TWO Phishing in Many Contexts CHAPTER THREE Advertisers Discover How to Zoom In on Our Weak Spots 45 CHAPTER FOUR Rip-offs Regarding Cars, Houses, and Credit Cards 60 CHAPTER FIVE Phishing in Politics 72 CHAPTER SIX Phood, Pharma, and Phishing 84 CHAPTER SEVEN Innovation: The Good, the Bad, and the Ugly 96 CHAPTER EIGHT Tobacco and Alcohol 103 CHAPTER NINE Bankruptcy for Profit 117 CHAPTER TEN Michael Milken Phishes with Junk Bonds as Bait 124 CHAPTER ELEVEN The Resistance and Its Heroes 136 PART THREE Conclusion and Afterword CONCLUSION: EXAMPLES AND GENERAL LESSONS New Story in America and Its Consequences 149 AFTERWORD The Significance of Phishing Equilibrium 163 ACKNOWLEDGMENTS 175 NOTES 181 BIBLIOGRAPHY 233 INDEX 257 PREFACE It’s “the economy, stupid!”

Rosner, Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon (New York: Times Books/Henry Holt, 2011), on Fannie Mae and Freddie Mac; Henry M. Paulson, On the Brink: Inside the Race to Stop the Collapse of the Global Financial System (New York: Business Plus, 2010), on the US Treasury; Raghuram Rajan, Fault Lines: How Hidden Fractures Still Threaten the World Economy (Princeton: Princeton University Press, 2010), on the financial system; Robert J. Shiller, Subprime Solution: How Today’s Global Financial Crisis Happened and What to Do about It (Princeton: Princeton University Press, 2008); Andrew Ross Sorkin, Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System (New York: Viking, 2009), on the US Treasury; Gillian Tett, Fool’s Gold: How the Bold Dream of a Small Tribe at J. P. Morgan Was Corrupted by Wall Street Greed (New York: Free Press, 2009); and David Wessel, In Fed We Trust: Ben Bernanke’s War on the Great Panic (New York: Crown Business, 2009).


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Servant Economy: Where America's Elite Is Sending the Middle Class by Jeff Faux

back-to-the-land, Bernie Sanders, Black Swan, Bretton Woods, BRICs, British Empire, business cycle, call centre, centre right, cognitive dissonance, collateralized debt obligation, collective bargaining, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, David Brooks, David Ricardo: comparative advantage, disruptive innovation, falling living standards, financial deregulation, financial innovation, full employment, hiring and firing, Howard Zinn, Hyman Minsky, illegal immigration, indoor plumbing, informal economy, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, Kickstarter, lake wobegon effect, Long Term Capital Management, market fundamentalism, Martin Wolf, McMansion, medical malpractice, mortgage debt, Myron Scholes, Naomi Klein, new economy, oil shock, old-boy network, Paul Samuelson, plutocrats, Plutocrats, price mechanism, price stability, private military company, Ralph Nader, reserve currency, rising living standards, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, school vouchers, Silicon Valley, single-payer health, South China Sea, statistical model, Steve Jobs, Thomas L Friedman, Thorstein Veblen, too big to fail, trade route, Triangle Shirtwaist Factory, union organizing, upwardly mobile, urban renewal, War on Poverty, We are the 99%, working poor, Yogi Berra, Yom Kippur War

Dean Baker, Plunder and Blunder: The Rise and Fall of the Bubble Economy (San Francisco: Berrett-Kochler, 2009), 75. 22. Robert Shiller. Irrational Exuberance (New York: Crown, 2006), xiii. 23. Edmund L. Andrews, “Greenspan Concedes Error on Regulation,” New York Times, October 23, 2008. 24. Alan Greenspan, Age of Turbulence: Adventures in a New World (New York: Penguin Press, 2002), 508. 25. Alan Greenspan, “The Challenge of Central Banking in a Democratic Society,” speech to American Enterprise Institute, December 5, 1996. 26. Robert Rubin, In an Uncertain World: Tough Choices from Wall Street to Washington (New York: Random House, 2003), 257–258. 27. Lewis, “The End.” 28. Robert Shiller, “Challenging the World in Whispers, Not Shouts,” New York Times, November 2, 2008. 29. Gretchen Morgenson, “Seeing versus Doing,” New York Times, September 26, 2010. 30.

If anything, the Internet was making telecommuting easier and allowing people to make a living farther away from their offices. Fourth, there was no evidence of an accelerated tightening of environmental restrictions since they had become common in the 1960s. Finally, noted Baker, as the prices of owner-occupied housing accelerated, rents had actually declined, suggesting that the housing-price boom was being driven not by a supply shortage but by a speculative boom. Other prominent analysts agreed. Robert Shiller, a codeveloper of the most widely used housing price index and the foremost U.S. housing economist, had been predicting a collapse of housing and stock market prices for several years. In a book called Irrational Exuberance, he wrote that “significant further rises in these markets could lead, eventually, to even more significant declines.”22 The late economist Edward Gramlich, then a member of the Federal Reserve Board of Governors, raised concerns about subprime lending practices and an overheated housing market as early as 2000.

They told her that she didn’t know what she was talking about, and they engineered an extraordinary congressional resolution forbidding either the CFTC or the Securities and Exchange Commission to even propose rules to regulate derivatives, swaps, and other exotic securities. The treatment of Born by Rubin, Greenspan, and Gramm was a warning to everyone throughout the government that dissent from the new economic orthodoxy would not be tolerated. There would be no questioning of the system that was feeding the global expansion of the U.S. finance industry. Self-censorship followed. Robert Shiller, who was a member of the economic advisory panel to the Federal Reserve Board, observed that in professional circles, “people compete for stature, and the ideas just lag behind. The economists who advise the policymakers are no different. We all want to associate ourselves with dignified people and dignified ideas. Speculative bubbles, and those who study them, have been deemed undignified.”28 Clayton Holdings is a firm that analyzed mortgage pools for Citigroup, Goldman-Sachs, and other prominent Wall Street firms.


pages: 295 words: 66,824

A Mathematician Plays the Stock Market by John Allen Paulos

Benoit Mandelbrot, Black-Scholes formula, Brownian motion, business climate, business cycle, butter production in bangladesh, butterfly effect, capital asset pricing model, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, diversified portfolio, dogs of the Dow, Donald Trump, double entry bookkeeping, Elliott wave, endowment effect, Erdős number, Eugene Fama: efficient market hypothesis, four colour theorem, George Gilder, global village, greed is good, index fund, intangible asset, invisible hand, Isaac Newton, John Nash: game theory, Long Term Capital Management, loss aversion, Louis Bachelier, mandelbrot fractal, margin call, mental accounting, Myron Scholes, Nash equilibrium, Network effects, passive investing, Paul Erdős, Paul Samuelson, Ponzi scheme, price anchoring, Ralph Nelson Elliott, random walk, Richard Thaler, Robert Shiller, Robert Shiller, short selling, six sigma, Stephen Hawking, stocks for the long run, survivorship bias, transaction costs, ultimatum game, Vanguard fund, Yogi Berra

Did I really believe this? Of course not, but I acted as if I did, and “averaging down” continued to seem like an irresistible opportunity. I believed in the company, but greed and fear were already doing their usual two-step in my head and, in the process, stepping all over my critical faculties. Emotional Overreactions and Homo Economicus Investors can become (to borrow a phrase Alan Greenspan and Robert Shiller made famous) irrationally exuberant, or, changing the arithmetical sign, irrationally despairing. Some of the biggest daily point gains and declines in Nasdaq’s history occurred in a single month in early 2000, and the pattern has continued unabated in 2001 and 2002, the biggest point gain since 1987 occurring on July 24, 2002. (The increase in volatility, although substantial, is a little exaggerated since our perception of gains and losses have been distorted by the rise in the indices.

Although this sounds very hard-headed and far removed from psychological considerations, it is not. The discounting of future dividends and the future stock price is dependent on your estimate of future interest rates, dividend policies, and a host of other uncertain quantities, and calling them fundamentals does not make them immune to emotional and cognitive distortion. The tango of exuberance and despair can and does affect estimates of stock’s fundamental value. As the economist Robert Shiller has long argued quite persuasively, however, the fundamentals of a stock don’t change nearly as much or as rapidly as its price. Ponzi and the Irrational Discounting of the Future Before returning to other applications of these financial notions, it may be helpful to take a respite and examine an extreme case of undervaluing the future: pyramids, Ponzi schemes, and chain letters. These differ in their details and colorful storylines.

Then their prices will rise because risk-averse investors will need less inducement to buy them; the “equity-risk premium,” the amount by which stock returns must exceed bond returns to attract investors, will decline. And the rates of return will fall because prices will be higher. And stocks will therefore be riskier because of their lower returns. Viewed as less risky, stocks become risky; viewed as risky, they become less risky. This is yet another instance of the skittish, self-reflective, self-corrective dynamic of the market. Interestingly, Robert Shiller, a personal friend of Siegel, looks at the data and sees considerably lower stock returns for the next ten years. Market practitioners as well as academics disagree. In early October 2002, I attended a debate between Larry Kudlow, a CNBC commentator and Wall Street fixture, and Bob Prechter, a technical analyst and Elliot wave proponent. The audience at the CUNY graduate center in New York seemed affluent and well-educated, and the speakers both seemed very sure of themselves and their predictions.


pages: 405 words: 109,114

Unfinished Business by Tamim Bayoumi

algorithmic trading, Asian financial crisis, bank run, banking crisis, Basel III, battle of ideas, Ben Bernanke: helicopter money, Berlin Wall, Big bang: deregulation of the City of London, Bretton Woods, British Empire, business cycle, buy and hold, capital controls, Celtic Tiger, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, currency manipulation / currency intervention, currency peg, Doha Development Round, facts on the ground, Fall of the Berlin Wall, financial deregulation, floating exchange rates, full employment, hiring and firing, housing crisis, inflation targeting, Just-in-time delivery, Kenneth Rogoff, liberal capitalism, light touch regulation, London Interbank Offered Rate, Long Term Capital Management, market bubble, Martin Wolf, moral hazard, oil shale / tar sands, oil shock, price stability, prisoner's dilemma, profit maximization, quantitative easing, race to the bottom, random walk, reserve currency, Robert Shiller, Robert Shiller, Rubik’s Cube, savings glut, technology bubble, The Great Moderation, The Myth of the Rational Market, the payments system, The Wisdom of Crowds, too big to fail, trade liberalization, transaction costs, value at risk

The strong belief in the efficient markets hypothesis by macroeconomics was particularly striking as it was out of step with the concurrent trends in financial economics. Within academic finance, models of asset pricing based only on efficient markets had been found wanting. Empirical work had increasingly added variables that reflected market inefficiencies, such as the observation that smaller and relatively less liquid firms attracted higher returns. More generally, skeptics of the efficient markets hypothesis such as Professor Robert Shiller of Yale University argued that consistently following simple strategies such as investing in firms with low share prices compared to their earnings could achieve long-term returns modestly above the average without taking on more risk (the trading philosophy used by Warren Buffett). Against this, however, was always the rejoinder that this could be a statistical fluke and that if such models worked then why was the proponent not rich?

But there is a very real issue as to how the North Atlantic crisis could have come as such a surprise to the vast majority of observers and policymakers—the rare exceptions being those who saw financial imbalances as a clear and present danger either because of their background in emerging markets (such as Professor Nouriel Roubini of New York University) or their belief that markets were often irrational and needed to be closely supervised (such as Bill White of the Bank of International Settlements, Professor Robert Shiller of Yale, and IMF Economic Counsellor Raghuram Rajan). The inadequate intellectual apparatus was not simply unfortunate in the sense that it allowed the crisis to build. It also meant that policymakers needed to respond hurriedly to unexpected challenges within badly designed structures. This led to policy missteps such as the bankruptcy of Lehman Brothers and the premature tightening of fiscal policies in the Euro area.

The desire for social acceptance that makes people want to fit in with the views of others provides an obvious conduit through which views about the long-run can form. The innate desire not to be seen as disruptive discourages individuals from questioning the perceived wisdom of other investors, as underlined, for example, in the account of how a few outliers did resist such pressure in the book about the financial crisis, Michael Lewis’s The Big Short. More generally, Professor Robert Shiller of Yale, one of the few prominent economists who recognized that the US housing market was in a massive bubble before the crisis, has been one of several financial economists to suggest that financial market bubbles can be modeled as social waves in which ideas catch fire and become self-reinforcing before eventually deflating.7 Such social eruptions can be modeled using similar tools to those used to examine epidemics, involving the probability of passing on an infection from one person to the other and a rate at which people stop being infectious, which define the height and longevity of the craze.


pages: 226 words: 59,080

Economics Rules: The Rights and Wrongs of the Dismal Science by Dani Rodrik

airline deregulation, Albert Einstein, bank run, barriers to entry, Bretton Woods, business cycle, butterfly effect, capital controls, Carmen Reinhart, central bank independence, collective bargaining, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, distributed generation, Donald Davies, Edward Glaeser, endogenous growth, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, Fellow of the Royal Society, financial deregulation, financial innovation, floating exchange rates, fudge factor, full employment, George Akerlof, Gini coefficient, Growth in a Time of Debt, income inequality, inflation targeting, informal economy, information asymmetry, invisible hand, Jean Tirole, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, labor-force participation, liquidity trap, loss aversion, low skilled workers, market design, market fundamentalism, minimum wage unemployment, oil shock, open economy, Pareto efficiency, Paul Samuelson, price stability, prisoner's dilemma, profit maximization, quantitative easing, randomized controlled trial, rent control, rent-seeking, Richard Thaler, risk/return, Robert Shiller, Robert Shiller, school vouchers, South Sea Bubble, spectrum auction, The Market for Lemons, the scientific method, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, Thomas Malthus, trade liberalization, trade route, ultimatum game, University of East Anglia, unorthodox policies, Vilfredo Pareto, Washington Consensus, white flight

These new derivatives were supposed to have distributed risk to those who were willing to bear it. Instead, they facilitated risk taking and overuse of leverage. They also connected disparate segments of the economy in ways that no one fully grasped at the time, ensuring that failure at one end would precipitate collapse at the other. With a few, but notable, exceptions, such as the future Nobel Prize winner Robert Shiller and the future governor of India’s Central Bank and Chicago economist Raghu Rajan, economists overlooked the extent of problems in housing and finance. Shiller had long argued that asset prices were excessively volatile and had focused on a bubble in housing prices.5 Rajan had fretted about the downside of what was then praised as “financial innovation” and warned as early as 2005 that bankers were taking excessive risks, earning a rebuke from Larry Summers, then president of Harvard, as a “Luddite.”6 That economists were mostly blind-sided by the crisis is undeniable.

All the steps in between—the reduction in interest rates as demand for dollar assets went up, the incentive of poorly supervised financial institutions to seek riskier instruments to maintain profits, the building up of financial fragility as portfolios expanded through short-term borrowing, the inability of shareholders to properly rein in bank CEOs, the bubble in housing prices—could be readily explained by existing frameworks. But economists had placed excessive faith in some models at the expense of others, and that turned out to be a big problem. Many of the favored models revolved around the “efficient-markets hypothesis” (EMH).7 The hypothesis had been formulated by Eugene Fama, a Chicago finance professor who would subsequently receive the Nobel Prize, somewhat awkwardly, in the same year as Robert Shiller. It says, in brief, that market prices reflect all information available to traders. For an individual investor, the EMH means that, without access to inside information, beating the market repeatedly is impossible. For central bankers and financial regulators, the EMH cautions against trying to move the market in one direction or another. Since all the relevant information is already contained in market prices, any intervention is more likely to distort the market than to correct it.

module=BlogPost-Title&version=Blog%20Main&contentCollection=Opinion&action=Click&pgtype=Blogs&region=Body. 3. Greg Mankiw, “News Flash: Economists Agree,” February 14, 2009, Greg Mankiw’s Blog, http://gregmankiw.blogspot.com/2009/02/news-flash-economists-agree.html. 4. Richard A. Posner, “Economists on the Defensive—Robert Lucas,” Atlantic, August 9, 2009, http://www.theatlantic.com/business/archive/2009/08/economists-on-the-defensive-robert-lucas/22979. 5. Robert Shiller, Irrational Exuberance, 2nd ed. (Princeton, NJ: Princeton University Press, 2005). 6. Raghuram G. Rajan, “The Greenspan Era: Lessons for the Future” (remarks at a symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, WY, August 27, 2005), https://www.imf.org/external/np/speeches/2005/082705.htm; Charles Ferguson, “Larry Summers and the Subversion of Economics,” Chronicle of Higher Education, October 3, 2010, http://chronicle.com/article/Larry-Summersthe/124790. 7.


pages: 393 words: 115,263

Planet Ponzi by Mitch Feierstein

Affordable Care Act / Obamacare, Albert Einstein, Asian financial crisis, asset-backed security, bank run, banking crisis, barriers to entry, Bernie Madoff, break the buck, centre right, collapse of Lehman Brothers, collateralized debt obligation, commoditize, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, disintermediation, diversification, Donald Trump, energy security, eurozone crisis, financial innovation, financial intermediation, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, high net worth, High speed trading, illegal immigration, income inequality, interest rate swap, invention of agriculture, light touch regulation, Long Term Capital Management, low earth orbit, mega-rich, money market fund, moral hazard, mortgage debt, negative equity, Northern Rock, obamacare, offshore financial centre, oil shock, pensions crisis, plutocrats, Plutocrats, Ponzi scheme, price anchoring, price stability, purchasing power parity, quantitative easing, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, too big to fail, trickle-down economics, value at risk, yield curve

It explains why I’m not comforted by the idea that the US market has ‘normalized.’ It reminds us that volatility cuts in two directions. Two decades on from the collapse of its own bubble, the Japanese property market is more than 35% below its own ‘normal’ value. My own guess is that the US market will need to touch those levels before it will truly shake off the effects of the last decade. I’m not alone in thinking so. Robert Shiller himself said that a further fall of 10–25% ‘wouldn’t surprise me at all,’ commenting that, ‘in real terms, there has never been a bust of this proportion.’15 He’s right. We’re in new territory, desolate and hostile. We’ll talk about the implications for the banks in another chapter. Needless to say, those implications aren’t going to be pretty. And the greater the pressure on the banks, the more they’ll seek to conserve their liquidity position by refusing mortgage request applications.

It’s no coincidence that the developed world’s most successful governments‌—‌currently Canada, Sweden, and Germany‌—‌have consistently resisted these temptations. If anything, the world economy (or at least the American, European, and Japanese parts of it) has lost value over the past two years. At the very least, the hole we’re in has just got a few trillion dollars deeper. But let’s return to the question of where equity markets ought to be. Robert Shiller, the un-Ponzi-ish economist who produced the housing index reviewed in the previous chapter, has produced a wonderful tool for examining fundamental value in the equity markets. We’ll look at that in a moment, but first a brief refresher on equity valuation. When you buy stock in a company, you become a part-owner of the firm, entitled to a share of its profits. Some firms will return a large proportion of those profits to shareholders by way of dividends (or share buybacks).

Now, we’ve already discussed the fact that the commercial property sector is in serious difficulties, but we’re simply going to set that aside for the time being‌—‌all $2.4 trillion of it‌—‌and simply examine the $11.3 trillion residential mortgage sector.8 We saw in an earlier chapter that the US housing market is in serious trouble. Almost a third of all home sales are triggered by financial distress. Almost a quarter of all homeowners are suffering negative equity. The noted economist Robert Shiller suggests that further house price falls of 10–25% are perfectly feasible.9 The truth is that house price falls of 25% simply don’t bear thinking about. If prices sank that low, countless homeowners would seek to walk away from their mortgages, or sell their houses, sooner than service their debts. It would be appropriate and orderly to do so. Mortgage companies could hardly even offer a threat of repossession, because to repossess something is pointless unless you figure you can sell it, and under the scenario we’re discussing the market would be all but bombed out.


pages: 317 words: 71,776

Inequality and the 1% by Danny Dorling

Affordable Care Act / Obamacare, banking crisis, battle of ideas, Bernie Madoff, Big bang: deregulation of the City of London, Boris Johnson, Branko Milanovic, buy and hold, call centre, Capital in the Twenty-First Century by Thomas Piketty, centre right, collective bargaining, conceptual framework, corporate governance, credit crunch, David Attenborough, David Graeber, delayed gratification, Dominic Cummings, double helix, Downton Abbey, en.wikipedia.org, Etonian, family office, financial deregulation, full employment, Gini coefficient, high net worth, housing crisis, income inequality, land value tax, longitudinal study, low skilled workers, lump of labour, mega-rich, Monkeys Reject Unequal Pay, Mont Pelerin Society, mortgage debt, negative equity, Neil Kinnock, Occupy movement, offshore financial centre, plutocrats, Plutocrats, precariat, quantitative easing, race to the bottom, Robert Shiller, Robert Shiller, TaskRabbit, The Spirit Level, The Wealth of Nations by Adam Smith, trickle-down economics, unpaid internship, very high income, We are the 99%, wealth creators, working poor

HM821.D6697 2014 305.50941–dc23 v3.1 To Carl Lee – who knows what matters most Contents Cover Title Page Copyright Dedication 1. Can We Afford the Superrich? 2. Childhood 3. Work 4. Wealth 5. Health Conclusion: Towards a Fairer Society Acknowledgements Notes Index 1 Can We Afford the Superrich? The most important problem we are facing now, today … is rising inequality. Robert Shiller, recipient of the 2013 Nobel Prize in Economics1 Growing income and wealth inequality is recognised as the greatest social threat of our times. Robert Shiller suggests that the renewed greed of the top 1 per cent has had worse effects than even the financial crash of 2008. The top 1 per cent contribute to rising inequality, not just by taking more and more, but by suggesting that such greed is justifiable and using their enormous wealth to promote that concept. As Warren Buffett, the second richest American in 2011, put it: ‘there’s been class warfare going on for the last twenty years, and my class has won.

Office of the Children’s Commissioner, ‘A Child Rights Impact Assessment of Budget Decisions – Children and Young People’s Version’, 27 June 2013, at childrenscommissioner.gov.uk. 64. D. Leigh Scott, ‘How the American University was Killed, in Five Easy Steps’, OpEdNews.com, 19 August 2012, at opednews.com. 3. Work 1. J. Stiglitz, ‘Inequality Is a Choice’, New York Times, 13 October 2013, at opinionator.blogs.nytimes.com. 2. Including a growing number of Nobel Laureates such as Joseph Stiglitz and Robert Shiller (see Chapter 1, above). Ever since Sweden’s own banking crisis, more laureates have been awarded to more sceptical economists. 3. K. A. Weeden and D. N. Grusky, ‘Inequality and Market Failure’, American Behavioural Scientist, 2013 (pre-print). 4. B. Bell and J. V. Van Reenen, ‘Extreme Wage Inequality: Pay at the Very Top’, Centre for Economic Performance, Occasional Paper 34 (2013), at cep.lse.ac.uk. 5.


pages: 389 words: 98,487

The Undercover Economist: Exposing Why the Rich Are Rich, the Poor Are Poor, and Why You Can Never Buy a Decent Used Car by Tim Harford

Albert Einstein, barriers to entry, Berlin Wall, business cycle, collective bargaining, congestion charging, Corn Laws, David Ricardo: comparative advantage, decarbonisation, Deng Xiaoping, Fall of the Berlin Wall, George Akerlof, information asymmetry, invention of movable type, John Nash: game theory, John von Neumann, Kenneth Arrow, Kickstarter, market design, Martin Wolf, moral hazard, new economy, Pearl River Delta, price discrimination, Productivity paradox, race to the bottom, random walk, rent-seeking, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, sealed-bid auction, second-price auction, second-price sealed-bid, Shenzhen was a fishing village, special economic zone, spectrum auction, The Market for Lemons, Thomas Malthus, trade liberalization, Vickrey auction

When pension salesmen showed me graphs like this in 2000, what they hoped they were telling me was that the stock market was going to keep soaring. But what I saw was a message that it was bound to crash. Historically, long-term price-earnings ratios have always been around 16. They have often drifted away from 16 but have always returned to that figure. Yale economist Robert Shiller has devoted some effort to establishing this pattern of always drifting back to a P/E ratio of 16, and he has collected price/earnings ratios back to 1881. (Robert Shiller’s data is used in the graphs for both figures. In fact, the first figure is just an extract from the second. The impression the two graphs give is rather different.) What comes out very clearly from Shiller’s data is that a ratio over 30 is not normal. It only happened once before the 1990s, in 1928. As in 2000, people in 1928 came up with many rationalizations for the high share prices at the time.

They point out, correctly, that nobody could call the market in the short term; they predict a rebound for the market over time. (They are no longer emphasizing the fact that in Dow 36,000 they predicted that the market might take “three or five years” to soar . . . that is, until the end of 2004.) Glassman and Hassett argue that the stock market has been undervalued for a hundred years, so the historical data produced by Robert Shiller does not prove that investors in the future will make the same mistake. Perhaps investors have indeed been wrong for the past century. As we’ve already discovered, once economists abandon the view that people are acting sensibly, it is very hard for us to say very much at all. A more productive line of inquiry is to ask whether, as bubble valuations suggested, company profits will really be so dramatically much higher in the next few years.

(See the interview with eBay’s Meg Whitman in Business Week, October 2, 2002.) Other sources for statistics: Amazon.com stock price data comes from the Amazon.com investor relations website and other information comes from Amazon.com’s 2003 Annual Report. Losses due to internet music piracy from “Rock profits and boogie woogie blues,” May 2, 2004, BBC Online News, http://news.bbc.co.uk/1/hi/business/ 3622285.stm. Data from Robert Shiller are available at his home page, http:// aida.econ.yale.edu/~shiller/. Chapter 7 See Prisoner’s Dilemma by William Poundstone (New York: Doubleday, 1992) to find out more about Von Neumann and the use of game theory in the cold war. For an analysis of poker models by Emile Borel, Von Neumann, John Nash, and Lloyd Shapley, see chapter 12 of Ken Binmore’s textbook Fun and Games (Lexington: D.


pages: 204 words: 58,565

Keeping Up With the Quants: Your Guide to Understanding and Using Analytics by Thomas H. Davenport, Jinho Kim

Black-Scholes formula, business intelligence, business process, call centre, computer age, correlation coefficient, correlation does not imply causation, Credit Default Swap, en.wikipedia.org, feminist movement, Florence Nightingale: pie chart, forensic accounting, global supply chain, Hans Rosling, hypertext link, invention of the telescope, inventory management, Jeff Bezos, Johannes Kepler, longitudinal study, margin call, Moneyball by Michael Lewis explains big data, Myron Scholes, Netflix Prize, p-value, performance metric, publish or perish, quantitative hedge fund, random walk, Renaissance Technologies, Robert Shiller, Robert Shiller, self-driving car, sentiment analysis, six sigma, Skype, statistical model, supply-chain management, text mining, the scientific method, Thomas Davenport

Frei and Mathew Perlberg, “Discovering Hidden Gems: The Story of Daryl Morey, Shane Battier, and the Houston Rockets (B),” Harvard Business School case study (Boston: Harvard Business Publishing, September 2010), 1. Chapter 7 1. Personal communication with author. 2. “Surveying the Economic Horizon: A Conversation with Robert Shiller,” McKinsey Quarterly, April 2009, http://www.mckinseyquarterly.com/Surveying_ the_economic_horizon_A_conversation_with_Robert_Shiller_2345. 3. David Olive, “Getting Wise Before That ‘One Big Mistake,’” Toronto Star, December 17, 2007. 4. Charles Duhigg, The Power of Habit: Why We Do What We Do in Life and Business (New York: Random House, 2012). 5. Gary Loveman, “Foreword,” in Thomas H. Davenport and Jeanne G. Harris, Competing on Analytics: The New Science of Winning (Boston: Harvard Business School Press, 2007), x. 6.

In this data-intensive society and business culture, you simply can’t understand how data and analytics can be applied to decision making without some mathematical sophistication. Those who lack understanding can get into trouble easily, as the Joe Cassano example at AIG Financial Products in chapter 1 illustrates. Many businesses increasingly use statistical and mathematical models in their business operations. Therefore, a key principle is that managers shouldn’t build analytical models into their businesses that they don’t understand. As Yale economist Robert Shiller puts it (in the context of explaining some of the reasons for the 2008–2009 financial crisis, which he anticipated), “You have to be a quantitative person if you’re managing a company. The quantitative details really matter.”2 Some organizations insist on a familiarity with math and models. Ed Clark, the CEO of TD Bank Group, who has a PhD in economics from Harvard, avoided the problems that many US banks encountered in the financial crisis.


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The Long Good Buy: Analysing Cycles in Markets by Peter Oppenheimer

"Robert Solow", asset allocation, banking crisis, banks create money, barriers to entry, Berlin Wall, Big bang: deregulation of the City of London, Bretton Woods, business cycle, buy and hold, Cass Sunstein, central bank independence, collective bargaining, computer age, credit crunch, debt deflation, decarbonisation, diversification, dividend-yielding stocks, equity premium, Fall of the Berlin Wall, financial innovation, fixed income, Flash crash, forward guidance, Francis Fukuyama: the end of history, George Akerlof, housing crisis, index fund, invention of the printing press, Isaac Newton, James Watt: steam engine, joint-stock company, Joseph Schumpeter, Kickstarter, liberal capitalism, light touch regulation, liquidity trap, Live Aid, market bubble, Mikhail Gorbachev, mortgage debt, negative equity, Network effects, new economy, Nikolai Kondratiev, Nixon shock, oil shock, open economy, price stability, private sector deleveraging, Productivity paradox, quantitative easing, railway mania, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, secular stagnation, Simon Kuznets, South Sea Bubble, special economic zone, stocks for the long run, technology bubble, The Great Moderation, too big to fail, total factor productivity, trade route, tulip mania, yield curve

Following on from this idea is the argument that an investor cannot really predict the market, or how a company will perform. This is because no individual will have more information than is already reflected in the market at any time, because the market is always efficient and prices change in fundamental factors (such as economic events) immediately. But theory is one thing and practice is another. Nobel Laureate Robert Shiller, for example, showed that while stock prices are extremely volatile over the short term, their valuation, or price/earnings ratio, provides information which makes them somewhat predictable over long periods (Shiller 1980), suggesting that valuation at least provides something of a guide to future returns. Others have argued that the returns one can expect from financial assets are linked to economic conditions and therefore the probability of certain outcomes can be assessed even if accurate forecasts are not particularly reliable.

So, given a choice of equal probability, most investors would choose to protect their existing wealth rather than risk the chance to increase wealth.20 But this tendency to protect what you have rather than risk a lot for future gains seems to disappear in extreme situations when markets increase a great deal and a fear of missing out becomes a dominant driver of behaviour. Since the financial crisis, the interest in behavioural explanations and the psychology of markets has increased, and this information helps to better understand how and why financial cycles develop and can often significantly exaggerate the developments of economic and financial variables on which they are driven. Nobel Prize winners George A. Akerlof and Robert J. Shiller wrote that ‘the crisis was not foreseen, and is still not fully understood … because there have been no principles in conventional economic theories regarding animal spirits’.21 It is the impact of human behaviour and the way in which information is processed by humans that makes the forecasting of markets so much more complicated than forecasting physical systems such as the weather. In this sense, forecasting physical science, such as weather forecasts, is different because these forecasts are not affected by how inputs change the behaviour of people.

As an example, if you were to start the long-run sample period in 1926 at a price-to-earnings (P/E) ratio of about 10 times and end the period at a P/E of about 20 times (for example, in the 1990s), the actual return on equities would be higher than investors expected or required at the outset, so that the actual historical achieved rate of return (the ex post risk premium) overstates the future expected return (the ex ante risk premium). This finding was strengthened by the work of Fama and French (2002), which used a discounted dividend model (the DDM) to show that investors from 1926 onwards had an expected equity risk premium that averaged about 3%. Others have emphasised that spot valuations can also distort the expectations for returns. In particular, Robert Shiller in his book Irrational Exuberance (2000) argued that stocks can become overextended, so that returns can be above normal and then below normal for extended periods. He introduced the valuation measure called CAPE (cyclically adjusted price-to-earnings ratio), which uses 10 years of trailing earnings data in the denominator rather than just 1 year of forward expected earnings, as in the standard valuation tool of the P/E ratio.


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The Irrational Economist: Making Decisions in a Dangerous World by Erwann Michel-Kerjan, Paul Slovic

"Robert Solow", Andrei Shleifer, availability heuristic, bank run, Black Swan, business cycle, Cass Sunstein, clean water, cognitive dissonance, collateralized debt obligation, complexity theory, conceptual framework, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, cross-subsidies, Daniel Kahneman / Amos Tversky, endowment effect, experimental economics, financial innovation, Fractional reserve banking, George Akerlof, hindsight bias, incomplete markets, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, Isaac Newton, iterative process, Kenneth Arrow, Loma Prieta earthquake, London Interbank Offered Rate, market bubble, market clearing, money market fund, moral hazard, mortgage debt, Pareto efficiency, Paul Samuelson, placebo effect, price discrimination, price stability, RAND corporation, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, source of truth, statistical model, stochastic process, The Wealth of Nations by Adam Smith, Thomas Bayes, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transaction costs, ultimatum game, University of East Anglia, urban planning, Vilfredo Pareto

Unpublished paper, Yale University. Barberis, Nicholas, and Richard Thaler (2003). “A Survey of Behavioral Finance.” In George Constantinides, Milton Harris, and René Stulz, eds. Handbook of the Economics of Finance. New York: Elsevier Science. Campbell, John Y., and Robert J. Shiller (1987). “Cointegration and Tests of Present Value Models.” Journal of Political Economy 97, no. 5: 1062-1088. Higgins, Adrian (2005). “Why the Red Delicious No Longer Is.” Washington Post, August 5, p. A1. Jung, Jeeman, and Robert J. Shiller (2005). “Samuelson’s Dictum and the Stock Market.” Economic Inquiry 43, no. 2: 221-228. Keynes, John Maynard. (1936/2009). The General Theory of Employment, Interest and Money. Kindle: Signalman Publishing. LeRoy, Stephen, and Richard Porter (1981). “Stock Price Volatility: A Test Based on Implied Variance Bounds.”

Professor Schoemaker received an MBA in finance, an MA in management, and a PhD in decision sciences from The Wharton School at the University of Pennsylvania. He was Howard Kunreuther’s first PhD student at Wharton, with whom he co-authored several papers and the book Decision Sciences, An Integrated Perspective, with Paul Kleindorfer and Howard Kunreuther (Cambridge University Press, 1993). Robert J. Shiller, Yale University Robert Shiller is the Arthur M. Okun Professor of Economics at Yale University and Professor of Finance and Fellow at the International Center for Finance, Yale School of Management. He received his PhD in economics from MIT in 1972. Professor Shiller has written on financial markets, financial innovation, behavioral economics, macroeconomics, real estate, and statistical methods as well as on public attitudes, opinions, and moral judgments regarding markets.

Cambridge: Cambridge University Press. Schelling, Thomas (1996). “Coping Rationally with Lapses from Rationality,” Eastern Economic Journal (Summer): 251-269. Reprinted in Thomas Schelling, Strategies of Commitment and Other Essays (Cambridge, MA: Harvard University Press, 2006.) 2 Berserk Weather Forecasters, Beauty Contests, and Delicious Apples on Wall Street GEORGE A. AKERLOF AND ROBERT J. SHILLER No one has ever made rational sense of the wild gyrations in financial prices, such as stock prices.1 These fluctuations are as old as the financial markets themselves. And yet these prices are essential factors in investment decisions, which are fundamental to the economy. Corporate investment is much more volatile than aggregate GDP, and it appears to be an important driver of economic fluctuations.


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Who Stole the American Dream? by Hedrick Smith

Affordable Care Act / Obamacare, Airbus A320, airline deregulation, anti-communist, asset allocation, banking crisis, Bonfire of the Vanities, British Empire, business cycle, business process, clean water, cloud computing, collateralized debt obligation, collective bargaining, commoditize, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, David Brooks, Deng Xiaoping, desegregation, Double Irish / Dutch Sandwich, family office, full employment, global supply chain, Gordon Gekko, guest worker program, hiring and firing, housing crisis, Howard Zinn, income inequality, index fund, industrial cluster, informal economy, invisible hand, Joseph Schumpeter, Kenneth Rogoff, Kitchen Debate, knowledge economy, knowledge worker, laissez-faire capitalism, late fees, Long Term Capital Management, low cost airline, low cost carrier, manufacturing employment, market fundamentalism, Maui Hawaii, mega-rich, MITM: man-in-the-middle, mortgage debt, negative equity, new economy, Occupy movement, Own Your Own Home, Paul Samuelson, Peter Thiel, Plutonomy: Buying Luxury, Explaining Global Imbalances, Ponzi scheme, Powell Memorandum, Ralph Nader, RAND corporation, Renaissance Technologies, reshoring, rising living standards, Robert Bork, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, shareholder value, Shenzhen was a fishing village, Silicon Valley, Silicon Valley startup, Steve Jobs, The Chicago School, The Spirit Level, too big to fail, transaction costs, transcontinental railway, union organizing, Unsafe at Any Speed, Vanguard fund, We are the 99%, women in the workforce, working poor, Y2K

The Wall Street Journal, June 9, 2007. 38 “Like a city with a murder law” Gramlich, “Booms and Busts.” 39 “What we forgot” Johnson and Kwak, 13 Bankers, 142–44. 40 No Bush official wanted Jo Becker, Sheryl Gay Stolberg, and Stephen Labaton, “White House Philosophy Stoked Mortgage Bonfire,” The New York Times, December 21, 2008. 41 Mortgage debt had reached dangerous levels David Cay Johnston, “Business; In Debate Over Housing Bubble, a Winner Also Loses,” The New York Times, April 11, 2004. 42 Shiller’s warning was more stark Robert J. Shiller, “Household Reactions to Changes in Housing Wealth,” Discussion Paper 1459 (New Haven, CT: Cowles Foundation, Yale University, April 2004), http://​cowles.​econ.​yale.​edu. 43 “May be the biggest bubble in U.S. history” Robert J. Shiller, cited in Paul Krugman, “Running Out of Bubbles,” The New York Times, May 27, 2005. 44 “When home prices do start down” Fleckenstein, Greenspan’s Bubbles, 145. 45 Greenspan dismissed talk of a housing “bubble” Alan Greenspan, “The Economic Outlook,” opening statement, Joint Economic Committee, U.S.

Building America’s Future Educational Fund. “Falling Apart and Falling Behind: Transportation Infrastructure Report 2011.” http://​www.​bafuture.​org. Butz, William, Terrence K. Kelly, David M. Adamson, et al. “Will the Scientific and Technology Workforce Meet the Requirements of the Federal Government?” Rand Corporation, 2004. Case, Karl E., and Robert J. Shiller. “Is There a Housing Bubble?” Brookings Papers on Economic Activity 2, no. 2 (2003): 299–342. Case, Karl E., John M. Quigley, and Robert J. Shiller. “Wealth Effects Revisited 1978–2009.” Cowles Foundation for Research in Economics, Yale University, New Haven, CT, February 2011. Cassidy, John. “The Greed Cycle.” The New Yorker, September 23, 2002. Congressional Research Service. “State, Foreign Operations, and Related Programs: FY2012 Budget and Appropriations.”

Operating at full steam in 2005, housing, construction, and real estate were pumping an enormous stimulus into the nation’s economy—more than $1 trillion a year, by one economist’s estimate. But danger lay in what became the meteoric rise of housing prices. Cheap money and rising home prices made people feel richer than they really were, so everyone took big risks. People borrowed more than they should have. Yale University’s Robert J. Shiller, one of America’s premier housing economists, compared the price binge to a “rocket taking off,” a spurt without precedent, except after World War II. In the 114 years from the 1890s to 2004, Shiller reported, housing prices had risen only 66 percent, adjusted for inflation, or less than ½ percent a year on average. But from 1997 to 2004, in just eight years, prices had shot up 52 percent.


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The Gig Economy: The Complete Guide to Getting Better Work, Taking More Time Off, and Financing the Life You Want by Diane Mulcahy

Affordable Care Act / Obamacare, Airbnb, Amazon Mechanical Turk, basic income, Clayton Christensen, cognitive bias, collective bargaining, creative destruction, David Brooks, deliberate practice, diversification, diversified portfolio, fear of failure, financial independence, future of work, gig economy, helicopter parent, Home mortgage interest deduction, housing crisis, job satisfaction, Kickstarter, loss aversion, low skilled workers, Lyft, mass immigration, mental accounting, minimum wage unemployment, mortgage tax deduction, negative equity, passive income, Paul Graham, remote working, risk tolerance, Robert Shiller, Robert Shiller, Silicon Valley, Snapchat, TaskRabbit, Uber and Lyft, uber lyft, universal basic income, wage slave, Y Combinator, Zipcar

Pew Research Center, “The American Middle Class Is Losing Ground: No Longer the Majority and Falling Behind Financially,” Washington, D.C., December 2015. www.pewsocialtrends.org/files/2015/12/2015-12-09_middle-class_FINAL-report.pdf 5. Yale economist Robert Shiller analyzed home prices and concluded that “From 1890 to 1990, real inflation-corrected home prices were virtually unchanged.” www.cnbc.com/2014/12/08/where-to-put-your-cash-a-house-or-a-stock.html and www.usatoday.com/story/money/personalfinance/2014/05/10/why-your-home-is-not-a-good-investment/8900911/. Shiller’s housing market data is found at www.econ.yale.edu/~shiller/data.htm See also, Robert Shiller, “Buying a House is a ‘Consumption Choice,’ Not an Investment,” theweek.com/speedreads/563510/economist-robert-shiller-buying-house-consumption-choice-not-investment 6. Wolff, Edward N., “Household Wealth Trends in the United States, 1962–2013: What Happened over the Great Recession?”


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Who's Your City?: How the Creative Economy Is Making Where to Live the Most Important Decision of Your Life by Richard Florida

active measures, assortative mating, barriers to entry, big-box store, blue-collar work, borderless world, BRICs, business climate, Celebration, Florida, correlation coefficient, creative destruction, dark matter, David Brooks, David Ricardo: comparative advantage, deindustrialization, demographic transition, edge city, Edward Glaeser, epigenetics, extreme commuting, Geoffrey West, Santa Fe Institute, happiness index / gross national happiness, high net worth, income inequality, industrial cluster, invention of the telegraph, Jane Jacobs, job satisfaction, Joseph Schumpeter, knowledge economy, knowledge worker, low skilled workers, megacity, new economy, New Urbanism, Peter Calthorpe, place-making, post-work, Richard Florida, risk tolerance, Robert Gordon, Robert Shiller, Robert Shiller, Seaside, Florida, Silicon Valley, Silicon Valley startup, superstar cities, The Death and Life of Great American Cities, The Wealth of Nations by Adam Smith, Thomas L Friedman, urban planning, World Values Survey, young professional

Bureau of the Census, American Community Survey, www.census.gov/acs/www. 2 Peter Coy, “The Richest Zip Codes-and How They Got That Way,” Business Week, April 2, 2007. 3 Knight Frank, 2008 Annual Wealth Report: Prime Residential Property, Knight Frank UK, 2008. 4 Joseph Gyourko, Christopher Mayer, and Todd Sinai, “Superstar Cities,” National Bureau of Economic Research, Working Paper no. 12355, July 2006. 5 Robert Shiller, “Superstar Cities May be Investors’ Superstardust,” Shanghai Daily, May 22, 2007, www.taipeitimes.com/News/editorials/archives/2007/05/20/2003361715. 6 Robert Shiller, Historic Turning Points in Real Estate, Yale University, Cowles Foundation for Research in Economics Discussion Paper no. 1610, June 2007. Available at http://cowles.econ.yale.edu/P/cd/d16a/d1610.pdf. Detailed data from the Case-Shiller Home Price Index are available at http://macromarkets.com/csi_housing/sp_caseshiller.asp.

With the rise of a spiky world organized around a relatively small number of global megaregions, we may be entering a new phase in real estate in which the housing market splits into globally oriented centers where prices rise considerably over time and local ones where prices are stable or, in some cases, decline. However, not all economists think that high real estate prices in superstar cities are here to stay. Among those who see this trend ending is Yale economist Robert Shiller, author of the best-selling Irrational Exuberance, which predicted the collapse of tech stocks in the early 2000s. In a May 2007 op-ed, Shiller asked, “Why should home values in glamour cities increase forever?” 5 To be sure, there is no way to increase the size of superstar cities like New York or London. But “in every case,” Shiller writes, “there are vast amounts of land where a new city could be started,” as has been done time and time again in the past.


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Hubris: Why Economists Failed to Predict the Crisis and How to Avoid the Next One by Meghnad Desai

"Robert Solow", 3D printing, bank run, banking crisis, Berlin Wall, Big bang: deregulation of the City of London, Bretton Woods, BRICs, British Empire, business cycle, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, correlation coefficient, correlation does not imply causation, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, deindustrialization, demographic dividend, Eugene Fama: efficient market hypothesis, eurozone crisis, experimental economics, Fall of the Berlin Wall, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, German hyperinflation, Gunnar Myrdal, Home mortgage interest deduction, imperial preference, income inequality, inflation targeting, invisible hand, Isaac Newton, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, laissez-faire capitalism, liquidity trap, Long Term Capital Management, market bubble, market clearing, means of production, Mexican peso crisis / tequila crisis, mortgage debt, Myron Scholes, negative equity, Northern Rock, oil shale / tar sands, oil shock, open economy, Paul Samuelson, price stability, purchasing power parity, pushing on a string, quantitative easing, reserve currency, rising living standards, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, secular stagnation, seigniorage, Silicon Valley, Simon Kuznets, The Chicago School, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Wealth of Nations by Adam Smith, Tobin tax, too big to fail, women in the workforce

While some economists urge abandonment of the fancy models and going back to the older theories of Keynes with a policy of greater public spending, the bulk of the economics profession in the best universities is as smug as ever. The award of the Nobel (actually the Royal Bank of Sweden) Prize in Economics in recent years is a clue to how unshaken the profession is in its self image. Thus in 2013 the Nobel Prize was given to Eugene Fama (Chicago), Lars Peter Hansen (Chicago) and Robert Shiller (Yale). Only Shiller is at all unorthodox, though a fully paid member of the mathematical macromodeling club. Thomas Sargent (formerly Minnesota now New York University) and Christopher Sims (Princeton) received the Prize in 2011 and both are original contributors to the “new classical economics” paradigm which is thought to have been discredited by the recession. Paul Krugman received the Prize in 2008 for his contribution to international trade theory not for his defense of Keynesian policies.

This insight led to the idea of the efficient market hypothesis (EMH). The idea is associated with the Chicago economist Eugene Fama, who did extensive statistical research on stock prices. The result was that the change in a stock price between today and tomorrow could not be predicted from the change over the previous 24 hours or earlier. When he was jointly awarded the Nobel Prize in 2013 with Lars Peter Hansen, also of University of Chicago, and Robert Shiller of Yale University, it was for “empirical analysis of asset prices.” What this implied is that in any market where there are many participants and plentiful information, the buyers and sellers will form their best expectations depending on all the information available. An important ingredient of this information is their knowledge of how prices are determined by demand and supply. People will form their expectations using all the information added to their knowledge of the “model” of how prices are formed.

Hayek’s insights were ignored by the new classical economists since they viewed the market to be infallible and omniscient. The efficient market hypothesis became not just a hypothesis but also a revealed truth. Thus bubbles – the movement of the price of an asset, usually upward – were ruled out on the basis of EMH. There were long debates about the occurrence of bubbles, with new classical economists treating the possibility as absurd and Keynesians taking up bubbles as their disproof of EMH. Robert Shiller, who had argued that the stock market in the 1990s was in a fervor of “irrational exuberance” since stock prices bore little relation to underlying fundamentals, asserted the theoretical and empirical possibility of bubbles. A similar story can be told about rational expectations (RE). Expectations used to mean your notion of what might be the course of some variable tomorrow or next week.


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Narrative Economics: How Stories Go Viral and Drive Major Economic Events by Robert J. Shiller

agricultural Revolution, Albert Einstein, algorithmic trading, Andrei Shleifer, autonomous vehicles, bank run, banking crisis, basic income, bitcoin, blockchain, business cycle, butterfly effect, buy and hold, Capital in the Twenty-First Century by Thomas Piketty, Cass Sunstein, central bank independence, collective bargaining, computerized trading, corporate raider, correlation does not imply causation, cryptocurrency, Daniel Kahneman / Amos Tversky, debt deflation, disintermediation, Donald Trump, Edmond Halley, Elon Musk, en.wikipedia.org, Ethereum, ethereum blockchain, full employment, George Akerlof, germ theory of disease, German hyperinflation, Gunnar Myrdal, Gödel, Escher, Bach, Hacker Ethic, implied volatility, income inequality, inflation targeting, invention of radio, invention of the telegraph, Jean Tirole, job automation, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, litecoin, market bubble, money market fund, moral hazard, Northern Rock, nudge unit, Own Your Own Home, Paul Samuelson, Philip Mirowski, plutocrats, Plutocrats, Ponzi scheme, publish or perish, random walk, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, Rubik’s Cube, Satoshi Nakamoto, secular stagnation, shareholder value, Silicon Valley, speech recognition, Steve Jobs, Steven Pinker, stochastic process, stocks for the long run, superstar cities, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, theory of mind, Thorstein Veblen, traveling salesman, trickle-down economics, tulip mania, universal basic income, Watson beat the top human players on Jeopardy!, We are the 99%, yellow journalism, yield curve, Yom Kippur War

narrative economics Robert J. Shiller narrative economics How Stories Go Viral & Drive Major Economic Events princeton university press princeton & oxford Copyright © 2019 by Robert J. Shiller Requests for permission to reproduce material from this work should be sent to permissions@press.princeton.edu Published by Princeton University Press 41 William Street, Princeton, New Jersey 08540 6 Oxford Street, Woodstock, Oxfordshire OX20 1TR press.princeton.edu All Rights Reserved ISBN 9780691182292 ISBN (e-book) 9780691189970 Version 1.0 British Library Cataloging-in-Publication Data is available Editorial: Peter Dougherty and Alena Chekanov Production Editorial: Terri O’Prey Text Design: Leslie Flis Jacket Design: Faceout Studio Contents List of Figures  vii Preface: What Is Narrative Economics?  

The correlation between the CAPE ratio and real home prices over the same interval is 0.42. 2. “Movie Ticker Blamed for Wild Trading in Stocks,” Austin Statesman, May 24, 1928, p. 3. 3. Kempton, 1998 [1955], prelude, location 153. 4. Alexander Dana Noyes, Globe (Toronto), October 22, p. 8, 1928, quoting “Financial Markets,” New York Times, October 22, 1928, p. 36. 5. Rappoport and White, 1994. 6. Robert Shiller, “Lessons from the October 1987 Market Plunge,” New York Times, October 22, 2017, p. BU3, https://www.nytimes.com/2017/10/19/business/stock-market-crash-1987.html. 7. Galbraith, 1955. He contradicted others’ claims: “Rise in Suicide Rate Laid to Depression: National Survey Shows 20.5 of 100,000 People Took Their Lives in 1931—Highest Figure since 1915,” New York Times, June 23, 1939, p. 24.

Uncharted: Big Data as a Lens on Human Culture. New York: Riverhead Books, Penguin Group. Akerlof, George A. 2007. “The Missing Motivation in Macroeconomics” (AEA Presidential Address). American Economic Review 97(1):3–36. Akerlof, George A., and Rachel Kranton. 2011. Identity Economics: How Our Identities Shape Our Work, Wages, and Well-Being. Princeton, NJ: Princeton University Press. Akerlof, George A., and Robert J. Shiller. 2009. Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism. Princeton, NJ: Princeton University Press. ________. 2015. Phishing for Phools: The Economics of Manipulation and Deception. Princeton, NJ: Princeton University Press. Akerlof, George A., and Janet L. Yellen. 1985. “A Near-Rational Model of the Business Cycle, with Wage and Price Inertia.”


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Superforecasting: The Art and Science of Prediction by Philip Tetlock, Dan Gardner

Affordable Care Act / Obamacare, Any sufficiently advanced technology is indistinguishable from magic, availability heuristic, Black Swan, butterfly effect, buy and hold, cloud computing, cuban missile crisis, Daniel Kahneman / Amos Tversky, desegregation, drone strike, Edward Lorenz: Chaos theory, forward guidance, Freestyle chess, fundamental attribution error, germ theory of disease, hindsight bias, index fund, Jane Jacobs, Jeff Bezos, Kenneth Arrow, Laplace demon, longitudinal study, Mikhail Gorbachev, Mohammed Bouazizi, Nash equilibrium, Nate Silver, Nelson Mandela, obamacare, pattern recognition, performance metric, Pierre-Simon Laplace, place-making, placebo effect, prediction markets, quantitative easing, random walk, randomized controlled trial, Richard Feynman, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, scientific worldview, Silicon Valley, Skype, statistical model, stem cell, Steve Ballmer, Steve Jobs, Steven Pinker, the scientific method, The Signal and the Noise by Nate Silver, The Wisdom of Crowds, Thomas Bayes, Watson beat the top human players on Jeopardy!

The probabilistic thinker would say, “Yes, it was extremely improbable that I would meet my partner that night, but I had to be somewhere and she had to be somewhere and happily for us our somewheres coincided.” The economist and Nobel laureate Robert Shiller tells the story of how Henry Ford decided to hire workers at the then-astonishingly high rate of $5 a day, which convinced both his grandfathers to move to Detroit to work for Ford. If someone had made one of his grandfathers a better job offer, if one of his grandfathers had been kicked in the head by a horse, if someone had convinced Ford he was crazy to pay $5 a day … if an almost infinite number of events had turned out differently, Robert Shiller would not have been born. But rather than see fate in his improbable existence, Shiller repeats the story as an illustration of how radically indeterminate the future is.

Holman, “Searching for and Finding Meaning in Collective Trauma: Results from a National Longitudinal Study of the 9/11 Terrorist Attacks,” Journal of Personality and Social Psychology 95, no. 3 (2008): 709–22. 29. Laura Kray, Linda George, Katie Liljenquist, Adam Galinsky, Neal Roese, and Philip Tetlock, “From What Might Have Been to What Must Have Been: Counterfactual Thinking Creates Meaning,” Journal of Personality and Social Psychology 98, no. 1 (2010): 106–18. 30. Robert Shiller, interview with the author, August 13, 2013. 7. Supernewsjunkies? 1. David Budescu and Eva Chen have invented a contribution-weighted method of scoring forecasters that gives special weight to those who see things before others do; see D. V. Budescu and E. Chen, “Identifying Expertise to Extract the Wisdom of Crowds,” Management Science 61, no. 2 (2015): 267–80. 2. Doug Lorch, in discussion with the author, September 30, 2014.

Kiesler, The Psychology of Commitment: Experiments Linking Behavior to Belief (New York: Academic Press, 1971). 9. Jean-Pierre Beugoms, in discussion with the author, March 4, 2013. 10. P. E. Tetlock and Richard Boettger, “Accountability: A Social Magnifier of the Dilution Effect,” Journal of Personality and Social Psychology 57 (1989): 388–98. 11. For one of the earliest demonstrations of excess volatility in asset market prices, see Robert Shiller, “Do Stock Prices Move Too Much to Be Justified by Subsequent Changes in Dividends?,” National Bureau of Economic Research Working Paper no. 456, 1980; Terrance Odean, “Do Investors Trade Too Much?,” American Economic Review 89, no. 5 (1999): 1279–98. 12. John Maynard Keynes, The General Theory of Employment, Interest, and Money (CreateSpace Independent Publishing Platform, 2011), p. 63. 13.


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What Went Wrong: How the 1% Hijacked the American Middle Class . . . And What Other Countries Got Right by George R. Tyler

8-hour work day, active measures, activist fund / activist shareholder / activist investor, affirmative action, Affordable Care Act / Obamacare, bank run, banking crisis, Basel III, Black Swan, blood diamonds, blue-collar work, Bolshevik threat, bonus culture, British Empire, business cycle, business process, buy and hold, capital controls, Carmen Reinhart, carried interest, cognitive dissonance, collateralized debt obligation, collective bargaining, commoditize, corporate governance, corporate personhood, corporate raider, corporate social responsibility, creative destruction, credit crunch, crony capitalism, crowdsourcing, currency manipulation / currency intervention, David Brooks, David Graeber, David Ricardo: comparative advantage, declining real wages, deindustrialization, Diane Coyle, disruptive innovation, Double Irish / Dutch Sandwich, eurozone crisis, financial deregulation, financial innovation, fixed income, Francis Fukuyama: the end of history, full employment, George Akerlof, George Gilder, Gini coefficient, Gordon Gekko, hiring and firing, income inequality, invisible hand, job satisfaction, John Markoff, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, labor-force participation, laissez-faire capitalism, lake wobegon effect, light touch regulation, Long Term Capital Management, manufacturing employment, market clearing, market fundamentalism, Martin Wolf, minimum wage unemployment, mittelstand, moral hazard, Myron Scholes, Naomi Klein, Northern Rock, obamacare, offshore financial centre, Paul Samuelson, pension reform, performance metric, pirate software, plutocrats, Plutocrats, Ponzi scheme, precariat, price stability, profit maximization, profit motive, purchasing power parity, race to the bottom, Ralph Nader, rent-seeking, reshoring, Richard Thaler, rising living standards, road to serfdom, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, Sand Hill Road, shareholder value, Silicon Valley, Social Responsibility of Business Is to Increase Its Profits, South Sea Bubble, sovereign wealth fund, Steve Ballmer, Steve Jobs, The Chicago School, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, transcontinental railway, transfer pricing, trickle-down economics, tulip mania, Tyler Cowen: Great Stagnation, union organizing, Upton Sinclair, upwardly mobile, women in the workforce, working poor, zero-sum game

[it] “relied on self-regulation that, in effect, meant no regulation; on market discipline that does not exist when there is euphoria and irrational exuberance; on internal risk management models that fail….”42 Behind Friedman’s Influence Market fundamentalism was pretty thin gruel for economists schooled in history. It quickly attracted as sharp critics the British economist Andrew Smithers and Yale economist Robert J. Shiller, who as early as 1984 judged the underlying theory “one of the most remarkable errors in the history of economic thought.”43 It actually faded in popularity quickly as the profession came to terms with its unreal assumptions. So an obvious question is this: How did laissez-faire economics, discredited as recently as the 1930s and lacking any theoretical basis, actually reemerge as American economic dogma?

As explained by his biographer, Robert Skidelsky, Keynes supported regulation to “redress the failings of society not because he loved it, but because he saw it, in the last resort, as the savior of capitalism from the temptations of collectivism or worse.”56, 57 In clarifying a capitalism that sanctified family prosperity, Keynes and others fended off the Bolsheviks and provided the intellectual heft and insights vital to victory later during the Cold War. As much as Adam Smith, Keynes created the moral high ground enjoyed by free-market capitalism today by explaining how the abusive greed of markets could be ameliorated and corralled to avoid the unemployment and periodic financial panics of laissez-faire Reaganomics. As Yale economist Robert Shiller explained, Keynes’ “… General Theory also had a deeper, more fundamental message about how capitalism worked, if only briefly spelled out. It explained why capitalist economies, left to their own devices, without the balancing of government, were essentially unstable. And it explained why, for capitalist economies to work well, the government should serve as a counterbalance…. Its role is to ensure a ‘wise laissez-faire.’”58 Family capitalism was born in the wake of World War II, as western European officials clarified the role that enterprises should play in marshaling and deploying the risk capital needed for productivity growth and production.

And yet, the supervisory role of the government in the United States in particular has been, over the same period, sharply curtailed, fed by an increasing belief in the self-regulatory nature of the market economy. Precisely as the need for state surveillance has grown, the provision of the needed supervision has shrunk.”58 Now you understand why Bernanke was so frustrated with Greenspan and his acolytes. He rolled back regulation. He rejected warnings from private economists like Robert Shiller of Yale.59 He even overruled more insightful colleagues hoping to bolster regulation by enlisting the forces of the marketplace itself. And that brings us to Arthur Levitt, Jr. Greenspan faced a few courageous opponents in Washington who favored tighter regulation, but he succeeded in either chasing them from Washington (Brooksley Born, chairperson of the Commodities Futures Trading Commission from 1996–1999) or marginalizing them (Arthur Levitt, Jr.).


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The Cost of Inequality: Why Economic Equality Is Essential for Recovery by Stewart Lansley

"Robert Solow", banking crisis, Basel III, Big bang: deregulation of the City of London, Bonfire of the Vanities, borderless world, Branko Milanovic, Bretton Woods, British Empire, business cycle, business process, call centre, capital controls, collective bargaining, corporate governance, corporate raider, correlation does not imply causation, creative destruction, credit crunch, Credit Default Swap, crony capitalism, David Ricardo: comparative advantage, deindustrialization, Edward Glaeser, Everybody Ought to Be Rich, falling living standards, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, Goldman Sachs: Vampire Squid, high net worth, hiring and firing, Hyman Minsky, income inequality, James Dyson, Jeff Bezos, job automation, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, laissez-faire capitalism, light touch regulation, Long Term Capital Management, low skilled workers, manufacturing employment, market bubble, Martin Wolf, mittelstand, mobile money, Mont Pelerin Society, Myron Scholes, new economy, Nick Leeson, North Sea oil, Northern Rock, offshore financial centre, oil shock, plutocrats, Plutocrats, Plutonomy: Buying Luxury, Explaining Global Imbalances, Right to Buy, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, shareholder value, The Great Moderation, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, too big to fail, Tyler Cowen: Great Stagnation, Washington Consensus, Winter of Discontent, working-age population

Sunday Times CONTENTS Title Page Epigraph Introduction 1 An Economic Megashift 2 ‘Zapping Labour’ 3 The Vanishing Middle 4 A Faustian Pact 5 The Incessant Pressure to Transact 6 The Age of Turbulence 7 Living on Borrowed Time 8 A Consumer Society without the Capacity to Consume 9 The Cuckoo in the Nest 10 Walking away with Giant Jackpots 11 The Bigger Picture 12 The Scale of the Task Ahead Acknowledgements Also by Stewart Lansley: Copyright ‘The most essential long-term economic problem of this century is the risk that income inequality will get substantially worse… economic growth will be a positive development only if we do not see at the same time a huge increase in inequality, which could mean that the economic gains are concentrated in a rich class. The mere prospect of a winner-takes-all world ought to strike fear into our hearts.’ Robert J Shiller Notes 1 Robert J Shiller, Inequality-Indexing of the Tax System, The Tobin Project, 2007. 1 Introduction While personal fortunes at the top have soared to levels not seen since before the Second World War, living standards for most Britons have fallen well behind general rises in prosperity. In the United States, nine-tenths of the population has faced stagnant incomes over the last three decades. As a result, the big divide in British and American society is now less between the top, the middle and the bottom, than between a tiny group at the very top and nearly everyone else.

Limits should be imposed on the extent to which leveraged loans can be used to offset profits in the case of acquired companies. To prevent high levels of earnings being disguised as a capital gain, such gains should be taxed at the same rate as income with an adjustment to tax windfall gains more heavily than entrepreneurial success. Wealth should be taxed more heavily, with, for example, capital transfers being more highly taxed.425 The American academic, Robert Shiller—an economist with a strong track record in predicting financial bubbles —has called for a much more radical proposal on the tax system, that it should be indexed to the level of income inequality. Under what he calls ‘The Rising Tide Tax System’, taxes would automatically become more progressive if inequality became more acute. Shiller has found that if such a reform had been instituted 30 years ago in the United States, even in a partial form, economic inequality would have been lessened.426 More progressive systems of income tax can help to dampen turbulence as they act as ‘automatic stabilisers’, reducing the tax take and encouraging consumption during downturns and imposing a break when the economy becomes overheated.

In 2006, before the onset of the credit crunch, the Nobel-prize winning economist Robert Solow claimed that an economy that doesn’t distribute its gain more widely is ‘poorly performing’. In the same year Ben Bernanke said that corporations should ‘use some of those (higher) profit margins to meet demands for higher wages from workers. 434 In 2007 Germany’s finance minister called on European companies to ‘give workers a fairer share of their soaring profits.’435 In 2007, Robert Shiller warned that: ‘The most essential long-term economic problem of this century is the risk that income inequality will get substantially worse… The mere prospect of a winner-takes-all world ought to strike fear into our hearts.’436 It was a theme echoed at the 2011 World Economic Forum at Davos. One senior business leader admitted to the meeting that during the crisis, companies across the world had ‘sacrificed the workers to please the shareholders’ and called for a more ‘humanistic’ approach.


pages: 543 words: 147,357

Them And Us: Politics, Greed And Inequality - Why We Need A Fair Society by Will Hutton

Andrei Shleifer, asset-backed security, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Blythe Masters, Boris Johnson, Bretton Woods, business cycle, capital controls, carbon footprint, Carmen Reinhart, Cass Sunstein, centre right, choice architecture, cloud computing, collective bargaining, conceptual framework, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, debt deflation, decarbonisation, Deng Xiaoping, discovery of DNA, discovery of the americas, discrete time, diversification, double helix, Edward Glaeser, financial deregulation, financial innovation, financial intermediation, first-past-the-post, floating exchange rates, Francis Fukuyama: the end of history, Frank Levy and Richard Murnane: The New Division of Labor, full employment, George Akerlof, Gini coefficient, global supply chain, Growth in a Time of Debt, Hyman Minsky, I think there is a world market for maybe five computers, income inequality, inflation targeting, interest rate swap, invisible hand, Isaac Newton, James Dyson, James Watt: steam engine, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, knowledge worker, labour market flexibility, liberal capitalism, light touch regulation, Long Term Capital Management, Louis Pasteur, low cost airline, low-wage service sector, mandelbrot fractal, margin call, market fundamentalism, Martin Wolf, mass immigration, means of production, Mikhail Gorbachev, millennium bug, money market fund, moral hazard, moral panic, mortgage debt, Myron Scholes, Neil Kinnock, new economy, Northern Rock, offshore financial centre, open economy, plutocrats, Plutocrats, price discrimination, private sector deleveraging, purchasing power parity, quantitative easing, race to the bottom, railway mania, random walk, rent-seeking, reserve currency, Richard Thaler, Right to Buy, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, Rory Sutherland, Satyajit Das, shareholder value, short selling, Silicon Valley, Skype, South Sea Bubble, Steve Jobs, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, the scientific method, The Wealth of Nations by Adam Smith, too big to fail, unpaid internship, value at risk, Vilfredo Pareto, Washington Consensus, wealth creators, working poor, zero-sum game, éminence grise

But none of these is sufficiently reliable to be useful in making predictions about economic behaviour. Economists do know, however, that human beings possess one predictable instinct: they will always try to maximise their profit. So economics tries to box as much human reaction as possible into this simple and universal theorem. But economics cannot proceed by ignoring the reality that human beings value – indeed, are passionate about – fairness. As economists Robert Shiller and George Akerlof prove,2 unemployment, recessions, swings in confidence and much other economic activity are simply inexplicable using the standard theorems of economics. But if progress is to be made, there has to be a capacity to model what human beings actually think and value reliably – and to get a grip on apparent inconsistencies. Here behavioural psychology has begun to open up incredible insights through a wider range of laboratory tests.3 For instance, we know that people value cooperation, punish cheats, believe that effort should be rewarded, understand the case for salary differentials, value equity and believe that the very poor should have a reasonable standard of living.

Over the last thirty years, ordinary people have had to assume ever more risk as decent pensions and tenured work have become increasingly hard to find, while social insurance has become more means tested and miserly. Everyone lives within this environment, so everyone needs better tools to manage it. Thankfully, the intellectual climate is shifting away from the argument that meanness in social security provision spurs innovation and deters slacking. Instead, for example, Professor Robert Shiller argues that a switch from unemployment to employment insurance, so that employees can insure their wage or salary against job loss, would make them more ready to run and manage risks because their income would be higher than the minimal job-seeker’s allowance.50 Daron Acemoglu and Robert Shimer make a similar point, arguing that unemployment insurance is a tool of economic efficiency.51 If workers know that their income will be cushioned by unemployment insurance, they will be more likely to accept jobs in riskier enterprises at a lower risk premium.

commented David Sarnoff Associates in rejecting a proposal for investment in the radio in the 1920s. 24 Thérèse Delpech (2007) Savage Century: Back to Barbarism, Carnegie Endowment for International Peace. 25 National Intelligence Council (2008) Global Trends 2025: A World Transformed, US Government Printing Office. 26 George Orwell (1938; 1962) Homage to Catalonia, Penguin, p. 221. Chapter Two: Why Fair? 1 Literary analysis and history also testify to the importance of balance: see Margaret Atwood (2008) Payback – Debt and the Shadow Side of Wealth, Bloomsbury. 2 George Akerlof and Robert Shiller (2009) Animal Spirits: How Human Psychology Drives the Economy and Why it Matters for Global Capitalism, Princeton University Press. 3 Some philosophical work is also beginning to take seriously concrete popular conceptions of justice: see David Miller (2001) Principles of Social Justice, Harvard University Press. More generally, for a social-psychological account, see Michael Ross and Dale Miller (eds) (2002) The Justice Motive in Everday Life, Cambridge University Press. 4 Ulpian in the digest of the Roman book of law, Corpus Juris, circa 200 BC. 5 Thomas Hurka, ‘Desert: Individualistic and Holistic’, in Serena Olsaretti (ed.) (2007) Desert and Justice, Oxford University Press. 6 George Sher (1987) Desert, Princeton University Press, p. 53. 7 Marc Hauser (2006) Moral Minds: How Nature Designed Our Universal Sense of Right and Wrong, Ecco Press. 8 Alan Norrie (2001) Crime, Reason and History: A Critical Introduction to Criminal Law, Cambridge University Press. 9 Cited by Jan Narveson, ‘Deserving Profits’, in Robin Cowan and Mario J.


pages: 121 words: 31,813

The Art of Execution: How the World's Best Investors Get It Wrong and Still Make Millions by Lee Freeman-Shor

Black Swan, buy and hold, cognitive bias, collapse of Lehman Brothers, credit crunch, Daniel Kahneman / Amos Tversky, diversified portfolio, family office, I think there is a world market for maybe five computers, index fund, Isaac Newton, Jeff Bezos, Long Term Capital Management, loss aversion, Richard Thaler, Robert Shiller, Robert Shiller, rolodex, Skype, South Sea Bubble, Stanford marshmallow experiment, Steve Jobs, technology bubble, The Wisdom of Crowds, too big to fail, tulip mania, zero-sum game

As they eventually do revise them, this in turn results in a stock being either re-rated or attracting buyers as it surprises – despite nothing fundamentally having changed. Another possible explanation is a simple bandwagon effect: investors buy winning stocks because that is what the herd is doing. The longer a winning streak goes on, the narrower and narrower the market gets as all the buyers end up moving into the same winning stocks and sectors. Everyone loves a winner and a stock whose share price keeps going up and up becomes a market darling. Robert Shiller’s findings from research he conducted in 1981 suggest that stock prices are driven more by speculators than by company fundamentals.50 He showed that stock market prices move well beyond what would be predicted by a rational investment model. Quite simply, stock index returns are too volatile relative to aggregate dividends. Indeed, consider the fact that in December 2006, Alan Greenspan, when he was the chairman of the Federal Reserve, publicly declared that markets were being driven higher due to “irrational exuberance”.

, EFA, by Brad Barber and Terrance Odean (1999). 40 ‘Trading is hazardous to your wealth: the common stock investment performance of individual investors’, The Journal of Finance, by Brad Barber and Terrance Odean (2000). 41 Kahneman and Tversky (1979). 42 ‘Focusing on the Forgone: How Value Can Appear So Different to Buyers and Sellers’, Journal of Consumer Research, by Ziv Carmon and Dan Ariely (2000). 43 The Psychology of Finance, by Lars Tvede (1999). 44 More Than You Know, by Michael Mauboussin (2006). 45 Mauboussin (2006). 46 Mean Genes, by Terry Burnham and Jay Phelan (2001). 47 Lynch (2000). 48 Thaler and Johnson (1990). 49 ‘Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency’, Journal of Finance, by Narasimhan Jegadeesh and Sheridan Titman (1993). 50 ‘Do Stock Prices Move Too Much to Be Justified by Subsequent Changes in Dividends?’, American Economic Review, by Robert Shiller (1981). 51 Druckenmiller is a very famous investor who achieved compounded returns of ~30% from 1986 to 2010 before announcing he was returning all outside investor capital from his Duquesne fund and forming a family office. 52 Schwager (1994). 53 Those of you with a keen eye will note that this was the same date as for Spirax-Sarco. The reason is simple.


pages: 446 words: 117,660

Arguing With Zombies: Economics, Politics, and the Fight for a Better Future by Paul Krugman

affirmative action, Affordable Care Act / Obamacare, Andrei Shleifer, Asian financial crisis, bank run, banking crisis, basic income, Berlin Wall, Bernie Madoff, bitcoin, blockchain, Bonfire of the Vanities, business cycle, capital asset pricing model, carbon footprint, Carmen Reinhart, central bank independence, centre right, Climategate, cognitive dissonance, cryptocurrency, David Ricardo: comparative advantage, different worldview, Donald Trump, Edward Glaeser, employer provided health coverage, Eugene Fama: efficient market hypothesis, Fall of the Berlin Wall, fiat currency, financial deregulation, financial innovation, financial repression, frictionless, frictionless market, fudge factor, full employment, Growth in a Time of Debt, hiring and firing, illegal immigration, income inequality, index fund, indoor plumbing, invisible hand, job automation, John Snow's cholera map, Joseph Schumpeter, Kenneth Rogoff, knowledge worker, labor-force participation, large denomination, liquidity trap, London Whale, market bubble, market clearing, market fundamentalism, means of production, New Urbanism, obamacare, oil shock, open borders, Paul Samuelson, plutocrats, Plutocrats, Ponzi scheme, price stability, quantitative easing, road to serfdom, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, secular stagnation, The Chicago School, The Great Moderation, the map is not the territory, The Wealth of Nations by Adam Smith, trade liberalization, transaction costs, universal basic income, very high income, working-age population

If housing prices actually started falling, we’d be looking at a very nasty scene, in which both construction and consumer spending would plunge, pushing the economy right back into recession. That’s why it’s so ominous to see signs that America’s housing market, like the stock market at the end of the last decade, is approaching the final, feverish stages of a speculative bubble. Some analysts still insist that housing prices aren’t out of line. But someone will always come up with reasons why seemingly absurd asset prices make sense. Remember Dow 36,000? Robert Shiller, who argued against such rationalizations and correctly called the stock bubble in his book Irrational Exuberance, has added an ominous analysis of the housing market to the new edition, and says the housing bubble “may be the biggest bubble in U.S. history.” In parts of the country there’s a speculative fever among people who shouldn’t be speculators that seems all too familiar from past bubbles—the shoeshine boys with stock tips in the 1920s, the beer-and-pizza joints showing CNBC, not ESPN, on their TV sets in the 1990s.

Larry Summers, now the top economic adviser in the Obama administration, once mocked finance professors with a parable about “ketchup economists” who “have shown that two-quart bottles of ketchup invariably sell for exactly twice as much as one-quart bottles of ketchup,” and conclude from this that the ketchup market is perfectly efficient. But neither this mockery nor more polite critiques from economists like Robert Shiller of Yale had much effect. Finance theorists continued to believe that their models were essentially right, and so did many people making real-world decisions. Not least among these was Alan Greenspan, who was then the Fed chairman and a long-time supporter of financial deregulation whose rejection of calls to rein in subprime lending or address the ever-inflating housing bubble rested in large part on the belief that modern financial economics had everything under control.

In recent, rueful economics discussions, an all-purpose punch line has become “Nobody could have predicted . . .” It’s what you say with regard to disasters that could have been predicted, should have been predicted, and actually were predicted by a few economists who were scoffed at for their pains. Take, for example, the precipitous rise and fall of housing prices. Some economists, notably Robert Shiller, did identify the bubble and warn of painful consequences if it were to burst. Yet key policymakers failed to see the obvious. In 2004, Alan Greenspan dismissed talk of a housing bubble: “a national severe price distortion,” he declared, was “most unlikely.” Home-price increases, Ben Bernanke said in 2005, “largely reflect strong economic fundamentals.” How did they miss the bubble? To be fair, interest rates were unusually low, possibly explaining part of the price rise.


pages: 249 words: 77,342

The Behavioral Investor by Daniel Crosby

affirmative action, Asian financial crisis, asset allocation, availability heuristic, backtesting, bank run, Black Swan, buy and hold, cognitive dissonance, colonial rule, compound rate of return, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, endowment effect, feminist movement, Flash crash, haute cuisine, hedonic treadmill, housing crisis, IKEA effect, impulse control, index fund, Isaac Newton, job automation, longitudinal study, loss aversion, market bubble, market fundamentalism, mental accounting, meta analysis, meta-analysis, Milgram experiment, moral panic, Murray Gell-Mann, Nate Silver, neurotypical, passive investing, pattern recognition, Ponzi scheme, prediction markets, random walk, Richard Feynman, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, science of happiness, Shai Danziger, short selling, South Sea Bubble, Stanford prison experiment, Stephen Hawking, Steve Jobs, stocks for the long run, Thales of Miletus, The Signal and the Noise by Nate Silver, tulip mania, Vanguard fund

Psychologists call this fallibility in your memory retrieval mechanism the availability heuristic, which simply means that we predict the likelihood of an event based on how easily we can call it to mind rather than how probable it is. Kahneman and Tversky first observed this effect in their 1973 paper where they noted that an information signal is salient (i.e., memorable) if it has characteristics that differ from the background or a past state. Thus, we have a good memory for both the exceedingly commonplace (by virtue of repetition) and the exceptionally strange. Behavioral economist Robert Shiller suggested that the ubiquity of the internet made it easier for investors to bid up the prices of internet stocks to unprecedented levels during the dot.com bubble. Evidence of the usefulness of the WWW was everywhere, making it easy to create internal narratives about how the internet could be paradigm changing. Likewise, we see the effects of black swan events like the Great Recession linger in the public consciousness for years after the fact, unusual and impactful as they are.

As Michael Batnick of Ritholtz Wealth Management writes in his summary of their research, “If shares in an industry increased by 50%, the probability of a crash over the next two years is just 20%. A 100% return increased the odds of a crash to 53%, and a 150% return increased the odds of a crash to 80%.” The takeaway? Only about half of bubbles burst, but when they do – watch out. Can you spot a bubble? Dr. Robert Shiller, Nobel Laureate in Economics, suggests that bubbles can be diagnosed using a checklist in much the same manner that a psychologist would examine the mental health of a patient against the diagnostic criteria for a given mental illness. Dr. Shiller offers the following as a starting point for spotting bubbles: Have asset prices increased sharply? Is there public excitement about these price increases?

Bubbles are born and die on fundamentals but are fueled by our need to create stories all along the way. The process typically looks something like this: Price gains occur for fundamental reasons. Increasing prices attract attention. Narratives emerge to explain price gains. The positive narrative begets a cascade of increased price and volume. Narrative is broken, causing a return to fundamentals. Robert Shiller defines a bubble as “a social epidemic where price increases lead to further price increases” and stories are the means by which a spark of fundamental value becomes a raging fire of irrationality. Teeter and Sandberg speak to the power of story to create and sustain bubbles in the aptly named, ‘Cracking the Enigma of Asset Bubbles with Narratives’ and cite three specific reasons why narrative is so powerful.


pages: 484 words: 136,735

Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis by Anatole Kaletsky

"Robert Solow", bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Black Swan, bonus culture, Bretton Woods, BRICs, business cycle, buy and hold, Carmen Reinhart, cognitive dissonance, collapse of Lehman Brothers, Corn Laws, correlation does not imply causation, creative destruction, credit crunch, currency manipulation / currency intervention, David Ricardo: comparative advantage, deglobalization, Deng Xiaoping, Edward Glaeser, Eugene Fama: efficient market hypothesis, eurozone crisis, experimental economics, F. W. de Klerk, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, George Akerlof, global rebalancing, Hyman Minsky, income inequality, information asymmetry, invisible hand, Isaac Newton, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, Kickstarter, laissez-faire capitalism, Long Term Capital Management, mandelbrot fractal, market design, market fundamentalism, Martin Wolf, money market fund, moral hazard, mortgage debt, Nelson Mandela, new economy, Northern Rock, offshore financial centre, oil shock, paradox of thrift, Pareto efficiency, Paul Samuelson, peak oil, pets.com, Ponzi scheme, post-industrial society, price stability, profit maximization, profit motive, quantitative easing, Ralph Waldo Emerson, random walk, rent-seeking, reserve currency, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, statistical model, The Chicago School, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, too big to fail, Vilfredo Pareto, Washington Consensus, zero-sum game

According to Soros, the interaction between these financial and political processes, and their reflexive influence on one another, created a super-bubble that culminated in the unprecedented bust of 2008. Behavioral finance, a blend of traditional economics and experimental psychology, became a popular theory of boom-bust cycles after Alan Greenspan coined the phrase “irrational exuberance” in a 1996 speech.7 The idea that financial instability is a consequence of various forms of irrational behavior was elaborated and popularized a few years later by the Yale economics professor Robert Shiller in his best-selling book Irrational Exuberance, 8 published three months before the bursting of the technology stock bubble. Among the sources of irrationality discussed by behavioral economists and demonstrated in their financial experiments are herd instinct, overconfidence, and anchoring. In the anchoring syndrome, people base expectations about inherently uncertain events on whatever magic numbers or trends are brought to their notice, even if these bear no rational relationship to the events they are trying to predict.

Despite the near-monopoly enjoyed by rational expectations and mathematical modeling in elite university departments since the 1980s, many new and interesting approaches to economics based on psychology, sociology, control engineering, chaos theory, psychiatry, and practical business insights have been developing in the shadows of the official doctrine. Some of these will doubtless spring to life in the years ahead. The approach receiving widest publicity during the crisis was behavioral economics. Popularized by Robert Shiller, behavioral economics considers a world in which investors and businesses are motivated by crowd psychology rather than the obsessive calculation of rational expectations. It is, however, the least radical of the alternative approaches because it does not challenge the central assumption of REH—that booms, busts, and recessions are all caused by various types of market failure and therefore that breakdowns in laissez-faire capitalism could, at least in principle, be prevented by making markets more perfect, for example, by disseminating information or strengthening the regulations against fraud.

But these broad national figures are published only quarterly rather than monthly, and with a considerable lag, and therefore receive less attention in the media and on Wall Street. Between January 2000 and the peak of the U.S. housing market in mid-2006, the NAR index increased by 68 percent, the CS National index by 92 percent, the CS 20 index by 106 percent, and the CS 10 index by 126 percent. By the middle of 2009, the Case-Shiller indices had fallen back and the CS National index showed a cumulative gain since 2000 only 2 percent higher than the NAR. 9 Professor Robert Shiller of Yale, probably the most famous and academically distinguished of these Cassandras, freely admitted in a talk he gave in January 2010 at the World Economic Forum in Davos that “many economists [presumably himself included] were predicting a housing crash for at least a decade before it occurred.” He added that Nouriel Roubini (another celebrated prophet of doom) “was predicting calamity for the U.S. economy from the moment I first met him back in 2000.” 10 Charles Prince quoted in Michiyo Nakamoto and David Wighton, “Citigroup Chief Stays Bullish on Buy-outs,” Financial Times, July 9, 2007. 11 Herbert Stepic, CEO of Raiffeisen International Bank, the second biggest lender in central Europe, speaking at the EBRD Annual Meeting in Kiev on May 19, 2008.


pages: 457 words: 128,838

The Age of Cryptocurrency: How Bitcoin and Digital Money Are Challenging the Global Economic Order by Paul Vigna, Michael J. Casey

Airbnb, altcoin, bank run, banking crisis, bitcoin, blockchain, Bretton Woods, buy and hold, California gold rush, capital controls, carbon footprint, clean water, collaborative economy, collapse of Lehman Brothers, Columbine, Credit Default Swap, cryptocurrency, David Graeber, disintermediation, Edward Snowden, Elon Musk, Ethereum, ethereum blockchain, fiat currency, financial innovation, Firefox, Flash crash, Fractional reserve banking, hacker house, Hernando de Soto, high net worth, informal economy, intangible asset, Internet of things, inventory management, Joi Ito, Julian Assange, Kickstarter, Kuwabatake Sanjuro: assassination market, litecoin, Long Term Capital Management, Lyft, M-Pesa, Marc Andreessen, Mark Zuckerberg, McMansion, means of production, Menlo Park, mobile money, money: store of value / unit of account / medium of exchange, Nelson Mandela, Network effects, new economy, new new economy, Nixon shock, offshore financial centre, payday loans, Pearl River Delta, peer-to-peer, peer-to-peer lending, pets.com, Ponzi scheme, prediction markets, price stability, profit motive, QR code, RAND corporation, regulatory arbitrage, rent-seeking, reserve currency, Robert Shiller, Robert Shiller, Ross Ulbricht, Satoshi Nakamoto, seigniorage, shareholder value, sharing economy, short selling, Silicon Valley, Silicon Valley startup, Skype, smart contracts, special drawing rights, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, supply-chain management, Ted Nelson, The Great Moderation, the market place, the payments system, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, Turing complete, Tyler Cowen: Great Stagnation, Uber and Lyft, uber lyft, underbanked, WikiLeaks, Y Combinator, Y2K, zero-sum game, Zimmermann PGP

Andreessen Horowitz venture capitalist: Chris Dixon, phone interview with Michael J. Casey, June 25, 2014. Asked to describe the job market: Daniel Larimer, interviewed by Michael J. Casey, April 8, 2014. As Tyler Cowen noted in his book: Tyler Cowan, Average Is Over: Powering America Beyond the Age of the Great Stagnation (Dutton, 2013). Yale’s Robert Shiller: Joe Weisenthal, “Robert Shiller: Bitcoin Is an Amazing Example of a Bubble,” Business Insider, January 24, 2014, http://www.businessinsider.com/robert-shiller-bitcoin-2014-1#ixzz3Cmp0YFyx. New York University’s Nouriel Roubini: Erik Holm, “Nouriel Roubini: Bitcoin Is a ‘Ponzi Game,’” March 10, 2014, Wall Street Journal, MoneyBeat blog, http://blogs.wsj.com/moneybeat/2014/03/10/nouriel-roubini-bitcoin-is-a-ponzi-game/. Former U.S. treasury secretary: Lawrence Summers, phone interview by Michael J.

These questions will be especially relevant in the age of cryptocurrency—certainly for all those working in “trust” industries challenged by blockchain automation. They could blindly hope that this strange new way of handling finance will never amount to anything, much as Eastman Kodak mistakenly did about the digital camera. But you’ve probably gathered by now that we think that’s a dangerously naïve viewpoint. While it’s true that quite a few prominent economists see bitcoin as a passing fad—Yale’s Robert Shiller and New York University’s Nouriel Roubini were still in that camp in mid-2014—the longer that digital currency defies these expectations and the further along the innovation curve bitcoin businesses go, the more out of touch such views will seem. Former U.S. treasury secretary Larry Summers, one of the most influential economic minds on the planet, recognizes the risks of ignoring this technology for a financial sector that’s “ripe for disruption.”


pages: 261 words: 70,584

Retirementology: Rethinking the American Dream in a New Economy by Gregory Brandon Salsbury

Albert Einstein, asset allocation, buy and hold, carried interest, Cass Sunstein, credit crunch, Daniel Kahneman / Amos Tversky, diversification, estate planning, financial independence, fixed income, full employment, hindsight bias, housing crisis, loss aversion, market bubble, market clearing, mass affluent, Maui Hawaii, mental accounting, mortgage debt, mortgage tax deduction, negative equity, new economy, RFID, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, side project, Silicon Valley, Steve Jobs, the rule of 72, Yogi Berra

A January 3, 2009, The Wall Street Journal article titled “Blame Television for the Bubble,” stated, “You couldn’t watch these shows without concluding you must be an idiot and a loser if you lived in a house you could actually afford.” America’s Housing Bust “Let’s hope we are all wealthy and retired by the time this house of cards falters.” —Excerpt from an S&P employee email, December 15, 200616 Nationwide, housing values started to fall in the autumn of 2007.17 To the surprise of no one with the benefit of hindsight, the Dow Jones Industrial Average peaked then as well at 14,164 on October 9, 2007.18 As Robert Shiller, Yale professor, economist, and long-time real estate expert predicted, so much of America’s wealth—or at least the wealth effect, the feeling that we were wealthy—was tied to the rising values of our homes.19 When people’s homes stopped appreciating in value, a homeowner could no longer draw money from it...and that homeowner certainly couldn’t draw money from a bank account that never had any money in it.

During the housing boom, millions of Americans used the equity in their homes like house money for home improvements, vacations, new cars, or even more houses.31 And now, for those who rode the perpetual rise of home appreciation, many bets are off. On the House Although there were myriad culprits behind the credit crunch, Boomer behavior such as the wealth effect and house money effect played a prominent role. Robert Shiller’s book Irrational Exuberance, published in 2000, detailed the trouble that awaited us all when the impending Nasdaq bubble burst. He argued that it was the artificial rise in home values, not the tech stock boom, that was creating the dangerous wealth effect. And that was in spite of the fact that demand was decreasing in important markets such as Silicon Valley.32 As tech stock values were pushed higher by a bubble, the wealth effect took hold and had people feeling wealthier than they were, and the same thing happened with the housing bubble that followed.


pages: 263 words: 75,455

Quantitative Value: A Practitioner's Guide to Automating Intelligent Investment and Eliminating Behavioral Errors by Wesley R. Gray, Tobias E. Carlisle

activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, asset allocation, Atul Gawande, backtesting, beat the dealer, Black Swan, business cycle, butter production in bangladesh, buy and hold, capital asset pricing model, Checklist Manifesto, cognitive bias, compound rate of return, corporate governance, correlation coefficient, credit crunch, Daniel Kahneman / Amos Tversky, discounted cash flows, Edward Thorp, Eugene Fama: efficient market hypothesis, forensic accounting, hindsight bias, intangible asset, Louis Bachelier, p-value, passive investing, performance metric, quantitative hedge fund, random walk, Richard Thaler, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, statistical model, survivorship bias, systematic trading, The Myth of the Rational Market, time value of money, transaction costs

Because the speculative public is clearly wrong in its attitude on this point, it would seem that its errors should afford profitable opportunities to the more logically minded to buy common stocks at the low prices occasioned by temporarily reduced earnings and to sell them at inflated prices created by abnormal prosperity. Graham suggested a methodology to avoid such errors and to exploit the variation in earnings: normalized earnings power. He recommended that investors calculate normalized earnings power by taking the average of earnings over a period of between 5 and 10 years. Robert Shiller extended Graham's recommendation by suggesting that investors adjust average earnings for inflation, and use a longer-term average with a minimum period of 10 years. Such a long-run, inflation-adjusted average smooths the peaks and valleys in earnings, making the earnings appear higher in the trough, and lower at the peak, than a single-year metric. In this chapter, we analyze long-run and composite price metrics.

The rationale is that the extremes found at the peak and trough of the business cycle do not represent the “normal” earning power of the business, which is likely lower than at the peak and higher than at the trough. Earnings tend to be mean reverting, so we need to normalize the extremes to make them less attractive at the peak and more attractive at the trough. We can achieve this taking an average of earnings over the business cycle. We can't know how long a business cycle will last, so Graham recommended using an average of between 5 and 10 years. More recently, Robert Shiller, author of the book Irrational Exuberance, which took for its title the phrase then-chairman of the Federal Reserve Alan Greenspan used to warn of the dot-com bubble in 1996, collaborated with John Campbell to argue2 that annual earnings are too “noisy” to use as the denominator in price-to-earnings (P/E) ratios. Campbell and Shiller point out that extremes in a price ratio can be remedied only by the denominator's or numerator's moving in a direction that restores the ratio to a more normal level.

In the next part, we consider several different signals sent by market participants to find those that forecast market-beating performance. We examine buy-backs, insider buying, activism, institutional investors, and short selling. NOTES 1. Benjamin Graham, and David Dodd, Security Analysis: The Classic 1934 Edition (McGraw-Hill, 1996). 2. J. Y. Campbell and R. J. Shiller, “Valuation Ratios and the Long-Run Stock Market Outlook.” Journal of Portfolio Management (Winter 1998): 11–26. 3. John Y. Campbell and Robert J. Shiller, “Valuation Ratios and the Long-Run Stock Market Outlook: An Update (April 2001).” NBER Working Paper Series, Vol. w8221, 2001. Available at http://ssrn.com/abstract=266191. 4. K. P. Anderson and Chris Brooks, “The Long-Term Price-Earnings Ratio.” Journal of Business Finance & Accounting 33(7–8) (September/October 2006): 1063–1086. Available at http://ssrn.com/abstract=934618 or http://dx.doi.org/10.1111/j.1468-5957.2006.00621.x. 5.


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Fed Up: An Insider's Take on Why the Federal Reserve Is Bad for America by Danielle Dimartino Booth

Affordable Care Act / Obamacare, asset-backed security, bank run, barriers to entry, Basel III, Bernie Sanders, break the buck, Bretton Woods, business cycle, central bank independence, collateralized debt obligation, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, financial deregulation, financial innovation, fixed income, Flash crash, forward guidance, full employment, George Akerlof, greed is good, high net worth, housing crisis, income inequality, index fund, inflation targeting, interest rate swap, invisible hand, John Meriwether, Joseph Schumpeter, liquidity trap, London Whale, Long Term Capital Management, margin call, market bubble, Mexican peso crisis / tequila crisis, money market fund, moral hazard, Myron Scholes, natural language processing, negative equity, new economy, Northern Rock, obamacare, price stability, pushing on a string, quantitative easing, regulatory arbitrage, Robert Shiller, Robert Shiller, Ronald Reagan, selection bias, short selling, side project, Silicon Valley, The Great Moderation, The Wealth of Nations by Adam Smith, too big to fail, trickle-down economics, yield curve

With rates so low, they had to make up what they were losing on that spread with volume, or trash their lending standards to charge higher interest rates to subprime borrowers. Relaxed mortgage lending standards sent house prices soaring around the country, especially in California, Florida, and Nevada. Households were buying a lot more home than they could afford, courtesy of subprime mortgages. The market was so hot it had started to look suspiciously like another bubble. The classic definition of an asset bubble was coined by economist Robert Shiller, who called it an unsustainable condition in which “price increases beget further price increases.” I preferred Warren Buffett’s definition: “It’s like most trends—at the beginning it’s driven by fundamentals; in the end, by speculation. It’s just like the old adage: ‘What the wise man does in the beginning, the fool does in the end.’” By all measures of the data, the fools had piled in.

Blamed for a 95-point drop: Scott Patterson, “Fed Comments Roil the Market,” Wall Street Journal, October 6, 2005, www.wsj.com/articles/SB112859671097461506. Unlike many other Fed District Bank presidents: Mark Gongloff, Scott Patterson, and David Gaffen, “Who Will Wield Influence After Greenspan Departs?,” Wall Street Journal, November 18, 2005, www.wsj.com/articles/SB113225663185000372. The classic definition of an asset bubble: Robert J. Shiller, “Speculative Asset Prices,” Nobel Prize Lecture, nobelprize.org, December 8, 2013, 460–61. His more detailed version of a bubble: “A situation in which news of price increases spurs investor enthusiasm which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increase and bringing in a larger and larger class of investors, who, despite doubts about the real value of the investment are drawn to it partly through envy of others’ successes and partly through a gambler’s excitement.”

The National Bureau of Economic Research: Chris Isidore, “Recession Officially Ended in June 2004,” cnnmoney.com, September 20, 2010. “Most, probably, of our decisions”: “Animal Spirits—J. M. Keynes,” economicshelp.org, November 28, 2012. Keynes describes animal spirits in his 1936 book General Theory of Employment, Interest and Money (London: Macmillan, 1936), 161–62. It was fitting that in 2009: George Akerlof and Robert Shiller, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism (Princeton, N.J.: Princeton University Press, 2009). “There’s a large amount of money”: Cullen Roche, “1930’s Déjà Vu,” BusinessInsider.com, September 4, 2009. “There is plenty of cash”: Richard Barley, “Fretful Investors Sidelined by Rally,” Wall Street Journal, September 12, 2009. In August, he announced: Jennifer Liberto, “Obama Taps Bernanke for Second Term,” CNNMoney.com, August 25, 2009.


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The Four: How Amazon, Apple, Facebook, and Google Divided and Conquered the World by Scott Galloway

activist fund / activist shareholder / activist investor, additive manufacturing, Affordable Care Act / Obamacare, Airbnb, Amazon Web Services, Apple II, autonomous vehicles, barriers to entry, Ben Horowitz, Bernie Sanders, big-box store, Bob Noyce, Brewster Kahle, business intelligence, California gold rush, cloud computing, commoditize, cuban missile crisis, David Brooks, disintermediation, don't be evil, Donald Trump, Elon Musk, follow your passion, future of journalism, future of work, global supply chain, Google Earth, Google Glasses, Google X / Alphabet X, Internet Archive, invisible hand, Jeff Bezos, Jony Ive, Khan Academy, longitudinal study, Lyft, Mark Zuckerberg, meta analysis, meta-analysis, Network effects, new economy, obamacare, Oculus Rift, offshore financial centre, passive income, Peter Thiel, profit motive, race to the bottom, RAND corporation, ride hailing / ride sharing, risk tolerance, Robert Mercer, Robert Shiller, Robert Shiller, Search for Extraterrestrial Intelligence, self-driving car, sentiment analysis, shareholder value, Silicon Valley, Snapchat, software is eating the world, speech recognition, Stephen Hawking, Steve Ballmer, Steve Jobs, Steve Wozniak, Stewart Brand, supercomputer in your pocket, Tesla Model S, Tim Cook: Apple, Travis Kalanick, Uber and Lyft, Uber for X, uber lyft, undersea cable, Whole Earth Catalog, winner-take-all economy, working poor, young professional

Denting the Universe The cocktail of low-cost product and premium prices has landed Apple with a cash pile greater than the GDP of Denmark, the Russian stock market, and the market cap of Boeing, Airbus, and Nike combined. At some point, does Apple have an obligation to spend its cash? If yes, then how? My suggestion: Apple should launch the world’s largest tuition-free university. “Do you hear that? It might be the growing sounds of pocketbooks snapping shut and the chickens coming home . . . .” AEIdeas, August 2016. http://bit.ly/2nHvdfr. Irrational Exuberance, Robert Shiller. http://amzn.to/2o98DZE. The education market is ripe, and I mean falling-off-the-tree ripe, to be disrupted. A sector’s vulnerability is a function of price increases relative to inflation and the underlying increases in productivity and innovation. The reason tech continues to eat more of the world’s GDP is a gestalt that says we need to make a much better product and lower price.

“Levi Strauss & Company Corporate Profile and Case Material.” Clean Clothes Campaign. Levi Strauss & Co., Form 10-K for the Period Ending November 27, 2005 (filed February 14, 2006), p. 26, from Levi Strauss & Co. website. Cost of College “Do you hear that? It might be the growing sounds of pocketbooks snapping shut and the chickens coming home . . .” AEIdeas, August 2016. http://bit.ly/2nHvdfir. Irrational Exuberance, Robert Shiller. http://amzn.to/2o98DZE. Time Spent on Facebook, Instagram, & WhatsApp per Day, December 2016 “How Much Time Do People Spend on Social Media?” MediaKix. Number of Timeline Posts per Day—Single vs. In a Relationship Meyer, Robinson. “When You Fall in Love This Is What Facebook Sees.” The Atlantic. Individuals Moving from/to WPP to Facebook & Google L2 Analysis of LinkedIn Data.

Annual Report for the Period Ending December 31, 2016 (filed February 28, 2017), p. 42, from International Business Machines Corporation website. https://www.ibm.com/investor/financials/financial-reporting.html. Chapter 10: The Four and You 1. “Do you hear that? It might be the growing sounds of pocketbooks snapping shut and the chickens coming home . . .” AEIdeas, August 2016. http://bit.ly/2nHvdfr. 2. Irrational Exuberance, Robert Shiller. http://amzn.to/2o98DZE. 3. https://www.nytimes.com/2017/03/14/books/henry-lodge-dead-co-author-younger-next-year.html?_r=1. Chapter 11: After the Horsemen 1. Yahoo! Finance. https://finance.yahoo.com/. 2. Facebook, Inc. https://newsroom.fb.com/company-info/. 3. Yahoo! Finance. https://finance.yahoo.com/. 4. “The World’s Biggest Public Companies.” Forbes. May 2016. https://www.forbes.com/global2000/list/. 5.


Evidence-Based Technical Analysis: Applying the Scientific Method and Statistical Inference to Trading Signals by David Aronson

Albert Einstein, Andrew Wiles, asset allocation, availability heuristic, backtesting, Black Swan, butter production in bangladesh, buy and hold, capital asset pricing model, cognitive dissonance, compound rate of return, computerized trading, Daniel Kahneman / Amos Tversky, distributed generation, Elliott wave, en.wikipedia.org, feminist movement, hindsight bias, index fund, invention of the telescope, invisible hand, Long Term Capital Management, mental accounting, meta analysis, meta-analysis, p-value, pattern recognition, Paul Samuelson, Ponzi scheme, price anchoring, price stability, quantitative trading / quantitative finance, Ralph Nelson Elliott, random walk, retrograde motion, revision control, risk tolerance, risk-adjusted returns, riskless arbitrage, Robert Shiller, Robert Shiller, Sharpe ratio, short selling, source of truth, statistical model, stocks for the long run, systematic trading, the scientific method, transfer pricing, unbiased observer, yield curve, Yogi Berra

The failure of prices to respond rapidly is caused by a several cognitive errors that afflict investors, such as the conservatism bias and the anchoring effect. These are discussed later in this chapter. Another popular justification of TA is based on pop psychology. By pop psychology, I mean principles of human behavior that seem plausible but lack scientific support. According to noted economist and authority in the field of behavioral finance, Robert Shiller, “In considering lessons from psychology, it must be noted that the many popular accounts of the 334 METHODOLOGICAL, PSYCHOLOGICAL, PHILOSOPHICAL, STATISTICAL FOUNDATIONS psychology of investing are simply not credible. Investors are said to be euphoric or frenzied during booms or panic-stricken during market crashes. In both booms and crashes, investors are descried as blindly following the herd like so many sheep, with no minds of their own.”6 The fact is, people are more rational than these pop-psychology theories suggest.

However, information that diffuses slowly allows for gradual, systematic price movements that can be exploited by TA methods. Despite the prevalence of advanced communications technology, the preferred method of exchanging investment information is still a good story told person to person. This predilection, a result of several million years of evolution, has been confirmed by the studies of behavioral-economist Robert Shiller. He has shown that the word-of-mouth effect is strong even among people who read a lot. A story about a hot new issue has greater impact in conversation than a statistic about the high failure rate of new companies. The way stories spread among investors has been studied with mathematical models similar to those used by epidemiologists to study the spread of disease within a population. Unfortunately, these models have not been as accurate in the investor domain as they have been in the realm of biology.

Numerous instances of expert error are attributable to missing important details. However, before outcomes are known, we never know which details deserve our attention. Among the automatic unconscious rules used by the brain to filter relevant from irrelevant information is the rule to look to other people for cues. In other words, we presume that what grabs the attention of others must be worthy of our attention as well. According to economist Robert Shiller, “the phenomenon of social attention is one of the great creations of behavioral evolution and is critical for the functioning of human society.”79 Although communal attention has great social value, because it promotes collaborative action, it has a downside. It can lead an entire group to hold an incorrect view and take similar mistaken actions. In the opposite situation, where individuals form their own views independently, errors of attention would be random and self-canceling.


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Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets by Nassim Nicholas Taleb

Antoine Gombaud: Chevalier de Méré, availability heuristic, backtesting, Benoit Mandelbrot, Black Swan, commoditize, complexity theory, corporate governance, corporate raider, currency peg, Daniel Kahneman / Amos Tversky, discounted cash flows, diversified portfolio, endowment effect, equity premium, fixed income, global village, hedonic treadmill, hindsight bias, Kenneth Arrow, Long Term Capital Management, loss aversion, mandelbrot fractal, mental accounting, meta analysis, meta-analysis, Myron Scholes, Paul Samuelson, quantitative trading / quantitative finance, QWERTY keyboard, random walk, Richard Feynman, road to serfdom, Robert Shiller, Robert Shiller, selection bias, shareholder value, Sharpe ratio, Steven Pinker, stochastic process, survivorship bias, too big to fail, Turing test, Yogi Berra

There seems to be some evidence that conversations and correspondence with intelligent people is a better engine for personal edification than plain library-ratting (human warmth: Something in our nature may help us grow ideas while dealing and socializing with other people). Somehow there was the pre-and post-Fooled life. While the acknowledgments for the first edition hold more than ever, I would like to add here my newly incurred debt. Shrinking the World I first met Robert Shiller in person as we were seated next to each other at a breakfast panel discussion. I found myself inadvertently eating all the fruits on his plate and drinking his coffee and water, leaving him with the muffins and other unfashionable food (and nothing to drink). He did not complain (he may have not noticed). I did not know Shiller when I featured him in the first edition and was surprised by his accessibility, his humility, and his charm (by some heuristic one does not expect people who have vision to be also personable).

Listening to the media, mostly because I am not used to it, can cause me on occasion to jump out of my seat and become emotional in front of the moving image (I grew up with no television and was in my late twenties when I learned to operate a TV set). One illustration of a dangerous refusal to consider alternative histories is provided by the interview that media person George Will, a “commentator” of the extensively commenting variety, conducted with Professor Robert Shiller, a man known to the public for his bestselling book Irrational Exuberance, but known to the connoisseur for his remarkable insights about the structure of market randomness and volatility (expressed in the precision of mathematics). The interview is illustrative of the destructive aspect of the media, in catering to our heavily warped common sense and biases. I was told that George Will was very famous and extremely respected (that is, for a journalist).

This problem is similar to the weaknesses in our ability to correct for past errors: Like a health club membership taken out to satisfy a New Year’s resolution, people often think that it will surely be the next batch of news that will really make a difference to their understanding of things.) Shiller Redux Much of the thinking about the negative value of information on society in general was sparked by Robert Shiller. Not just in financial markets; but overall his 1981 paper may be the first mathematically formulated introspection on the manner in which society in general handles information. Shiller made his mark with his 1981 paper on the volatility of markets, where he determined that if a stock price is the estimated value of “something” (say the discounted cash flows from a corporation), then market prices are way too volatile in relation to tangible manifestations of that “something” (he used dividends as proxy).


pages: 353 words: 98,267

The Price of Everything: And the Hidden Logic of Value by Eduardo Porter

Alvin Roth, Asian financial crisis, Ayatollah Khomeini, banking crisis, barriers to entry, Berlin Wall, British Empire, capital controls, Carmen Reinhart, Cass Sunstein, clean water, Credit Default Swap, Deng Xiaoping, Edward Glaeser, European colonialism, Fall of the Berlin Wall, financial deregulation, Ford paid five dollars a day, full employment, George Akerlof, Gordon Gekko, guest worker program, happiness index / gross national happiness, housing crisis, illegal immigration, immigration reform, income inequality, income per capita, informal economy, Intergovernmental Panel on Climate Change (IPCC), invisible hand, Jean Tirole, John Maynard Keynes: technological unemployment, Joshua Gans and Andrew Leigh, Kenneth Rogoff, labor-force participation, laissez-faire capitalism, longitudinal study, loss aversion, low skilled workers, Martin Wolf, means of production, Menlo Park, Mexican peso crisis / tequila crisis, Monkeys Reject Unequal Pay, new economy, New Urbanism, peer-to-peer, pension reform, Peter Singer: altruism, pets.com, placebo effect, price discrimination, price stability, rent-seeking, Richard Thaler, rising living standards, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, Silicon Valley, stem cell, Steve Jobs, Stewart Brand, superstar cities, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, trade route, transatlantic slave trade, ultimatum game, unpaid internship, urban planning, Veblen good, women in the workforce, World Values Survey, Yom Kippur War, young professional, zero-sum game

The tally of countries that have escaped banking crises is by Carmen Reinhart and Kenneth Rogoff, “Banking Crises: An Equal Opportunity Menace,” NBER Working Paper, December 2008. 236-239 What Rationality?: Eugene Fama’s quote is in Douglas Clement, “Interview with Eugene Fama,” The Region, Federal Reserve Bank of Minnesota, December 2007. Keynes’s quote is in John Maynard Keynes, The General Theory of Employment, Interest and Money (New York: Harcourt Brace and World, 1965), p. 161. Robert Shiller’s theory is described in George Akerlof and Robert Shiller, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism (Princeton: Princeton University Press, 2010). 240-246 Economics for a New World: Limits to the assumption of human rationality and self-regard are discussed in Herbert Gintis, “Five Principles for the Unification of the Behavioral Sciences,” Working Paper, May 13, 2008.

A Cambridge don and Bloomsbury habitué, a British representative to the peace talks in Versailles, where he argued that imposing tough reparation payments on Germany after World War I would impoverish Germans and lead them to extremism, Keynes was also a savvy investor who made a lot of money in the market. His experience in finance informed his perception that most of the time investors don’t know what they are doing. Investment decisions, he thought, are the result of “animal spirits—of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.” Robert Shiller, an economist at Yale, has proposed a model based on Keynes’s insight. In it, rationality takes a hike: a plausible new economic opportunity—say the Internet or new trade routes across the Atlantic—leads early investors to make a lot of money. This generates enthusiasm. The prices of the hot new asset—dot-com stocks, shares in shipping companies, whatever—are bid up as investors rush to partake of the profits.


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A Failure of Capitalism: The Crisis of '08 and the Descent Into Depression by Richard A. Posner

Andrei Shleifer, banking crisis, Bernie Madoff, business cycle, collateralized debt obligation, collective bargaining, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, diversified portfolio, equity premium, financial deregulation, financial intermediation, Home mortgage interest deduction, illegal immigration, laissez-faire capitalism, Long Term Capital Management, market bubble, money market fund, moral hazard, mortgage debt, Myron Scholes, oil shock, Ponzi scheme, price stability, profit maximization, race to the bottom, reserve currency, risk tolerance, risk/return, Robert Shiller, Robert Shiller, savings glut, shareholder value, short selling, statistical model, too big to fail, transaction costs, very high income

Had the mistakes that brought down the banking industry been readily avoidable, they would have been avoided. There were plenty of warnings of a housing bubble, beginning in 2003; warnings about excessive leverage in financial firms; and even rather precise predictions of the debacle that has ensued, as in "When Bubbles Burst," an eerily prescient paper by Thomas Helbling and Marco Terrones published in October 2003. Robert Shiller wrote a similar paper in April of the following year, as did another economist, Avinash Persaud, the same month. The Economist magazine spotted the housing bubble in September 2002 and soon became obsessed with it and its possible broader implications for the financial system and the U.S. economy as a whole; in an article published on July 3, 2004, we read: "Housing optimists dismiss these fears by pointing out that doomsters such as The Economist began wringing their hands about a property bubble a year ago, and yet prices have continued to climb.

A restructuring of the immensely complex financial sector should await, if not the end of the depression, at least the beginning of the end. 8 The Economics Profession Asleep at the Switch One Of The biggest Puzzles about the failure to anticipate the financial crisis is the lack of foresight of so many academic economists. There were exceptions; Nouriel Roubini was only the most emphatic of the Cassandras. Raghuram Rajan issued strong warnings in 2005, Paul Krugman in the summer of 2007, Martin Feldstein that fall. I mentioned Robert Shiller. The collapse of Bear Stearns in March 2008 elicited warnings from other economists, such as Alan Blinder and Lawrence Summers —the latter of whom, however, had sarcastically dismissed Rajan's warnings three years earlier as "leaden-eyed." But as far as I know, only Roubini among prominent academic economists forecast an actual depression. Warnings about recession do not attract much attention, and perhaps should not.

Parker, The Economics of the Great De- pression: A Twenty-First Century Inok Back at the Economics of the Interwar Era (2007). Lubos Pastor and Pietro Veronesi, "Was There a NASDAQ Bubble in the Late 1990s?" journal of Financial Economics 81 (2006): 61. Raghuram G. Rajan, "Has Financial Development Made the World Riskier?" in The Greenspan Era: Lessons for the Future: A Symposium Spon- sored hy the Federal Reserve Bank of Kansas City (2005), 213. Robert J. Shiller, The Suhprime Solution: How To- day's Financial Crisis Happened, and What to Do about It (2008). Andrei Shleifer, Inefficient Markets: An Introduction to Behavioral Finance (2000). Mark Zandi, Financial Shock: A 5600 hmk at the Suhprime Mortgage Implosion, and How to Avoid the Next Financial Crisis (2008). Luigi Zingales, "The Future of Securities Regula- tion" (University of Chicago, Booth Graduate School of Business, Dec. 2008).


pages: 309 words: 78,361

Plenitude: The New Economics of True Wealth by Juliet B. Schor

Asian financial crisis, big-box store, business climate, business cycle, carbon footprint, cleantech, Community Supported Agriculture, creative destruction, credit crunch, Daniel Kahneman / Amos Tversky, decarbonisation, dematerialisation, demographic transition, deskilling, Edward Glaeser, en.wikipedia.org, Gini coefficient, global village, IKEA effect, income inequality, income per capita, Intergovernmental Panel on Climate Change (IPCC), Isaac Newton, Joseph Schumpeter, Kenneth Arrow, knowledge economy, life extension, McMansion, new economy, peak oil, pink-collar, post-industrial society, prediction markets, purchasing power parity, ride hailing / ride sharing, Robert Shiller, Robert Shiller, sharing economy, Simon Kuznets, single-payer health, smart grid, The Chicago School, Thomas L Friedman, Thomas Malthus, too big to fail, transaction costs, Zipcar

Among the public, there has been tremendous interest in how economists think, with Paul Krugman’s hugely popular writing, bestsellers such as Freakonomics, and ongoing columns, such as David Leonhardt’s for the New York Times, devoted to the profession. But, with some notable exceptions, economists failed to see the financial, housing, and economic crises coming. Princeton’s Uwe Reinhardt noted that they “slept comfortably” while Wall Street imploded. Yale’s Robert Shiller has invoked the concept of “groupthink” to explain why. Whatever the reason, what occurred in 2007 and 2008 was a monumental blunder. We can’t afford a repeat when it comes to the health of the planet. And we don’t have to. What’s odd about the narrowness of the national economic conversation is that it leaves out theoretical advances in economics and related fields that have begun to change our basic understandings of what motivates and enriches people.

For a popular account of anthropogenic mass extinction, see Kolbert (2009). 9 oceans will be devoid of fish: Jackson (2008). 9 primary source of animal protein for a billion people: Tidwell and Allan (2001). 9 not to say that economists were intellectually stuck: The postcrash reaction of professional economists is discussed by Cohen (2009). 10 A declining fraction of the population considered appliances: Morin and Taylor (2009). 10 “goodbye homo economicus”: Context-Based Research Group and Carton Donofrio Partners (2008). 10 Surveys I worked on as early as 2004: Widmeyer Research and Polling (2004). 10 some notable exceptions: Examples of those who did see the crisis coming are Paul Krugman of Princeton, Nouriel Roubini of New York University, Robert Shiller of Yale, Jane D’Arista of the Financial Markets Center, and James Crotty and Gerald Epstein of the University of Massachusetts. 10 “slept comfortably”: Uwe Reinhardt (2009). 10 “groupthink”: Shiller (2008). In response to a query from Queen Elizabeth about why economists failed to see what was happening, a group of U.K. economists attributed the failure to the “feel-good” factor and a failure of the “collective imagination.”


No Slack: The Financial Lives of Low-Income Americans by Michael S. Barr

active measures, asset allocation, Bayesian statistics, business cycle, Cass Sunstein, conceptual framework, Daniel Kahneman / Amos Tversky, financial exclusion, financial innovation, Home mortgage interest deduction, income inequality, information asymmetry, labor-force participation, late fees, London Interbank Offered Rate, loss aversion, market friction, mental accounting, Milgram experiment, mobile money, money market fund, mortgage debt, mortgage tax deduction, New Urbanism, p-value, payday loans, race to the bottom, regulatory arbitrage, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, the payments system, transaction costs, unbanked and underbanked, underbanked

his career to finding it.” k SHEILA BAIR, former chair of the Federal Deposit Insurance Corporation “It is inspiring to see such a thoughtful analysis of the deep financial problems that make life miserable for so many people, and to see that many of these problems can be solved with suitable behaviorally informed financial innovations. Barr faces the real subtlety and complexity of the problems that leave so many people with no slack.” k ROBERT SHILLER, Arthur M. Okun Professor of Economics, Yale University “In many respects the American economy is too financialized. But as Michael Barr highlights in this important book, millions lack access to basic financial services and protections. Barr draws on his unmatched combination of academic expertise and policy experience to define the challenge and suggest ways to meet it. This book deserves to be an important part of any discussion of the future of the financial sector or the prospects for low-income Americans.” k LAWRENCE H.

his career to finding it.” k SHEILA BAIR, former chair of the Federal Deposit Insurance Corporation “It is inspiring to see such a thoughtful analysis of the deep financial problems that make life miserable for so many people, and to see that many of these problems can be solved with suitable behaviorally informed financial innovations. Barr faces the real subtlety and complexity of the problems that leave so many people with no slack.” k ROBERT SHILLER, Arthur M. Okun Professor of Economics, Yale University “In many respects the American economy is too financialized. But as Michael Barr highlights in this important book, millions lack access to basic financial services and protections. Barr draws on his unmatched combination of academic expertise and policy experience to define the challenge and suggest ways to meet it. This book deserves to be an important part of any discussion of the future of the financial sector or the prospects for low-income Americans.” k LAWRENCE H.

his career to finding it.” k SHEILA BAIR, former chair of the Federal Deposit Insurance Corporation “It is inspiring to see such a thoughtful analysis of the deep financial problems that make life miserable for so many people, and to see that many of these problems can be solved with suitable behaviorally informed financial innovations. Barr faces the real subtlety and complexity of the problems that leave so many people with no slack.” k ROBERT SHILLER, Arthur M. Okun Professor of Economics, Yale University “In many respects the American economy is too financialized. But as Michael Barr highlights in this important book, millions lack access to basic financial services and protections. Barr draws on his unmatched combination of academic expertise and policy experience to define the challenge and suggest ways to meet it. This book deserves to be an important part of any discussion of the future of the financial sector or the prospects for low-income Americans.” k LAWRENCE H.


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Radical Uncertainty: Decision-Making for an Unknowable Future by Mervyn King, John Kay

"Robert Solow", Airbus A320, Albert Einstein, Albert Michelson, algorithmic trading, Antoine Gombaud: Chevalier de Méré, Arthur Eddington, autonomous vehicles, availability heuristic, banking crisis, Barry Marshall: ulcers, battle of ideas, Benoit Mandelbrot, bitcoin, Black Swan, Bonfire of the Vanities, Brownian motion, business cycle, business process, capital asset pricing model, central bank independence, collapse of Lehman Brothers, correlation does not imply causation, credit crunch, cryptocurrency, cuban missile crisis, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, demographic transition, discounted cash flows, disruptive innovation, diversification, diversified portfolio, Donald Trump, easy for humans, difficult for computers, Edmond Halley, Edward Lloyd's coffeehouse, Edward Thorp, Elon Musk, Ethereum, Eugene Fama: efficient market hypothesis, experimental economics, experimental subject, fear of failure, feminist movement, financial deregulation, George Akerlof, germ theory of disease, Hans Rosling, Ignaz Semmelweis: hand washing, income per capita, incomplete markets, inflation targeting, information asymmetry, invention of the wheel, invisible hand, Jeff Bezos, Johannes Kepler, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Snow's cholera map, John von Neumann, Kenneth Arrow, Long Term Capital Management, loss aversion, Louis Pasteur, mandelbrot fractal, market bubble, market fundamentalism, Moneyball by Michael Lewis explains big data, Nash equilibrium, Nate Silver, new economy, Nick Leeson, Northern Rock, oil shock, Paul Samuelson, peak oil, Peter Thiel, Philip Mirowski, Pierre-Simon Laplace, popular electronics, price mechanism, probability theory / Blaise Pascal / Pierre de Fermat, quantitative trading / quantitative finance, railway mania, RAND corporation, rent-seeking, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Coase, sealed-bid auction, shareholder value, Silicon Valley, Simon Kuznets, Socratic dialogue, South Sea Bubble, spectrum auction, Steve Ballmer, Steve Jobs, Steve Wozniak, Tacoma Narrows Bridge, Thales and the olive presses, Thales of Miletus, The Chicago School, the map is not the territory, The Market for Lemons, The Nature of the Firm, The Signal and the Noise by Nate Silver, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Bayes, Thomas Davenport, Thomas Malthus, Toyota Production System, transaction costs, ultimatum game, urban planning, value at risk, World Values Survey, Yom Kippur War, zero-sum game

The role of the economist in an investment bank is to provide stories with which salesmen can regale their clients, and with which clients can be entertained over lunch. In the worst, but not uncommon, excesses of the use of narratives in finance, traders propagate false narratives in schemes such as ‘Dr Evil’ and ‘Darth Vader’ with the aim of disrupting bona fide transactions in bonds and electricity to their advantage. Narratives, true and false, play a central role in financial markets. The American economist Robert Shiller has recently documented the importance and contagious nature of narratives in financial markets, and Tuckett’s ‘conviction narrative’ account of the behaviour of traders is based on extensive interview material. 27 Narratives in finance and business may be true or false, damaging or benign, but are rarely innocuous. The false beliefs that thunder had a supernatural explanation and that the solar system revolved around the Earth did not affect stock prices, or have much effect on any other economic phenomena.

But Tucker was not talking about the US criminal justice system, nor Akerlof impugning the integrity of members of the Retail Motor Federation. And no information about the production costs of textile mills refutes Ricardo’s exposition of the principle of comparative advantage. The efficient market hypothesis is one of the most controversial models in economics – so controversial that in 2013 Eugene Fama, who developed the model, shared the Nobel Prize with Robert Shiller, who has worked to refute it. The essential insight is that publicly available information is incorporated in securities prices. The explanation of the seemingly contradictory accolades – it is hard to believe that a similar award would be made in the natural sciences – is that it is a mistake either to believe that the hypothesis is true or to assert that it is false. Most public information is incorporated in securities prices, but not always or perfectly, and that latter fact makes it possible to design successful investment strategies.

We have made suggestions for such reforms in our own earlier writings. The more regulators attempt to define precise, detailed rules, which confuse more than clarify, the more likely is a counter-productive outcome. If only someone would stand back and ask ‘What is going on here?’ rather than tweak processes which have acquired their own seemingly irresistible momentum! More narratives of finance In chapter 12 we described how Robert Shiller has argued that swings in sentiment are important in understanding why large and disruptive changes in economic behaviour occur – whether stock market bubbles and crashes or sharp collapses in output during a depression. 11 But Shiller’s focus on narratives is rather one-sided. He uses the concept to explain behaviour which others have called ‘fads and fashions’. In other words, he sees narratives as a departure from ‘rational’ optimising behaviour and therefore as irrational and emotional, despite their importance in explaining behaviour.


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Fault Lines: How Hidden Fractures Still Threaten the World Economy by Raghuram Rajan

accounting loophole / creative accounting, Andrei Shleifer, Asian financial crisis, asset-backed security, assortative mating, bank run, barriers to entry, Bernie Madoff, Bretton Woods, business climate, business cycle, Clayton Christensen, clean water, collapse of Lehman Brothers, collateralized debt obligation, colonial rule, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, diversification, Edward Glaeser, financial innovation, fixed income, floating exchange rates, full employment, global supply chain, Goldman Sachs: Vampire Squid, illegal immigration, implied volatility, income inequality, index fund, interest rate swap, Joseph Schumpeter, Kenneth Rogoff, knowledge worker, labor-force participation, Long Term Capital Management, longitudinal study, market bubble, Martin Wolf, medical malpractice, microcredit, money market fund, moral hazard, new economy, Northern Rock, offshore financial centre, open economy, price stability, profit motive, Real Time Gross Settlement, Richard Florida, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, school vouchers, short selling, sovereign wealth fund, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, upwardly mobile, Vanguard fund, women in the workforce, World Values Survey

Some in the economics community wrote articles or convened conferences to examine how they could have gotten it so wrong; others engaged in a full-throated defense of their profession.1 For many who were hostile to the fundamental assumptions of mainstream economics, the crisis was proof that they had been right all along: the emperor was finally shown to have no clothes. Public confidence in authority was badly shaken. Of course, it is incorrect to say that no one saw this crisis coming. Some hedge fund managers and traders in investment banks put their money instead of their mouths to work. A few government and Federal Reserve officials expressed deep concern. A number of economists, such as Kenneth Rogoff, Nouriel Roubini, Robert Shiller, and William White, repeatedly sounded warnings about the levels of U.S. house prices and household indebtedness. Niall Ferguson, a historian, drew parallels to past booms that ended poorly. The problem was not that no one warned about the dangers; it was that those who benefited from an overheated economy—which included a lot of people—had little incentive to listen. Critics were often written off as Cassandras or “permabears”: predict a downturn long enough, the thinking went, and you would eventually be proved right, much as a broken clock is correct twice a day.

A number of financial innovations that would allow households to purchase insurance against home-price declines have been proposed, and in light of the recent crisis, demand for these instruments may increase.33 This is also a reason why the government’s focus on encouraging home ownership needs to be revisited. Although the modern economy needs some workers to specialize, workers like Badri, encountered in chapter 4, may tend to grow overly specialized in one industry. Robert Shiller of Yale University has argued for “livelihood” insurance—insurance that would protect workers against a decline in incomes or jobs in their particular areas of specialization. In a sense, long-term unemployment insurance is a form of livelihood insurance provided by society. The downside of such insurance is that it reduces worker incentives to keep their human capital relevant. Having an unproductive underclass that lives off their insurance payments is better than having a destitute underclass, but it is best if such payments simply help sustain them while they retool to become productive members of society again.

Fisher, and Amitabh Chandra, “Malpractice Liability Costs and the Practice of Medicine in the Medicare Program,” Health Affairs 26, no. 3 (May–June 2007): 841–52. 32 For the highly paid workers in the financial sector, I argue that having a stake in the firm can improve incentives. However, some reasonable portion of their savings should be independent of the health of their firms. 33 See, for instance, Robert Shiller, The New Financial Order (Princeton, NJ: Princeton University Press, 2003), 118–19. 34 The next few paragraphs draw on my previous book with Luigi Zingales, Saving Capitalism from the Capitalists (Princeton, NJ: Princeton University Press, 2004). 35 Shlomo Benartzi and Richard Thaler, “Save More Tomorrow: Using Behavioral Economics to Increase Employee Savings,” unpublished manuscript, University of Chicago.


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After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead by Alan S. Blinder

"Robert Solow", Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, banks create money, break the buck, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, conceptual framework, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Detroit bankruptcy, diversification, double entry bookkeeping, eurozone crisis, facts on the ground, financial innovation, fixed income, friendly fire, full employment, hiring and firing, housing crisis, Hyman Minsky, illegal immigration, inflation targeting, interest rate swap, Isaac Newton, Kenneth Rogoff, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, market bubble, market clearing, market fundamentalism, McMansion, money market fund, moral hazard, naked short selling, new economy, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, price mechanism, quantitative easing, Ralph Waldo Emerson, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, statistical model, the payments system, time value of money, too big to fail, working-age population, yield curve, Yogi Berra

In fact, spending on residential construction started to decline well before house prices topped out. Sounds surprising but it’s true. The data on housing show clearly that homebuilding peaked in 2005. Home prices tell a messier story, however: They peaked either in 2006 or in 2007, depending on what measure you use. Two major competing indexes of national average house prices are shown in figure 1.4. The upper line plots a celebrated index devised by Charles “Chip” Case of Wellesley and Robert Shiller of Yale, and now maintained commercially by Standard & Poor’s. The lower line plots an index maintained by the government—specifically, by the Federal Housing Finance Agency (FHFA), which is the regulator of Fannie Mae and Freddie Mac. You can see that they tell rather different stories. FIGURE 1.4 Take Your Pick Two indexes of national average house prices, 2000–2010 According to the Case-Shiller index, home prices peaked in May 2006, but the FHFA index dates the peak a year later.

Remember how the Internet was going to create a whole New Economy with different rules that made eyeballs more important than profits? It didn’t. The Housing Bubble All that said, there can be little doubt that the United States experienced a pretty gigantic housing bubble that blew up and then burst with disastrous consequences in, roughly, the years 2000–2009. Let’s look at some of the evidence, starting with the remarkable figure 2.1, which is due to the efforts of Robert Shiller, perhaps our nation’s most perspicacious chronicler of the housing bubble. Notice two things about this graph. First, the data go all the way back to 1890—over 120 years! That should be long enough to give us historical perspective. Second, the graph plots real house prices—that is, house prices deflated by the Consumer Price Index (CPI). In plain English, what we see here is the history of house prices relative to the prices of other things that consumers buy.

That is why, for example, you don’t see price declines during the Great Depression. House prices did fall quite a bit then, but so did other prices. Ranges in which the graph is relatively flat—such as the half century from the late 1940s to the late 1990s—connote periods when house prices moved more or less in tandem with other prices. FIGURE 2.1 Real House Prices: The Long View (index, 1890 = 100) SOURCE: Robert Shiller and author's calculations. Now compare the value of the index in 1890 with its value in the 1990s. The two look about the same. Specifically, the index, which is constructed to start at 100 in 1890, averages about 110 in the years 1995–1997. That historical comparison reveals a stunning—and virtually unknown—fact: On balance, the relative prices of houses in America barely changed over more than a century!


pages: 1,373 words: 300,577

The Quest: Energy, Security, and the Remaking of the Modern World by Daniel Yergin

"Robert Solow", addicted to oil, Albert Einstein, Asian financial crisis, Ayatollah Khomeini, banking crisis, Berlin Wall, bioinformatics, borderless world, BRICs, business climate, carbon footprint, Carmen Reinhart, cleantech, Climategate, Climatic Research Unit, colonial rule, Colonization of Mars, corporate governance, cuban missile crisis, data acquisition, decarbonisation, Deng Xiaoping, Dissolution of the Soviet Union, diversification, diversified portfolio, Elon Musk, energy security, energy transition, Exxon Valdez, facts on the ground, Fall of the Berlin Wall, fear of failure, financial innovation, flex fuel, global supply chain, global village, high net worth, hydraulic fracturing, income inequality, index fund, informal economy, interchangeable parts, Intergovernmental Panel on Climate Change (IPCC), James Watt: steam engine, John von Neumann, Kenneth Rogoff, life extension, Long Term Capital Management, Malacca Straits, market design, means of production, megacity, Menlo Park, Mikhail Gorbachev, Mohammed Bouazizi, mutually assured destruction, new economy, Norman Macrae, North Sea oil, nuclear winter, off grid, oil rush, oil shale / tar sands, oil shock, Paul Samuelson, peak oil, Piper Alpha, price mechanism, purchasing power parity, rent-seeking, rising living standards, Robert Metcalfe, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, Sand Hill Road, shareholder value, Silicon Valley, Silicon Valley startup, smart grid, smart meter, South China Sea, sovereign wealth fund, special economic zone, Stuxnet, technology bubble, the built environment, The Nature of the Firm, the new new thing, trade route, transaction costs, unemployed young men, University of East Anglia, uranium enrichment, William Langewiesche, Yom Kippur War

Senate Subcommittee on Energy and Water Development, June 25, 2008; Wall Street Journal, April 26, 2004 (“guidelines,” “curious,” “skeptically”). 4 IHS CERA, “Capital Costs Analysis Forum—Upstream,” January 2009. 5 Ke Tang and Wei Xiong , “Index Investment and the Financialization of Commodities” January 2011, p. 13 (“co-move”). 6 Daniel O’Sullivan, Black Gold, Paper Barrels and Oil Price Barrels (London: Harriman House, 2009). 7 Joe Roeber, The Evolution of Oil Markets: Trading Instruments and Their Role in Oil Price Formation (Royal Institute of International Affairs, 1993). 8 CME Group, “2010 Commodities Trading Challenge: Competition Rules and Procedures” (“anticipating”). 9 Interview. 10 Jim O’Neill to author; Jim O’Neill, “Building Better Global Economic BRICs, Goldman Sachs Global Economics Paper No. 66, November 30, 2001; Financial Times, January 15, 2010. 11 Interview with Mark Fisher. 12 Interview with Robert Shiller. Shiller’s definition of a speculative bubble: “A situation in which news of price increases spur investor enthusiasm, which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increases and bringing in a larger and larger class of investors, who, despite doubts about the real value of an investment, are drawn to it partly through envy of others’ successes and partly through a gambler’s excitement.” In the case of oil, hower, it would seem that many of the investors had deep convictions but few doubts about what they took to be the “real”—or future—value of petroleum. See Robert Shiller, Irrational Exuberance, 2nd ed. (New York: Broadway Books, 2005), p. 2. 13 Peter Jackson and Keith Eastwood, “Finding the Critical Numbers: What Are the Real Decline Rates of Global Oil Production?

It was also possible to do much larger deals without calling attention to oneself and thus prematurely forcing the price up or down, depending on the nature of the hedge. Overall, more and more money was coming into the oil market, through all the different kinds of funds and financial instruments. All this engendered increased activity, and more and more “investor excitement,” to borrow a phrase from Professor Robert Shiller, the student of financial bubbles and the explicator of the term “irrational exuberance.” Traders saw momentum in the market, which meant rising prices, and as they put money to work and prices went up, it added to the momentum, providing yet more reason to put more money to work, further fueling the momentum. And so prices kept going up. THE BELIEF SYSTEM There was method in all this momentum, a well-articulated belief system that explained rising prices.

On the basis of the transaction’s success, Mexico’s finance minister received a unique honor—he was dubbed the “world’s most successful, but worst paid, oil manager.”28 How much of what happened in the oil market can be ascribed to the fundamentals, to what was happening in the physical market, and how much to financialization and what was happening in the financial markets? In truth, there is no sharp dividing line. Price is shaped by what happens both in the physical and financial markets.29 A couple of years later, Robert Shiller, who had become prominent for calling the Internet stock bubble and then the real estate bubble, was having breakfast in the restaurant of the Study, a new hotel on Chapel Street in New Haven, before walking over to lecture in his famous Yale class on financial markets. By then, with recovery well along in the global economy, the price of oil had more than doubled from its lows back to a range of $70 to $80 a barrel.


Infotopia: How Many Minds Produce Knowledge by Cass R. Sunstein

affirmative action, Andrei Shleifer, availability heuristic, Build a better mousetrap, c2.com, Cass Sunstein, cognitive bias, cuban missile crisis, Daniel Kahneman / Amos Tversky, Edward Glaeser, en.wikipedia.org, feminist movement, framing effect, hindsight bias, information asymmetry, Isaac Newton, Jean Tirole, jimmy wales, market bubble, market design, minimum wage unemployment, prediction markets, profit motive, rent control, Richard Stallman, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, slashdot, stem cell, The Wisdom of Crowds, winner-take-all economy

If the prices of some stocks are extremely low and about to rise, leaving neglected investment opportunities, then many minds aren’t doing so well. 128 / Infotopia So, too, if the prices of some stocks are extremely high and about to fall, ensuring that many minds are losing a lot of money. Is it possible for stocks to be significantly overvalued or undervalued? Many specialists think so. Robert Shiller argues that the increase in the stock market from 1994 to 2000 was not justified “in any reasonable terms. Basic economic indicators did not come close to tripling,” even though stock prices did. In that period, the ratio between stock prices and stock earnings was extreme by historical standards, with prices wildly inflated as compared to an objective measure of the profit-making ability of corporations.50 On this view, many minds were prone to error, leading to overvaluation.

., Drug War Heresies: Learning from Other Vices, Times, and Places (New York: Cambridge University Press, 2001). 46. The Federalist No. 14 (James Madison). 47. For a good overview, see Andrei Shleifer, Inefficient Markets: An Introduction to Behavioral Finance (Oxford: Oxford University Press, 2000). 48. See Richard Thaler, ed., Advances in Behavioral Finance, vol. 2 (Princeton, NJ: Princeton University Press, 2005). 49. In fact, some rigorous tests have raised doubts about it. See ibid. 50. Robert Shiller, Irrational Exuberance, 2d ed. (Princeton, NJ: Princeton University Press, 2005), 2, 5. 51. Ibid., 11. 52. See Erica Klarreich, “Best Guess,” Science News, Oct. 18, 2003, 252, available at http://www.sciencenews.org/articles/20031018/ bob9.asp. Notes to Pages 119–30 / 249 53. Note, however, that Hewlett Packard produced good predictions even in a thin market. Chen and Plott, Information Aggregation Mechanisms, 5, 12. 54.


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The End of the Suburbs: Where the American Dream Is Moving by Leigh Gallagher

Airbnb, big-box store, Burning Man, call centre, car-free, Celebration, Florida, clean water, collaborative consumption, Columbine, commoditize, crack epidemic, East Village, edge city, Edward Glaeser, extreme commuting, helicopter parent, Home mortgage interest deduction, housing crisis, Jane Jacobs, Kickstarter, low skilled workers, Mark Zuckerberg, McMansion, Menlo Park, mortgage tax deduction, negative equity, New Urbanism, peak oil, Peter Calthorpe, Ponzi scheme, Richard Florida, Robert Shiller, Robert Shiller, Sand Hill Road, Seaside, Florida, Silicon Valley, Steve Jobs, Stewart Brand, the built environment, The Death and Life of Great American Cities, Tony Hsieh, transit-oriented development, upwardly mobile, urban planning, urban sprawl, Victor Gruen, walkable city, white flight, white picket fence, young professional, Zipcar

But when the people who have delivered the same kind of one-size-fits-all suburban subdivisions over the past few decades are tearing up their blueprints, venturing gingerly into urban markets, and actually fainting at the thought of what the future holds, something big is afoot. The reliable expansion of our suburbs, the steady growth of the housing industry, and the seemingly unending supply of new single-family homes—and home owners—that we became used to over the past several decades may well be a thing of the past. Robert Shiller, a Yale University economist, founder of the Case-Shiller Home Price Indices, and the forecaster who predicted both the dot-com and housing bubbles, has said we may be in for a new normal. According to Shiller, U.S. suburban development since the 1950s was “unusual” in its reliance on the automobile and the highway system; the bursting of the bubble may result in a bigger, more structural change.

Meanwhile, a cache: Edward Glaeser, Triumph of the City: How Our Greatest Invention Makes Us Richer, Smarter, Greener, Healthier, and Happier (Penguin Press, 2011); Hope Yen, “Census Finds Record Low Growth in Outlying Suburbs,” Associated Press, April 5, 2012; Hope Yen and Kristen Wyatt, “Big Cities Boom as Young Adults Shun Suburbs,” Associated Press, June 28, 2012. in 2011, for the first time in a hundred years: U.S. Census Bureau, “Texas Dominates List of Fastest-Growing Large Cities Since 2010 Census, Census Bureau Reports,” June 28, 2012. Construction permit data shows: Residential Construction Trends in America’s Metropolitan Regions, 2010 ed., Development, Community and Environment Division, U.S. Environmental Protection Agency. Robert Shiller: Yen, “Census Finds Record Low Growth in Outlying Suburbs.” On March 27, 2012, in an interview with Yahoo! Finance’s Aaron Task, Shiller also suggested that dispersed single-family homes are not adequately built for management as rentals, and “that’s one reason why dispersed suburban housing may not do well in decades to come.” There are roughly 132 million: U.S. Census Bureau, 2011 American Housing Survey.


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Rebel Cities: From the Right to the City to the Urban Revolution by David Harvey

Bretton Woods, business cycle, collateralized debt obligation, commoditize, creative destruction, David Graeber, deindustrialization, financial innovation, Guggenheim Bilbao, Hernando de Soto, housing crisis, illegal immigration, indoor plumbing, invisible hand, Jane Jacobs, late capitalism, Long Term Capital Management, market bubble, market fundamentalism, means of production, moral hazard, mortgage debt, mortgage tax deduction, New Urbanism, Ponzi scheme, precariat, profit maximization, race to the bottom, Robert Shiller, Robert Shiller, special economic zone, the built environment, the High Line, The Wealth of Nations by Adam Smith, transcontinental railway, urban planning, We are the 99%, William Langewiesche, Works Progress Administration

That collective right, as b oth a working slogan and a political ideal, brings us back to the age- old question of who it is that commands th e inner connection between urb an ization and surplus produc tion and use. Perhaps, after all, L efebvre was right, more than forty years ago, to insist that the revolution in our times has to be urban-or nothing. C HAPT E R TWO T h e U rba n Roots of Ca p ita l i st C ri ses I "Housing Bubbles Are Few and Far B e tween ;' Robert Shiller, the econo­ n an article in the New York Times o n February 5 , 2 0 1 1 , entitled mist who many consider the great housing expert in the US, given his role in the construction of the Case-Shiller index o f housing prices, reas­ sured everyone that the recent housing bubble was a "rare event, not to be repeated for many decades:' The "enormous housing b ubble" of the early 2000s "isn't comparable to any national or international housing cycle in history.

Ananya Roy, Poverty Capital: Microfinance and the Making ofDevelopment, New York: Routledge, 20 1 0; C.K. Prahalad, The Fortu ne at the Bottom of the Pyram id: Eradicating Poverty Through Profits, New York: Pearson Prentice Hall, 2009. 2 1 . Scott Larson, "Building Like Moses with Jane Jacobs in Mind;' PhD dis­ sertation, Earth and Environmental Sciences Program, City University of New York, 20 1 0 . C HA PT E R TWO : T H E U R BA N ROOTS OF CA PITALI ST C R I S ES 1 . Robert Shiller, "Housing Bubbles are Few and Far Between;' New York Times, February 5, 20 1 1 . 2 . "It is indeed shocking;' writes Charles Leung, i n "Macroeconomics and Housing: A Review of the Literature;' Journal of Housing Econom ics 1 3 (2004): 249-67, "that there has been so little overlap and i nteraction between the macroeconomics and the housing literature:' 3. World Development Report 2009: Reshaping Economic Geography, Washington, DC: World Bank, 2009; David Harvey, ''Assessment: Reshaping Economic Geography: The World Development Report;' Development and Change Forum 2009, 40: 6 (2009): 1 ,269-78. 4.


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A Pelican Introduction Economics: A User's Guide by Ha-Joon Chang

Affordable Care Act / Obamacare, Albert Einstein, Asian financial crisis, asset-backed security, bank run, banking crisis, banks create money, Berlin Wall, bilateral investment treaty, borderless world, Bretton Woods, British Empire, call centre, capital controls, central bank independence, collateralized debt obligation, colonial rule, Corn Laws, corporate governance, corporate raider, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, deindustrialization, discovery of the americas, Eugene Fama: efficient market hypothesis, eurozone crisis, experimental economics, Fall of the Berlin Wall, falling living standards, financial deregulation, financial innovation, Francis Fukuyama: the end of history, Frederick Winslow Taylor, full employment, George Akerlof, Gini coefficient, global value chain, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, Gunnar Myrdal, Haber-Bosch Process, happiness index / gross national happiness, high net worth, income inequality, income per capita, information asymmetry, intangible asset, interchangeable parts, interest rate swap, inventory management, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, knowledge economy, laissez-faire capitalism, land reform, liberation theology, manufacturing employment, Mark Zuckerberg, market clearing, market fundamentalism, Martin Wolf, means of production, Mexican peso crisis / tequila crisis, Nelson Mandela, Northern Rock, obamacare, offshore financial centre, oil shock, open borders, Pareto efficiency, Paul Samuelson, post-industrial society, precariat, principal–agent problem, profit maximization, profit motive, purchasing power parity, quantitative easing, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, savings glut, Scramble for Africa, shareholder value, Silicon Valley, Simon Kuznets, sovereign wealth fund, spinning jenny, structural adjustment programs, The Great Moderation, The Market for Lemons, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, trade liberalization, transaction costs, transfer pricing, trickle-down economics, Vilfredo Pareto, Washington Consensus, working-age population, World Values Survey

Please give it a try. Notes PROLOGUE: WHY BOTHER?: WHY DO YOU NEED TO LEARN ECONOMICS? 1. These are the first sentences of his article ‘The macroeconomist as scientist and engineer’, Journal of Economic Perspectives, vol. 20, no. 4 (2006). 2. For a similar view, see the article, ‘Is economics a science?’ by Robert Shiller, one of the 2013 Nobel Economics laureates. The article can be downloaded at: http://www.theguardian.com/business/economics-blog/2013/nov/06/is-economics-a-science-robert-shiller. CHAPTER 1: LIFE, THE UNIVERSE AND EVERYTHING: WHAT IS ECONOMICS? 1. R. Lucas, ‘Macroeconomic priorities’, American Economic Review, vol. 93, no. 1 (2003). This was his presidential address to the American Economic Association. 2. This is brilliantly explained by Felix Martin in his book Money: The Unauthorised Biography (London: The Bodley Head, 2013). 3.

* The fact that Walmart, the biggest private sector employer in the US, employs only about 1 per cent of the US labour force (1.4 million people) puts the number in perspective. * The most important regional multilateral banks are the Asian Development Bank (ADB), the African Development Bank (AfDB) and the Inter-American Development Bank (IDB). * There is a huge amount of evidence, well presented in accessible form in books like Peter Ubel’s Free Market Madness, George Akerlof’s and Robert Shiller’s Animal Spirits and the psychologist and 2002 Nobel Economics laureate Daniel Kahnemann’s Thinking, Fast and Slow. * A very rough but useful rule of thumb is that the value-added figure is usually around one-third of sales (turnover) figure of a company. * What really represents a nation’s productivity is how much people have to work in order to produce a given amount of output, rather than what the output is for each person alive.


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Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present by Jeff Madrick

accounting loophole / creative accounting, Asian financial crisis, bank run, Bretton Woods, business cycle, capital controls, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, desegregation, disintermediation, diversified portfolio, Donald Trump, financial deregulation, fixed income, floating exchange rates, Frederick Winslow Taylor, full employment, George Akerlof, Hyman Minsky, income inequality, index fund, inflation targeting, inventory management, invisible hand, John Meriwether, Kitchen Debate, laissez-faire capitalism, locking in a profit, Long Term Capital Management, market bubble, minimum wage unemployment, MITM: man-in-the-middle, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Myron Scholes, new economy, North Sea oil, Northern Rock, oil shock, Paul Samuelson, Philip Mirowski, price stability, quantitative easing, Ralph Nader, rent control, road to serfdom, Robert Bork, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, Ronald Reagan: Tear down this wall, shareholder value, short selling, Silicon Valley, Simon Kuznets, technology bubble, Telecommunications Act of 1996, The Chicago School, The Great Moderation, too big to fail, union organizing, V2 rocket, value at risk, Vanguard fund, War on Poverty, Washington Consensus, Y2K, Yom Kippur War

Earlier that year, in his January State of the Union address, Clinton had announced proudly that it was the “end of the era of big government.” He also renominated Greenspan for a third term, proof to Wall Street that he understood their concerns. It was, after all, a presidential election year. But Greenspan had a new worry. In October 1996, the Dow Jones Industrials exceeded 6,000, compared to roughly 4,000 in early 1995. The Yale economist Robert Shiller, a stock market historian, had warned repeatedly that stock prices were running at historically high levels. If stock prices were forming a speculative bubble that was likely to burst, it could jeopardize the economic expansion. Both business and consumers would reduce their spending. Raising interest rates to subdue the stock market might diminish the market enthusiasm, but it might also weaken the economy.

Not only did his interest rate increases fail to dampen the financing, but they encouraged Wall Street to take more risks and mortgage brokers to write more bad loans because their profit margins had narrowed. They made up in quantity what was lacking in quality. The high dollar coupled with the trade deficit, which put even more dollars in foreign hands, which they in turn confidently invested in U.S. securities, provided ample funds. Between 2000 and 2005, according to Wellesley economist Karl Case and Yale’s Robert Shiller, house prices rose faster than at any time in modern history, and the number of mortgages being written exploded. But when Greenspan raised rates in 2004—on which adjustable rate mortgages were based—the clock began to tick. The rates on tens of billions of dollars of ARMs would be reset upward in 2006. That year, default rates on mortgages started to rise rapidly and home prices for the first time started to fall.

Glantz went on: “It is an open secret that ‘strong buy’ now means ‘buy,’ ‘buy’ means ‘hold,’ ‘hold’ means that the company isn’t an investment banking client, and ‘sell’ means that the company is no longer an investment client.” Rising stock prices made overly optimistic recommendations seem correct and reinforced the practice. Most stocks rose in the first half of the 1990s. But from 1994 on, they soared. It was what economist Robert Shiller, as noted, a historian of stock trends, labeled “the biggest historical example to date of a speculative upsurge in the stock market.” The economy’s prospects improved markedly. But they did not improve as rapidly as the market did. From the end of 1994 to 2000, stock prices roughly tripled while corporate profits rose by only one and a half times. High-technology stocks rose faster still, often before the companies produced any earnings.


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The Signal and the Noise: Why So Many Predictions Fail-But Some Don't by Nate Silver

"Robert Solow", airport security, availability heuristic, Bayesian statistics, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, big-box store, Black Swan, Broken windows theory, business cycle, buy and hold, Carmen Reinhart, Claude Shannon: information theory, Climategate, Climatic Research Unit, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, complexity theory, computer age, correlation does not imply causation, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, Daniel Kahneman / Amos Tversky, diversification, Donald Trump, Edmond Halley, Edward Lorenz: Chaos theory, en.wikipedia.org, equity premium, Eugene Fama: efficient market hypothesis, everywhere but in the productivity statistics, fear of failure, Fellow of the Royal Society, Freestyle chess, fudge factor, George Akerlof, global pandemic, haute cuisine, Henri Poincaré, high batting average, housing crisis, income per capita, index fund, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), Internet Archive, invention of the printing press, invisible hand, Isaac Newton, James Watt: steam engine, John Nash: game theory, John von Neumann, Kenneth Rogoff, knowledge economy, Laplace demon, locking in a profit, Loma Prieta earthquake, market bubble, Mikhail Gorbachev, Moneyball by Michael Lewis explains big data, Monroe Doctrine, mortgage debt, Nate Silver, negative equity, new economy, Norbert Wiener, PageRank, pattern recognition, pets.com, Pierre-Simon Laplace, prediction markets, Productivity paradox, random walk, Richard Thaler, Robert Shiller, Robert Shiller, Rodney Brooks, Ronald Reagan, Saturday Night Live, savings glut, security theater, short selling, Skype, statistical model, Steven Pinker, The Great Moderation, The Market for Lemons, the scientific method, The Signal and the Noise by Nate Silver, The Wisdom of Crowds, Thomas Bayes, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transaction costs, transfer pricing, University of East Anglia, Watson beat the top human players on Jeopardy!, wikimedia commons

When you can’t state your innocence, proclaim your ignorance: this is often the first line of defense when there is a failed forecast.13 But Sharma’s statement was a lie, in the grand congressional tradition of “I did not have sexual relations with that woman” and “I have never used steroids.” What is remarkable about the housing bubble is the number of people who did see it coming—and who said so well in advance. Robert Shiller, the Yale economist, had noted its beginnings as early as 2000 in his book Irrational Exuberance.14 Dean Baker, a caustic economist at the Center for Economic and Policy Research, had written about the bubble in August 2002.15 A correspondent at the Economist magazine, normally known for its staid prose, had spoken of the “biggest bubble in history” in June 2005.16 Paul Krugman, the Nobel Prize–winning economist, wrote of the bubble and its inevitable end in August 2005.17 “This was baked into the system,” Krugman later told me.

Too many investors mistook these confident conclusions for accurate ones, and too few made backup plans in case things went wrong. And yet, while the ratings agencies bear substantial responsibility for the financial crisis, they were not alone in making mistakes. The story of the financial crisis as a failure of prediction can be told in three acts. Act I: The Housing Bubble An American home has not, historically speaking, been a lucrative investment. In fact, according to an index developed by Robert Shiller and his colleague Karl Case, the market price of an American home has barely increased at all over the long run. After adjusting for inflation, a $10,000 investment made in a home in 1896 would be worth just $10,600 in 1996. The rate of return had been less in a century than the stock market typically produces in a single year.47 But if a home was not a profitable investment it had at least been a safe one.

Simply looking at periods when the stock market has increased at a rate much faster than its historical average can give you some inkling of a bubble. Of the eight times in which the S&P 500 increased in value by twice its long-term average over a five-year period,43 five cases were followed by a severe and notorious crash, such as the Great Depression, the dot-com bust, or the Black Monday crash of 1987.44 A more accurate and sophisticated bubble-detection method is proposed by the Yale economist Robert J. Shiller, whose prescient work on the housing bubble I discussed in chapter 1. Shiller is best known for his book Irrational Exuberance. Published right as the NASDAQ achieved its all-time high during the dot-com bubble, the book served as an antidote to others, such as Dow 36,000, Dow 40,000 and Dow 100,00045 that promised prices would keep going up, instead warning investors that stocks were badly overpriced on the basis of the fundamentals.


EuroTragedy: A Drama in Nine Acts by Ashoka Mody

"Robert Solow", Andrei Shleifer, asset-backed security, availability heuristic, bank run, banking crisis, Basel III, Berlin Wall, book scanning, Bretton Woods, call centre, capital controls, Carmen Reinhart, Celtic Tiger, central bank independence, centre right, credit crunch, Daniel Kahneman / Amos Tversky, debt deflation, Donald Trump, eurozone crisis, Fall of the Berlin Wall, financial intermediation, floating exchange rates, forward guidance, George Akerlof, German hyperinflation, global supply chain, global value chain, hiring and firing, Home mortgage interest deduction, income inequality, inflation targeting, Irish property bubble, Isaac Newton, job automation, Johann Wolfgang von Goethe, Johannes Kepler, Kenneth Rogoff, Kickstarter, liberal capitalism, light touch regulation, liquidity trap, loadsamoney, London Interbank Offered Rate, Long Term Capital Management, low-wage service sector, Mikhail Gorbachev, mittelstand, money market fund, moral hazard, mortgage tax deduction, neoliberal agenda, offshore financial centre, oil shock, open borders, pension reform, premature optimization, price stability, purchasing power parity, quantitative easing, rent-seeking, Republic of Letters, Robert Gordon, Robert Shiller, Robert Shiller, short selling, Silicon Valley, The Great Moderation, The Rise and Fall of American Growth, too big to fail, total factor productivity, trade liberalization, transaction costs, urban renewal, working-age population, Yogi Berra

Soon, in the same way as the United States was transmitting its domestic consumer-​led economic growth to the rest of the world, the United States sparked global financial exuberance. Banks and investors worldwide wanted their share of the growing financial bounty in the United States, or else they sought easy riches nearer home. The risk was real that US and global asset prices would keep rising and then quickly and sharply reverse, as they had in Japan in 1990. The person who sounded the loudest warning was Yale University economist Robert Shiller. He emphasized that bouts of irrational exuberance had recurred throughout history. Each bout arose from the same fundamental “human vulnerability to error” and did not just cause gyrations in financial markets but created pervasive instability in the “capitalist system.”6 Many European policymakers believed that Europe was less susceptible to irrational exuberance and to the instability it could spawn than the United States was.

In 2006, by which time the bubble was surely a mania, the words “boom” and “bubble” found no place in the IMF’s annual review.111 To the contrary, the IMF’s special assessment of the Irish financial sector delivered a glowing report. Yes, some tweaking was necessary, but it was all good, the IMF concluded.112 Nyberg wrote that the IMF’s endorsement reinforced confidence in the “soundness” of the banking system and in the system’s guardians, the central bank and the financial regulator.113 Yale University’s Robert Shiller says that in all episodes of irrational exuberance, initial concerns give way to the belief that this time is different. Some of those who see the craziness and hold back are sucked in to the euphoria eventually. “People who thought there was a bubble, and that prices were too high, find themselves questioning their own earlier judgments, and start to wonder whether fundamentals are indeed driving the price increase.”

John Maynard Keynes, perhaps the most renowned economist of the twentieth century, had vigorously argued the need for fiscal stimulus to pull an economy out of a recession.121 The direct beneficiaries of lower taxes and recipients of larger government transfers begin spending more, which creates additional incomes for others, thus activating a “multiplier effect” through a steadily widening circle of consumers and investors. George Akerlof and Robert Shiller, both recipients of the Nobel Prize for Economics, have noted that the mere knowledge that others have increased their spending creates a more optimistic view of the future. Hesitant consumers make purchases that they were postponing; investors take new initiatives. The optimism spreads through a “confidence multiplier.”122 Production increases, and economic recovery gathers momentum. A fiscal stimulus has especially high value when the economy is in a deep recession.


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Think Twice: Harnessing the Power of Counterintuition by Michael J. Mauboussin

affirmative action, asset allocation, Atul Gawande, availability heuristic, Benoit Mandelbrot, Bernie Madoff, Black Swan, butter production in bangladesh, Cass Sunstein, choice architecture, Clayton Christensen, cognitive dissonance, collateralized debt obligation, Daniel Kahneman / Amos Tversky, deliberate practice, disruptive innovation, Edward Thorp, experimental economics, financial innovation, framing effect, fundamental attribution error, Geoffrey West, Santa Fe Institute, George Akerlof, hindsight bias, hiring and firing, information asymmetry, libertarian paternalism, Long Term Capital Management, loose coupling, loss aversion, mandelbrot fractal, Menlo Park, meta analysis, meta-analysis, money market fund, Murray Gell-Mann, Netflix Prize, pattern recognition, Philip Mirowski, placebo effect, Ponzi scheme, prediction markets, presumed consent, Richard Thaler, Robert Shiller, Robert Shiller, statistical model, Steven Pinker, The Wisdom of Crowds, ultimatum game

Sapolsky, Why Zebras Don’t Get Ulcers: An Updated Guide to Stress, Stress-Related Disease, and Coping (New York: W.H. Freeman and Company, 1994); and Samuel M. McClure, David I Laibson, George Loewsenstein, and Jonathan D. Cohen, “Separate Neural Systems Value Immediate and Delayed Monetary Rewards,” Science 306 (October 15, 2004), 503–507. 28. Jerome Groopman tells a similar story. See Groopman, How Doctors Think, 225–233. 29. George A. Akerlof and Robert J. Shiller, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism (Princeton, NJ: Princeton University Press, 2009), 36–37; and Whitney Tilson and Glenn Tongue, More Mortgage Meltdown: 6 Ways to Profit in These Bad Times (New York: John Wiley & Sons, 2009), 29–47. 30. Alan Greenspan, “Testimony to the Committee of Government Oversight and Reform,” October 23, 2008. 31.

Prediction markets are real-money exchanges where people can bet on events with binary and temporally defined outcomes; hence the price reflects the probability of the event occurring. See Kenneth J. Arrow, Robert Forsythe, Michael Gorham, Robert Hahn, Robin Hansen, John O. Ledyard, Saul Levmore, Robert Litan, Paul Milgrom, Forrest D. Nelson, George R. Neumann, Marco Ottaviani, Thomas C. Schelling, Robert J. Shiller, Vernon L. Smith, Erik Snowberg, Cass R. Sunstein, Paul C. Tetlock, Philip E. Tetlock, Hal R. Varian, Justin Wolfers, and Eric Zitzewitz, “The Promise of Prediction Markets,” Science 320 (May 16, 2008):877–878; Bo Cowgill, Justin Wolfers, and Eric Zitzewitz, “Using Prediction Markets to Track Information Flows: Evidence from Google,” working paper, 2008. 4. Phred Dvorak, “Best Buy Taps ‘Prediction Market,’” Wall Street Journal, September 16, 2008. 5.

Edward Russo, and Nancy Pennington, “Back to the Future: Temporal Perspective in the Explanation of Events,” Journal of Behavioral Decision Making 2, no. 1 (1989): 25–38. 9. Warren E. Buffett, “Chairman’s Letter,” Berkshire Hathaway Annual Report to Shareholders, 1996. BIBLIOGRAPHY Abernathy, Charles M., and Robert M. Hamm. Surgical Intuition: What It Is and How to Get It. Philadelphia, PA: Hanley & Belfus, 1995. Akerlof, George A., and Robert J. Shiller. Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters For Global Capitalism. Princeton, NJ: Princeton University Press, 2009. Alicke, Mark D., and Olesya Govorun. “The Better-Than-Average Effect.” In The Self in Social Judgment, edited by Mark D. Alicke, David A. Dunning, and Joachim I. Krueger, 85–106. New York: Psychology Press, 2005. Anderson, Camilla. “Iceland Gets Help to Recover from Historic Crisis.”


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Wall Street: How It Works And for Whom by Doug Henwood

accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, affirmative action, Andrei Shleifer, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, borderless world, Bretton Woods, British Empire, business cycle, capital asset pricing model, capital controls, central bank independence, computerized trading, corporate governance, corporate raider, correlation coefficient, correlation does not imply causation, credit crunch, currency manipulation / currency intervention, David Ricardo: comparative advantage, debt deflation, declining real wages, deindustrialization, dematerialisation, diversification, diversified portfolio, Donald Trump, equity premium, Eugene Fama: efficient market hypothesis, experimental subject, facts on the ground, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, George Akerlof, George Gilder, hiring and firing, Hyman Minsky, implied volatility, index arbitrage, index fund, information asymmetry, interest rate swap, Internet Archive, invisible hand, Irwin Jacobs, Isaac Newton, joint-stock company, Joseph Schumpeter, kremlinology, labor-force participation, late capitalism, law of one price, liberal capitalism, liquidationism / Banker’s doctrine / the Treasury view, London Interbank Offered Rate, Louis Bachelier, market bubble, Mexican peso crisis / tequila crisis, microcredit, minimum wage unemployment, money market fund, moral hazard, mortgage debt, mortgage tax deduction, Myron Scholes, oil shock, Paul Samuelson, payday loans, pension reform, plutocrats, Plutocrats, price mechanism, price stability, prisoner's dilemma, profit maximization, publication bias, Ralph Nader, random walk, reserve currency, Richard Thaler, risk tolerance, Robert Gordon, Robert Shiller, Robert Shiller, selection bias, shareholder value, short selling, Slavoj Žižek, South Sea Bubble, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Market for Lemons, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, transcontinental railway, women in the workforce, yield curve, zero-coupon bond

Academic students of finance have increasingly recognized that lots of old-fashioned impressionistic notions about market volatility may be truer than rationalists could imagine. The notion that fads and bubbles and panics drive security prices far from their fundamental value — deviations that end not by returning to that fundamental value but typically by overshooting it to the other extreme — now enjoys a scholarly respectability that it didn't 15 or 20 years ago. In an influential series of papers published during the 1980s, Robert Shiller developed a theory of financial market volatility powered by horde psychology. His 1981 paper, "Do stock prices move too much to be justified by subsequent changes in dividends?" (reprinted in Shiller 1991) took aim at the EMH's claim that stock prices are the rational discounted present value of rationally anticipated future dividends or profits. On the second page of his article, Shiller charted the value of stock prices against the WALL STREET "true" value a perfectly rational market should have been assigning stocks based on how dividends actually turned out (a highly defensible use of 20/20 hindsight) from 1871-1979"" The line representing dividends is remarkably stable, even through the Great Depression, but the line representing stock prices zigs and zags wildly, remaining at extremes of over-and under-valuation for years, even decades.

Robert Monks (1995), a former Reaganite who is an eager polemicist on behalf of share- WALL STREET holder rights, is imaginative enough to argue that since pension funds represent the masses' capital, they are the institutions to which corporations should be accountable. (By pension funds he means their managers, of course.) This accountability represents a check on what Monks admits to be the rather anomalous position of corporations in a professedly democratic society. 25. The Twentieth Century Fund's (1992) most recent take on governance, Who's Minding the Store?, is built around an essay by Robert Shiller on excess volatility. Yet the policy conclusions the Fund draws from Shiller's work are the weakest tea imaginable: encouraging patient capital through moral suasion, while taking no tax or regulatory steps towards that goal. 26. In some cases, like Japan and South Korea, the protectionist strategies succeeded; in Latin America, however, they often protected corrupt and incompetent friends of the government.

The latter institutions have contributed greatly to creating the borderless world Tobin bemoans, but liberals rarely seem to have problems with contradictions like this. Tobin has also argued for a similar tax on stock trades. Tobin lodged a dissent from the tame official recommendations of the Twentieth Century Fund's (1992) Task Force on Market Speculation and Corporate Governance. The report's centerpiece was a long essay by Robert Shiller (1992) on markets' excessive volatility, and the dangers of taking guidance on how to run real corporations from movements in their stock prices. But having raised that interesting question, the worthies on the Fund's panel decided against a transactions tax, preferring instead a revolution in the consciousness of institutional investors — the sprouting of a new culture of patience and self-discipline, as incredible as that may sound to any student of the markets.


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How to Predict the Unpredictable by William Poundstone

accounting loophole / creative accounting, Albert Einstein, Bernie Madoff, Brownian motion, business cycle, butter production in bangladesh, buy and hold, buy low sell high, call centre, centre right, Claude Shannon: information theory, computer age, crowdsourcing, Daniel Kahneman / Amos Tversky, Edward Thorp, Firefox, fixed income, forensic accounting, high net worth, index card, index fund, John von Neumann, market bubble, money market fund, pattern recognition, Paul Samuelson, Ponzi scheme, prediction markets, random walk, Richard Thaler, risk-adjusted returns, Robert Shiller, Robert Shiller, Rubik’s Cube, statistical model, Steven Pinker, transaction costs

This was due to banks and other companies writing off a mountain of bad debt all at once. After the purge, earnings promptly bounced back. The market is supposed to take a long-term outlook and price stocks according to the whole future stream of earnings. But investors, like everyone else, believe in the representativeness of small samples. PE valuations have too much to do with the latest news cycle, the latest quarter, and the last few years. Yale economist Robert Shiller devised a better way of gauging stock market valuation. It’s the current S&P 500 price divided by a ten-year moving average of earnings. This has the merit of smoothing out business cycles and much of the duplicity in corporate earnings reports — for there are cycles of candor as well as profit. A ten-year average of corporate earnings is about as truthful as these things get. Shiller’s idea wasn’t entirely new.

Provo, Utah: Brigham Young University Testing Services. Butler, Sarah Lorge (2010). “NCAA Brackets: How to Win Your March Madness Pool.” CBS News, Mar. 12, 2010. www.cbsnews.com/8301-505123_162-51403055/ncaa-brackets-how-to-win-your-march-madness-pool/. Camerer, Colin F. (1989). “Does the Basketball Market Believe in the ‘Hot Hand’?” American Economic Review 79, 1257–1261. Campbell, John Y., and Robert J. Shiller (1998). “Valuation Ratios and the Long-Run Stock Market Outlook.” Journal of Portfolio Management, Winter 1998, 11–26. Cassidy, John (2007). “The Blow-Up Artist.” New Yorker, Oct. 15, 2007. Chapanis, Alphonse (1953). “Random-number Guessing Behavior.” American Psychologist 8, 332. ——— (1995). “Human Production of ‘Random’ Numbers.” Perceptual and Motor Skills 81, 1347–1363. ——— (1999).


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The Wisdom of Finance: Discovering Humanity in the World of Risk and Return by Mihir Desai

activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, assortative mating, Benoit Mandelbrot, Brownian motion, capital asset pricing model, carried interest, Charles Lindbergh, collective bargaining, corporate governance, corporate raider, discounted cash flows, diversified portfolio, Eugene Fama: efficient market hypothesis, financial innovation, follow your passion, George Akerlof, Gordon Gekko, greed is good, housing crisis, income inequality, information asymmetry, Isaac Newton, Jony Ive, Kenneth Rogoff, longitudinal study, Louis Bachelier, moral hazard, Myron Scholes, new economy, out of africa, Paul Samuelson, Pierre-Simon Laplace, principal–agent problem, Ralph Waldo Emerson, random walk, risk/return, Robert Shiller, Robert Shiller, Ronald Coase, Silicon Valley, Steve Jobs, Thales and the olive presses, Thales of Miletus, The Market for Lemons, The Nature of the Firm, The Wealth of Nations by Adam Smith, Tim Cook: Apple, transaction costs, zero-sum game

A textbook treatment of the ideas of finance is an excellent next step for those interested in learning more. I recommend Bodie, Zvi, Alex Kane, and Alan J. Marcus. Investments. Boston: McGraw-Hill Irwin, 2013; and Berk, Jonathan B., and Peter M. DeMarzo. Corporate Finance. Boston: Pearson Addison Wesley, 2013. A more accessible treatment of these ideas for practitioners is provided in Higgins, Robert C. Analysis for Financial Management. 11th ed. New York: McGraw-Hill Education, 2016. Robert Shiller’s Finance and the Good Society. Princeton, NJ: Princeton University Press, 2012, is another excellent general source. My own effort at making finance accessible is the HBX online course “Leading with Finance.” MOV. Boston: President & Fellows of Harvard College, 2016. Author’s Note “My object in living”: The Frost quote is an excerpt of the last stanza of “Two Tramps in Mud Time.” From The Poetry of Robert Frost.

Quarterly Journal of Economics 127, no. 4 (November 2012): 1551–611. For a discussion of the rise of the alternative asset industry and its effect on Wall Street, see Desai, Mihir A. “The Incentive Bubble.” Harvard Business Review 90, no. 3 (March 2012): 123–29. For an excellent but rigorous overview of the state of play in asset pricing generally, see Campbell, John Y. “Empirical Asset Pricing: Eugene Fama, Lars Peter Hansen, and Robert Shiller.” Scandinavian Journal of Economics 116, no. 3 (2014): 593–634; and Cochrane, John H. Asset Pricing. Princeton, NJ: Princeton University Press, 2001. A slightly more accessible version of these ideas is provided in Cochrane, John H., and Christopher L. Culp. “Equilibrium Asset Pricing and Discount Factors: Overview and Implications for Derivatives Valuation and Risk Management.” In Modern Risk Management: A History, 57–92.


Early Retirement Guide: 40 is the new 65 by Manish Thakur

"side hustle", Airbnb, diversified portfolio, financial independence, hedonic treadmill, index fund, Lyft, passive income, passive investing, risk tolerance, Robert Shiller, Robert Shiller, time value of money, uber lyft, Vanguard fund, Zipcar

The popular thinking with houses is that they are an investment; the logic being that when the mortgage is paid down and the house is sold 30 years down the road for a higher price, it's money earned. In reality, if we were evaluating houses as an investment, they would have a terrible return, or even a negative return when including interest, property taxes, and repairs. In most economic times, houses only retain their value, increasing with the rate of inflation, rather than growing in actual value. Yale professor Robert Shiller found that when property taxes, maintenance, and other housing costs are accounted for, houses usually have a negative return. Since our timeline to become financially independent is much shorter than 30 years, we don't want those large mortgage payments eating away at our 4% withdrawal each year just to have a larger home. Purchasing or renting a home that meets our space requirements, rather than exceeding them, means a smaller mortgage that could be paid off in a shorter time, resulting in less money going to interest payments, and more money going to actual investments.


pages: 322 words: 87,181

Straight Talk on Trade: Ideas for a Sane World Economy by Dani Rodrik

3D printing, airline deregulation, Asian financial crisis, bank run, barriers to entry, Berlin Wall, Bernie Sanders, blue-collar work, Bretton Woods, BRICs, business cycle, call centre, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, central bank independence, centre right, collective bargaining, conceptual framework, continuous integration, corporate governance, corporate social responsibility, currency manipulation / currency intervention, David Ricardo: comparative advantage, deindustrialization, Donald Trump, endogenous growth, Eugene Fama: efficient market hypothesis, eurozone crisis, failed state, financial deregulation, financial innovation, financial intermediation, financial repression, floating exchange rates, full employment, future of work, George Akerlof, global value chain, income inequality, inflation targeting, information asymmetry, investor state dispute settlement, invisible hand, Jean Tirole, Kenneth Rogoff, low skilled workers, manufacturing employment, market clearing, market fundamentalism, meta analysis, meta-analysis, moral hazard, Nelson Mandela, new economy, offshore financial centre, open borders, open economy, Pareto efficiency, postindustrial economy, price stability, pushing on a string, race to the bottom, randomized controlled trial, regulatory arbitrage, rent control, rent-seeking, Richard Thaler, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, Sam Peltzman, Silicon Valley, special economic zone, spectrum auction, Steven Pinker, The Rise and Fall of American Growth, the scientific method, The Wealth of Nations by Adam Smith, Thomas L Friedman, too big to fail, total factor productivity, trade liberalization, transaction costs, unorthodox policies, Washington Consensus, World Values Survey, zero-sum game, éminence grise

Should they just say “I don’t know” when their science has not developed strong evidence and let others with even worse understanding take over the public conversation? If economists want to enhance their public engagement, they will need to pay greater attention to these and other questions discussed in the next few chapters. Nobel Confusion? When the 2013 Nobel Prize in economics (technically the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel) was awarded to Eugene Fama and Robert Shiller, along with Lars Peter Hansen, many were puzzled by the selection. Fama and Shiller are both distinguished and highly regarded scholars, so it was not their qualifications that raised eyebrows. What seemed odd was that the committee had picked them together. The two economists seem to hold diametrically opposed views on how financial markets work. Fama, the University of Chicago economist, is the father of the “efficient market hypothesis,” the theory that asset prices reflect all publicly available information, with the implication that it is impossible to consistently beat the market.

It was economists who had legitimized and popularized the view that unfettered finance was a boon to society. They had spoken with near unanimity when it came to the “dangers of government over-regulation.” Their technical expertise—or what seemed like it at the time—had given them a privileged position as opinion makers, as well as access to the corridors of power. Very few among them had raised alarm bells about the crisis to come (Robert Shiller was one such Cassandra). Perhaps worse, the profession failed to provide helpful guidance in steering the world economy out of its mess. Economists’ opinion on monetary, fiscal, and regulatory remedies for longer term recovery and growth never converged. Many outsiders concluded that economics was in need of a major shake-up. Burn the textbooks and rewrite them from scratch, they said. The paradox is that macroeconomics and finance did not lack the tools needed to understand how the crisis arose and unfolded.


pages: 524 words: 155,947

More: The 10,000-Year Rise of the World Economy by Philip Coggan

"Robert Solow", accounting loophole / creative accounting, Ada Lovelace, agricultural Revolution, Airbnb, airline deregulation, Andrei Shleifer, anti-communist, assortative mating, autonomous vehicles, bank run, banking crisis, banks create money, basic income, Berlin Wall, Bob Noyce, Branko Milanovic, Bretton Woods, British Empire, business cycle, call centre, capital controls, carbon footprint, Carmen Reinhart, Celtic Tiger, central bank independence, Charles Lindbergh, clean water, collective bargaining, Columbian Exchange, Columbine, Corn Laws, credit crunch, Credit Default Swap, crony capitalism, currency peg, debt deflation, Deng Xiaoping, discovery of the americas, Donald Trump, Erik Brynjolfsson, European colonialism, eurozone crisis, falling living standards, financial innovation, financial intermediation, floating exchange rates, Fractional reserve banking, Frederick Winslow Taylor, full employment, germ theory of disease, German hyperinflation, gig economy, Gini coefficient, global supply chain, global value chain, Gordon Gekko, greed is good, Haber-Bosch Process, Hans Rosling, Hernando de Soto, hydraulic fracturing, Ignaz Semmelweis: hand washing, income inequality, income per capita, indoor plumbing, industrial robot, inflation targeting, Isaac Newton, James Watt: steam engine, job automation, John Snow's cholera map, joint-stock company, joint-stock limited liability company, Kenneth Arrow, Kula ring, labour market flexibility, land reform, land tenure, Lao Tzu, large denomination, liquidity trap, Long Term Capital Management, Louis Blériot, low cost airline, low skilled workers, lump of labour, M-Pesa, Malcom McLean invented shipping containers, manufacturing employment, Marc Andreessen, Mark Zuckerberg, Martin Wolf, McJob, means of production, Mikhail Gorbachev, mittelstand, moral hazard, Murano, Venice glass, Myron Scholes, Nelson Mandela, Network effects, Northern Rock, oil shale / tar sands, oil shock, Paul Samuelson, popular capitalism, popular electronics, price stability, principal–agent problem, profit maximization, purchasing power parity, quantitative easing, railway mania, Ralph Nader, regulatory arbitrage, road to serfdom, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, savings glut, Scramble for Africa, Second Machine Age, secular stagnation, Silicon Valley, Simon Kuznets, South China Sea, South Sea Bubble, special drawing rights, spice trade, spinning jenny, Steven Pinker, TaskRabbit, Thales and the olive presses, Thales of Miletus, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Malthus, Thorstein Veblen, trade route, transaction costs, transatlantic slave trade, transcontinental railway, Triangle Shirtwaist Factory, universal basic income, Unsafe at Any Speed, Upton Sinclair, V2 rocket, Veblen good, War on Poverty, Washington Consensus, Watson beat the top human players on Jeopardy!, women in the workforce, Yom Kippur War, zero-sum game

Several countries indulged in creative accounting to pass the budget test, and another criterion – a 60% cap on government debt to GDP – was effectively ignored. And the decline in interest rates across the region fuelled speculative bubbles, as we shall see. The build-up to the crisis The crisis that ended this era had its roots in an unexpected place – the American housing market. What happened to US house prices in the late 1990s and early 2000s was most unusual. Robert Shiller of Yale University had looked at the long-term history of house prices in the US and found that the real price increase between 1890 and 1997 was about 12%. Then, in the eight years between 1998 and 2006, they rose 85%. Nothing like it had been seen before. This was not caused by population growth, which was only rising steadily, nor by building costs. Nor could it plausibly be ascribed to a shortage of housing.

Philip Coggan, Paper Promises: Money, Debt and the New World Order 34. David M. Kennedy, Freedom from Fear: The American People in Depression and War 1929–1945 35. Source: https://inflationdata.com/articles/inflation-consumer-price-index-decade-commentary/inflation-cpi-consumer-price-index-1920–1929/ 36. Ahamed, Lords of Finance, op. cit. 37. Source: https://fred.stlouisfed.org/series/M1109BUSM293NNBR 38. The figures come from Robert Shiller of Yale University and his website: www.irrationalexuberance.com 39. “Florida’s land boom”, https://fcit.usf.edu/florida/lessons/ld_boom/ld_boom1.htm 40. The city’s name had been changed from St Petersburg during the war. It would be changed again to Leningrad before reverting to St Petersburg in the post-communist era. 41. Robert Service, The Penguin History of Modern Russia: From Tsarism to the Twenty-First Century 42.

Barry Eichengreen and Charles Wyplosz, “The unstable EMS”, https://www.Brookings.Edu/Wp-Content/Uploads/1993/01/1993a_Bpea_Eichengreen_Wyplosz_Branson_Dornbusch.Pdf 39. Source: https://www.nber.org/cycles.html 40. The day was dubbed Black Wednesday although, in fact, it allowed Britain to slash interest rates and let the economy recover. Longer term, it soured British politics by making many on the right hostile to the EU in general. 41. Robert Shiller, Irrational Exuberance, third edition 42. Judith Yates, “Housing in Australia in the 2000s: on the agenda too late?”, https://www.rba.gov.au/publications/confs/2011/yates.html 43. Tobias Buck, “Spain: boom to bust and back again”, Financial Times, April 6th 2017 44. Ben S. Bernanke, “The global saving glut and the US current account deficit”, the Sandridge Lecture, Virginia Association of Economists, Richmond, Virginia, March 10th 2005 Chapter 15 – Government: an ever-present force 1.


pages: 459 words: 138,689

Slowdown: The End of the Great Acceleration―and Why It’s Good for the Planet, the Economy, and Our Lives by Danny Dorling, Kirsten McClure

Affordable Care Act / Obamacare, Berlin Wall, Bernie Sanders, Boris Johnson, British Empire, business cycle, capital controls, clean water, creative destruction, credit crunch, Donald Trump, drone strike, Elon Musk, en.wikipedia.org, Flynn Effect, full employment, future of work, gender pay gap, global supply chain, Google Glasses, Henri Poincaré, illegal immigration, immigration reform, income inequality, Intergovernmental Panel on Climate Change (IPCC), Internet of things, Isaac Newton, James Dyson, jimmy wales, John Harrison: Longitude, Kickstarter, low earth orbit, Mark Zuckerberg, market clearing, Martin Wolf, mass immigration, means of production, megacity, meta analysis, meta-analysis, mortgage debt, nuclear winter, pattern recognition, Ponzi scheme, price stability, profit maximization, purchasing power parity, QWERTY keyboard, random walk, rent control, rising living standards, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, Scramble for Africa, sexual politics, Skype, Stephen Hawking, Steven Pinker, structural adjustment programs, the built environment, Tim Cook: Apple, transatlantic slave trade, trickle-down economics, very high income, wealth creators, wikimedia commons, working poor

In 1988, economists Karl Case and Robert J. Shiller sent 2,030 questionnaires to recent home buyers in four U.S. cities asking them what they thought had determined recent changes in housing prices where they lived. “Not a single person from among the 886 respondents cited any quantitative evidence about future trends in supply or demand, or professional forecasts of future supply or demand.”30 At the time, the economists concluded, “There is a peculiar lack of interest in objective evidence about fundamentals.” They would have been more insightful if they had recognized that buyers knew that supply and demand is not a fundamental determinant of price—how could it be, when housing supply in the United States had also been growing so quickly throughout the childhoods of Generation X? Robert J. Shiller was awarded the Nobel Memorial Prize for economics twenty-five years after sending out those questionnaires with his colleague Karl Case.

“Gold Supply and Demand Statistics,” World Gold Council, accessed 6 May 2019, https://www.gold.org/goldhub/data/gold-supply-and-demand-statistics. 30. Robert Shiller, “Speculative Prices and Popular Models,” Journal of Economic Perspectives 4, no. 2 (1990): 59, http://www.jstor.org/stable/1942890. Note: Case and Shiller worked together for decades, but this paper was written by Shiller alone. 31. John Muellbauer and Anthony Murphy, “Booms and Busts in the UK Housing Market,” Economic Journal 107, no. 445 (1997): 1701–27, http://onlinelibrary.wiley.com/doi/10.1111/j.1468-0297.1997.tb00076.x/full. 32. Mervyn King, “An Econometric Model of Tenure Choice and Demand for Housing as a Joint Decision,” Journal of Public Economics 14, no. 2 (1980): 137–59, https://doi.org/10.1016/0047-2727(80)90038-9. 33. James Poterba, David Weil, and Robert Shiller, “House Price Dynamics: The Role of Tax Policy and Demography,” Brookings Papers on Economic Activity, no. 2 (1991): 183, http://www.jstor.org/stable/2534591. 34.


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The Ascent of Money: A Financial History of the World by Niall Ferguson

Admiral Zheng, Andrei Shleifer, Asian financial crisis, asset allocation, asset-backed security, Atahualpa, bank run, banking crisis, banks create money, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, BRICs, British Empire, business cycle, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, collateralized debt obligation, colonial exploitation, commoditize, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, deglobalization, diversification, diversified portfolio, double entry bookkeeping, Edmond Halley, Edward Glaeser, Edward Lloyd's coffeehouse, financial innovation, financial intermediation, fixed income, floating exchange rates, Fractional reserve banking, Francisco Pizarro, full employment, German hyperinflation, Hernando de Soto, high net worth, hindsight bias, Home mortgage interest deduction, Hyman Minsky, income inequality, information asymmetry, interest rate swap, Intergovernmental Panel on Climate Change (IPCC), Isaac Newton, iterative process, John Meriwether, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, knowledge economy, labour mobility, Landlord’s Game, liberal capitalism, London Interbank Offered Rate, Long Term Capital Management, market bubble, market fundamentalism, means of production, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, mortgage tax deduction, Myron Scholes, Naomi Klein, negative equity, Nelson Mandela, Nick Leeson, Northern Rock, Parag Khanna, pension reform, price anchoring, price stability, principal–agent problem, probability theory / Blaise Pascal / Pierre de Fermat, profit motive, quantitative hedge fund, RAND corporation, random walk, rent control, rent-seeking, reserve currency, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, seigniorage, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spice trade, stocks for the long run, structural adjustment programs, technology bubble, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Bayes, Thomas Malthus, Thorstein Veblen, too big to fail, transaction costs, undersea cable, value at risk, Washington Consensus, Yom Kippur War

Financial illiteracy may be ubiquitous, but somehow we were all experts on one branch of economics: the property market. We all knew that property was a one-way bet. Except that it wasn’t. (In the last quarter of 2007, Glasgow house prices fell by 2.1 per cent. The only consolation was that in Edinburgh they fell by 5.8 per cent.) In cities all over the world, house prices soared far above what was justified in terms of rental income or construction costs. There was, as the economist Robert Shiller has said, simply a ‘widespread perception that houses are a great investment’, which generated a ‘classic speculative bubble’ via the same feedback mechanism which has more commonly affected stock markets since the days of John Law. In short, there was irrational exuberance about bricks and mortar and the capital gains they could yield.74 This perception, as we have seen, was partly political in origin.

ID=18579. 72 CNN, 9 July 2000. 73 Testimony of Chairman Alan Greenspan, Federal Reserve Board’s semi-annual Monetary Policy Report to the Congress, before the Committee on Banking, Housing, and Urban Affairs, US Senate, 16 February 2005. 3. Blowing Bubbles 1 For a recent contribution to a vast literature, see Timothy Guinnane, Ron Harris, Naomi R. Lamoreaux, and Jean-Laurent Rosenthal, ‘Putting the Corporation in its Place’, NBER Working Paper 13109 (May 2007). 2 See especially Robert J. Shiller, Irrational Exuberance (2nd edn., Princeton, 2005). 3 See Charles P. Kindleberger, Manias, Panics and Crashes: A History of Financial Crises (3rd edn., New York / Chichester / Brisbane / Toronto / Singapore, 1996), pp. 12-16. Kindleberger owed a debt to the pioneering work of Hyman Minsky. For two of his key essays, see Hyman P. Minsky, ‘Longer Waves in Financial Relations: Financial Factors in the More Severe Depressions’, American Economic Review, 54, 3 (May 1964), pp. 324-35; idem, ‘Financial Instability Revisited: The Economics of Disaster’, in idem (ed.), Inflation, Recession and Economic Policy (Brighton, 1982), pp. 117-61. 4 Kindleberger, Manias, p. 14. 5 ‘The Death of Equities’, Business Week, 13 August 1979. 6 ‘Dow 36,000’, Business Week, 27 September 1999. 7 William N.

Litan, ‘Sharing and Reducing the Financial Risks of Future Mega-Catastrophes’, Brookings Issues in Economic Policy, 4 (March 2006). 87 William Hutchings, ‘Citadel Builds a Diverse Business’, Financial News, 3 October 2007. 88 Marcia Vickers, ‘A Hedge Fund Superstar’, Fortune, 3 April 2007. 89 Joseph Santos, ‘A History of Futures Trading in the United States’, South Dakota University MS, n.d. 5. Safe as Houses 1 Philip E. Orbanes, Monopoly: The World’s Most Famous Game - And How It Got That Way (New York, 2006), pp. 10-71. 2 Ibid., p. 50. 3 Ibid., pp. 86f. 4 Ibid., p. 90. 5 Robert J. Shiller, ‘Understanding Recent Trends in House Prices and Home Ownership’, paper presented at Federal Reserve Bank of Kansas City’s Jackson Hole Conference (August 2007). 6 http://www.canongate.net/WhoOwnsBritain/DoTheMathsOnLand Ownership . 7 David Cannadine, Aspects of Aristocracy: Grandeur and Decline in Modern Britain (New Haven, 1994), p. 170. 8 I am grateful to Gregory Clark for these statistics. 9 Frederick B.


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Unconventional Success: A Fundamental Approach to Personal Investment by David F. Swensen

asset allocation, asset-backed security, buy and hold, capital controls, cognitive dissonance, corporate governance, diversification, diversified portfolio, fixed income, index fund, law of one price, Long Term Capital Management, market bubble, market clearing, market fundamentalism, money market fund, passive investing, Paul Samuelson, pez dispenser, price mechanism, profit maximization, profit motive, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, Silicon Valley, Steve Ballmer, stocks for the long run, survivorship bias, technology bubble, the market place, transaction costs, Vanguard fund, yield curve, zero-sum game

Thousands upon thousands of professionally managed funds routinely fall short of producing even market-matching results. If highly compensated, specially trained, handsomely supported investment professionals fail, what leads part-time, financially untutored, resource-deficient individuals to believe they can succeed? The unrealistic belief in success emanates from a failure by individuals to recognize their investment limitations. Yale economist Robert Shiller observes that “a pervasive human tendency towards overconfidence” causes investors “to express overly strong opinions and rush to summary judgments.”2 Overconfidence contributes to a litany of investor errors, including inadequate diversification, overzealous security selection, and counterproductive market timing. In the overwhelming number of cases, misplaced confidence in forecasts of return prospects for broad asset classes and individual securities causes investors to misallocate assets and actively trade securities, thereby incurring higher costs, producing greater risks, and generating lower returns.

Suggesting that TIAA-CREF participants learned little from the experience of the 1990s, during 2003 a resurgent stock market once again increased participant equity holdings, setting the stage for another leg of the roller coaster trip. Market forces provided a wild ride for TIAA-CREF participants. RETURN AND RISK BENEFITS FROM REBALANCING When markets exhibit excess volatility, rebalancing enhances portfolio returns. Excess volatility, a phenomenon described by Yale economist Robert Shiller, refers to a situation in which market prices fluctuate more than necessary to reflect changes in fundamental drivers of security values, such as corporate earnings and interest rates. Since stock prices tend to fluctuate around fair value, excess volatility allows systematic rebalancers to buy low (on relative declines) and sell high (on relative increases). Consider TIAA-CREF participants’ experience from year-end 1992 to year-end 2002.

Terry Pristin, “Commercial Real Estate; So-Called Private REIT’s Are Gaining Ground, and Their Share of Critics,” and New York Times, 4 August 2004. 37. TIAA-CREF, College Retirement Equities Fund Prospectus, 1 May 2003: 27. 38. The Vangard Group, Vanguard REIT Index Fund Investor Shares Prospectus, 25 November 2003: 3. 39. Wells Real Estate Funds, Wells STP REIT Index Fund Prospectus, 25 November 2003: 3. CHAPTER 3: PORTFOLIO CONSTRUCTION 1. John Maynard Keynes, Monetary Reform (New York: Harcourt, Brace, 1924): 88. 2. Robert J. Shiller, Irrational Exuberance (Princeton: Princeton University Press, 2000): 142. CHAPTER 4: NON-CORE ASSET CLASSES 1. Marie Nelson, “Debt Ratings,” Moody’s Investors Service, 23 July 2003. 2. “WorldCom’s Credit Rating Sliced to Junk by Moody’s,” Bloomberg, 9 May 2002. 3. Sharon Ou and David T. Hamilton, “Moody’s Dollar Volume-Weighted Default Rates,” Moody’s Investors Service, March 2003. 4.


Small Change: Why Business Won't Save the World by Michael Edwards

Bernie Madoff, clean water, corporate governance, corporate social responsibility, different worldview, high net worth, invisible hand, knowledge economy, light touch regulation, Mahatma Gandhi, Mark Shuttleworth, market bubble, microcredit, Nelson Mandela, New Journalism, Ponzi scheme, profit motive, Robert Shiller, Robert Shiller, shareholder value, Silicon Valley, Silicon Valley startup, Social Responsibility of Business Is to Increase Its Profits, The Fortune at the Bottom of the Pyramid, The Spirit Level, The Wealth of Nations by Adam Smith, transaction costs

What is “inherently efficient” about business thinking and the market? That’s just ideology — pure, simple, and absolutely incorrect. Not all philanthrocapitalists talk or feel this way, but the mix of arrogance and ignorance revealed in these quotations sure takes some explaining. What lies behind the rise of this phenomenon? The philanthrocapitalists are drinking from a heady and seductive cocktail, one part “irrational exuberance,” as Robert Shiller puts it,10 that is characteristic of market thinking; two parts believing that success in business equips them to make the same impact on society at large; a dash or two of the excitement that accompanies any high-profile new solution; and an extra degree of fizz from the oxygen of publicity that is created when philanthropists get the chance to mix with the world’s richest and most famous people.


pages: 58 words: 18,747

The Rent Is Too Damn High: What to Do About It, and Why It Matters More Than You Think by Matthew Yglesias

Edward Glaeser, falling living standards, Home mortgage interest deduction, income inequality, industrial robot, Jane Jacobs, land reform, mortgage tax deduction, New Urbanism, pets.com, rent control, rent-seeking, Robert Gordon, Robert Shiller, Robert Shiller, Saturday Night Live, Silicon Valley, statistical model, transcontinental railway, urban sprawl, white picket fence

Similarly, nobody wants to pay a premium for your old plumbing fixtures or your old washer/dryer. This is stuff you’re going to have to fix, not stuff that’s going to increase in value. The house probably comes with some grass and other plants that you’ll have to take care of, a roof that might leak, and windows that will get dirty. Lots of people buy RVs, but nobody “invests” in them. And what’s a house but a giant RV with no wheels? Yale economist Robert Shiller observes in his book Subprime Solution that, once upon a time, “People thought of their homes as depreciating manufactured goods, like cars and boats, which require a lot of upkeep and eventually go out of style.” When people buy new cars, they consider the car’s resale value. But that doesn’t mean they expect to turn a profit when selling it. They wonder how much value the car is likely to lose over time.


pages: 358 words: 104,664

Capital Without Borders by Brooke Harrington

banking crisis, Big bang: deregulation of the City of London, British Empire, capital controls, Capital in the Twenty-First Century by Thomas Piketty, complexity theory, corporate governance, corporate social responsibility, diversified portfolio, estate planning, eurozone crisis, family office, financial innovation, ghettoisation, haute couture, high net worth, income inequality, information asymmetry, Joan Didion, job satisfaction, joint-stock company, Joseph Schumpeter, liberal capitalism, mega-rich, mobile money, offshore financial centre, race to the bottom, regulatory arbitrage, Robert Shiller, Robert Shiller, South Sea Bubble, the market place, Thorstein Veblen, transaction costs, upwardly mobile, wealth creators, web of trust, Westphalian system, Wolfgang Streeck, zero-sum game

They are charged with deciding what kinds of legal, organizational, and financial structures are best suited to contain assets, and where to base those assets geographically. These decisions depend on the type of asset in question (is it a yacht, an art collection, or a stock portfolio?) as well as on the goals of the client. What wealth managers do As a practical matter, wealth managers’ daily practice is somewhat like that of architects, in that they design complex, multifunction structures. Indeed, the Nobel Prize–winning economist Robert Shiller recently defined finance as “the science of goal architecture—of the structuring of the economic arrangements necessary to achieve a set of goals and the stewardship of the assets needed for that achievement.”21 From this perspective, wealth management is a profession operating at the very core of finance. The financial architecture created by wealth managers contains assets rather than people; instead of bricks and mortar, the structures are composed of linked organizational entities, such as trusts, corporations, and foundations.

For further discussion, see Jens Beckert, “The Longue Durée of Inheritance Law: Discourses and Institutional Development in France, Germany and the United States since 1800,” Archives of European Sociology 48 (2007): 79–120. 18. Harrington, “Trust and Estate Planning.” 19. Lawrence Friedman, Dead Hands: A Social History of Wills, Trusts, and Inheritance Law (Stanford, CA: Stanford University Press, 2009). 20. Ronen Palan, Richard Murphy, and Christian Chavagneux, Tax Havens: How Globalization Really Works (Ithaca, NY: Cornell University Press, 2010). 21. Robert Shiller, Finance and the Good Society (Princeton, NJ: Princeton University Press, 2012). 22. Michael Parkinson, Trustee Investment and Financial Appraisal, 4th ed. (Birmingham, UK: Central Law Training, 2008), 20. 23. Michael Parkinson, Trust Creation: Law and Practice (Birmingham, UK: Central Law Training, 2005), 220. 24. Stephane Fitch, “Pritzker vs. Pritzker,” Forbes, November 24, 2003. 25. Graham Moffat, Trust Law: Text and Materials (Cambridge, UK: Cambridge University Press, 2009), 5. 26.


Adam Smith: Father of Economics by Jesse Norman

"Robert Solow", active measures, Andrei Shleifer, balance sheet recession, bank run, banking crisis, Basel III, Berlin Wall, Black Swan, Branko Milanovic, Bretton Woods, British Empire, Broken windows theory, business cycle, business process, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, centre right, cognitive dissonance, collateralized debt obligation, colonial exploitation, Corn Laws, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, David Brooks, David Ricardo: comparative advantage, deindustrialization, Eugene Fama: efficient market hypothesis, experimental economics, Fall of the Berlin Wall, Fellow of the Royal Society, financial intermediation, frictionless, frictionless market, future of work, George Akerlof, Hyman Minsky, income inequality, incomplete markets, information asymmetry, intangible asset, invention of the telescope, invisible hand, Isaac Newton, Jean Tirole, John Nash: game theory, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, lateral thinking, loss aversion, market bubble, market fundamentalism, Martin Wolf, means of production, money market fund, Mont Pelerin Society, moral hazard, moral panic, Naomi Klein, negative equity, Network effects, new economy, non-tariff barriers, Northern Rock, Pareto efficiency, Paul Samuelson, Peter Thiel, Philip Mirowski, price mechanism, principal–agent problem, profit maximization, purchasing power parity, random walk, rent-seeking, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, scientific worldview, seigniorage, Socratic dialogue, South Sea Bubble, special economic zone, speech recognition, Steven Pinker, The Chicago School, The Myth of the Rational Market, The Nature of the Firm, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Malthus, Thorstein Veblen, time value of money, transaction costs, transfer pricing, Veblen good, Vilfredo Pareto, Washington Consensus, working poor, zero-sum game

Adam Smith: Critical Assessments, 7 vols., Routledge 1983–94 Young, Jeffrey T. (ed.), The Elgar Companion to Adam Smith, Edward Elgar 2009 OTHER WORKS Acemoglu, Daron and James A. Robinson, Why Nations Fail, Profile Books 2012 Akerlof, George A. and Rachel E. Kranton, Identity Economics, Princeton University Press 2010 Akerlof, George A. and Robert J. Shiller, Animal Spirits, Princeton University Press 2009 Akerlof, George A. and Robert J. Shiller, Phishing for Phools: The Economics of Manipulation and Deception, Princeton University Press 2015 Allen, Robert, The British Industrial Revolution in Global Perspective, Cambridge University Press 2009 Anderson, James, An Enquiry into the Nature of the Corn Laws, Mrs Mundell 1777 Ariely, Dan, The (Honest) Truth about Dishonesty: How We Lie to Everyone—Especially Ourselves, HarperCollins 2012 Arrow, Kenneth, Social Choice and Individual Values, John Wiley 1951 Arrow, Kenneth and Frank Hahn, General Competitive Analysis, Holden-Day 1971 Bagehot, Walter, Economic Studies, ed.

It is now the fashion to ridicule this taste as unnatural… In the cabbage-garden of a tallow-chandler we may sometimes perhaps have seen as many columns and vases, and other ornaments in yew, as there are in marble and porphyry at Versailles: it is this vulgarity which has disgraced them. The rich and the great, the proud and the vain, will not admit into their gardens an ornament which the meanest of the people can have as well as they.’ History of manias, bubbles and crashes: there is considerable controversy as to the correct explanation for different bubbles or manias. See e.g. Charles P. Kindleberger, Manias, Panics, and Crashes, 4th edn, John Wiley 2000; Robert Shiller, Irrational Exuberance, Princeton University Press 2000; Peter Garber, Famous First Bubbles: The Fundamentals of Early Manias, MIT Press 2000; and for finance, Carmen Reinhart and Kenneth Rogoff, This Time is Different, Princeton University Press 2011 Keynes’s beauty competition: J. M. Keynes, The General Theory of Employment, Interest and Money, Macmillan 1936 Asset markets and credit creation: see George Cooper, The Origin of Financial Crises, 2nd edn, Harriman House 2010 Hyman Minsky: see his Stabilizing an Unstable Economy, Yale University Press 1986.

Contours of the World Economy 1–2030 AD, Oxford University Press 2007; there is a very vigorous debate on all sides of this issue. On progress and inequality—and the dynamic ebb and flow between them—see Angus Deaton, The Great Escape: Health, Wealth, and the Origins of Inequality, Princeton University Press 2013 GDP disparity between West and East Germany: CIA World Factbook, 1990 Incentives within capitalism encouraging rip-offs and exploitation: see George A. Akerlof and Robert J. Shiller, Phishing for Phools: The Economics of Manipulation and Deception, Princeton University Press 2015 ‘“Free Trade” is an accepted maxim of tedious orthodoxy’: Walter Bagehot, ‘Adam Smith and our Modern Economy’, reprinted in Economic Studies, ed. R. H. Hutton, Longman, Green 1895 Hamiltonian arguments for managed trade: cf. John Stuart Mill, Principles of Political Economy, John W. Parker 1848; Friedrich List, The National System of Political Economy, J.


pages: 278 words: 82,069

Meltdown: How Greed and Corruption Shattered Our Financial System and How We Can Recover by Katrina Vanden Heuvel, William Greider

Asian financial crisis, banking crisis, Bretton Woods, business cycle, buy and hold, capital controls, carried interest, central bank independence, centre right, collateralized debt obligation, conceptual framework, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, declining real wages, deindustrialization, Exxon Valdez, falling living standards, financial deregulation, financial innovation, Financial Instability Hypothesis, fixed income, floating exchange rates, full employment, housing crisis, Howard Zinn, Hyman Minsky, income inequality, information asymmetry, John Meriwether, kremlinology, Long Term Capital Management, margin call, market bubble, market fundamentalism, McMansion, money market fund, mortgage debt, Naomi Klein, new economy, offshore financial centre, payday loans, pets.com, plutocrats, Plutocrats, Ponzi scheme, price stability, pushing on a string, race to the bottom, Ralph Nader, rent control, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, sovereign wealth fund, structural adjustment programs, The Great Moderation, too big to fail, trade liberalization, transcontinental railway, trickle-down economics, union organizing, wage slave, Washington Consensus, women in the workforce, working poor, Y2K

In a way, they did—eventually and violently—by succumbing to a massive “correction”—much to the sorrow of millions of hapless investors, pension funds and others who had gotten no timely warnings from their government about what was ahead. Greenspan could not claim ignorance. In private meetings with Federal Reserve Board colleagues as far back as 1996, he was repeatedly warned of the dangers posed by the growing stock-price bubble. He declined to take any action or even warn the public. Yale economist Robert Shiller, whose book Irra- tional Exuberance impressively predicted the coming blood-bath, was a rare critic. A public official who fails to alert investors to such risks “is no better than a doctor who, having diagnosed high blood pressure in a patient, says nothing because he thinks the patient might be lucky and show no ill effects,” Shiller wrote. The Price of “Sound Money” The lopsided focus of Greenspan’s Fed—exalting financial markets over the real economy—is perhaps his greatest ideology-driven error, and it caused the deepest damage to society.

The logical response is a fundamental policy shift in favor of work and wages—boosting incomes and demand—but that approach would require taboo measures from the Keynesian past that even most Democrats don’t understand or support. Meanwhile, the financial froth of speculative bubbles—and their dangers—are another enduring legacy of the Greenspan era. “Irrational exuberance really is still with us,” Robert Shiller wrote in the new, revised edition of his book. Notwithstanding the earlier meltdown, the stock market remains dangerously overvalued by historical measures, Shiller warns, and is now accompanied by dramatic price inflation in real estate. These two bubbles are false valuations by markets and will burst sooner or later. Shiller urges investors to recognize the “risk that in 2010 or even 2015, the stock market will be lower still in real, inflation-corrected terms, than it was in 2005.”


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MONEY Master the Game: 7 Simple Steps to Financial Freedom by Tony Robbins

3D printing, active measures, activist fund / activist shareholder / activist investor, addicted to oil, affirmative action, Affordable Care Act / Obamacare, Albert Einstein, asset allocation, backtesting, bitcoin, buy and hold, clean water, cloud computing, corporate governance, corporate raider, correlation does not imply causation, Credit Default Swap, Dean Kamen, declining real wages, diversification, diversified portfolio, Donald Trump, estate planning, fear of failure, fiat currency, financial independence, fixed income, forensic accounting, high net worth, index fund, Internet of things, invention of the wheel, Jeff Bezos, Kenneth Rogoff, lake wobegon effect, Lao Tzu, London Interbank Offered Rate, market bubble, money market fund, mortgage debt, new economy, obamacare, offshore financial centre, oil shock, optical character recognition, Own Your Own Home, passive investing, profit motive, Ralph Waldo Emerson, random walk, Ray Kurzweil, Richard Thaler, risk tolerance, riskless arbitrage, Robert Shiller, Robert Shiller, self-driving car, shareholder value, Silicon Valley, Skype, Snapchat, sovereign wealth fund, stem cell, Steve Jobs, survivorship bias, telerobotics, the rule of 72, thinkpad, transaction costs, Upton Sinclair, Vanguard fund, World Values Survey, X Prize, Yogi Berra, young professional, zero-sum game

Americans have learned a hard lesson in recent years about the dangers of house flipping and using their homes like ATMs. A home, if it’s your primary residence, shouldn’t be seen as an investment to leverage, and it shouldn’t be counted on to produce a gigantic return. But wait, haven’t we always been told that your home is your best investment because it always goes up in value? In my search for answers, I sat down with the Nobel Prize–winning economist Robert Shiller, the leading expert on real estate markets, and creator of the Case-Shiller home price index of housing prices. His breakthrough insights were used to create the following chart. Shiller found that when he adjusted for inflation, US housing prices have been nearly flat for a century! He exploded one of the biggest myths of our time: that home prices keep going up and up. “Unless there’s a bubble,” he told me.

One of my favorites that I mentioned to you already is investing in senior housing, where you get both the income and the potential growth in appreciation as well. Or you can buy REITs: real estate investment trusts. These are trusts that own big chunks of commercial real estate (or mortgages) and sell shares to small investors, like mutual funds. REITs trade like stocks, and you can also buy shares of a REIT index fund, which gives you a diversity of many different REITs. For growth, the Nobel economist Robert Shiller told me that you’re better off investing in REITs than owning your own home (which belongs in the Security Bucket, anyway). “Buying an apartment REIT sounds to me like maybe a better investment than buying your own house,” he said, “because there seems to be a tilt toward renting now.” That could change, of course. And, as with any investment, you’ve got to pause and think, “What am I betting on?”

So I consider it my job not just to lead our teams but to get in the trenches alongside them and join them on the journey. I think in many ways you’re either born with leadership or not, but that doesn’t mean you’re not constantly working at it, honing it, and figuring out what works and what doesn’t. The style of leadership will change with different people or different situations, but the basic tenets of leadership are consistent. TR: I recently interviewed Dr. Robert Shiller, who just won the Nobel Prize in economics, and he was talking about all the good that financial institutions do in the world that people take for granted. Why do you think their reputations have shifted, and what can be done to turn it around? ME: Following the financial crisis, it’s easy to understand why some people lost trust in the industry. In hindsight, there were some things that needed to change—products that were too complex or confusing.


Firefighting by Ben S. Bernanke, Timothy F. Geithner, Henry M. Paulson, Jr.

Asian financial crisis, asset-backed security, bank run, Basel III, break the buck, Build a better mousetrap, business cycle, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Doomsday Book, financial deregulation, financial innovation, housing crisis, Hyman Minsky, income inequality, invisible hand, Kenneth Rogoff, labor-force participation, light touch regulation, London Interbank Offered Rate, Long Term Capital Management, margin call, money market fund, moral hazard, mortgage debt, negative equity, Northern Rock, pets.com, price stability, quantitative easing, regulatory arbitrage, Robert Shiller, Robert Shiller, savings glut, short selling, sovereign wealth fund, special drawing rights, The Great Moderation, too big to fail

Quarterly real GDP growth, percent change from preceding period Source: Bureau of Economic Analysis via Federal Reserve Economic Data (FRED) ANTECEDENTS Long-term interest rates had been falling for decades, reflecting decreasing inflation, an aging workforce, and a rise in global savings. Benchmark interest rates, monthly Sources: Federal Reserve Board and Freddie Mac Primary Mortgage Market Survey® via Federal Reserve Economic Data (FRED) ANTECEDENTS Home prices across the country had been rising rapidly for nearly a decade. Real home price index, percentage change from 1890 Source: U.S. Home Price and Related Data, Robert J. Shiller, Irrational Exuberance ANTECEDENTS Household debt as a share of income had risen to alarming heights. Aggregate household debt as a share of disposable personal income Source: Federal Reserve Board Financial Accounts of the United States, based on Ahn et al. (2018) ANTECEDENTS Credit and risk had migrated outside the regulated banking system. Credit market debt outstanding, by holder, as a share of nominal GDP Source: Federal Reserve Board Financial Accounts of the United States Notes: GSE: government-sponsored enterprise (including Fannie Mae and Freddie Mac); ABS: asset-backed securities issuers; MMF: money market funds ANTECEDENTS The amount of financial assets financed with short-term liabilities had also risen sharply, increasing the vulnerability of the financial system to runs.

SDR data were converted to U.S. dollars at $1.355820 per SDR (the rate on July 31, 1997) for the AFC and $1.557220 per SDR (the rate on Sept. 30, 2008) for the GFC. Outcomes OUTCOMES The severity of the stress of the 2008 financial crisis was, in some respects, worse than in the Great Depression. Sources: Stock prices: The Center for Research in Security Prices at Chicago Booth via Wharton Research Data Services (WRDS); housing prices: U.S. home price and related data, Robert J. Shiller, Irrational Exuberance; GD household wealth: Mishkin (1978); GR household wealth: Federal Reserve Board Financial Accounts of the United States OUTCOMES The U.S. government response ultimately stopped the panic and stabilized the financial system . . . Bank CDS spreads and Libor-OIS spread Sources: Libor-OIS: Bloomberg Finance L.P.; CDS spreads: Bloomberg Finance L.P., IHS Markit Note: Credit default swap spreads are equal-weighted averages of JPMorgan Chase, Citigroup, Wells Fargo, Bank of America, Morgan Stanley, and Goldman Sachs.

Louis Financial Crisis Policy Response Timeline; Federal Reserve Board; Federal Reserve Economic Data (FRED); International Monetary Fund; Macroeconomic Advisers®; Mishkin (1978); Organisation for Economic Co-operation and Development; U.S. Dept. of Treasury NOTES Cumulative growth in average income: Re-created with data underlying Figure 10, “The Distribution of Household Income, 2014,” Congressional Budget Office (2018), www.cbo.gov/publication/53597. See link for definitions of income and income groups. Real home price index: Based on Figure 3.1, U.S. home price and related data, Robert J. Shiller, Irrational Exuberance, 3rd ed. (Princeton, NJ: Princeton University Press, 2015), as updated by the author, www.econ.yale.edu/~shiller/data.htm. Aggregate household debt: Based on Figure 1, Panel 1, Michael Ahn, Michael Batty, and Ralf Meisenzahl, “Household Debt-to-Income Ratios in the Enhanced Financial Accounts,” FEDS Notes (Washington, DC: Board of Governors of the Federal Reserve System, January 11, 2018), https://doi.org/10.17016/2380-7172.2138.


pages: 453 words: 111,010

Licence to be Bad by Jonathan Aldred

"Robert Solow", Affordable Care Act / Obamacare, Albert Einstein, availability heuristic, Ayatollah Khomeini, Benoit Mandelbrot, Berlin Wall, Black Swan, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, Cass Sunstein, clean water, cognitive dissonance, corporate governance, correlation does not imply causation, cuban missile crisis, Daniel Kahneman / Amos Tversky, Donald Trump, Douglas Engelbart, Douglas Engelbart, Edward Snowden, Fall of the Berlin Wall, falling living standards, feminist movement, framing effect, Frederick Winslow Taylor, From Mathematics to the Technologies of Life and Death, full employment, George Akerlof, glass ceiling, Intergovernmental Panel on Climate Change (IPCC), invisible hand, Isaac Newton, Jeff Bezos, John Nash: game theory, John von Neumann, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, meta analysis, meta-analysis, Mont Pelerin Society, mutually assured destruction, Myron Scholes, Nash equilibrium, Norbert Wiener, nudge unit, obamacare, offshore financial centre, Pareto efficiency, Paul Samuelson, plutocrats, Plutocrats, positional goods, profit maximization, profit motive, race to the bottom, RAND corporation, rent-seeking, Richard Thaler, ride hailing / ride sharing, risk tolerance, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, Skype, Social Responsibility of Business Is to Increase Its Profits, spectrum auction, The Nature of the Firm, The Wealth of Nations by Adam Smith, transaction costs, trickle-down economics, Vilfredo Pareto, wealth creators, zero-sum game

Moreover, ‘big data’ and improvements in information technology have allowed theories to be tested in a way that was previously impossible. So yes, economics research focused on empirical evidence has recently become more common. Yet economists are still reluctant to ‘get their hands dirty’ with the messiness of real life. Most contemporary economists mainly use just one type of empirical evidence – large statistical datasets – which can be accessed without leaving your office. Nobel laureate Robert Shiller describes the problem as ‘an attitude in the profession that collecting data is for lesser people’.9 Before ‘physics envy’ led mainstream economics from the 1960s onwards to become dominated by mathematical modelling, economists had drawn on a broader mix of evidence including case studies and interviews – often involving going out and talking to people in the real economy. Even if we ignore this problem of the narrow evidence base of modern economics, historians have shown that empirical research in economics today is still rarer than it was in the 1950s.10 So the ‘data revolution’ claims made by recent economists are misleading.

Van Horn (2012), ‘Inland Empire: Economics’ Imperialism as an Imperative of Chicago Neoliberalism’, Journal of Economic Methodology, 19 (3), 259–82. 7 Fourcade, M., Ollion, E., and Algan, Y. (2015), ‘The Superiority of Economists’, Journal of Economic Perspectives, 29 (1), table 2. 8 Van Noorden, R. (2015), ‘Interdisciplinary Research by the Numbers’, Nature, 525 (7569): 306–30. 9 Sommer, Jeff, ‘Robert Shiller: A Skeptic and a Nobel Winner’, New York Times, 19 October 2013. 10 Backhouse, R., and Cherrier, B. (2017), ‘The Age of the Applied Economist’, History of Political Economy, 49 (supplement), 1–33. 11 Backhouse, R., and Cherrier, B. (2017), ‘“It’s Computers, Stupid!” The Spread of Computers and the Changing Roles of Theoretical and Applied Economics’, History of Political Economy, 49 (supplement), 103–26. 12 http://web.mit.edu/krugman/www/howiwork.html. 13 At the ASSA meetings, Chicago, January 2017.


Money and Government: The Past and Future of Economics by Robert Skidelsky

anti-globalists, Asian financial crisis, asset-backed security, bank run, banking crisis, banks create money, barriers to entry, Basel III, basic income, Ben Bernanke: helicopter money, Big bang: deregulation of the City of London, Bretton Woods, British Empire, business cycle, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, constrained optimization, Corn Laws, correlation does not imply causation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, David Graeber, David Ricardo: comparative advantage, debt deflation, Deng Xiaoping, Donald Trump, Eugene Fama: efficient market hypothesis, eurozone crisis, financial deregulation, financial innovation, Financial Instability Hypothesis, forward guidance, Fractional reserve banking, full employment, Gini coefficient, Growth in a Time of Debt, Hyman Minsky, income inequality, incomplete markets, inflation targeting, invisible hand, Isaac Newton, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, labour mobility, law of one price, liberal capitalism, light touch regulation, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, market clearing, market friction, Martin Wolf, means of production, Mexican peso crisis / tequila crisis, mobile money, Mont Pelerin Society, moral hazard, mortgage debt, new economy, Nick Leeson, North Sea oil, Northern Rock, offshore financial centre, oil shock, open economy, paradox of thrift, Pareto efficiency, Paul Samuelson, placebo effect, price stability, profit maximization, quantitative easing, random walk, regulatory arbitrage, rent-seeking, reserve currency, Richard Thaler, rising living standards, risk/return, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, secular stagnation, shareholder value, short selling, Simon Kuznets, structural adjustment programs, The Chicago School, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, too big to fail, trade liberalization, value at risk, Washington Consensus, yield curve, zero-sum game

The trouble, explained his Chancellor, Alistair Darling, was the ‘Taliban wing’ of the Treasury who thought Snowden was right.8 The global turning point can be dated from the meeting of the G7’s finance ministers at Iqaluit in Canada in February 2010, which, dominated by the Greek crisis, committed governments to slashing deficits.9 Orthodox economists argued that cutting public spending would boost output by reducing borrowing costs and increasing confidence. 224 t h e di s a bl e m e n t of f i s c a l p ol ic y In a pallid echo of Keynes’s ‘paradox of thrift’, the larger G20 acknowledged, in a declaration following its 2010 Toronto summit, that ‘synchronised financial adjustment [i.e. if all governments tried to reduce their deficits simultaneously] across several major economies could adversely impact the recovery’,10 but only President Obama stood out against the stampede towards what Germany’s Finance Minister Wolfgang Schäuble approvingly dubbed ‘expansionary fiscal consolidation’. Obama was supported by economists Paul Krugman, Joseph Stiglitz, Robert Shiller, Larry Summers, Nouriel Roubini and Brad DeLong. But ‘expansionary fiscal consolidation’ became the consensual view of Europe’s finance ministers.11 The majority of financial economists supinely followed the lead of the consolidators. Of the UK’s top economic journalists, Martin Wolf and Samuel Brittan of the Financial Times and Larry Elliott of the Guardian were lonely dissenters. This was at a time when global output was still 5 per cent below what it had been pre-crash.12 The British economics profession was largely silent.

It presents a vulgarized picture of the discipline, the way, perhaps, it is understood by non-economists (including politicians and some badly trained officials), but remote from the mental universe of practising economists. They will also point to the progressive elements in the economists’ research programme. What is called ‘behavioural economics’ only really took off after the crisis, although in 1984 Robert Shiller, the doyen of behavioural economics, had already labelled the Efficient Market Hypothesis ‘one of the most remarkable errors in the history of economic thought’.53 Behavioural economics utilizes empirical psychology to explain why individual behaviour does not conform to the neo-classical model of rationality. One might think this is an act of supererogation, were it not for the primitive character of economists’ understanding of psychology.

The Queen’s question might have been more accurately posed as ‘Why did no one in mainstream economics see it coming?’ What follows is about the views of the economists ‘in power’. To a number of economists outside the mainstream, such as William Black, Stephen Keen, Randall Wray and James Galbraith, it was obvious that the financial system was on an unsustainable roll. Of those in the mainstream, Raghuram Rajan and Robert Shiller can claim credit for having foreseen a crisis, for various reasons. The general cause of the financial collapse had been previsioned by Hyman Minsky in his ‘financial instability hypothesis’: see Minsky (1992). 3. Quoted in Kynaston (2017), p. 358. Montagu Norman to Henry Clay. 4. The original is a bit more verbose than the familiar form given above. Ronald Reagan’s actual words were: ‘In this present crisis, government is not the solution to our problem; government is the problem.’


pages: 407 words: 114,478

The Four Pillars of Investing: Lessons for Building a Winning Portfolio by William J. Bernstein

asset allocation, Bretton Woods, British Empire, business cycle, butter production in bangladesh, buy and hold, buy low sell high, carried interest, corporate governance, cuban missile crisis, Daniel Kahneman / Amos Tversky, Dava Sobel, diversification, diversified portfolio, Edmond Halley, equity premium, estate planning, Eugene Fama: efficient market hypothesis, financial independence, financial innovation, fixed income, George Santayana, German hyperinflation, high net worth, hindsight bias, Hyman Minsky, index fund, invention of the telegraph, Isaac Newton, John Harrison: Longitude, Long Term Capital Management, loss aversion, market bubble, mental accounting, money market fund, mortgage debt, new economy, pattern recognition, Paul Samuelson, quantitative easing, railway mania, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Robert Shiller, South Sea Bubble, stocks for the long run, stocks for the long term, survivorship bias, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, the rule of 72, transaction costs, Vanguard fund, yield curve, zero-sum game

In the first place, before 1980, companies kept far more than 2.6% of their capital value in retained earnings. In the second place, there is voluminous evidence that excess corporate cash from “retained earnings” (that is, earnings not paid out to the shareholders, but instead reinvested in the company) tends to be wasted. And finally, it just isn’t happening. In Figure 2-4, I’ve plotted the dividends and earnings of the stock market since 1900 (courtesy of Robert Shiller at Yale). Figure 2-4 is another one of those confusing “semilog” graphs. Their major advantage is that they allow you to estimate the percent rate of increase of earnings and dividends across a wide range of values. This is not true of standard “arithmetic” plots. With a semilog graph, a constant growth rate produces a plot that moves up at a fairly constant angle, called the slope. This is approximately what is seen in Figure 2-4.

Clearly the rapidly accelerating trend of earnings and dividend growth frequently cited by today’s New Era enthusiasts is nowhere to be seen. This analysis also demolishes another one of the supposed props of current stock valuations: stock buybacks, which should also increase per-share stock dividends. This is what is actually plotted in Figure 2-4. Figure 2-4. Nominal earnings and dividends, S&P 500. (Source: Robert Shiller, Yale University). • Bogle’s speculative return—the growth of the dividend multiple—could continue to provide future stock price increases with further growth of the dividend multiple. Why, you might ask, can’t the dividend multiple grow at 3% per year from here, yielding 3% of extra return? Unfortunately, this means that the dividend multiple would have to double every 24 years. While it is possible that this could occur for another decade or two, it is not sustainable in the long term.


pages: 94 words: 26,453

The End of Nice: How to Be Human in a World Run by Robots (Kindle Single) by Richard Newton

3D printing, Black Swan, British Empire, Buckminster Fuller, Clayton Christensen, crowdsourcing, deliberate practice, disruptive innovation, fear of failure, Filter Bubble, future of work, Google Glasses, Isaac Newton, James Dyson, Jaron Lanier, Jeff Bezos, job automation, lateral thinking, Lean Startup, low skilled workers, Mark Zuckerberg, move fast and break things, move fast and break things, Paul Erdős, Paul Graham, recommendation engine, rising living standards, Robert Shiller, Robert Shiller, Silicon Valley, Silicon Valley startup, skunkworks, social intelligence, Steve Ballmer, Steve Jobs, Y Combinator

What will change your world is not just what happens to your block of wood. Society initially changes gradually, Jenga block by Jenga block, but when it tumbles, the collapse happens all at once. Preparing for this is easier to do while the edifice still appears sound. “It’s going to be much harder if we wait until 70% of the population is out of a job,” said the Nobel Prize-winning economist Robert Shiller, during a McKinsey talk in 2014. The new normal This isn’t about temporary acceleration. This is not a phase through which you can simply hold your breath and cling on tight while you wait for stability to resume. That won’t happen because this is permanent. Permanent acceleration is our new normal. Change will come at us faster and faster. The 40-60 hour work week, one-track careers, growing wealth inequality and the shape of modern capitalism and society have all come to be seen as the inevitable, inescapable, and natural order of things.


pages: 306 words: 78,893

After the New Economy: The Binge . . . And the Hangover That Won't Go Away by Doug Henwood

"Robert Solow", accounting loophole / creative accounting, affirmative action, Asian financial crisis, barriers to entry, borderless world, Branko Milanovic, Bretton Woods, business cycle, capital controls, corporate governance, corporate raider, correlation coefficient, credit crunch, deindustrialization, dematerialisation, deskilling, ending welfare as we know it, feminist movement, full employment, gender pay gap, George Gilder, glass ceiling, Gordon Gekko, greed is good, half of the world's population has never made a phone call, income inequality, indoor plumbing, intangible asset, Internet Archive, job satisfaction, joint-stock company, Kevin Kelly, labor-force participation, liquidationism / Banker’s doctrine / the Treasury view, manufacturing employment, means of production, minimum wage unemployment, Naomi Klein, new economy, occupational segregation, pets.com, post-work, profit maximization, purchasing power parity, race to the bottom, Ralph Nader, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, Silicon Valley, Simon Kuznets, statistical model, structural adjustment programs, Telecommunications Act of 1996, telemarketer, The Bell Curve by Richard Herrnstein and Charles Murray, The Wealth of Nations by Adam Smith, total factor productivity, union organizing, War on Poverty, women in the workforce, working poor, zero-sum game

In some sense, EM theory is trivially true: of course prices reflect the collective judgments of investors, or at least their buying and selling. But what about the quaHty of those judgments? If markets are affected by crowd psychology, then prices could be efficiently reflecting delusions. Certainly you wouldn't need a lot of heavy math to prove this to someone who's lived through the past few years. Cracks began appearing in the EM consensus in the early 1980s. In a classic 1981 paper, Robert Shiller—later more famous as the author of Irrational Exuberance —showed that stock prices were far more volatile than were dividends, typically exaggerating the up-and-down moves through the economic cycle; if the market were rationally valuing shares, prices and underlying dividends should move more or less in tandem. (Shiller used dividends, but the concept would work with profits as well.) Shiller subsequently developed theories of markets as arenas of crowd psychology, tending toward fad and overreaction.


pages: 290 words: 76,216

What's Wrong with Economics? by Robert Skidelsky

"Robert Solow", additive manufacturing, agricultural Revolution, Black Swan, Bretton Woods, business cycle, Cass Sunstein, central bank independence, cognitive bias, conceptual framework, Corn Laws, corporate social responsibility, correlation does not imply causation, creative destruction, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, disruptive innovation, Donald Trump, full employment, George Akerlof, George Santayana, global supply chain, global village, Gunnar Myrdal, happiness index / gross national happiness, hindsight bias, Hyman Minsky, income inequality, index fund, inflation targeting, information asymmetry, Internet Archive, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, Joseph Schumpeter, Kenneth Arrow, knowledge economy, labour market flexibility, loss aversion, Mark Zuckerberg, market clearing, market friction, market fundamentalism, Martin Wolf, means of production, moral hazard, paradox of thrift, Pareto efficiency, Paul Samuelson, Philip Mirowski, precariat, price anchoring, principal–agent problem, rent-seeking, Richard Thaler, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, shareholder value, Silicon Valley, Simon Kuznets, survivorship bias, technoutopianism, The Chicago School, The Market for Lemons, The Nature of the Firm, the scientific method, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, Thomas Malthus, Thorstein Veblen, transaction costs, transfer pricing, Vilfredo Pareto, Washington Consensus, Wolfgang Streeck, zero-sum game

Everyone then says, ‘Oh, I always knew there was something wrong there . . .’ These examples upend the central verity of modern economics, that people always have rational expectations. They often make choices which they ought to know will leave them worse off. Advertisers were exploiting this propensity long before economists started to notice it. In their book, Phishing for Phools (2015), Nobel Laureates George Akerlof (b.1940) and Robert Shiller (b.1946) show, with many examples both amusing and appalling, that misperception and deception are rampant in market economies. ‘Phishing’ is a ‘fraud on the internet in order to glean personal information from individuals’ to get them to do things in the interest of the ‘phisherman’ rather than the ‘phools’. The two authors divide ‘phools’ into two classes – those too emotional to make sensible choices, and those victimised by misleading information.


pages: 756 words: 120,818

The Levelling: What’s Next After Globalization by Michael O’sullivan

"Robert Solow", 3D printing, Airbnb, algorithmic trading, bank run, banking crisis, barriers to entry, Bernie Sanders, bitcoin, Black Swan, blockchain, Boris Johnson, Branko Milanovic, Bretton Woods, British Empire, business cycle, business process, capital controls, Celtic Tiger, central bank independence, cloud computing, continuation of politics by other means, corporate governance, credit crunch, cryptocurrency, deglobalization, deindustrialization, disruptive innovation, distributed ledger, Donald Trump, eurozone crisis, financial innovation, first-past-the-post, fixed income, Geoffrey West, Santa Fe Institute, Gini coefficient, global value chain, housing crisis, income inequality, Intergovernmental Panel on Climate Change (IPCC), knowledge economy, liberal world order, Long Term Capital Management, longitudinal study, market bubble, minimum wage unemployment, new economy, Northern Rock, offshore financial centre, open economy, pattern recognition, Peace of Westphalia, performance metric, private military company, quantitative easing, race to the bottom, reserve currency, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, Scramble for Africa, secular stagnation, Silicon Valley, Sinatra Doctrine, South China Sea, South Sea Bubble, special drawing rights, supply-chain management, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, total factor productivity, trade liberalization, tulip mania, Valery Gerasimov, Washington Consensus

Even the Wall Street Journal editorial team has warned that the Trump trade team is like Senator Reed Smoot and Representative Willis Hawley, promotors of the disastrous 1930 Smoot-Hawley Tariff Act that aided and abetted the onset of the Great Depression with the introduction of tariffs of up to 60 percent on twenty thousand types of goods imported into the United States.11 The net effect of the act was to squash any hope of an economic recovery in the aftermath of the Great Depression and to cut world trade by 33 percent. In addition, readers might tremble to know that Hoover took office with US equity valuations at very high levels. Robert Shiller’s excellent database highlights that the US long-term market’s price to earnings ratio was at 32 in January 1929 (the highest it reached was 44 in December 1999) and that it reads 28 today, which is 69 percent higher than the historical average of 16 and thus puts the market in expensive territory from a valuation standpoint.12 Eight months into Hoover’s term the Wall Street Crash occurred, and the United States lurched first into recession and then into the Great Depression.

Credit Suisse Research Institute, Credit Suisse Investment Returns Yearbook 2018, https://www.credit-suisse.com/corporate/en/research/research-institute/publications.html. 10. An NBER working paper by Grace Xing Hu, Jun Pan, and Jang Wang gives a very good overview of the development of China’s capital market development. Hu, Pan, and Wang, “The Chinese Capital Market.” 11. “Trump’s Trade Folly,” editorial, Wall Street Journal, March 1, 2018. 12. Analysis drawn from data in Robert Shiller’s historic stock market data found at http://www.econ.yale.edu/~shiller/data.htm. 13. See, for example, Bernanke, “The Macroeconomics of the Great Depression.” 14. One of Ben Bernanke’s fields of expertise is the Great Depression; see, for example, his Essays on the Great Depression. 15. Buckles, Hungermann, and Lugauer, “Is Fertility a Leading Economic Indicator?.” 16. Freedman, The Future of War, 264. 17.


pages: 172 words: 54,066

The End of Loser Liberalism: Making Markets Progressive by Dean Baker

Asian financial crisis, banking crisis, Bernie Sanders, business cycle, collateralized debt obligation, collective bargaining, corporate governance, currency manipulation / currency intervention, Doha Development Round, financial innovation, full employment, Home mortgage interest deduction, income inequality, inflation targeting, invisible hand, manufacturing employment, market clearing, market fundamentalism, medical residency, patent troll, pets.com, pirate software, price stability, quantitative easing, regulatory arbitrage, rent-seeking, Robert Shiller, Robert Shiller, Silicon Valley, too big to fail, transaction costs

[27] The adjusted savings rate adds the statistical discrepancy in the national income accounts to income, under the assumption that most of the change in the statistical discrepancy through time is attributable to capital gains income showing up as normal income (Rosnick and Baker, 2011b). This explains the fact that the statistical discrepancy shifted from being positive through most of the postwar period to being a large negative at the peaks of the stock and housing bubbles. [28] The evidence is laid out in Baker (2002b). [29] The existence of a 100-year-long trend was uncovered in research by Robert Shiller (2006), which was not yet available in 2002. However, it was possible to use publicly available data sources to determine that nationwide home prices had just tracked inflation since 1953 (see Baker 2002b). [30] Greenspan (2002). [31] There was the possibility that the gap between home sale prices and rent was driven by the extraordinarily low mortgage rates available at the time. This argument has two problems.


pages: 130 words: 32,279

Beyond the 4% Rule: The Science of Retirement Portfolios That Last a Lifetime by Abraham Okusanya

asset allocation, diversification, diversified portfolio, high net worth, longitudinal study, market design, mental accounting, Paul Samuelson, quantitative easing, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, transaction costs

Why do we invest in equities, rather than keep money under the mattress over a very long term? Because equity past performance tells us that they’ll most likely outperform cash over the long term. How do we know that equities tend to outperform bonds over the long term? Past performance tells us so. And of course, basic reasoning backs this up. Renowned academics, from Harry Markowitz, Paul Samuelson and William Sharpe to Robert Shiller and Gene Fama, have greatly improved our understanding of how the capital markets work. In the process, they’ve won Nobel Prizes! Much of their work is based on the exploration of asset classes using extensive historical performance data. If it’s good enough for Fama or Sharpe, it’s good enough for me. Financial planners can gain incredible insight by looking at how a financial plan would have fared under various real, past market scenarios.


How an Economy Grows and Why It Crashes by Peter D. Schiff, Andrew J. Schiff

Bretton Woods, business climate, currency peg, hiring and firing, indoor plumbing, offshore financial centre, price stability, Robert Shiller, Robert Shiller, technology bubble

In addition to the profits made by real estate “flippers” (those who serially bought and sold properties), homeowners extracted hundreds of billions of dollars per year from their homes. The process turned houses into tax-free ATM machines. People used the money to renovate their homes, take vacations, pay for college, buy cars and electronics, and just generally live better than they would have if their homes had not appreciated in value. But the wealth was simply a mirage. In his book Irrational Exuberance economist Robert Shiller determined that in the 100 years between 1900 and 2000, home prices in the United States increased by an average of 3.4 percent per year (which is just slightly higher than the average rate of inflation). There were good reasons for this. Prices were firmly tied to people’s ability to pay, which is a function of income and credit availability. But from 1997 to 2006 national home prices gained an astounding 19.4 percent per year on average.


pages: 416 words: 106,532

Cryptoassets: The Innovative Investor's Guide to Bitcoin and Beyond: The Innovative Investor's Guide to Bitcoin and Beyond by Chris Burniske, Jack Tatar

Airbnb, altcoin, asset allocation, asset-backed security, autonomous vehicles, bitcoin, blockchain, Blythe Masters, business cycle, business process, buy and hold, capital controls, Carmen Reinhart, Clayton Christensen, clean water, cloud computing, collateralized debt obligation, commoditize, correlation coefficient, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, disintermediation, distributed ledger, diversification, diversified portfolio, Donald Trump, Elon Musk, en.wikipedia.org, Ethereum, ethereum blockchain, fiat currency, financial innovation, fixed income, George Gilder, Google Hangouts, high net worth, Jeff Bezos, Kenneth Rogoff, Kickstarter, Leonard Kleinrock, litecoin, Marc Andreessen, Mark Zuckerberg, market bubble, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Network effects, packet switching, passive investing, peer-to-peer, peer-to-peer lending, Peter Thiel, pets.com, Ponzi scheme, prediction markets, quantitative easing, RAND corporation, random walk, Renaissance Technologies, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ross Ulbricht, Satoshi Nakamoto, Sharpe ratio, Silicon Valley, Simon Singh, Skype, smart contracts, social web, South Sea Bubble, Steve Jobs, transaction costs, tulip mania, Turing complete, Uber for X, Vanguard fund, WikiLeaks, Y2K

On the first day of trading, the coin momentarily achieved a price of 3,300 bitcoin, or more than $2 million dollars per zcash, on Poloniex.24 Within two days it had crashed below 1 bitcoin per zcash and continued to fall, closing out 2016 at a price of .05 bitcoin per zcash, or roughly $48.25 While zcash has since stabilized and continues to hold great promise as a cryptoasset, its rocky start was caused by mass speculation. Words of Warning for the Innovative Investor Tempted by Bubbles Robert Shiller, author, professor, and Nobel Prize winner, defined a bubble as “a social epidemic that involves extravagant expectations for the future.”26 We’ve talked much about the expectations for the future of cryptoassets. However, we also believe innovative investors must be grounded in common sense in order to identify proper investments from improper ones, and they need to recognize when buying opportunities exist and when the madness of the crowd has taken over.

Recall that a coinbase transaction is the transaction that pays the miner with newly minted units of a cryptoasset in exchange for the miner having appended a new block to the blockchain. 23. https://cryptohustle.com/zcash-launch-breaks-records. 24. http://www.coindesk.com/bitcoin-breaks-700-zcash-steals-show/. 25. https://www.cryptocompare.com/coins/zec/charts/BTC?p=ALL. 26. http://www.zerohedge.com/news/2015-05-29/robert-shiller-unlike-1929-time-everything-stocks-bonds-and-housing-overvalued. 27. https://hbr.org/2014/01/what-alan-greenspan-has-learned-since-2008. 28. Edward Chancellor, Devil Take the Hindmost. 29. http://query.nytimes.com/gst/abstract.html?res=9806E6DF1639E03ABC4E52DFB6678382639EDE&legacy=true. 30. http://time.com/3207128/stock-market-high-1929/. 31. Edward Chancellor, Devil Take the Hindmost. 32.


pages: 398 words: 111,333

The Einstein of Money: The Life and Timeless Financial Wisdom of Benjamin Graham by Joe Carlen

Albert Einstein, asset allocation, Bernie Madoff, Bretton Woods, business cycle, business intelligence, discounted cash flows, Eugene Fama: efficient market hypothesis, full employment, index card, index fund, intangible asset, invisible hand, Isaac Newton, laissez-faire capitalism, margin call, means of production, Norman Mailer, oil shock, post-industrial society, price anchoring, price stability, reserve currency, Robert Shiller, Robert Shiller, the scientific method, Vanguard fund, young professional

“Great Investors: Philip Fisher—Fisher's Investment Philosophy,” Morningstar.com, http://news.morningstar.com/classroom2/course.asp?docId=145662&page=2&CN=com (accessed April 9, 2012). 17. Buffett, “Superinvestors of Graham and Doddsville.” 18. Charles T. Munger, Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger, expanded 3rd ed., ed. Peter D. Kaufman (Florence, KY: Wadsworth, 2005), p. 63. 19. Buffett, “Superinvestors of Graham and Doddsville.” 20. Ibid. 21. Robert Shiller (Yale University Economics Department) and Yahoo! Finance, “CAGR of the Stock Market (Annualized Returns),” MoneyChimp, http://www.moneychimp.com/features/market_cagr.htm (accessed November 14, 2011). 22. Buffett, “Superinvestors of Graham and Doddsville.” 23. Ibid. 24. Roger Lowenstein, Buffett: The Making of an American Capitalist (New York: Random House, 1995), p. 135. 25. Warren Buffett, “Chairman's Letter,” Berkshire Hathaway, Inc., 2010 Annual Report, February 26, 2011, p. 2. 26.

Zagorin, Francis Bacon, p. 127. CHAPTER 13. STRANGER THAN FICTION 1. “Notes to Financial Statements: Note A—Liquidation-Dissolution- Liquidating Distributions,” Graham-Newman Corporation, January 31, 1958. 2. Letter, Graham-Newman Corporation, 1946. 3. Irving Kahn and Robert Milne, Benjamin Graham: The Father of Financial Analysis (Charlottesville, VA: Financial Analysts Research Foundation, 1977). 4. Robert Shiller (Yale University Economics Department) and Yahoo! Finance, “CAGR of the Stock Market (Annualized Returns),” MoneyChimp, http://www.moneychimp.com/features/market_cagr.htm (accessed November 14, 2011). 5. Ibid. 6. “Stockholder's Letter,” Graham-Newman Corporation, February 25, 1949, p. 6. 7. Michael Quint, “Buffett Moves to Acquire All of GEICO,” New York Times, August 26, 1995. 8. Ibid. 9.


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Red-Blooded Risk: The Secret History of Wall Street by Aaron Brown, Eric Kim

activist fund / activist shareholder / activist investor, Albert Einstein, algorithmic trading, Asian financial crisis, Atul Gawande, backtesting, Basel III, Bayesian statistics, beat the dealer, Benoit Mandelbrot, Bernie Madoff, Black Swan, business cycle, capital asset pricing model, central bank independence, Checklist Manifesto, corporate governance, creative destruction, credit crunch, Credit Default Swap, disintermediation, distributed generation, diversification, diversified portfolio, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, experimental subject, financial innovation, illegal immigration, implied volatility, index fund, Long Term Capital Management, loss aversion, margin call, market clearing, market fundamentalism, market microstructure, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, natural language processing, open economy, Pierre-Simon Laplace, pre–internet, quantitative trading / quantitative finance, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, special drawing rights, statistical arbitrage, stochastic volatility, stocks for the long run, The Myth of the Rational Market, Thomas Bayes, too big to fail, transaction costs, value at risk, yield curve

Open-source products available free are often better than commercial creations. Each of these cycles has its own form of money and its own form of risk management. Even in the paid economy, more and more goods are distributed on the basis of status, such as club memberships for airlines, hotels, discount shopping stores, and so on. Status becomes a kind of money. My final suggestion comes from Robert Shiller, who envisions derivatives for all major life decisions. Going to medical school next year? Why not sell half the median income of a cohort of medical school entrants similar to you and reduce your exposure to future changes in doctors’ wages? You couldn’t sell half of your personal income, because once you did, you might work less. But selling the cohort average wage protects you from things outside your control while insulating the buyer from your personal motivations.

The view of quantitative finance described in Red-Blooded Risk has a lot of overlap with two pathbreaking but eccentric works: The Handbook of Portfolio Mathematics: Formulas for Optimal Allocation & Leverage by Ralph Vince and Finding Alpha: The Search for Alpha When Risk and Return Break Down by Eric Falkenstein. A more famous pathbreaking and eccentric work is Benoit Mandelbrot’s The (Mis)behavior of Markets. Two of the best books on the future of finance are The New Financial Order: Risk in the 21st Century by Robert J. Shiller and Financing the Future: Market-Based Innovations for Growth by Franklin Allen and Glenn Yago. Both cover quite a bit of history to ground their predictions in something solid. If you like to study your quantitative finance through people, Espen Haug’s Derivatives Models on Models is an excellent choice. Also consider The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It by Scott Patterson, My Life as a Quant: Reflections on Physics and Finance by Emanuel Derman, Inside the House of Money: Top Hedge Fund Traders on Profiting in the Global Markets by Steven Drobny, and More Money Than God: Hedge Funds and the Making of a New Elite by Sebastian Mallaby.

McMahon’s Happiness: A History covers a lot of related history and psychology. Kenneth R. French gathered some of the world’s top financial economists in Squam Lake, New Hampshire, to discuss the 2007–2009 financial crisis. Martin N. Baily, John Y. Campbell, John H. Cochrane, Douglas W. Diamond, Darrell Duffie, Anil K. Kashyap, Frederic S. Mishkin, Raghuram G. Rajan, David S. Scharfstein, Robert J. Shiller, Hyun Song Shin, Matthew J. Slaughter, Jeremy C. Stein, and Rene M. Stulz collaborated to write The Squam Lake Report: Fixing the Financial System. The result has the strengths and weaknesses of a consensus report, but it remains one of the best places to start understanding recent financial events. How Big Banks Fail and What to Do about It by Darrell Duffie is more direct and narrower in focus.


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People, Power, and Profits: Progressive Capitalism for an Age of Discontent by Joseph E. Stiglitz

"Robert Solow", affirmative action, Affordable Care Act / Obamacare, barriers to entry, basic income, battle of ideas, Berlin Wall, Bernie Madoff, Bernie Sanders, business cycle, Capital in the Twenty-First Century by Thomas Piketty, carried interest, central bank independence, clean water, collective bargaining, corporate governance, corporate social responsibility, creative destruction, Credit Default Swap, crony capitalism, deglobalization, deindustrialization, disintermediation, diversified portfolio, Donald Trump, Edward Snowden, Elon Musk, Erik Brynjolfsson, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, Firefox, Fractional reserve banking, Francis Fukuyama: the end of history, full employment, George Akerlof, gig economy, global supply chain, greed is good, income inequality, information asymmetry, invisible hand, Isaac Newton, Jean Tirole, Jeff Bezos, job automation, John Maynard Keynes: Economic Possibilities for our Grandchildren, John von Neumann, Joseph Schumpeter, labor-force participation, late fees, low skilled workers, Mark Zuckerberg, market fundamentalism, mass incarceration, meta analysis, meta-analysis, minimum wage unemployment, moral hazard, new economy, New Urbanism, obamacare, patent troll, Paul Samuelson, pension reform, Peter Thiel, postindustrial economy, price discrimination, principal–agent problem, profit maximization, purchasing power parity, race to the bottom, Ralph Nader, rent-seeking, Richard Thaler, Robert Bork, Robert Gordon, Robert Mercer, Robert Shiller, Robert Shiller, Ronald Reagan, secular stagnation, self-driving car, shareholder value, Shoshana Zuboff, Silicon Valley, Simon Kuznets, South China Sea, sovereign wealth fund, speech recognition, Steve Jobs, The Chicago School, The Future of Employment, The Great Moderation, the market place, The Rise and Fall of American Growth, the scientific method, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, transaction costs, trickle-down economics, two-sided market, universal basic income, Unsafe at Any Speed, Upton Sinclair, uranium enrichment, War on Poverty, working-age population

And this lowered private investment bodes poorly for future growth.50 There is a further effect that has already been noted: innovation that should be directed at creating more efficient ways of producing better products is instead directed at better ways of creating and maintaining market power and exploiting consumers. While our financial firms have excelled in the latter arena, they are not alone, as Nobel Prize winners George Akerlof and Robert Shiller demonstrate forcefully in their 2015 book Phishing for Phools: The Economics of Manipulation and Deception.51 We’ve described, for instance, how our cigarette, pharmaceutical, and food companies have profited from producing products that are addictive, and not only not needed, but are also actually harmful. We used to think that high profits were a sign of the successful working of the American economy, a better product, a better service.

Markets are only efficient in the absence of distortionary asymmetries in information, whether those were natural or created by the market. Big Data is increasing these asymmetries, and thereby potentially making resource allocations less efficient. 19.Jennifer Valentino-DeVries, Jeremy Singer-Vine, and Ashkan Soltani, “Websites Vary Prices, Deals Based on Users’ Information,” Wall Street Journal, Dec. 24, 2012. 20.To use the colorful language of Nobel Prize winners George Akerlof and Robert Shiller, to “phish for phools.” See Akerlof and Shiller, Phishing for Phools. 21.See Tüfekçi’s TED talk, “We’re Building a Dystopia Just to Make People Click on Ads,” Oct. 27, 2017. 22.Others joined in the suit against Myriad, including the University of Pennsylvania and researchers at Columbia, NYU, Emory, and Yale. The American Civil Liberties Union and the Public Patent Foundation provided legal representation for the plaintiffs.


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The End of Alchemy: Money, Banking and the Future of the Global Economy by Mervyn King

"Robert Solow", Andrei Shleifer, Asian financial crisis, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, Bretton Woods, British Empire, business cycle, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, centre right, collapse of Lehman Brothers, creative destruction, Credit Default Swap, crowdsourcing, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, distributed generation, Doha Development Round, Edmond Halley, Fall of the Berlin Wall, falling living standards, fiat currency, financial innovation, financial intermediation, floating exchange rates, forward guidance, Fractional reserve banking, Francis Fukuyama: the end of history, full employment, German hyperinflation, Hyman Minsky, inflation targeting, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, labour market flexibility, large denomination, lateral thinking, liquidity trap, Long Term Capital Management, manufacturing employment, market clearing, Martin Wolf, Mexican peso crisis / tequila crisis, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, Nick Leeson, North Sea oil, Northern Rock,