Robert Shiller

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The Euro: How a Common Currency Threatens the Future of Europe by Joseph E. Stiglitz, Alex Hyde-White

"there is no alternative" (TINA), "World Economic Forum" Davos, Alan Greenspan, bank run, banking crisis, barriers to entry, battle of ideas, behavioural economics, Berlin Wall, Bretton Woods, business cycle, buy and hold, capital controls, carbon tax, Carmen Reinhart, cashless society, central bank independence, centre right, cognitive dissonance, collapse of Lehman Brothers, collective bargaining, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, currency peg, dark matter, David Ricardo: comparative advantage, disintermediation, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, fiat currency, financial innovation, full employment, George Akerlof, Gini coefficient, global supply chain, Great Leap Forward, Growth in a Time of Debt, housing crisis, income inequality, incomplete markets, inflation targeting, information asymmetry, investor state dispute settlement, invisible hand, Kenneth Arrow, Kenneth Rogoff, knowledge economy, light touch regulation, low interest rates, manufacturing employment, market bubble, market friction, market fundamentalism, Martin Wolf, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mortgage debt, neoliberal agenda, new economy, open economy, paradox of thrift, pension reform, pensions crisis, price stability, profit maximization, purchasing power parity, quantitative easing, race to the bottom, risk-adjusted returns, Robert Shiller, Ronald Reagan, Savings and loan crisis, savings glut, secular stagnation, Silicon Valley, sovereign wealth fund, the payments system, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, transfer pricing, trickle-down economics, Washington Consensus, working-age population

More modern theories emphasize imperfectly informed and often irrational consumers and firms operating in markets with imperfect and asymmetric information, where profits can typically be enhanced more by exploiting these market imperfections than in any other way. Nobel Prize–winning economists George Akerlof and Rob Shiller document this widespread behavior in their brilliant book Phishing for Phools—using the term for Internet scammers who systematically “fish for fools.”16 With financial products moving ever more easily throughout Europe, the opportunity to take advantage of a whole continent of people who might be duped into buying financial products that were not suitable for them proved irresistible.

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See Nikolaos Antonakakis and Alan Collins, “The Impact of Fiscal Austerity on Suicide: On the Empirics of a Modern Greek Tragedy” 112 (2014): 39–50. 24 The current account is the balance of trade, net primary income or factor income (earnings on foreign investments minus payments made to foreign investors), and net cash transfers, that have taken place over a given period of time. 25 As Keynes once wrote, “In the long run we are all dead.” A Tract on Monetary Reform (London: Macmillan, 1923), p. 80. 26 For instance, they do not build in, or build in in a fully adequate way, essential market imperfections—for example, the irrationality of financial markets, as emphasized by the research of Nobel Prize–winning economist Rob Shiller (see, for instance, his book Irrational Exuberance [Princeton, NJ: Princeton University Press, 2000]) or the pervasive imperfections of information (as emphasized by Nobel Prize–winning economists Michael Spence, George Akerlof, and myself). For a more extensive discussion of the failures of the standard macroeconomic models, see, for instance, Stiglitz, “Rethinking Macroeconomics: What Failed and How to Repair It,” Journal of the European Economic Association 9, no. 4 (2011): 591–645; and Stiglitz, “Stable Growth in an Era of Crises: Learning from Economic Theory and History,” Ekonomi-tek 2, no. 1 (2013): 1–38 (originally delivered as keynote lecture to the Turkish Economic Association, Izmir, November, 2012).

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As this book goes to press, traders convicted in the scandal were appealing their verdicts. Meanwhile, some banks were still under investigation. In another case of massive market manipulation, Citigroup, JPMorgan, Barclays, Royal Bank of Scotland, and UBS agreed to plead guilty to a felony of market manipulation. 16 George A. Akerlof and Robert A. Shiller, Phishing for Phools: The Economics of Manipulation and Deception (Princeton, NJ: Princeton University Press, 2015). 17 In the United States almost unbounded campaign contributions are made to the individual and the party that comes the closest to leaving the sector unregulated, with significant amounts given to the opposition for good measure.

Beyond Diversification: What Every Investor Needs to Know About Asset Allocation by Sebastien Page

Andrei Shleifer, asset allocation, backtesting, Bernie Madoff, bitcoin, Black Swan, Bob Litterman, book value, business cycle, buy and hold, Cal Newport, capital asset pricing model, commodity super cycle, coronavirus, corporate governance, COVID-19, cryptocurrency, currency risk, discounted cash flows, diversification, diversified portfolio, en.wikipedia.org, equity risk premium, Eugene Fama: efficient market hypothesis, fixed income, future of work, Future Shock, G4S, global macro, implied volatility, index fund, information asymmetry, iterative process, loss aversion, low interest rates, market friction, mental accounting, merger arbitrage, oil shock, passive investing, prediction markets, publication bias, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Feynman, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, robo advisor, seminal paper, shareholder value, Sharpe ratio, sovereign wealth fund, stochastic process, stochastic volatility, stocks for the long run, systematic bias, systematic trading, tail risk, transaction costs, TSMC, value at risk, yield curve, zero-coupon bond, zero-sum game

., 186–187, 197–198 Sapra, Steve, 132 Satchell, Stephen, 212 Scenario analysis: in asset allocation, 134 and asset class changes over time, 158–162 defensive use of, 157–167 defining scenarios in, 158 factor-based, 162–165 forward-looking scenarios in, 165–168 offensive use of, 167–168 Scherer, Bernd, 2, 117 Schoar, Antoinette, 221, 222 Seasholes, Mark, 31 Sentiment, 69, 131–132 Sharpe, Bill, 6, 7, 9, 13, 151 Sharpe ratios, 150 Sharps, Rob, 228 Shiller, Robert, 13, 14, 25–26 “The Shiller CAPE Ratio” (Siegel), 26 Shive, Sophie, 235 Shkreli, Martin, 238 Shorter-term investments, macro factors for, 63–66 Shorter-term valuation signals, 45–59 for relative valuation between stocks and bonds and across bond markets, 56–59 for tactical asset allocation, 45–59 Shriver, Charles, 57, 62, 94 Siegel, Jeremy, 12–14, 25, 26 Simonato, Jean-Guy, 143 Single-period portfolio optimization, 194–195, 197–215, 268 issues with concentrated and unstable solutions, 207–210 mean-variance optimization, 198, 203–207 and risk parity, 212–215 and usefulness of optimizers, 211–212 Size of measurement errors, 148 Skewness, 118 of call options, 118 mean reversion of, 118–119 persistence of, 117–119 positive vs. negative, 207 and risk forecasting, 144–145 (See also Negative skewness) “Skulls, Financial Turbulence, and Risk Management” (Kritzman and Li), 205 Smart betas, 179, 235 S.M.O.O.T.H. fund, 224–225 Smoothing bias, 128–130 Sovereign wealth funds, 37, 128–130, 194 S&P 500: in March 2018, 12 P/E ratio of, 30–31 realized one-month volatility on, 103–104 recent earnings on, 27 sector weights in, 159 and tech bubble, 163 Spread duration, 40–42 Stock market: used as market portfolio, 17–18 valuation changes in, 31–34 Stock picking, 233–243 “The Stock-Bond Correlation” (Johnson et al.), 132–133 Stocks: beta and relative returns of bonds and, 10–11 CAPM and returns on, 5–14, 20 correlation of bonds and, 132–134 of emerging markets, 159–160 and human capital, 189–190 international equity diversion, 125–126 in market portfolio, 17–19 P/E ratio and real return for, 12–13 P/E ratio vs.

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For inflation, we can use a market-implied or “breakeven” estimate, as measured by the difference between the yield of a nominal bond and an inflation-linked bond. In March 2018, 10-year inflation breakevens were around 2%. If we add inflation to the real return estimate, we get an expected nominal equity return of 7% (5% + 2%). Not bad. On the other hand, Robert Shiller, Yale professor and Nobel laureate, uses a P/E ratio that normalizes earnings over the last 10 years and adjusts for inflation (the cyclically adjusted price-earnings ratio, or CAPE). The 10-year period is meant to represent a full business cycle. His approach yields a meager 1% expected real return for US stocks, or 3% nominal if we assume 2% inflation.6 The CAPE is higher than the current P/E in part because earnings have increased significantly over the last 10 years.

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But on the other hand, valuations are more attractive than they were back in 2018, in a way that may offset lower rates. 4. For the nine years ending March 23, 2018. 5. Robert Huebscher, “Jeremy Siegel’s Predictions for 2018,” Advisor Perspectives, February 5, 2018. 6. Robert Huebscher, “Jeremy Siegel Versus Robert Shiller on Equity Valuations,” Advisor Perspectives, February 23, 2017. As of Q1 2018, the CAPE ratio was still relatively close to where it was when this article was published, hovering around 30. With the CAPE at 30, a simple earnings yield calculation would imply a 3.3% real return. It’s not clear how Shiller arrives at 1%, but I suspect he’s using a regression between the CAPE and subsequent returns to account for the fact that the relationship is not one-to-one. 7. http://shiller.barclays.com/SM/12/en/indices/welcome.app.

In Pursuit of the Perfect Portfolio: The Stories, Voices, and Key Insights of the Pioneers Who Shaped the Way We Invest by Andrew W. Lo, Stephen R. Foerster

Alan Greenspan, Albert Einstein, AOL-Time Warner, asset allocation, backtesting, behavioural economics, Benoit Mandelbrot, Black Monday: stock market crash in 1987, Black-Scholes formula, Bretton Woods, Brownian motion, business cycle, buy and hold, capital asset pricing model, Charles Babbage, Charles Lindbergh, compound rate of return, corporate governance, COVID-19, credit crunch, currency risk, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, Edward Glaeser, equity premium, equity risk premium, estate planning, Eugene Fama: efficient market hypothesis, fake news, family office, fear index, fiat currency, financial engineering, financial innovation, financial intermediation, fixed income, hiring and firing, Hyman Minsky, implied volatility, index fund, interest rate swap, Internet Archive, invention of the wheel, Isaac Newton, Jim Simons, John Bogle, John Meriwether, John von Neumann, joint-stock company, junk bonds, Kenneth Arrow, linear programming, Long Term Capital Management, loss aversion, Louis Bachelier, low interest rates, managed futures, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, money market fund, money: store of value / unit of account / medium of exchange, Myron Scholes, new economy, New Journalism, Own Your Own Home, passive investing, Paul Samuelson, Performance of Mutual Funds in the Period, prediction markets, price stability, profit maximization, quantitative trading / quantitative finance, RAND corporation, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Solow, Ronald Reagan, Savings and loan crisis, selection bias, seminal paper, shareholder value, Sharpe ratio, short selling, South Sea Bubble, stochastic process, stocks for the long run, survivorship bias, tail risk, Thales and the olive presses, Thales of Miletus, The Myth of the Rational Market, The Wisdom of Crowds, Thomas Bayes, time value of money, transaction costs, transfer pricing, tulip mania, Vanguard fund, yield curve, zero-coupon bond, zero-sum game

See “Remarks by Chairman Alan Greenspan” (our emphasis), Federal Reserve, December 5, 1996, http://www.federalreserve.gov/boarddocs/speeches/1996/19961205.htm. 35. From Robert J. Shiller, “Definition of Irrational Exuberance,” http://www.irrationalexuberance.com/definition.htm. 36. Leonhardt (2005). 37. Leonhardt (2005). 38. Greenspan (2007, 176). 39. Greenspan (2007, 177). 40. See “Robert Shiller: Stocks, Bonds and Real Estate are Overvalued,” GuruFocus, May 30, 2015, https://www.gurufocus.com/news/338699/robert-shiller-stocks-bonds-and-real-estate-are-overvalued. 41. Grove (2008). 42. Kindleberger (2000). 43. Kindleberger (2000, 16). 44. See “Robert Shiller: Stocks, Bonds and Real Estate are Overvalued,” GuruFocus, May 30, 2015, https://www.gurufocus.com/news/338699/robert-shiller-stocks-bonds-and-real-estate-are-overvalued. 45.

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See “Robert Shiller: Stocks, Bonds and Real Estate are Overvalued,” GuruFocus, May 30, 2015, https://www.gurufocus.com/news/338699/robert-shiller-stocks-bonds-and-real-estate-are-overvalued. 45. Rotblut and Shiller (2015). 46. For a discussion of narrative economics, see Shiller (2017). 47. Rotblut and Shiller (2015). 48. See “Robert Shiller: Stocks, Bonds and Real Estate are Overvalued,” GuruFocus, May 30, 2015, https://www.gurufocus.com/news/338699/robert-shiller-stocks-bonds-and-real-estate-are-overvalued. 49. Shiller (2014). 50. Milner (2015). 51. Interview with authors. 52. Interview with authors. 53. Interview with authors. 54.

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Others actually sold their equities only because they found themselves in massive liquidity squeezes, some of which were predictable. So, as investors, you should have a plan for liquidity needs in the face of deep trouble. And you should have some plan, in advance, for how you’re going to rebalance and move forward.”74 To create a Perfect Portfolio, you need to start with a plan. 9 Robert Shiller and Irrational Exuberance ROBERT (BOB) SHILLER’S most famous work was a challenge to the conventional wisdom that financial markets are efficient. Although the Nobel Prize committee would later call it the centerpiece of his work, many in the academic profession originally greeted it with harsh criticism. It wasn’t easy for him to endure the attacks on his work.

Capital Ideas Evolving by Peter L. Bernstein

Albert Einstein, algorithmic trading, Andrei Shleifer, asset allocation, behavioural economics, Black Monday: stock market crash in 1987, Bob Litterman, book value, business cycle, buy and hold, buy low sell high, capital asset pricing model, commodity trading advisor, computerized trading, creative destruction, currency risk, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, diversification, diversified portfolio, endowment effect, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, financial engineering, 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, Performance of Mutual Funds in the Period, price anchoring, price stability, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, seminal paper, Sharpe ratio, short selling, short squeeze, Silicon Valley, South Sea Bubble, statistical model, survivorship bias, systematic trading, tail risk, technology bubble, The Wealth of Nations by Adam Smith, transaction costs, yield curve, Yogi Berra, zero-sum game

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.

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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.

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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.

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

Alan Greenspan, Andrei Shleifer, asset allocation, asset-backed security, availability heuristic, backtesting, balance sheet recession, bank run, banking crisis, barriers to entry, behavioural economics, Bernie Madoff, Black Swan, Bob Litterman, bond market vigilante , book value, Bretton Woods, business cycle, buy and hold, buy low sell high, capital asset pricing model, capital controls, carbon credits, Carmen Reinhart, central bank independence, classic study, collateralized debt obligation, commoditize, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, deal flow, debt deflation, deglobalization, delta neutral, demand response, discounted cash flows, disintermediation, diversification, diversified portfolio, dividend-yielding stocks, equity premium, equity risk 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 macro, 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, inverted yield curve, invisible hand, John Bogle, junk bonds, Kenneth Rogoff, laissez-faire capitalism, law of one price, London Interbank Offered Rate, Long Term Capital Management, loss aversion, low interest rates, managed futures, 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, pension time bomb, performance metric, Phillips curve, Ponzi scheme, prediction markets, price anchoring, price stability, principal–agent problem, private sector deleveraging, proprietary trading, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Robert Shiller, savings glut, search costs, selection bias, seminal paper, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stochastic volatility, stock buybacks, stocks for the long run, survivorship bias, systematic trading, tail risk, 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

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.

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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.

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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.

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

Alan Greenspan, Andrei Shleifer, asset allocation, banking crisis, benefit corporation, Benoit Mandelbrot, book value, 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, Mahbub ul Haq, 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, Phillips curve, Ponzi scheme, price anchoring, random walk, Richard Thaler, risk tolerance, Robert Shiller, Ronald Reagan, Small Order Execution System, spice trade, statistical model, stocks for the long run, Suez crisis 1956, survivorship bias, the market place, Tobin tax, transaction costs, tulip mania, uptick rule, urban decay, Y2K

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.

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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.

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.: 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.”

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

"Friedman doctrine" OR "shareholder theory", Abraham Wald, activist fund / activist shareholder / activist investor, Alan Greenspan, Albert Einstein, Andrei Shleifer, AOL-Time Warner, asset allocation, asset-backed security, bank run, beat the dealer, behavioural economics, Benoit Mandelbrot, Big Tech, Black Monday: stock market crash in 1987, Black-Scholes formula, book value, Bretton Woods, Brownian motion, business cycle, buy and hold, capital asset pricing model, card file, Carl Icahn, Cass Sunstein, collateralized debt obligation, compensation consultant, complexity theory, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, democratizing finance, Dennis Tito, discovery of the americas, diversification, diversified portfolio, Dr. Strangelove, Edward Glaeser, Edward Thorp, endowment effect, equity risk premium, Eugene Fama: efficient market hypothesis, experimental economics, financial innovation, Financial Instability Hypothesis, fixed income, floating exchange rates, George Akerlof, Glass-Steagall Act, Henri Poincaré, Hyman Minsky, implied volatility, impulse control, index arbitrage, index card, index fund, information asymmetry, invisible hand, Isaac Newton, John Bogle, John Meriwether, John Nash: game theory, John von Neumann, joint-stock company, Joseph Schumpeter, junk bonds, Kenneth Arrow, libertarian paternalism, linear programming, Long Term Capital Management, Louis Bachelier, low interest rates, mandelbrot fractal, market bubble, market design, Michael Milken, Myron Scholes, New Journalism, Nikolai Kondratiev, Paul Lévy, Paul Samuelson, pension reform, performance metric, Ponzi scheme, power law, prediction markets, proprietary trading, prudent man rule, 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, rolodex, Ronald Reagan, seminal paper, shareholder value, Sharpe ratio, short selling, side project, Silicon Valley, Skinner box, Social Responsibility of Business Is to Increase Its Profits, South Sea Bubble, statistical model, stocks for the long run, tech worker, 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, Two Sigma, Tyler Cowen, value at risk, Vanguard fund, Vilfredo Pareto, volatility smile, Yogi Berra

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?”

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.: 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.

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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.

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

Alan Greenspan, AOL-Time Warner, Asian financial crisis, asset allocation, backtesting, banking crisis, Bear Stearns, behavioural economics, Black Monday: stock market crash in 1987, Black-Scholes formula, book value, 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, currency risk, Daniel Kahneman / Amos Tversky, Deng Xiaoping, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, equity risk 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, Glass-Steagall Act, housing crisis, Hyman Minsky, implied volatility, income inequality, index arbitrage, index fund, indoor plumbing, inflation targeting, invention of the printing press, Isaac Newton, it's over 9,000, John Bogle, joint-stock company, London Interbank Offered Rate, Long Term Capital Management, loss aversion, machine readable, market bubble, mental accounting, Minsky moment, Money creation, 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, proprietary trading, purchasing power parity, quantitative easing, random walk, Richard Thaler, risk free rate, risk tolerance, risk/return, Robert Gordon, 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, Tyler Cowen: Great Stagnation, uptick rule, 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.

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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.

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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.

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

"there is no alternative" (TINA), Adam Curtis, Alan Greenspan, Alvin Roth, An Inconvenient Truth, Andrei Shleifer, asset-backed security, bank run, barriers to entry, Basel III, Bear Stearns, behavioural economics, Berlin Wall, Bernie Madoff, Bernie Sanders, Black Swan, blue-collar work, bond market vigilante , bread and circuses, Bretton Woods, Brownian motion, business cycle, capital controls, carbon credits, 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, democratizing finance, disinformation, do-ocracy, Edward Glaeser, Eugene Fama: efficient market hypothesis, experimental economics, facts on the ground, Fall of the Berlin Wall, financial deregulation, financial engineering, financial innovation, Flash crash, full employment, George Akerlof, Glass-Steagall Act, Goldman Sachs: Vampire Squid, Greenspan put, Hernando de Soto, housing crisis, Hyman Minsky, illegal immigration, income inequality, incomplete markets, information asymmetry, invisible hand, Jean Tirole, joint-stock company, junk bonds, 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, Phillips curve, Ponzi scheme, Post-Keynesian economics, precariat, prediction markets, price mechanism, profit motive, public intellectual, quantitative easing, race to the bottom, random walk, rent-seeking, Richard Thaler, road to serfdom, Robert Shiller, Robert Solow, Ronald Coase, Ronald Reagan, Savings and loan crisis, savings glut, school choice, sealed-bid auction, search costs, Silicon Valley, South Sea Bubble, Steven Levy, subprime mortgage crisis, tail risk, technoutopianism, The Chicago School, The Great Moderation, the map is not the territory, The Myth of the Rational Market, the scientific method, The Theory of the Leisure Class by Thorstein Veblen, The Wisdom of Crowds, theory of mind, Thomas Kuhn: the structure of scientific revolutions, Thorstein Veblen, Tobin tax, tontine, too big to fail, transaction costs, Tyler Cowen, vertical integration, Vilfredo Pareto, War on Poverty, Washington Consensus, We are the 99%, working poor

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.

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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.

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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.

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, Alan Greenspan, asset allocation, backtesting, behavioural economics, Black-Scholes formula, book value, 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, currency risk, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, Everybody Ought to Be Rich, fixed income, German hyperinflation, implied volatility, index arbitrage, index fund, Isaac Newton, it's over 9,000, John Bogle, joint-stock company, Long Term Capital Management, loss aversion, machine readable, market bubble, mental accounting, Money creation, Myron Scholes, new economy, oil shock, passive investing, Paul Samuelson, popular capitalism, prediction markets, price anchoring, price stability, proprietary trading, purchasing power parity, random walk, Richard Thaler, risk free rate, risk tolerance, risk/return, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, stock buybacks, stocks for the long run, subprime mortgage crisis, survivorship bias, technology bubble, The Great Moderation, The Wisdom of Crowds, transaction costs, tulip mania, uptick rule, Vanguard fund, vertical integration

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.

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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.

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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.

Crisis Economics: A Crash Course in the Future of Finance by Nouriel Roubini, Stephen Mihm

Alan Greenspan, Asian financial crisis, asset-backed security, balance sheet recession, bank run, banking crisis, barriers to entry, Bear Stearns, behavioural economics, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, bond market vigilante , bonus culture, Bretton Woods, BRICs, British Empire, business cycle, call centre, capital controls, Carmen Reinhart, central bank independence, centralized clearinghouse, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, dark matter, David Ricardo: comparative advantage, debt deflation, Eugene Fama: efficient market hypothesis, Fall of the Berlin Wall, fiat currency, financial deregulation, financial engineering, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, George Akerlof, Glass-Steagall Act, global pandemic, global reserve currency, Gordon Gekko, Greenspan put, Growth in a Time of Debt, housing crisis, Hyman Minsky, information asymmetry, interest rate swap, invisible hand, Joseph Schumpeter, junk bonds, Kenneth Rogoff, laissez-faire capitalism, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, low interest rates, margin call, market bubble, market fundamentalism, Martin Wolf, means of production, Minsky moment, money market fund, moral hazard, mortgage debt, mortgage tax deduction, new economy, Northern Rock, offshore financial centre, oil shock, Paradox of Choice, paradox of thrift, Paul Samuelson, Ponzi scheme, price stability, principal–agent problem, private sector deleveraging, proprietary trading, pushing on a string, quantitative easing, quantitative trading / quantitative finance, race to the bottom, random walk, regulatory arbitrage, reserve currency, risk tolerance, Robert Shiller, Satyajit Das, Savings and loan crisis, savings glut, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, subprime mortgage crisis, Suez crisis 1956, The Great Moderation, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, too big to fail, tulip mania, Tyler Cowen, unorthodox policies, value at risk, We are all Keynesians now, Works Progress Administration, yield curve, Yom Kippur War

., September 7, 2006, transcript. 2 elaborated on his pessimistic vision: Nouriel Roubini, “The Rising Risk of a Systemic Financial Meltdown: The Twelve Steps to Financial Disaster,” February 5, 2008, online at http://www.roubini.com/analysis/44763.php; Stephen Mihm, “Dr. Doom,” New York Times Magazine, August 15, 2008. 3 Robert Shiller: Robert Shiller, Irrational Exuberance (Princeton, N.J.: Princeton University Press, 2000); Karl E. Case and Robert J. Shiller, “Is There a Bubble in the Housing Market?” Brookings Papers on Economic Activity 2 (2003), 299-362. 3 Raghuram Rajan: Raghuram G. Rajan, “Has Financial Development Made the World Riskier?” speech delivered at Federal Reserve Bank of Kansas City symposium, “The Greenspan Era: Lessons for the Future,” Jackson Hole, Wyo., August 27, 2005. 3 “the greatest of all credit bubbles”: Justin Lahart, “NASDAQ: Five Years after the Peak,” Wall Street Journal, March 7, 2005. 3 William White: Beat Balzli and Michaela Schiessl, “The Man Nobody Wanted to Hear,” Der Spiegel, July 8, 2009. 3 Maurice Obstfeld and Kenneth Rogoff: Maurice Obstfeld and Kenneth Rogoff, “The Unsustainable US Current Account Position Revisited,” National Bureau of Economic Research Working Paper no. 10869, November 2004. 3 Stephen Roach: Brett Arends, “Economic ‘Armageddon’ Predicted,” Boston Herald, November 23, 2004. 5 “animal spirits”: John Maynard Keynes, The General Theory of Employment, Interest, and Money (New York: Harcourt, Brace, and World, 1936), 161. 5 “the ideas of economists . . .”: Ibid., 383. 11 “The decadent international . . .”: John Maynard Keynes, “National Self-Sufficiency,” Yale Review 22 (1933): 760-61.

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Norton, 1973). 41 “Don’t bother . . .”: Andrew W. Lo and A. Craig MacKinlay, A Non-Random Walk Down Wall Street (Princeton, N.J.: Princeton University Press, 1999), 6. 41 Yale economist Robert Shiller: Robert J. Shiller, “Consumption, Asset Markets and Macroeconomic Fluctuations,” Carnegie-Rochester Conference Series on Public Policy 17 (1982): 203-38. 42 “While markets are not totally crazy . . .”: Robert J. Shiller, “From Efficient Markets Theory to Behavioral Finance,” Journal of Economic Perspectives 17 (2003): 90. 42 “models of human psychology . . .”: Ibid. 42 recent research in behavioral finance: Ibid.; Fox, Myth of the Rational Market, 175-210, 247-64. 42 “fundamental parameters . . .”: Shiller, “From Efficient Markets Theory,” 94. 42 “biased self-attribution”: Kent Daniel, David Hirshleifer, and Avanidhar Subramanyam, “Investor Psychology and Security Market Under- and Overreactions,” Journal of Finance 53 (1998): 1839-85. 43 “some accident . . . sets speculation . . .”: John Stuart Mill, Principles of Political Economy (London: Longmans Green, 1909): 527-29. 45 William Stanley Jevons: Sandra J.

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“The Panic of 1857: Origins, Transmission, and Containment.” Journal of Economic History 51 (1991): 807-34. Capie, Forrest, and Geoffrey E. Wood, eds. Financial Crises and the World Banking System. New York: St. Martin’s Press, 1986. Case, Karl E., John M. Quigley, and Robert J. Shiller. “Comparing Wealth Effects: The Stock Market versus the Housing Market.” Advances in Macroeconomics 5 (2005): 1-34. Case, Karl E., and Robert J. Shiller. “Is There a Bubble in the Housing Market?” Brookings Papers on Economic Activity 2 (2003): 299-362. Cassidy, John. How Markets Fail: The Logic of Economic Calamities. New York: Farrar, Straus and Giroux, 2009. Cihák, Martin, and Erlend W.

Market Sense and Nonsense by Jack D. Schwager

3Com Palm IPO, asset allocation, Bear Stearns, Bernie Madoff, Black Monday: stock market crash in 1987, 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, global macro, high net worth, implied volatility, index arbitrage, index fund, Jim Simons, junk bonds, London Interbank Offered Rate, Long Term Capital Management, low interest rates, managed futures, margin call, market bubble, market fundamentalism, Market Wizards by Jack D. Schwager, merger arbitrage, negative equity, pattern recognition, performance metric, pets.com, Ponzi scheme, proprietary trading, quantitative trading / quantitative finance, random walk, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, selection bias, Sharpe ratio, short selling, statistical arbitrage, statistical model, subprime mortgage crisis, survivorship bias, tail risk, 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.

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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.

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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.

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

Andrei Shleifer, asset-backed security, balance sheet recession, bank run, banking crisis, behavioural economics, 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, low interest rates, market bubble, Martin Wolf, money market fund, moral hazard, mortgage debt, negative equity, paradox of thrift, quantitative easing, Robert Shiller, Robert Solow, school choice, seminal paper, shareholder value, subprime mortgage crisis, 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.

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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.

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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.

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

accounting loophole / creative accounting, Alan Greenspan, Albert Einstein, asset allocation, asset-backed security, backtesting, Bear Stearns, beat the dealer, Bernie Madoff, book value, 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 engineering, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Japanese asset price bubble, John Bogle, junk bonds, Long Term Capital Management, loss aversion, low interest rates, margin call, market bubble, Mary Meeker, money market fund, mortgage tax deduction, new economy, Own Your Own Home, PalmPilot, 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 free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, stock buybacks, stocks for the long run, sugar pill, survivorship bias, The Myth of the Rational Market, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond

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.

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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.

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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.

Boom and Bust: A Global History of Financial Bubbles by William Quinn, John D. Turner

accounting loophole / creative accounting, Alan Greenspan, algorithmic trading, AOL-Time Warner, bank run, banking crisis, barriers to entry, Bear Stearns, behavioural economics, Big bang: deregulation of the City of London, bitcoin, blockchain, book value, Bretton Woods, business cycle, buy and hold, capital controls, Celtic Tiger, collapse of Lehman Brothers, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, cryptocurrency, debt deflation, deglobalization, Deng Xiaoping, different worldview, discounted cash flows, Donald Trump, equity risk premium, Ethereum, ethereum blockchain, eurozone crisis, fake news, financial deregulation, financial intermediation, Flash crash, Francis Fukuyama: the end of history, George Akerlof, government statistician, Greenspan put, high-speed rail, information asymmetry, initial coin offering, intangible asset, Irish property bubble, Isaac Newton, Japanese asset price bubble, joint-stock company, Joseph Schumpeter, junk bonds, land bank, light touch regulation, low interest rates, margin call, market bubble, market fundamentalism, Martin Wolf, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, negative equity, Network effects, new economy, Northern Rock, oil shock, Ponzi scheme, quantitative easing, quantitative trading / quantitative finance, railway mania, Right to Buy, Robert Shiller, Shenzhen special economic zone , short selling, short squeeze, Silicon Valley, smart contracts, South Sea Bubble, special economic zone, subprime mortgage crisis, technology bubble, the built environment, total factor productivity, transaction costs, tulip mania, urban planning

Sir Isaac Newton, one of the most brilliant and influential scientists in all of history, lost a fortune by investing in the South Sea Bubble. When questioned about his losses, he is reputed to have said ‘that he could not calculate the madness of the people’.29 This madness-of-crowds hypothesis has been refined and expanded by the likes of Kindleberger, John Kenneth Galbraith and, most recently, Nobel Laureate Robert Shiller.30 Shiller and other economists argue that bubbles can largely be explained by behavioural economics, with cognitive failings and psychological biases on the part of investors causing prices to rise beyond their objective value.31 A subset of investors, for example, may suffer from an overconfidence bias, whereby they overestimate the future performance of a company stock, or they may have a representativeness bias, whereby they incorrectly extrapolate from a series of good news announcements and overreact.32 Other investors may simply follow or emulate this subset of investors simply because of herd behaviour and naivety on their part.33 The view that bubbles are largely a product of irrationality has been contradicted by economists who, like Nobel Laureate Eugene Fama, believe investors to be rational and markets to be efficient.34 Much recent research on the subject has thus focused on establishing whether a particular bubble was ‘rational’ or not.35 This is unfortunate, because the rational/irrational framework is almost useless for understanding bubbles.

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The S&P 500 index, covering the largest US-based companies, rose by 115 per cent between January 1990 and 156 THE DOT-COM BUBBLE December 1996, prompting concern that the equity market was overheating. These gains appeared to be somewhat out of proportion with the money being made by its constituent firms. Robert Shiller’s cyclically adjusted price-to-earnings ratio (CAPE) stood at 28, meaning that S&P 500 companies were, after adjusting for the business cycle, valued at an average of 28 times their annual earnings. This was well above the longterm average of 15, leading Shiller to advise the Federal Reserve that a correction was due.19 Alan Greenspan, the Federal Reserve’s Chairman, gave what would become an iconic speech 3 days later, in which he questioned the point at which rising asset prices could be said to result from ‘irrational exuberance’ rather than changes in their intrinsic value.

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The Tiger Group of hedge funds began to bet against technology firms in 1998, underperforming its rivals for the next 2 years as a result. In the first quarter of 2000, its investors lost patience and withdrew their funds, forcing its closure only weeks before its strategy would have paid off.78 Perhaps the most influential explanation to emerge from the DotCom Bubble was that of Robert Shiller, whose bestseller Irrational Exuberance was published just as the bubble began to burst. While this book is most famous for emphasising the role of psychological factors in 168 THE DOT-COM BUBBLE driving share prices, this was only one part of a hypothesis that also referenced the aforementioned incentive problems, steady inflation, tax cuts and cultural factors.79 The long list of precipitating factors made it difficult to ascertain the relative importance of each one, but in part this reflected the difficulty of explaining a bubble which could not be neatly attributed to a single cause.

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

"World Economic Forum" Davos, Alan Greenspan, algorithmic trading, asset-backed security, bank run, banking crisis, Bear Stearns, 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 engineering, financial innovation, fixed income, Francis Fukuyama: the end of history, George Gilder, Glass-Steagall Act, housing crisis, Hyman Minsky, imperial preference, income inequality, index arbitrage, index fund, interest rate derivative, interest rate swap, Joseph Schumpeter, junk bonds, Kenneth Rogoff, large denomination, Long Term Capital Management, low interest rates, market bubble, Martin Wolf, Menlo Park, Michael Milken, military-industrial complex, Minsky moment, 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, Ponzi scheme, profit maximization, prosperity theology / prosperity gospel / gospel of success, Renaissance Technologies, reserve currency, risk tolerance, risk/return, Robert Shiller, Ronald Reagan, Satyajit Das, Savings and loan crisis, shareholder value, short selling, sovereign wealth fund, stock buybacks, subprime mortgage crisis, 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.

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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.

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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.

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

3Com Palm IPO, Alan Greenspan, Albert Einstein, Alvin Roth, Amazon Mechanical Turk, Andrei Shleifer, Apple's 1984 Super Bowl advert, Atul Gawande, behavioural economics, Berlin Wall, Bernie Madoff, Black-Scholes formula, book value, 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, equity risk 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, low interest rates, market clearing, Mason jar, mental accounting, meta-analysis, money market fund, More Guns, Less Crime, mortgage debt, Myron Scholes, Nash equilibrium, Nate Silver, New Journalism, nudge unit, PalmPilot, Paul Samuelson, payday loans, Ponzi scheme, Post-Keynesian economics, presumed consent, pre–internet, principal–agent problem, prisoner's dilemma, profit maximization, random walk, randomized controlled trial, Richard Thaler, risk free rate, Robert Shiller, Robert Solow, Ronald Coase, Silicon Valley, South Sea Bubble, Stanford marshmallow experiment, statistical model, Steve Jobs, sunk-cost fallacy, Supply of New York City Cabdrivers, systematic bias, 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

“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.

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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.

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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.

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

Alan Greenspan, American ideology, Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, banking crisis, Bear Stearns, Bernie Madoff, Black Monday: stock market crash in 1987, Bonfire of the Vanities, bonus culture, book value, break the buck, business cycle, business logic, 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, currency risk, Edward Glaeser, Eugene Fama: efficient market hypothesis, financial deregulation, financial engineering, financial innovation, financial intermediation, financial repression, fixed income, George Akerlof, Glass-Steagall Act, Gordon Gekko, greed is good, Greenspan put, Home mortgage interest deduction, Hyman Minsky, income per capita, information asymmetry, interest rate derivative, interest rate swap, junk bonds, Kenneth Rogoff, laissez-faire capitalism, late fees, light touch regulation, Long Term Capital Management, low interest rates, market bubble, market fundamentalism, Martin Wolf, Michael Milken, money market fund, moral hazard, mortgage tax deduction, Myron Scholes, Paul Samuelson, Ponzi scheme, price stability, profit maximization, proprietary trading, race to the bottom, regulatory arbitrage, rent-seeking, Robert Bork, Robert Shiller, Ronald Reagan, Saturday Night Live, Satyajit Das, Savings and loan crisis, sovereign wealth fund, Tax Reform Act of 1986, The Myth of the Rational Market, too big to fail, transaction costs, Tyler Cowen, value at risk, yield curve

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.

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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.

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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.

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

accounting loophole / creative accounting, Alan Greenspan, Albert Einstein, asset allocation, asset-backed security, beat the dealer, Bernie Madoff, bitcoin, book value, 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, equity risk premium, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial engineering, financial innovation, financial repression, fixed income, framing effect, George Santayana, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Japanese asset price bubble, John Bogle, junk bonds, Long Term Capital Management, loss aversion, low interest rates, margin call, market bubble, Mary Meeker, money market fund, mortgage tax deduction, new economy, Own Your Own Home, PalmPilot, 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 free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Salesforce, short selling, Silicon Valley, South Sea Bubble, stock buybacks, stocks for the long run, sugar pill, survivorship bias, Teledyne, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond, zero-sum game

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.

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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.

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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.

Finance and the Good Society by Robert J. Shiller

Alan Greenspan, Alvin Roth, bank run, banking crisis, barriers to entry, Bear Stearns, behavioural economics, benefit corporation, 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, democratizing finance, Deng Xiaoping, diversification, diversified portfolio, Donald Trump, Edward Glaeser, eurozone crisis, experimental economics, financial engineering, financial innovation, financial thriller, fixed income, full employment, fundamental attribution error, George Akerlof, Great Leap Forward, Ida Tarbell, income inequality, information asymmetry, invisible hand, John Bogle, 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, Ronald Reagan, selection bias, self-driving car, shareholder value, Sharpe ratio, short selling, Simon Kuznets, Skype, social contagion, Steven Pinker, tail risk, telemarketer, Thales and the olive presses, Thales of Miletus, The Market for Lemons, The Theory of the Leisure Class by Thorstein Veblen, 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.

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“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.

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., Xun Liu, Yang Jiang, Donald Lynam, and Thomas H. Kelly. 2008. “Neural Correlates of Emotional Reactivity in Sensation Seeking.” Psychological Science 20(2):215–23. Jung, Jeeman, and Robert J. Shiller. 2005. “A Simple Test of Samuelson’s Dictum for the Stock Market.” Economic Inquiry 43(2):263–92. Kahneman, Daniel, and Amos Tversky. 1979. “Prospect Theory: An Analysis of Decision under Risk.” Econometrica 47(2):263–92. Kamstra, Mark, and Robert J. Shiller. 2010. “Trills Instead of T-Bills: It’s Time to Replace Part of Government Debt with Shares in GDP.” The Economists’ Voice 7(3), Article 5, http://www.bepress.com/ev/vol7/iss3/art5.

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

Alan Greenspan, bank run, banking crisis, book value, business climate, business cycle, buy and hold, capital asset pricing model, compound rate of return, computerized trading, Cornelius Vanderbilt, credit crunch, cuban missile crisis, discounted cash flows, diversified portfolio, Donald Trump, equity risk premium, Eugene Fama: efficient market hypothesis, financial independence, financial innovation, fixed income, full employment, Glass-Steagall Act, income inequality, index arbitrage, index fund, joint-stock company, junk bonds, locking in a profit, Long Term Capital Management, Louis Bachelier, low interest rates, margin call, market clearing, merger arbitrage, Michael Milken, money market fund, Myron Scholes, Paul Samuelson, price stability, prudent man rule, random walk, Richard Thaler, risk free rate, risk tolerance, Robert Bork, Robert Shiller, Ronald Reagan, scientific management, 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.

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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.

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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.

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

Alan Greenspan, asset-backed security, bank run, banking crisis, Bear Stearns, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Monday: stock market crash in 1987, Black-Scholes formula, Blythe Masters, Celtic Tiger, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, Daniel Kahneman / Amos Tversky, diversified portfolio, double entry bookkeeping, Exxon Valdez, Fall of the Berlin Wall, financial deregulation, financial engineering, financial innovation, fixed income, George Akerlof, Glass-Steagall Act, greed is good, Greenspan put, hedonic treadmill, hindsight bias, housing crisis, Hyman Minsky, intangible asset, interest rate swap, invisible hand, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", Jane Jacobs, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, junk bonds, Kickstarter, laissez-faire capitalism, light touch regulation, liquidity trap, Long Term Capital Management, loss aversion, low interest rates, 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, off-the-grid, Own Your Own Home, Ponzi scheme, quantitative easing, reserve currency, Right to Buy, risk-adjusted returns, Robert Shiller, Ronald Reagan, Savings and loan crisis, shareholder value, South Sea Bubble, statistical model, Tax Reform Act of 1986, The Great Moderation, the payments system, too big to fail, tulip mania, Tyler Cowen, 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.

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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.

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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.

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

Affordable Care Act / Obamacare, Alan Greenspan, algorithmic trading, Andrei Shleifer, asset-backed security, availability heuristic, bank run, banking crisis, behavioural economics, Black Monday: stock market crash in 1987, 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 engineering, financial innovation, fixed income, Flash crash, Google Glasses, Gordon Gekko, high net worth, housing crisis, Hyman Minsky, impact investing, 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, low interest rates, margin call, Mark Zuckerberg, McMansion, Minsky moment, 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, Savings and loan crisis, short selling, Silicon Valley, Silicon Valley startup, Skype, South Sea Bubble, sovereign wealth fund, statistical model, subprime mortgage crisis, tail risk, Thales of Miletus, the long tail, transaction costs, Tunguska event, unbanked and underbanked, underbanked, Vanguard fund, web application

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.

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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.

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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.

Easy Money: Cryptocurrency, Casino Capitalism, and the Golden Age of Fraud by Ben McKenzie, Jacob Silverman

algorithmic trading, asset allocation, bank run, barriers to entry, Ben McKenzie, Bernie Madoff, Big Tech, bitcoin, Bitcoin "FTX", blockchain, capital controls, citizen journalism, cognitive dissonance, collateralized debt obligation, COVID-19, Credit Default Swap, credit default swaps / collateralized debt obligations, cross-border payments, cryptocurrency, data science, distributed ledger, Dogecoin, Donald Trump, effective altruism, Elon Musk, en.wikipedia.org, Ethereum, ethereum blockchain, experimental economics, financial deregulation, financial engineering, financial innovation, Flash crash, Glass-Steagall Act, high net worth, housing crisis, information asymmetry, initial coin offering, Jacob Silverman, Jane Street, low interest rates, Lyft, margin call, meme stock, money market fund, money: store of value / unit of account / medium of exchange, Network effects, offshore financial centre, operational security, payday loans, Peter Thiel, Ponzi scheme, Potemkin village, prediction markets, proprietary trading, pushing on a string, QR code, quantitative easing, race to the bottom, ransomware, regulatory arbitrage, reserve currency, risk tolerance, Robert Shiller, Robinhood: mobile stock trading app, Ross Ulbricht, Sam Bankman-Fried, Satoshi Nakamoto, Saturday Night Live, short selling, short squeeze, Silicon Valley, Skype, smart contracts, Steve Bannon, systems thinking, TikTok, too big to fail, transaction costs, tulip mania, uber lyft, underbanked, vertical integration, zero-sum game

The only thing needed to own a piece of the “future of money” was a willingness to part with the current version of it. The more people invested, the more prices rose, resulting in even more FOMO that drew in yet more people—a self-reinforcing dynamic common to economic bubbles and Ponzi schemes. Quite simply, crypto had gone viral. In his 2019 book Narrative Economics, Nobel Prize–winning economist Robert Shiller examined how economic narratives spread by drawing on decades of research from fields such as history, sociology, anthropology, psychology, marketing, literary criticism, and perhaps most fittingly for our purposes, epidemiology. He defined an economic narrative as “a contagious story that has the potential to change how people make economic decisions, such as the decision to . . . invest in a volatile speculative asset.”

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Times were good, and on paper it seemed as if almost everyone was richer, or at least a little more secure during some precarious times. But it was already clear that many of the economic gains during the pandemic were going to the ultrarich. And as an armchair economist, I saw far worse storm clouds forming on the horizon. Surveying the markets in the spring of 2021, I saw all the signs of what Robert Shiller describes as “naturally occurring Ponzi schemes.” The premise of a traditional Ponzi scheme is quite simple: A fraudster promises investors he can produce incredible returns if they give him money to invest on their behalf. Instead of legitimately investing that money, the con man pretends to have generated profits and uses that story to lure in more investors.

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I’m an actor with a barely used undergraduate degree in economics. I earned some money in showbiz but I’ve never worked on Wall Street or in finance. Who was I to call out a multi-trillion-dollar industry that very fancy people on TV assured us was the future of everything? Then again, I knew about money and lying. And Robert Shiller said something else: “We can think of history as a succession of rare big events in which a story goes viral, often (but not always) with the help of an attractive celebrity (even a minor celebrity or fictional stock figure) whose attachment to the narrative adds human interest.” A dim light clicked inside this middle-aged dad’s feeble brain.

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

Abraham Wald, Alan Greenspan, Albert Einstein, An Inconvenient Truth, Andrei Shleifer, anti-communist, AOL-Time Warner, asset allocation, asset-backed security, availability heuristic, bank run, banking crisis, Bear Stearns, behavioural economics, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Black Monday: stock market crash in 1987, Black-Scholes formula, Blythe Masters, book value, Bretton Woods, British Empire, business cycle, capital asset pricing model, carbon tax, Carl Icahn, 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 engineering, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, Garrett Hardin, George Akerlof, Glass-Steagall Act, 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, junk bonds, Kenneth Arrow, Kickstarter, laissez-faire capitalism, Landlord’s Game, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, low interest rates, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, Mikhail Gorbachev, military-industrial complex, Minsky moment, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Myron Scholes, Naomi Klein, negative equity, Network effects, Nick Leeson, Nixon triggered the end of the Bretton Woods system, Northern Rock, paradox of thrift, Pareto efficiency, Paul Samuelson, Phillips curve, Ponzi scheme, precautionary principle, price discrimination, price stability, principal–agent problem, profit maximization, proprietary trading, 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 Solow, Ronald Coase, Ronald Reagan, Savings and loan crisis, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, subprime mortgage crisis, tail risk, Tax Reform Act of 1986, technology bubble, The Chicago School, The Great Moderation, The Market for Lemons, The Wealth of Nations by Adam Smith, too big to fail, Tragedy of the Commons, transaction costs, Two Sigma, unorthodox policies, value at risk, Vanguard fund, Vilfredo Pareto, wealth creators, zero-sum game

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. Shiller, Irrational Exuberance, Second Edition, © 2005 Princeton University Press. Reprinted by permission of Princeton University Press.) Overall, between the fourth quarter of 1996 and the fourth quarter of 2006, average house prices nationwide rose by 129 percent.

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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.

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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.

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

Alan Greenspan, Albert Einstein, asset allocation, banking crisis, Bear Stearns, behavioural economics, book value, Bretton Woods, business cycle, buy and hold, collective bargaining, Columbine, cuban missile crisis, desegregation, diversified portfolio, fake news, financial engineering, floating exchange rates, Fractional reserve banking, full employment, Glass-Steagall Act, global macro, hindsight bias, Kickstarter, Long Term Capital Management, low interest rates, market bubble, Michael Milken, military-industrial complex, Money creation, mortgage tax deduction, Myron Scholes, new economy, Nixon triggered the end of the Bretton Woods system, oil shock, price stability, reserve currency, risk free rate, Robert Gordon, Robert Shiller, Ronald Reagan, short selling, stocks for the long run, yield curve, Yogi Berra

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.

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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.

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Cowles’ 1938 study shows earnings per share for the whole market declined 34% in the 40 years from 1881 until 1921, though earnings that year were very depressed. Figure 18 provides some of the low and high points for earnings per share. FIGURE 18. S&P COMPOSITE INDEX (1871=100) – PEAKS AND TROUGHS FROM INCEPTION Source: Robert Shiller, Market Volatility So what constitutes the normal level of earnings to be utilised in computing earnings growth over the period? If we use 1916 earnings, then the markets’ earnings growth over the 40 years was 250%. If we use 1921 earnings, then there was a contraction in earnings of 34%. Taking 1921 earnings as normal, the PE in January 1921 was 24.5x, but if 1916 earnings were considered normal, then the PE was 4.6x.

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

affirmative action, Andrei Shleifer, asset-backed security, bank run, banking crisis, Bear Stearns, behavioural economics, 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, Future Shock, 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, junk bonds, Long Term Capital Management, loss aversion, market bubble, market clearing, mental accounting, Michael Milken, 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, Phillips curve, plutocrats, Post-Keynesian economics, price stability, profit maximization, public intellectual, purchasing power parity, random walk, Richard Thaler, Robert Shiller, Robert Solow, Ronald Reagan, Savings and loan crisis, seminal paper, 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, W. E. B. Du Bois, We are all Keynesians now, 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.

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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.

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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?

A Wealth of Common Sense: Why Simplicity Trumps Complexity in Any Investment Plan by Ben Carlson

Albert Einstein, asset allocation, backtesting, Bernie Madoff, Black Monday: stock market crash in 1987, Black Swan, book value, business cycle, buy and hold, buy low sell high, commodity super cycle, corporate governance, delayed gratification, discounted cash flows, diversification, diversified portfolio, do what you love, endowment effect, family office, financial independence, fixed income, Gordon Gekko, high net worth, index fund, John Bogle, junk bonds, loss aversion, market bubble, medical residency, Occam's razor, paper trading, passive investing, Ponzi scheme, price anchoring, Reminiscences of a Stock Operator, Richard Thaler, risk tolerance, Robert Shiller, robo advisor, South Sea Bubble, sovereign wealth fund, stocks for the long run, technology bubble, Ted Nelson, transaction costs, Vanguard fund, Vilfredo Pareto

Rick Ferri, “Expect Years of Pain Before Market Gains,” RickFerri.com, November 28, 2011, www.rickferri.com/blog/markets/expect-years-of-pain-before-market-gain/. 12. Ben Carlson, “Are Commodities for Trading or Investing?” A Wealth of Common Sense (blog), August 12, 2014, http://awealthofcommonsense.com/commodities-trading-investing/. 13. Robert J. Shiller, Irrational Exuberance (Princeton, NJ: Princeton University Press, 2000). 14. Robert Shiller online data, available at www.econ.yale.edu/∼shiller/data.htm. 15. Robert Shiller, “Why Home Prices Change (or Don't),” New York Times, April 13, 2013, www.nytimes.com/2013/04/14/business/why-home-prices-change-or-dont.html. CHAPTER 5 Defining Your Investment Philosophy Investment philosophy is really about temperament, not raw intellect.

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Table 4.6 Every Cycle Is Unique Average Nominal Average Dividend Earnings GDP Inflation 10-Year Stock Bond Yield Growth Growth Rate Yield Returns Returns 1930s 5.5% –5.7% –1.4% –2.1% 2.9% –0.9% 4.0% 1940s 5.7% 9.9% 11.2% 5.6% 2.3% 8.5% 2.5% 1950s 4.9% 3.9% 6.3% 2.0% 3.0% 19.5% 0.8% 1960s 3.2% 5.5% 6.6% 2.3% 4.7% 7.7% 2.4% 1970s 4.0% 9.9% 9.7% 7.1% 7.5% 5.9% 5.4% 1980s 4.2% 4.4% 8.3% 5.5% 10.6% 17.3% 12.0% 1990s 2.4% 7.7% 5.6% 3.0% 6.7% 18.1% 7.4% 2000s 1.8% 0.6% 3.9% 2.6% 4.5% –1.0% 6.3% 2010s 2.0% 17.2% 2.1% 2.1% 2.5% 15.7% 4.2% Source: Robert Shiller. Try to find a pattern among those numbers. You will find no rhyme or reason from one decade to the next. There's no single indicator or variable that's going to give investors an edge. The only constant in the markets is the fact that they're cyclical. Nothing goes in one direction forever.

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Real estate investment trusts (REITs), commercial real estate securities that can be diversified by geography and different types of real estate—apartments, office complexes, shopping centers, and so on—were up more than 10 percent a year in that time frame. You would think that because housing prices tend to go up most of the time that housing would be a worthwhile investment. Here's Robert Shiller, who the Case-Shiller Index is named after, on why this isn't the case: Here is a harsh truth about homeownership: Over the long haul, it's hard for homes to compete with the stock market in real appreciation. That's because companies whose shares are traded on a stock exchange retain a good share of their earnings to plow back into the business.

Global Financial Crisis by Noah Berlatsky

"World Economic Forum" Davos, accounting loophole / creative accounting, Alan Greenspan, asset-backed security, banking crisis, Bear Stearns, 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, Glass-Steagall Act, God and Mammon, Gordon Gekko, housing crisis, illegal immigration, income inequality, low interest rates, market bubble, market fundamentalism, mass immigration, Money creation, moral hazard, new economy, Northern Rock, purchasing power parity, quantitative easing, race to the bottom, regulatory arbitrage, reserve currency, Robert Shiller, Ronald Reagan, Savings and loan crisis, shareholder value, social contagion, South China Sea, structural adjustment programs, subprime mortgage crisis, too big to fail, trade liberalization, transfer pricing, working poor

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.

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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.

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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.

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

Affordable Care Act / Obamacare, Airbnb, basic income, behavioural economics, Build a better mousetrap, business cycle, Cass Sunstein, choice architecture, creative destruction, Credit Default Swap, cross-border payments, do well by doing good, employer provided health coverage, financial exclusion, financial independence, financial innovation, gender pay gap, gentrification, George Akerlof, gig economy, Glass-Steagall Act, income inequality, independent contractor, informal economy, Jane Jacobs, Joseph Schumpeter, late fees, low interest rates, Lyft, M-Pesa, medical bankruptcy, microcredit, Occupy movement, payday loans, peer-to-peer lending, precariat, Ralph Nader, Richard Thaler, Robert Shiller, Ronald Reagan, Savings and loan crisis, sharing economy, subprime mortgage crisis, 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.

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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.”

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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.”

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

asset allocation, Bob Litterman, book value, Bretton Woods, business cycle, capital asset pricing model, capital controls, carried interest, commodity trading advisor, correlation coefficient, currency risk, diversification, diversified portfolio, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, family office, financial engineering, financial innovation, fixed income, German hyperinflation, global macro, high net worth, hiring and firing, housing crisis, income per capita, index fund, inventory management, junk bonds, Long Term Capital Management, low interest rates, managed futures, mortgage debt, Nixon triggered the end of the Bretton Woods system, passive investing, purchasing power parity, risk free rate, risk-adjusted returns, 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.

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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).

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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.

The Wisdom of Crowds by James Surowiecki

Alan Greenspan, AltaVista, Andrei Shleifer, Apollo 13, asset allocation, behavioural economics, Cass Sunstein, classic study, congestion pricing, coronavirus, Daniel Kahneman / Amos Tversky, experimental economics, Frederick Winslow Taylor, George Akerlof, Great Leap Forward, Gregor Mendel, Howard Rheingold, I think there is a world market for maybe five computers, interchangeable parts, Jeff Bezos, John Bogle, 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, Ronald Coase, Ronald Reagan, seminal paper, shareholder value, short selling, Silicon Valley, South Sea Bubble, tacit knowledge, The Nature of the Firm, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Toyota Production System, transaction costs, ultimatum game, vertical integration, world market for maybe five computers, Yogi Berra, zero-sum game

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.

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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.

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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.

Capitalism: Money, Morals and Markets by John Plender

activist fund / activist shareholder / activist investor, Alan Greenspan, Andrei Shleifer, asset-backed security, bank run, Berlin Wall, Big bang: deregulation of the City of London, Black Monday: stock market crash in 1987, Black Swan, bond market vigilante , 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, Cornelius Vanderbilt, 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 engineering, financial innovation, financial intermediation, Fractional reserve banking, full employment, Glass-Steagall Act, God and Mammon, Golden arches theory, Gordon Gekko, greed is good, Hyman Minsky, income inequality, industrial research laboratory, inflation targeting, information asymmetry, invention of the wheel, invisible hand, Isaac Newton, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", 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, price stability, principal–agent problem, profit motive, proprietary trading, quantitative easing, railway mania, regulatory arbitrage, Richard Thaler, rising living standards, risk-adjusted returns, Robert Gordon, 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.

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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.

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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.

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

"Friedman doctrine" OR "shareholder theory", "World Economic Forum" Davos, accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, additive manufacturing, Airbnb, Alan Greenspan, algorithmic trading, Alvin Roth, Asian financial crisis, asset allocation, bank run, Basel III, Bear Stearns, behavioural economics, Big Tech, bonus culture, Bretton Woods, British Empire, business cycle, buy and hold, call centre, Capital in the Twenty-First Century by Thomas Piketty, Carl Icahn, 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, data science, David Graeber, deskilling, Detroit bankruptcy, diversification, Double Irish / Dutch Sandwich, electricity market, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial deregulation, financial engineering, financial intermediation, Ford Model T, Frederick Winslow Taylor, George Akerlof, gig economy, Glass-Steagall Act, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, Greenspan put, guns versus butter model, 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, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", John Bogle, John Markoff, joint-stock company, joint-stock limited liability company, Kenneth Rogoff, Kickstarter, knowledge economy, labor-force participation, London Whale, Long Term Capital Management, low interest rates, 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, proprietary trading, quantitative easing, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, Rana Plaza, RAND corporation, random walk, rent control, Robert Shiller, Ronald Reagan, Satyajit Das, Savings and loan crisis, scientific management, 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, stock buybacks, subprime mortgage crisis, technology bubble, TED Talk, 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, Tragedy of the Commons, trickle-down economics, Tyler Cowen: Great Stagnation, Vanguard fund, vertical integration, zero-sum game

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.

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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.

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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.

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

activist fund / activist shareholder / activist investor, Airbnb, Albert Einstein, AOL-Time Warner, asset allocation, Bear Stearns, behavioural economics, bitcoin, Bretton Woods, buy and hold, buy low sell high, Carl Icahn, cognitive bias, cognitive dissonance, Credit Default Swap, cryptocurrency, Daniel Kahneman / Amos Tversky, endowment effect, financial engineering, financial innovation, fixed income, global macro, hindsight bias, index fund, initial coin offering, invention of the wheel, Isaac Newton, Jim Simons, John Bogle, John Meriwether, Kickstarter, Long Term Capital Management, loss aversion, low interest rates, Market Wizards by Jack D. Schwager, mega-rich, merger arbitrage, multilevel marketing, Myron Scholes, Paul Samuelson, Pershing Square Capital Management, quantitative easing, Reminiscences of a Stock Operator, Renaissance Technologies, Richard Thaler, Robert Shiller, short squeeze, Snapchat, Stephen Hawking, Steve Jobs, Steve Wozniak, stocks for the long run, subprime mortgage crisis, transcontinental railway, two and twenty, 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.

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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.

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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.

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

Andrei Shleifer, asset-backed security, Bear Stearns, behavioural economics, Bernie Madoff, business cycle, Capital in the Twenty-First Century by Thomas Piketty, Carl Icahn, collapse of Lehman Brothers, compensation consultant, 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, junk bonds, Kenneth Arrow, Kenneth Rogoff, late fees, loss aversion, market bubble, Menlo Park, mental accounting, Michael Milken, 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 Solow, Ronald Reagan, Savings and loan crisis, short selling, Silicon Valley, stock buybacks, the new new thing, The Predators' Ball, the scientific method, The Theory of the Leisure Class by Thorstein Veblen, 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.

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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.

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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.

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

air traffic controllers' union, Alan Greenspan, back-to-the-land, Bear Stearns, benefit corporation, Bernie Sanders, Black Swan, Bretton Woods, BRICs, British Empire, business cycle, call centre, centre right, classic study, 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, Glass-Steagall Act, guns versus butter model, high-speed rail, hiring and firing, Howard Zinn, Hyman Minsky, illegal immigration, indoor plumbing, informal economy, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, junk bonds, Kevin Roose, Kickstarter, lake wobegon effect, Long Term Capital Management, low interest rates, market fundamentalism, Martin Wolf, McMansion, medical malpractice, Michael Milken, military-industrial complex, Minsky moment, mortgage debt, Myron Scholes, Naomi Klein, new economy, oil shock, old-boy network, open immigration, Paul Samuelson, plutocrats, price mechanism, price stability, private military company, public intellectual, radical decentralization, Ralph Nader, reserve currency, rising living standards, Robert Shiller, rolodex, Ronald Reagan, Savings and loan crisis, school vouchers, Silicon Valley, single-payer health, Solyndra, South China Sea, statistical model, Steve Jobs, Suez crisis 1956, 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, you are the product

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.

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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.

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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.

A Mathematician Plays the Stock Market by John Allen Paulos

Alan Greenspan, AOL-Time Warner, Benoit Mandelbrot, Black-Scholes formula, book value, Brownian motion, business climate, business cycle, butter production in bangladesh, butterfly effect, capital asset pricing model, confounding variable, 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, equity risk premium, 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, it's over 9,000, John Bogle, John Nash: game theory, Larry Ellison, 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, Plato's cave, Ponzi scheme, power law, price anchoring, Ralph Nelson Elliott, random walk, Reminiscences of a Stock Operator, Richard Thaler, risk free rate, Robert Shiller, short selling, six sigma, Stephen Hawking, stocks for the long run, survivorship bias, transaction costs, two and twenty, ultimatum game, UUNET, Vanguard fund, Yogi Berra

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.

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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.

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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.

Unfinished Business by Tamim Bayoumi

Alan Greenspan, algorithmic trading, Asian financial crisis, bank run, banking crisis, Basel III, battle of ideas, Bear Stearns, behavioural economics, Ben Bernanke: helicopter money, Berlin Wall, Big bang: deregulation of the City of London, book value, 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, Glass-Steagall Act, Greenspan put, hiring and firing, housing crisis, inflation targeting, junk bonds, 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, Rubik’s Cube, Savings and loan crisis, 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

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?

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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.

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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.

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

airline deregulation, Alan Greenspan, Albert Einstein, bank run, barriers to entry, behavioural economics, Bretton Woods, business cycle, butterfly effect, capital controls, carbon tax, Carmen Reinhart, central bank independence, collective bargaining, congestion pricing, 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 elasticity of demand, price stability, prisoner's dilemma, profit maximization, public intellectual, quantitative easing, randomized controlled trial, rent control, rent-seeking, Richard Thaler, risk/return, 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

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.

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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.

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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.

Planet Ponzi by Mitch Feierstein

Affordable Care Act / Obamacare, Alan Greenspan, Albert Einstein, Asian financial crisis, asset-backed security, bank run, banking crisis, barriers to entry, Bear Stearns, Bernie Madoff, book value, 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, Future Shock, Glass-Steagall Act, government statistician, high net worth, High speed trading, illegal immigration, income inequality, interest rate swap, invention of agriculture, junk bonds, light touch regulation, Long Term Capital Management, low earth orbit, low interest rates, mega-rich, money market fund, moral hazard, mortgage debt, negative equity, Neil Armstrong, Northern Rock, obamacare, offshore financial centre, oil shock, pensions crisis, plutocrats, Ponzi scheme, price anchoring, price stability, proprietary trading, purchasing power parity, quantitative easing, risk tolerance, Robert Shiller, Ronald Reagan, tail risk, too big to fail, trickle-down economics, value at risk, yield curve

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.

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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.

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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.

Cogs and Monsters: What Economics Is, and What It Should Be by Diane Coyle

3D printing, additive manufacturing, Airbnb, Al Roth, Alan Greenspan, algorithmic management, Amazon Web Services, autonomous vehicles, banking crisis, barriers to entry, behavioural economics, Big bang: deregulation of the City of London, biodiversity loss, bitcoin, Black Lives Matter, Boston Dynamics, Bretton Woods, Brexit referendum, business cycle, call centre, Carmen Reinhart, central bank independence, choice architecture, Chuck Templeton: OpenTable:, cloud computing, complexity theory, computer age, conceptual framework, congestion charging, constrained optimization, coronavirus, COVID-19, creative destruction, credit crunch, data science, DeepMind, deglobalization, deindustrialization, Diane Coyle, discounted cash flows, disintermediation, Donald Trump, Edward Glaeser, en.wikipedia.org, endogenous growth, endowment effect, Erik Brynjolfsson, eurozone crisis, everywhere but in the productivity statistics, Evgeny Morozov, experimental subject, financial deregulation, financial innovation, financial intermediation, Flash crash, framing effect, general purpose technology, George Akerlof, global supply chain, Goodhart's law, Google bus, haute cuisine, High speed trading, hockey-stick growth, Ida Tarbell, information asymmetry, intangible asset, Internet of things, invisible hand, Jaron Lanier, Jean Tirole, job automation, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, knowledge economy, knowledge worker, Les Trente Glorieuses, libertarian paternalism, linear programming, lockdown, Long Term Capital Management, loss aversion, low earth orbit, lump of labour, machine readable, market bubble, market design, Menlo Park, millennium bug, Modern Monetary Theory, Mont Pelerin Society, multi-sided market, Myron Scholes, Nash equilibrium, Nate Silver, Network effects, Occupy movement, Pareto efficiency, payday loans, payment for order flow, Phillips curve, post-industrial society, price mechanism, Productivity paradox, quantitative easing, randomized controlled trial, rent control, rent-seeking, ride hailing / ride sharing, road to serfdom, Robert Gordon, Robert Shiller, Robert Solow, Robinhood: mobile stock trading app, Ronald Coase, Ronald Reagan, San Francisco homelessness, savings glut, school vouchers, sharing economy, Silicon Valley, software is eating the world, spectrum auction, statistical model, Steven Pinker, tacit knowledge, The Chicago School, The Future of Employment, The Great Moderation, the map is not the territory, The Rise and Fall of American Growth, the scientific method, The Signal and the Noise by Nate Silver, the strength of weak ties, The Wealth of Nations by Adam Smith, total factor productivity, transaction costs, Uber for X, urban planning, winner-take-all economy, Winter of Discontent, women in the workforce, Y2K

So a number of economists have objected to my suggestion that the excesses of the financial markets have anything to do with economics at all. After all, many economists were in fact warning of unsustainable asset bubbles in the run-up to the crash (albeit that few specifically predicted a major banking crisis). Robert Shiller’s Irrational Exuberance (2000) was a bestseller, and its warning featured widely in the media around the world. It is correct therefore to argue that political philosophy, the power of financial institutions, their lobbying of government, the incentives of credit rating agencies, and sheer greed and dishonesty all bear much greater responsibility than economics, or even than options markets.

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If politicians and regulators had really been listening to economists, the crisis might have been averted. There is also a good case to be made for the potential for financial markets to improve society. A well-ordered financial system helps individuals and businesses manage risk, and channels savings into productive investments. Robert Shiller, although famous as one of the economists who predicted something like the GFC, has also argued for an expansion of financial markets—for example, to help countries insure each other against the costs of natural disasters (Shiller 2000, 2003, 2013). But this defence overlooks the fundamental role played by economics in giving birth to modern financial markets.

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When the third quarter of 2014 GDP growth figure was published on the first day of the 2015 UK General Election campaign, 30 March, the Daily Telegraph headline was: ‘UK economy grew at fastest rate for nine years in 2014’, while the Guardian went with: ‘Data shows slowest recovery since 1920s’ (Khan 2015; Allen and Watt 2015). Subsequently, an apparent ‘double dip’ recession in the aftermath of the GFC has been revised away in the latest statistics. The idea of narrative economics has advocates (and narratives as an element in policy are cropping up in other domains such as the natural sciences or AI). Robert Shiller (2017, 967) compares economic narratives to epidemics, infections of the mind. He writes: ‘The field of economics should be expanded to include serious quantitative study of changing popular narratives,’ adding, ‘Narratives can be based on varying degrees of truth.’ Similarly, George Akerlof and Dennis Snower argue that neither conventional nor behavioural economics offers empirically valid general accounts of the way economies develop, whereas considering the role of narratives can account for the realisation of one among a number of indeterminate outcomes: narratives teach social norms, shape individuals’ identities and motivations, and prompt their decisions (Akerlof and Snower 2016).

Inequality and the 1% by Danny Dorling

Affordable Care Act / Obamacare, banking crisis, battle of ideas, Bear Stearns, 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, gentrification, Gini coefficient, high net worth, housing crisis, income inequality, land value tax, Leo Hollis, Londongrad, 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, precariat, quantitative easing, race to the bottom, Robert Shiller, Russell Brand, TaskRabbit, TED Talk, 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

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.

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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.

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

Alan Greenspan, 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, Great Leap Forward, household responsibility system, 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, Ronald Reagan, sealed-bid auction, second-price auction, second-price sealed-bid, Shenzhen special economic zone , Shenzhen was a fishing village, special economic zone, spectrum auction, The Market for Lemons, Thomas Malthus, trade liberalization, Vickrey auction

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.

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(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.

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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.

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

behavioural economics, Black-Scholes formula, business intelligence, business process, call centre, computer age, correlation coefficient, correlation does not imply causation, Credit Default Swap, data science, en.wikipedia.org, feminist movement, Florence Nightingale: pie chart, forensic accounting, global supply chain, Gregor Mendel, 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, self-driving car, sentiment analysis, six sigma, Skype, statistical model, supply-chain management, TED Talk, 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.

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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.

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

Alan Greenspan, asset allocation, banking crisis, banks create money, barriers to entry, behavioural economics, benefit corporation, Berlin Wall, Big bang: deregulation of the City of London, Black Monday: stock market crash in 1987, book value, Bretton Woods, business cycle, buy and hold, Cass Sunstein, central bank independence, collective bargaining, computer age, credit crunch, data science, debt deflation, decarbonisation, diversification, dividend-yielding stocks, equity premium, equity risk premium, Fall of the Berlin Wall, financial engineering, financial innovation, fixed income, Flash crash, foreign exchange controls, forward guidance, Francis Fukuyama: the end of history, general purpose technology, gentrification, geopolitical risk, George Akerlof, Glass-Steagall Act, household responsibility system, housing crisis, index fund, invention of the printing press, inverted yield curve, Isaac Newton, James Watt: steam engine, Japanese asset price bubble, joint-stock company, Joseph Schumpeter, Kickstarter, Kondratiev cycle, liberal capitalism, light touch regulation, liquidity trap, Live Aid, low interest rates, market bubble, Mikhail Gorbachev, mortgage debt, negative equity, Network effects, new economy, Nikolai Kondratiev, Nixon shock, Nixon triggered the end of the Bretton Woods system, oil shock, open economy, Phillips curve, price stability, private sector deleveraging, Productivity paradox, quantitative easing, railway mania, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Solow, Ronald Reagan, Savings and loan crisis, savings glut, secular stagnation, Shenzhen special economic zone , Simon Kuznets, South Sea Bubble, special economic zone, stocks for the long run, tail risk, Tax Reform Act of 1986, technology bubble, The Great Moderation, too big to fail, total factor productivity, trade route, tulip mania, yield curve

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.

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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.

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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.

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

"World Economic Forum" Davos, Alan Greenspan, An Inconvenient Truth, Andrei Shleifer, availability heuristic, bank run, behavioural economics, Black Swan, business cycle, Cass Sunstein, classic study, 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, Oklahoma City bombing, Pareto efficiency, Paul Samuelson, placebo effect, precautionary principle, price discrimination, price stability, RAND corporation, Richard Thaler, Robert Shiller, Robert Solow, Ronald Reagan, Savings and loan crisis, social discount rate, source of truth, statistical model, stochastic process, subprime mortgage crisis, 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

“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.

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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.

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“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.

Who Stole the American Dream? by Hedrick Smith

Affordable Care Act / Obamacare, Airbus A320, airline deregulation, Alan Greenspan, anti-communist, asset allocation, banking crisis, Bear Stearns, Boeing 747, 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, financial engineering, Ford Model T, full employment, Glass-Steagall Act, global supply chain, Gordon Gekko, guest worker program, guns versus butter model, high-speed rail, hiring and firing, housing crisis, Howard Zinn, income inequality, independent contractor, index fund, industrial cluster, informal economy, invisible hand, John Bogle, Joseph Schumpeter, junk bonds, Kenneth Rogoff, Kitchen Debate, knowledge economy, knowledge worker, laissez-faire capitalism, Larry Ellison, late fees, Long Term Capital Management, low cost airline, low interest rates, manufacturing employment, market fundamentalism, Maui Hawaii, mega-rich, Michael Shellenberger, military-industrial complex, 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, proprietary trading, Ralph Nader, RAND corporation, Renaissance Technologies, reshoring, rising living standards, Robert Bork, Robert Shiller, rolodex, Ronald Reagan, Savings and loan crisis, shareholder value, Shenzhen was a fishing village, Silicon Valley, Silicon Valley startup, Solyndra, Steve Jobs, stock buybacks, tech worker, Ted Nordhaus, 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.

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“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.

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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.

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, digital nomad, diversification, diversified portfolio, fear of failure, financial independence, future of work, gig economy, helicopter parent, Home mortgage interest deduction, housing crisis, independent contractor, job satisfaction, Kickstarter, loss aversion, low interest rates, 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, seminal paper, Silicon Valley, Snapchat, social contagion, TaskRabbit, TED Talk, the strength of weak ties, Uber and Lyft, uber lyft, universal basic income, wage slave, WeWork, Y Combinator, Zipcar

., 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.

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

3D printing, Alan Greenspan, bank run, banking crisis, Bear Stearns, 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, Glass-Steagall Act, 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, low interest rates, market bubble, market clearing, means of production, Meghnad Desai, Mexican peso crisis / tequila crisis, mortgage debt, Myron Scholes, negative equity, Northern Rock, oil shale / tar sands, oil shock, open economy, Paul Samuelson, Phillips curve, Post-Keynesian economics, price stability, purchasing power parity, pushing on a string, quantitative easing, reserve currency, rising living standards, risk/return, Robert Shiller, Robert Solow, Ronald Reagan, savings glut, secular stagnation, seigniorage, Silicon Valley, Simon Kuznets, subprime mortgage crisis, 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.

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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.

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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.

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

Abraham Maslow, active measures, assortative mating, back-to-the-city movement, 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, financial engineering, gentrification, 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, power law, Richard Florida, risk tolerance, Robert Gordon, Robert Shiller, Seaside, Florida, Silicon Valley, Silicon Valley startup, superstar cities, The Death and Life of Great American Cities, the strength of weak ties, The Wealth of Nations by Adam Smith, Thomas L Friedman, Tyler Cowen, 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.

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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.

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

agricultural Revolution, Alan Greenspan, Albert Einstein, algorithmic trading, Andrei Shleifer, autism spectrum disorder, autonomous vehicles, bank run, banking crisis, basic income, behavioural economics, 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, digital divide, disintermediation, Donald Trump, driverless car, Edmond Halley, Elon Musk, en.wikipedia.org, Ethereum, ethereum blockchain, fake news, financial engineering, Ford Model T, full employment, George Akerlof, germ theory of disease, German hyperinflation, Great Leap Forward, Gunnar Myrdal, Gödel, Escher, Bach, Hacker Ethic, implied volatility, income inequality, inflation targeting, initial coin offering, 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, low interest rates, machine translation, market bubble, Modern Monetary Theory, money market fund, moral hazard, Northern Rock, nudge unit, Own Your Own Home, Paul Samuelson, Philip Mirowski, plutocrats, Ponzi scheme, public intellectual, publish or perish, random walk, Richard Thaler, 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 Theory of the Leisure Class by Thorstein Veblen, 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?  

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“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.

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“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.

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, behavioural economics, Black Swan, butterfly effect, buy and hold, cloud computing, cognitive load, cuban missile crisis, Daniel Kahneman / Amos Tversky, data science, desegregation, drone strike, Edward Lorenz: Chaos theory, forward guidance, Freestyle chess, fundamental attribution error, germ theory of disease, hindsight bias, How many piano tuners are there in Chicago?, index fund, Jane Jacobs, Jeff Bezos, Kenneth Arrow, Laplace demon, longitudinal study, Mikhail Gorbachev, Mohammed Bouazizi, Nash equilibrium, Nate Silver, Nelson Mandela, obamacare, operational security, pattern recognition, performance metric, Pierre-Simon Laplace, place-making, placebo effect, precautionary principle, prediction markets, quantitative easing, random walk, randomized controlled trial, Richard Feynman, Richard Thaler, Robert Shiller, Ronald Reagan, Saturday Night Live, scientific worldview, Silicon Valley, Skype, statistical model, stem cell, Steve Ballmer, Steve Jobs, Steven Pinker, tacit knowledge, tail risk, 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.

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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.

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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.

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

"Friedman doctrine" OR "shareholder theory", "World Economic Forum" Davos, 8-hour work day, active measures, activist fund / activist shareholder / activist investor, affirmative action, Affordable Care Act / Obamacare, Alan Greenspan, bank run, banking crisis, Basel III, Bear Stearns, behavioural economics, benefit corporation, Black Swan, blood diamond, 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, company town, compensation consultant, 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 engineering, financial innovation, fixed income, Ford Model T, Francis Fukuyama: the end of history, full employment, George Akerlof, George Gilder, Gini coefficient, Glass-Steagall Act, Gordon Gekko, Greenspan put, hiring and firing, Ida Tarbell, income inequality, independent contractor, invisible hand, job satisfaction, John Markoff, joint-stock company, Joseph Schumpeter, junk bonds, Kenneth Rogoff, labor-force participation, laissez-faire capitalism, lake wobegon effect, light touch regulation, Long Term Capital Management, low interest rates, manufacturing employment, market clearing, market fundamentalism, Martin Wolf, minimum wage unemployment, mittelstand, Money creation, moral hazard, Myron Scholes, Naomi Klein, Northern Rock, obamacare, offshore financial centre, Paul Samuelson, Paul Volcker talking about ATMs, pension reform, performance metric, Pershing Square Capital Management, pirate software, plutocrats, Ponzi scheme, precariat, price stability, profit maximization, profit motive, prosperity theology / prosperity gospel / gospel of success, purchasing power parity, race to the bottom, Ralph Nader, rent-seeking, reshoring, Richard Thaler, rising living standards, road to serfdom, Robert Gordon, Robert Shiller, rolling blackouts, Ronald Reagan, Sand Hill Road, Savings and loan crisis, shareholder value, Silicon Valley, Social Responsibility of Business Is to Increase Its Profits, South Sea Bubble, sovereign wealth fund, Steve Ballmer, Steve Jobs, stock buybacks, subprime mortgage crisis, The Chicago School, The Spirit Level, The Theory of the Leisure Class by Thorstein Veblen, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, transcontinental railway, transfer pricing, trickle-down economics, tulip mania, Tyler Cowen, 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?

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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….

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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.).

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

"World Economic Forum" Davos, Adam Curtis, air traffic controllers' union, Alan Greenspan, AOL-Time Warner, 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 engineering, 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, job polarisation, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, laissez-faire capitalism, Larry Ellison, light touch regulation, Londongrad, Long Term Capital Management, low interest rates, low skilled workers, manufacturing employment, market bubble, Martin Wolf, Mary Meeker, mittelstand, mobile money, Mont Pelerin Society, Myron Scholes, new economy, Nick Leeson, North Sea oil, Northern Rock, offshore financial centre, oil shock, plutocrats, Plutonomy: Buying Luxury, Explaining Global Imbalances, proprietary trading, Right to Buy, rising living standards, Robert Shiller, Robert Solow, 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, 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.

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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.

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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.

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

Abraham Maslow, Alan Greenspan, Andrei Shleifer, asset-backed security, bank run, banking crisis, Bear Stearns, behavioural economics, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Blythe Masters, Boris Johnson, bread and circuses, Bretton Woods, business cycle, capital controls, carbon footprint, Carmen Reinhart, Cass Sunstein, centre right, choice architecture, cloud computing, collective bargaining, conceptual framework, Corn Laws, Cornelius Vanderbilt, corporate governance, creative destruction, credit crunch, Credit Default Swap, debt deflation, decarbonisation, Deng Xiaoping, discovery of DNA, discovery of the americas, discrete time, disinformation, diversification, double helix, Edward Glaeser, financial deregulation, financial engineering, 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, general purpose technology, George Akerlof, Gini coefficient, Glass-Steagall Act, 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, Japanese asset price bubble, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, knowledge worker, labour market flexibility, language acquisition, Large Hadron Collider, liberal capitalism, light touch regulation, Long Term Capital Management, long term incentive plan, Louis Pasteur, low cost airline, low interest rates, low-wage service sector, mandelbrot fractal, margin call, market fundamentalism, Martin Wolf, mass immigration, means of production, meritocracy, Mikhail Gorbachev, millennium bug, Money creation, money market fund, moral hazard, moral panic, mortgage debt, Myron Scholes, Neil Kinnock, new economy, Northern Rock, offshore financial centre, open economy, plutocrats, power law, price discrimination, private sector deleveraging, proprietary trading, 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, Ronald Reagan, Rory Sutherland, Satyajit Das, Savings and loan crisis, shareholder value, short selling, Silicon Valley, Skype, South Sea Bubble, Steve Jobs, systems thinking, tail risk, 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, three-masted sailing ship, too big to fail, unpaid internship, value at risk, Vilfredo Pareto, Washington Consensus, wealth creators, work culture , working poor, world market for maybe five computers, zero-sum game, éminence grise

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.

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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.

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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.

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

Alan Greenspan, behavioural economics, Black Swan, buy and hold, Carl Icahn, 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, Market Wizards by Jack D. Schwager, Pershing Square Capital Management, Richard Thaler, Robert Shiller, rolodex, Skype, South Sea Bubble, Stanford marshmallow experiment, Steve Jobs, technology bubble, The Wisdom of Crowds, too big to fail, tulip mania, world market for maybe five computers, zero-sum game

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.

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, 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.

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

affirmative action, Affordable Care Act / Obamacare, Alan Greenspan, Andrei Shleifer, antiwork, Asian financial crisis, bank run, banking crisis, basic income, behavioural economics, benefit corporation, Berlin Wall, Bernie Madoff, bitcoin, blockchain, bond market vigilante , Bonfire of the Vanities, business cycle, capital asset pricing model, carbon footprint, carbon tax, 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, fake news, Fall of the Berlin Wall, fiat currency, financial deregulation, financial innovation, financial repression, frictionless, frictionless market, fudge factor, full employment, green new deal, Growth in a Time of Debt, hiring and firing, illegal immigration, income inequality, index fund, indoor plumbing, invisible hand, it is difficult to get a man to understand something, when his salary depends on his not understanding it, job automation, John Snow's cholera map, Joseph Schumpeter, Kenneth Rogoff, knowledge worker, labor-force participation, large denomination, liquidity trap, London Whale, low interest rates, market bubble, market clearing, market fundamentalism, means of production, Modern Monetary Theory, New Urbanism, obamacare, oil shock, open borders, Paul Samuelson, plutocrats, Ponzi scheme, post-truth, price stability, public intellectual, quantitative easing, road to serfdom, Robert Gordon, Robert Shiller, Ronald Reagan, secular stagnation, Seymour Hersh, stock buybacks, 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, We are all Keynesians now, working-age population

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.

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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.

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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.”

The Behavioral Investor by Daniel Crosby

affirmative action, Asian financial crisis, asset allocation, availability heuristic, backtesting, bank run, behavioural economics, Black Monday: stock market crash in 1987, Black Swan, book value, buy and hold, cognitive dissonance, colonial rule, compound rate of return, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, disinformation, diversification, diversified portfolio, Donald Trump, Dunning–Kruger effect, endowment effect, equity risk premium, fake news, feminist movement, Flash crash, haute cuisine, hedonic treadmill, housing crisis, IKEA effect, impact investing, impulse control, index fund, Isaac Newton, Japanese asset price bubble, job automation, longitudinal study, loss aversion, market bubble, market fundamentalism, mental accounting, meta-analysis, Milgram experiment, moral panic, Murray Gell-Mann, Nate Silver, neurotypical, Nick Bostrom, passive investing, pattern recognition, Pepsi Challenge, Ponzi scheme, prediction markets, random walk, Reminiscences of a Stock Operator, Richard Feynman, Richard Thaler, risk tolerance, Robert Shiller, science of happiness, Shai Danziger, short selling, South Sea Bubble, Stanford prison experiment, Stephen Hawking, Steve Jobs, stocks for the long run, sunk-cost fallacy, systems thinking, TED Talk, Thales of Miletus, The Signal and the Noise by Nate Silver, Tragedy of the Commons, trolley problem, tulip mania, Vanguard fund, When a measure becomes a target

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.

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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?

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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.

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

"World Economic Forum" Davos, Alan Greenspan, bank run, banking crisis, Bear Stearns, behavioural economics, Benoit Mandelbrot, Berlin Wall, Black Swan, bond market vigilante , bonus culture, Bretton Woods, BRICs, business cycle, buy and hold, Carmen Reinhart, classic study, cognitive dissonance, collapse of Lehman Brothers, Corn Laws, correlation does not imply causation, creative destruction, credit crunch, currency manipulation / currency intervention, currency risk, David Ricardo: comparative advantage, deglobalization, Deng Xiaoping, eat what you kill, Edward Glaeser, electricity market, 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, foreign exchange controls, full employment, geopolitical risk, George Akerlof, global rebalancing, Goodhart's law, Great Leap Forward, Hyman Minsky, income inequality, information asymmetry, invisible hand, Isaac Newton, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, Kickstarter, laissez-faire capitalism, long and variable lags, Long Term Capital Management, low interest rates, mandelbrot fractal, market design, market fundamentalism, Martin Wolf, military-industrial complex, Minsky moment, Modern Monetary Theory, Money creation, money market fund, moral hazard, mortgage debt, Nelson Mandela, new economy, Nixon triggered the end of the Bretton Woods system, Northern Rock, offshore financial centre, oil shock, paradox of thrift, Pareto efficiency, Paul Samuelson, Paul Volcker talking about ATMs, 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 Solow, Ronald Reagan, Savings and loan crisis, seminal paper, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, statistical model, systems thinking, 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

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.

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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.

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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.”

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

Airbnb, Alan Greenspan, altcoin, Apple Newton, bank run, banking crisis, bitcoin, Bitcoin Ponzi scheme, blockchain, Bretton Woods, buy and hold, California gold rush, capital controls, carbon footprint, clean water, Cody Wilson, collaborative economy, collapse of Lehman Brothers, Columbine, Credit Default Swap, cross-border payments, cryptocurrency, David Graeber, decentralized internet, disinformation, disintermediation, Dogecoin, driverless car, Edward Snowden, Elon Musk, Ethereum, ethereum blockchain, fiat currency, financial engineering, financial innovation, Firefox, Flash crash, Ford Model T, Fractional reserve banking, Glass-Steagall Act, hacker house, Hacker News, 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 creation, money: store of value / unit of account / medium of exchange, Nelson Mandela, Network effects, new economy, new new economy, Nixon shock, Nixon triggered the end of the Bretton Woods system, off-the-grid, offshore financial centre, payday loans, Pearl River Delta, peer-to-peer, peer-to-peer lending, pets.com, Ponzi scheme, prediction markets, price stability, printed gun, profit motive, QR code, RAND corporation, regulatory arbitrage, rent-seeking, reserve currency, 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, Tyler Cowen: Great Stagnation, Uber and Lyft, uber lyft, underbanked, Vitalik Buterin, WikiLeaks, Y Combinator, Y2K, zero-sum game, Zimmermann PGP

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/.

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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.”

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

Alan Greenspan, Albert Einstein, asset allocation, Bear Stearns, behavioural economics, 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, National Debt Clock, negative equity, new economy, RFID, Richard Thaler, risk tolerance, Robert Shiller, side project, Silicon Valley, Steve Jobs, the rule of 72, Yogi Berra

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.

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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.

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, Alan Greenspan, Albert Einstein, Andrei Shleifer, asset allocation, Atul Gawande, backtesting, beat the dealer, Black Swan, book value, 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, financial engineering, forensic accounting, Henry Singleton, hindsight bias, intangible asset, Jim Simons, Louis Bachelier, p-value, passive investing, performance metric, quantitative hedge fund, random walk, Richard Thaler, risk free rate, risk-adjusted returns, Robert Shiller, shareholder value, Sharpe ratio, short selling, statistical model, stock buybacks, survivorship bias, systematic trading, Teledyne, 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.

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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.

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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.

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

Affordable Care Act / Obamacare, Alan Greenspan, asset-backed security, bank run, barriers to entry, Basel III, Bear Stearns, Bernie Sanders, Black Monday: stock market crash in 1987, 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 engineering, financial innovation, fixed income, Flash crash, forward guidance, full employment, George Akerlof, Glass-Steagall Act, greed is good, Greenspan put, high net worth, housing crisis, income inequality, index fund, inflation targeting, interest rate swap, invisible hand, John Meriwether, Joseph Schumpeter, junk bonds, liquidity trap, London Whale, Long Term Capital Management, low interest rates, margin call, market bubble, Mexican peso crisis / tequila crisis, money market fund, moral hazard, Myron Scholes, natural language processing, Navinder Sarao, negative equity, new economy, Northern Rock, obamacare, Phillips curve, price stability, proprietary trading, pushing on a string, quantitative easing, regulatory arbitrage, Robert Shiller, Ronald Reagan, selection bias, short selling, side project, Silicon Valley, stock buybacks, tail risk, The Great Moderation, The Wealth of Nations by Adam Smith, too big to fail, trickle-down economics, yield curve

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.’”

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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.”

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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.

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

"Susan Fowler" uber, activist fund / activist shareholder / activist investor, additive manufacturing, Affordable Care Act / Obamacare, Airbnb, Amazon Robotics, Amazon Web Services, Apple II, autonomous vehicles, barriers to entry, Ben Horowitz, Bernie Sanders, Big Tech, big-box store, Bob Noyce, Brewster Kahle, business intelligence, California gold rush, Cambridge Analytica, cloud computing, Comet Ping Pong, commoditize, cuban missile crisis, David Brooks, Didi Chuxing, digital divide, disintermediation, don't be evil, Donald Trump, Elon Musk, fake news, follow your passion, fulfillment center, future of journalism, future of work, global supply chain, Google Earth, Google Glasses, Google X / Alphabet X, Hacker Conference 1984, Internet Archive, invisible hand, Jeff Bezos, Jony Ive, Khan Academy, Kiva Systems, longitudinal study, Lyft, Mark Zuckerberg, 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, Search for Extraterrestrial Intelligence, self-driving car, sentiment analysis, shareholder value, Sheryl Sandberg, Silicon Valley, Snapchat, software is eating the world, speech recognition, Stephen Hawking, Steve Ballmer, Steve Bannon, Steve Jobs, Steve Wozniak, Stewart Brand, supercomputer in your pocket, Tesla Model S, the long tail, Tim Cook: Apple, Travis Kalanick, Uber and Lyft, Uber for X, uber lyft, undersea cable, vertical integration, warehouse automation, warehouse robotics, Wayback Machine, Whole Earth Catalog, winner-take-all economy, working poor, you are the product, young professional

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.

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., 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.”

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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!

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, book value, 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, equity risk premium, feminist movement, Great Leap Forward, hindsight bias, index fund, invention of the telescope, invisible hand, Long Term Capital Management, managed futures, mental accounting, 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 free rate, risk tolerance, risk-adjusted returns, riskless arbitrage, Robert Shiller, Sharpe ratio, short selling, source of truth, statistical model, stocks for the long run, sugar pill, 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.

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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.

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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.

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

Alan Greenspan, Antoine Gombaud: Chevalier de Méré, availability heuristic, backtesting, behavioural economics, 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, financial engineering, fixed income, global village, hedonic treadmill, hindsight bias, junk bonds, Kenneth Arrow, Linda problem, Long Term Capital Management, loss aversion, mandelbrot fractal, Mark Spitznagel, Market Wizards by Jack D. Schwager, mental accounting, meta-analysis, Michael Milken, Myron Scholes, PalmPilot, Paradox of Choice, Paul Samuelson, power law, proprietary trading, public intellectual, quantitative trading / quantitative finance, QWERTY keyboard, random walk, Richard Feynman, risk free rate, road to serfdom, Robert Shiller, selection bias, shareholder value, Sharpe ratio, Steven Pinker, stochastic process, survivorship bias, too big to fail, Tragedy of the Commons, 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).

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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.

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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).

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

Alan Greenspan, Alvin Roth, AOL-Time Warner, Asian financial crisis, Ayatollah Khomeini, banking crisis, barriers to entry, behavioural economics, Berlin Wall, British Empire, capital controls, carbon tax, Carmen Reinhart, Cass Sunstein, clean water, Credit Default Swap, Deng Xiaoping, Easter island, Edward Glaeser, European colonialism, Fall of the Berlin Wall, financial deregulation, financial engineering, flying shuttle, Ford paid five dollars a day, full employment, George Akerlof, Glass-Steagall Act, 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, junk bonds, 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, Michael Milken, Monkeys Reject Unequal Pay, new economy, New Urbanism, peer-to-peer, pension reform, Peter Singer: altruism, pets.com, placebo effect, precautionary principle, price discrimination, price stability, rent-seeking, Richard Thaler, rising living standards, risk tolerance, Robert Shiller, Ronald Reagan, search costs, Silicon Valley, stem cell, Steve Jobs, Stewart Brand, superstar cities, The Spirit Level, The Theory of the Leisure Class by Thorstein Veblen, 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

: 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.

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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.

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

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

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.

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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.

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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).

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

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

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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, behavioural economics, business cycle, Cass Sunstein, cognitive load, conceptual framework, Daniel Kahneman / Amos Tversky, financial exclusion, financial innovation, Home mortgage interest deduction, income inequality, information asymmetry, it's over 9,000, labor-force participation, late fees, London Interbank Offered Rate, loss aversion, low interest rates, machine readable, 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, search costs, subprime mortgage crisis, 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.

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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.

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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.

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

Airbus A320, Alan Greenspan, Albert Einstein, Albert Michelson, algorithmic trading, anti-fragile, Antoine Gombaud: Chevalier de Méré, Arthur Eddington, autonomous vehicles, availability heuristic, banking crisis, Barry Marshall: ulcers, battle of ideas, Bear Stearns, behavioural economics, Benoit Mandelbrot, bitcoin, Black Swan, Boeing 737 MAX, Bonfire of the Vanities, Brexit referendum, 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, DeepMind, demographic transition, discounted cash flows, disruptive innovation, diversification, diversified portfolio, Donald Trump, Dutch auction, easy for humans, difficult for computers, eat what you kill, Eddington experiment, 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, Goodhart's law, Hans Rosling, Helicobacter pylori, high-speed rail, Ignaz Semmelweis: hand washing, income per capita, incomplete markets, inflation targeting, information asymmetry, invention of the wheel, invisible hand, Jeff Bezos, Jim Simons, Johannes Kepler, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Snow's cholera map, John von Neumann, Kenneth Arrow, Kōnosuke Matsushita, Linda problem, Long Term Capital Management, loss aversion, Louis Pasteur, mandelbrot fractal, market bubble, market fundamentalism, military-industrial complex, Money creation, Moneyball by Michael Lewis explains big data, Monty Hall problem, Nash equilibrium, Nate Silver, new economy, Nick Leeson, Northern Rock, nudge theory, oil shock, PalmPilot, Paul Samuelson, peak oil, Peter Thiel, Philip Mirowski, Phillips curve, Pierre-Simon Laplace, popular electronics, power law, price mechanism, probability theory / Blaise Pascal / Pierre de Fermat, quantitative trading / quantitative finance, railway mania, RAND corporation, reality distortion field, rent-seeking, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Solow, Ronald Coase, sealed-bid auction, shareholder value, Silicon Valley, Simon Kuznets, Socratic dialogue, South Sea Bubble, spectrum auction, Steve Ballmer, Steve Jobs, Steve Wozniak, Suez crisis 1956, 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 market for maybe five computers, World Values Survey, Yom Kippur War, zero-sum game

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.

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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.

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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’.

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

"World Economic Forum" Davos, accounting loophole / creative accounting, Alan Greenspan, Andrei Shleifer, Asian financial crisis, asset-backed security, assortative mating, bank run, barriers to entry, Bear Stearns, behavioural economics, Bernie Madoff, Bretton Woods, business climate, business cycle, carbon tax, 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, currency risk, diversification, Edward Glaeser, financial innovation, fixed income, floating exchange rates, full employment, Glass-Steagall Act, global supply chain, Goldman Sachs: Vampire Squid, Greenspan put, illegal immigration, implied volatility, income inequality, index fund, interest rate swap, Joseph Schumpeter, Kaizen: continuous improvement, Kenneth Rogoff, knowledge worker, labor-force participation, Long Term Capital Management, longitudinal study, low interest rates, machine readable, market bubble, Martin Wolf, medical malpractice, microcredit, money market fund, moral hazard, new economy, Northern Rock, offshore financial centre, open economy, Phillips curve, price stability, profit motive, proprietary trading, Real Time Gross Settlement, Richard Florida, Richard Thaler, risk tolerance, Robert Shiller, Ronald Reagan, Savings and loan crisis, school vouchers, seminal paper, short selling, sovereign wealth fund, tail risk, 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

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.

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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.

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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.

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

Affordable Care Act / Obamacare, Alan Greenspan, asset-backed security, bank run, banking crisis, banks create money, Bear Stearns, book value, 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, currency risk, Detroit bankruptcy, diversification, double entry bookkeeping, eurozone crisis, facts on the ground, financial engineering, financial innovation, fixed income, friendly fire, full employment, Glass-Steagall Act, hiring and firing, housing crisis, Hyman Minsky, illegal immigration, inflation targeting, interest rate swap, Isaac Newton, junk bonds, Kenneth Rogoff, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low interest rates, market bubble, market clearing, market fundamentalism, McMansion, Minsky moment, money market fund, moral hazard, naked short selling, new economy, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, Paul Volcker talking about ATMs, price mechanism, proprietary trading, quantitative easing, Ralph Waldo Emerson, Robert Shiller, Robert Solow, Ronald Reagan, Savings and loan crisis, shareholder value, short selling, South Sea Bubble, statistical model, the payments system, time value of money, too big to fail, vertical integration, working-age population, yield curve, Yogi Berra

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.

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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).

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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!

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

"Hurricane Katrina" Superdome, "World Economic Forum" Davos, accelerated depreciation, addicted to oil, Alan Greenspan, Albert Einstein, An Inconvenient Truth, Asian financial crisis, Ayatollah Khomeini, banking crisis, Berlin Wall, bioinformatics, book value, borderless world, BRICs, business climate, California energy crisis, carbon credits, carbon footprint, carbon tax, Carl Icahn, Carmen Reinhart, clean tech, 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, electricity market, Elon Musk, energy security, energy transition, Exxon Valdez, facts on the ground, Fall of the Berlin Wall, fear of failure, financial innovation, flex fuel, Ford Model T, geopolitical risk, global supply chain, global village, Great Leap Forward, Greenspan put, high net worth, high-speed rail, hydraulic fracturing, income inequality, index fund, informal economy, interchangeable parts, Intergovernmental Panel on Climate Change (IPCC), It's morning again in America, James Watt: steam engine, John Deuss, John von Neumann, Kenneth Rogoff, life extension, Long Term Capital Management, Malacca Straits, market design, means of production, megacity, megaproject, Menlo Park, Mikhail Gorbachev, military-industrial complex, Mohammed Bouazizi, mutually assured destruction, new economy, no-fly zone, Norman Macrae, North Sea oil, nuclear winter, off grid, oil rush, oil shale / tar sands, oil shock, oil-for-food scandal, Paul Samuelson, peak oil, Piper Alpha, price mechanism, purchasing power parity, rent-seeking, rising living standards, Robert Metcalfe, Robert Shiller, Robert Solow, rolling blackouts, Ronald Coase, Ronald Reagan, Sand Hill Road, Savings and loan crisis, seminal paper, shareholder value, Shenzhen special economic zone , Silicon Valley, Silicon Valley billionaire, Silicon Valley startup, smart grid, smart meter, South China Sea, sovereign wealth fund, special economic zone, Stuxnet, Suez crisis 1956, 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, vertical integration, William Langewiesche, Yom Kippur War

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.

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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.

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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.”

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

affirmative action, Andrei Shleifer, availability heuristic, behavioural economics, 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, Free Software Foundation, 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, Ronald Reagan, Savings and loan crisis, slashdot, stem cell, systematic bias, Ted Sorensen, the Cathedral and the Bazaar, 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.

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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.

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

Airbnb, big-box store, bike sharing, Burning Man, call centre, car-free, Celebration, Florida, clean water, collaborative consumption, Columbine, commoditize, crack epidemic, demographic winter, East Village, edge city, Edward Glaeser, extreme commuting, Ford Model T, General Motors Futurama, gentrification, helicopter parent, Home mortgage interest deduction, housing crisis, Jane Jacobs, Kickstarter, Lewis Mumford, low skilled workers, Mark Zuckerberg, McMansion, Menlo Park, microapartment, mortgage tax deduction, negative equity, New Urbanism, peak oil, Peter Calthorpe, Ponzi scheme, Quicken Loans, Richard Florida, Robert Shiller, Sand Hill Road, Seaside, Florida, Silicon Valley, Steve Jobs, Stewart Brand, streetcar suburb, TED Talk, the built environment, The Death and Life of Great American Cities, Tony Hsieh, Tragedy of the Commons, 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.

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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.”

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

Alan Greenspan, Bretton Woods, business cycle, collateralized debt obligation, commoditize, creative destruction, David Graeber, deindustrialization, financial innovation, Garrett Hardin, gentrification, Guggenheim Bilbao, Hernando de Soto, high-speed rail, housing crisis, illegal immigration, indoor plumbing, invisible hand, Jane Jacobs, late capitalism, Lewis Mumford, Long Term Capital Management, low interest rates, market bubble, market fundamentalism, means of production, military-industrial complex, moral hazard, mortgage debt, mortgage tax deduction, Murray Bookchin, New Urbanism, Ponzi scheme, precariat, profit maximization, race to the bottom, radical decentralization, Robert Shiller, Savings and loan crisis, special economic zone, the built environment, the High Line, The Wealth of Nations by Adam Smith, Tragedy of the Commons, transcontinental railway, urban planning, We are the 99%, William Langewiesche, Works Progress Administration