Robert Shiller

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pages: 1,088 words: 228,743

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

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

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

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

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


pages: 461 words: 128,421

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

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

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

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

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

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

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

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

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

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


pages: 662 words: 180,546

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

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

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

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

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


pages: 297 words: 91,141

Market Sense and Nonsense by Jack D. Schwager

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

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

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

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


pages: 249 words: 66,383

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

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Andrei Shleifer, asset-backed security, balance sheet recession, bank run, banking crisis, Ben Bernanke: helicopter money, break the buck, 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, liquidity trap, Long Term Capital Management, market bubble, Martin Wolf, money market fund, moral hazard, mortgage debt, negative equity, paradox of thrift, quantitative easing, Robert Shiller, Robert Shiller, school choice, shareholder value, the payments system, the scientific method, tulip mania, young professional, zero-sum game

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

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

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


pages: 430 words: 109,064

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

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

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

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

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


pages: 500 words: 145,005

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

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

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

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

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


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

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3Com Palm IPO, accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, backtesting, beat the dealer, Bernie Madoff, BRICs, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, money market fund, mortgage tax deduction, new economy, Own Your Own Home, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, survivorship bias, The Myth of the Rational Market, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond

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

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

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


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

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

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

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

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


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

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

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

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

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


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

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

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

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

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


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

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

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

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

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

Global Financial Crisis by Noah Berlatsky

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

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

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

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


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Finance and the Good Society by Robert J. Shiller

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

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

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

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


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

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

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

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

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


pages: 326 words: 106,053

The Wisdom of Crowds by James Surowiecki

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

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

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

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


pages: 279 words: 76,796

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

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

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

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

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


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

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

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

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

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


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

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

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

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

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


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Capitalism: Money, Morals and Markets by John Plender

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

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

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

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


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

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3D printing, accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, additive manufacturing, Airbnb, algorithmic trading, Alvin Roth, Asian financial crisis, asset allocation, bank run, Basel III, bonus culture, Bretton Woods, British Empire, call centre, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, centralized clearinghouse, clean water, collateralized debt obligation, commoditize, computerized trading, corporate governance, corporate raider, corporate social responsibility, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, crowdsourcing, David Graeber, deskilling, Detroit bankruptcy, diversification, Double Irish / Dutch Sandwich, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial deregulation, financial intermediation, Frederick Winslow Taylor, George Akerlof, gig economy, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, High speed trading, Home mortgage interest deduction, housing crisis, Howard Rheingold, Hyman Minsky, income inequality, index fund, information asymmetry, interest rate derivative, interest rate swap, Internet of things, invisible hand, John Markoff, joint-stock company, joint-stock limited liability company, Kenneth Rogoff, knowledge economy, labor-force participation, labour mobility, London Whale, Long Term Capital Management, manufacturing employment, market design, Martin Wolf, money market fund, moral hazard, mortgage debt, mortgage tax deduction, new economy, non-tariff barriers, offshore financial centre, oil shock, passive investing, Paul Samuelson, pensions crisis, Ponzi scheme, principal–agent problem, quantitative easing, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, Rana Plaza, RAND corporation, random walk, rent control, Robert Shiller, Robert Shiller, Ronald Reagan, Satyajit Das, Second Machine Age, shareholder value, sharing economy, Silicon Valley, Silicon Valley startup, Snapchat, sovereign wealth fund, Steve Jobs, technology bubble, The Chicago School, the new new thing, The Spirit Level, The Wealth of Nations by Adam Smith, Tim Cook: Apple, Tobin tax, too big to fail, trickle-down economics, Tyler Cowen: Great Stagnation, Vanguard fund, zero-sum game

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

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

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


pages: 363 words: 28,546

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

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

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

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

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


pages: 295 words: 66,824

A Mathematician Plays the Stock Market by John Allen Paulos

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

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

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

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


pages: 411 words: 108,119

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

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

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

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

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


pages: 204 words: 58,565

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

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

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

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


pages: 389 words: 98,487

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

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

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

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

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


pages: 274 words: 93,758

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

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

Phishing for Phools Akerlof.indb 1 6/19/15 10:24 AM Akerlof.indb 2 6/19/15 10:24 AM Phishing for Phools t h e e co n o m i c s o f ma n i p u l at i o n a n d d e c e p t i o n GEORGE A. AKERLOF AND ROBERT J. SHILLER Princeton University Press • Akerlof.indb 3 PRINCETON AND OXFORD 6/19/15 10:24 AM 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. All Rights Reserved ISBN 978-0-691-16831-9 [FULL CIP TO COME] British Library Cataloging-in-Publication Data is available This book has been composed in Adobe Galliard and Formata by Princeton Editorial Associates Inc., Scottsdale, Arizona Printed on acid-free paper. ∞ Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 Akerlof.indb 4 6/19/15 10:24 AM co n t e n ts PREFACE vii INTRODUC TION   PART ONE   Expect to Be Manipulated: Phishing Equilibrium  1 Unpaid Bills and Financial Crash CHAPTER ONE   Temptation Strews Our Path  15 CHAPTER T WO   Reputation Mining and Financial Crisis 23 PART T WO   Phishing in Many Contexts CHAPTER THREE   Advertisers Discover How to Zoom In on Our Weak Spots 45 CHAPTER FOUR   Rip-offs Regarding Cars, Houses, and Credit Cards  60 Phishing in Politics  72 CHAPTER SIX   Phood, Pharma, and Phishing  84 CHAPTER SE VEN   Innovation: The Good, the Bad, and the Ugly  96 CHAPTER EIGHT   Tobacco and Alcohol  103 CHAPTER NINE   Bankruptcy for Profit  117 CHAPTER TEN   Michael Milken Phishes with Junk Bonds as Bait  124 CHAPTER ELE VEN   The Resistance and Its Heroes  136 CHAPTER FIVE   PART THREE   Conclusion and Epilogue CONCLUSON   New Story in America and Its Consequences  149 EPILOGUE   What Is New in Phishing for Phools? 

“Economics and Identity.” Quar­ terly Journal of Economics 115, no. 3 (August 2000): 715–53. —. Identity Economics: How Our Identities Shape Our Work, Wages, and Well-Being. Princeton: Princeton University Press, 2010. Akerlof, George A., and Paul M. Romer. “Looting: The Economic Underworld of Bankruptcy for Profit.” Brookings Papers on Economic Activity 2 (1993): 1–73. Akerlof, George A., and Robert J. Shiller. Animal Spirits: How Human Psychol­ ogy Drives the Economy, and Why It Matters for Global Capitalism. Princeton: Princeton University Press, 2009. Alessi, Christopher, Roya Wolverson, and Mohammed Aly Sergie. “The Credit Rating Controversy.” Council on Foreign Relations, Backgrounder. Updated October 22, 2013. Accessed November 8, 2014. http://www.cfr.org/ financial-crises/credit-rating-controversy/p22328.

Butler, Jeffrey Vincent. “Status and Confidence.” In “Essays on Identity and Economics.” PhD diss., University of California, Berkeley, 2008. Calomiris, Charles W. “The Subprime Crisis: What’s Old, What’s New, and What’s Next.” Paper prepared for the Federal Reserve Bank of St. Louis Economic Symposium, “Maintaining Stability in a Changing Financial System,” Jackson Hole, WY, August 2008. Campbell, John Y., and Robert J. Shiller. “Cointegration and Tests of Present Value Models.” Journal of Political Economy 95, no. 5 (October 1987): 1062–88. Carbone, Danielle. “The Impact of the Dodd-Frank Act’s Credit-Rating Agency Reform on Public Companies.” Corporate and Securities Law Advisor 24, no. 9 (September 2010): 1–7. http://www.shearman.com/~/media/Files/ NewsInsights/Publications/2010/09/The-Impact-of-the-DoddFrank-Acts -Credit-Rating-A__/Files/View-full-article-The-Impact-of-the-DoddFrank -Ac__/FileAttachment/CM022211InsightsCarbone.pdf.


pages: 270 words: 73,485

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

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

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

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

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


pages: 543 words: 147,357

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

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

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

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

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


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

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

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

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

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


pages: 121 words: 31,813

The Art of Execution by Lee Freeman-Shor

Black Swan, 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, price anchoring, Richard Thaler, Robert Shiller, Robert Shiller, rolodex, Skype, South Sea Bubble, Steve Jobs, technology bubble, The Wisdom of Crowds, too big to fail, tulip mania, zero-sum game

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

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


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Planet Ponzi by Mitch Feierstein

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

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

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

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


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

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

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

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

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


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

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

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

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

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


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

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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 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, falling living standards, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, Goldman Sachs: Vampire Squid, high net worth, hiring and firing, Hyman Minsky, income inequality, James Dyson, Jeff Bezos, job automation, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, laissez-faire capitalism, light touch regulation, Long Term Capital Management, low skilled workers, manufacturing employment, market bubble, Martin Wolf, mittelstand, mobile money, Mont Pelerin Society, Myron Scholes, new economy, Nick Leeson, North Sea oil, Northern Rock, offshore financial centre, oil shock, Plutocrats, plutocrats, Plutonomy: Buying Luxury, Explaining Global Imbalances, Right to Buy, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, shareholder value, The Great Moderation, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, too big to fail, Tyler Cowen: Great Stagnation, Washington Consensus, Winter of Discontent, working-age population

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

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

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


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

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

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

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

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


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

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

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

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


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

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

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

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

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


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

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

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

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


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

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

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

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

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


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

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3D printing, Airbnb, altcoin, bank run, banking crisis, bitcoin, blockchain, Bretton Woods, California gold rush, capital controls, carbon footprint, clean water, collaborative economy, collapse of Lehman Brothers, Columbine, Credit Default Swap, cryptocurrency, David Graeber, disintermediation, Edward Snowden, Elon Musk, ethereum blockchain, fiat currency, financial innovation, Firefox, Flash crash, Fractional reserve banking, hacker house, Hernando de Soto, high net worth, informal economy, intangible asset, Internet of things, inventory management, Julian Assange, Kickstarter, Kuwabatake Sanjuro: assassination market, litecoin, Long Term Capital Management, Lyft, M-Pesa, Marc Andreessen, Mark Zuckerberg, McMansion, means of production, Menlo Park, mobile money, money: store of value / unit of account / medium of exchange, Network effects, new economy, new new economy, Nixon shock, offshore financial centre, payday loans, Pearl River Delta, peer-to-peer, peer-to-peer lending, pets.com, Ponzi scheme, prediction markets, price stability, profit motive, QR code, RAND corporation, regulatory arbitrage, rent-seeking, reserve currency, Robert Shiller, Robert Shiller, Satoshi Nakamoto, seigniorage, shareholder value, sharing economy, short selling, Silicon Valley, Silicon Valley startup, Skype, smart contracts, special drawing rights, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, supply-chain management, Ted Nelson, The Great Moderation, the market place, the payments system, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, Turing complete, Tyler Cowen: Great Stagnation, Uber and Lyft, underbanked, WikiLeaks, Y Combinator, Y2K, zero-sum game, Zimmermann PGP

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

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


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Who Stole the American Dream? by Hedrick Smith

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

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

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

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


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

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

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

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

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


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

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

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

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

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


pages: 385 words: 111,807

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

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

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

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


pages: 296 words: 76,284

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

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

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

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

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

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

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

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


pages: 479 words: 113,510

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

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

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

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

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

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

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Airbnb, diversified portfolio, financial independence, index fund, Lyft, passive income, passive investing, risk tolerance, Robert Shiller, Robert Shiller, time value of money, Vanguard fund, Zipcar

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


pages: 586 words: 159,901

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

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

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

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

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

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

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

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

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

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


pages: 58 words: 18,747

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

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

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


pages: 840 words: 202,245

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

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

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

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

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


pages: 829 words: 186,976

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

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

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

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

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


pages: 278 words: 82,069

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

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

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

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


pages: 239 words: 69,496

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

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

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

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


pages: 94 words: 26,453

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

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

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


pages: 471 words: 124,585

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

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

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

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

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


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

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

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

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

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


pages: 306 words: 78,893

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

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accounting loophole / creative accounting, affirmative action, Asian financial crisis, barriers to entry, borderless world, Branko Milanovic, Bretton Woods, capital controls, corporate governance, corporate raider, correlation coefficient, credit crunch, deindustrialization, dematerialisation, deskilling, ending welfare as we know it, feminist movement, full employment, gender pay gap, George Gilder, glass ceiling, Gordon Gekko, greed is good, half of the world's population has never made a phone call, income inequality, indoor plumbing, intangible asset, Internet Archive, job satisfaction, joint-stock company, Kevin Kelly, labor-force participation, liquidationism / Banker’s doctrine / the Treasury view, manufacturing employment, means of production, minimum wage unemployment, Naomi Klein, new economy, occupational segregation, pets.com, profit maximization, purchasing power parity, race to the bottom, Ralph Nader, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, Silicon Valley, Simon Kuznets, statistical model, structural adjustment programs, Telecommunications Act of 1996, telemarketer, The Bell Curve by Richard Herrnstein and Charles Murray, The Wealth of Nations by Adam Smith, total factor productivity, union organizing, War on Poverty, women in the workforce, working poor, Y2K, zero-sum game

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


pages: 172 words: 54,066

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

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

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


pages: 487 words: 151,810

The Social Animal: The Hidden Sources of Love, Character, and Achievement by David Brooks

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Albert Einstein, asset allocation, assortative mating, Atul Gawande, Bernie Madoff, business process, Cass Sunstein, choice architecture, clean water, creative destruction, Daniel Kahneman / Amos Tversky, David Brooks, delayed gratification, deliberate practice, disintermediation, Donald Trump, Douglas Hofstadter, Emanuel Derman, en.wikipedia.org, fear of failure, financial deregulation, financial independence, Flynn Effect, George Akerlof, Henri Poincaré, hiring and firing, impulse control, invisible hand, Joseph Schumpeter, labor-force participation, loss aversion, medical residency, meta analysis, meta-analysis, Monroe Doctrine, Paul Samuelson, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, school vouchers, six sigma, Steve Jobs, Steven Pinker, the scientific method, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, transaction costs, Walter Mischel, young professional

Denis Diderot. 21 This mode, as Guy Claxton Guy Claxton, The Wayward Mind: An Intimate History of the Unconscious (New York: Little, Brown Book Group, 2006). 22 Lionel Trilling diagnosed Lionel Trilling, The Liberal Imagination: Essays on Literature and Society (New York: New York Review of Books, 2008), ix–xx. 23 “deals with introspection” Robert Skidelsky, Keynes: The Return of the Master (New York: PublicAffairs, 2009), 81. 24 Paul Samuelson applied Clive Cookson, Gillian Tett, and Chris Cook, “Organic Mechanics,” Financial Times, November 26, 2009, http://www.ft.com/cms/s/0/d0e6abde-dacb-11de-933d-00144feabdc0.html. 25 George A. Akerlof and Robert Shiller George A. Akerlof and Robert J. Shiller, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters (Princeton, NJ: Princeton University Press, 2010), 1. 26 Jim Collins argues Jim Collins, “How the Mighty Fall: A Primer on the Warning Signs,” Businessweek, May 14, 2009, http://www.businessweek.com/magazine/content/09_21/b4132026786379.htm. CHAPTER 15: MÉTIS 1 historian Johan Huizinga John Lukacs, Confessions of an Original Sinner (South Bend, IN: St.

On the finance side, Emanuel Derman was a physicist who became a financier and played a central role in developing the models for derivatives. While valuable tools for understanding economic behavior, mathematical models were also like lenses that filtered out certain aspects of human nature. They depended on the notion that people are basically regular and predictable. They assume, as George A. Akerlof and Robert Shiller have written, “that variations in individual feelings, impressions and passions do not matter in the aggregate and that economic events are driven by inscrutable technical factors or erratic government action.” Within a very short time economists were emphasizing monetary motivations to the exclusion of others. Homo Economicus was separated from Homo Sociologus, Homo Psychologicus, Homo Ethicus, and Homo Romanticus.


pages: 407 words: 114,478

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

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

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

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


pages: 483 words: 141,836

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

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

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

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

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


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The Shifts and the Shocks: What We've Learned--And Have Still to Learn--From the Financial Crisis by Martin Wolf

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air freight, anti-communist, Asian financial crisis, asset allocation, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Basel III, Ben Bernanke: helicopter money, Berlin Wall, Black Swan, bonus culture, break the buck, Bretton Woods, call centre, capital asset pricing model, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collateralized debt obligation, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, deglobalization, Deng Xiaoping, diversification, double entry bookkeeping, en.wikipedia.org, Erik Brynjolfsson, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, fiat currency, financial deregulation, financial innovation, financial repression, floating exchange rates, forward guidance, Fractional reserve banking, full employment, global rebalancing, global reserve currency, Growth in a Time of Debt, Hyman Minsky, income inequality, inflation targeting, information asymmetry, invisible hand, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, labour mobility, light touch regulation, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, mandatory minimum, margin call, market bubble, market clearing, market fragmentation, Martin Wolf, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mortgage debt, negative equity, new economy, North Sea oil, Northern Rock, open economy, paradox of thrift, Paul Samuelson, price stability, private sector deleveraging, purchasing power parity, pushing on a string, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, reserve currency, Richard Feynman, risk-adjusted returns, risk/return, road to serfdom, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, Second Machine Age, secular stagnation, shareholder value, short selling, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, too big to fail, Tyler Cowen: Great Stagnation, very high income, winner-take-all economy, zero-sum game

: What It Is, Why It Happened, How It Will Play Out, and What Will Follow’, April 2012, The Jerome Levy Forecasting Center, http://levyforecast.com/jlwp/wp-content/uploads/2012/04/The-Contained-Depression-April-2012.pdf. 16. Mark Easton, ‘The Great Myth of Urban Britain’, 28 June 2012, http://www.bbc.co.uk/news/uk-18623096. 17. The behavioural economist, Robert Shiller, understood the dynamics of the housing-market excess better than most, including most economists. See Robert Shiller, The Subprime Solution: How Today’s Financial Crisis Happened, and What to Do about It (Princeton: Princeton University Press, 2008). 18. Data come from the International Monetary Fund’s World Economic Outlook database, http://www.imf.org/external/pubs/ft/weo/2013/01/weodata/index.aspx. 19. Peter Temin and David Vines, The Leaderless Economy: Why the World Economic System Fell Apart and How to Fix It (Princeton and Oxford: Princeton University Press, 2013), ch. 4, especially pp. 142–3. 20.


pages: 504 words: 139,137

Efficiently Inefficient: How Smart Money Invests and Market Prices Are Determined by Lasse Heje Pedersen

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activist fund / activist shareholder / activist investor, algorithmic trading, Andrei Shleifer, asset allocation, backtesting, bank run, banking crisis, barriers to entry, Black-Scholes formula, Brownian motion, buy low sell high, capital asset pricing model, commodity trading advisor, conceptual framework, corporate governance, credit crunch, Credit Default Swap, currency peg, David Ricardo: comparative advantage, declining real wages, discounted cash flows, diversification, diversified portfolio, Emanuel Derman, equity premium, Eugene Fama: efficient market hypothesis, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, Gordon Gekko, implied volatility, index arbitrage, index fund, interest rate swap, late capitalism, law of one price, Long Term Capital Management, margin call, market clearing, market design, market friction, merger arbitrage, money market fund, mortgage debt, Myron Scholes, New Journalism, paper trading, passive investing, price discovery process, price stability, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, selection bias, shareholder value, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, survivorship bias, systematic trading, technology bubble, time value of money, total factor productivity, transaction costs, value at risk, Vanguard fund, yield curve, zero-coupon bond

EFFICIENTLY INEFFICIENT MARKETS To search for trading strategies that consistently make money over time, we need to understand the markets where securities are traded. The fundamental question concerning financial markets is whether they are efficient, a question that remains hotly debated. For instance, the Nobel Prize in economics in 2013 was awarded jointly to Eugene Fama, the father and defender of efficient markets, Robert Shiller, the father of behavioral economics, and Lars Hansen, who developed tests of market efficiency.2 As seen in Overview Table I, an efficient market, as defined by Fama, is one where market prices reflect all relevant information. In other words, the market price always equals the fundamental value and, as soon as news comes out, prices immediately react to fully reflect the new information. If markets are fully efficient, there is no point in active investing because the prices already reflect as much information as you could hope to collect.

For instance, the lowest observed dividend yield of 1.1% happened in 2000 during the height of the Internet bubble. Based on the regression estimates, this translates into an equity premium of . The highest observed dividend yield of 13.8% happened during the stock market trough of 1932, implying an equity premium of 41%. Figure 10.1. Dividend yield in the United States, 1871–2013. Source: Robert Shiller’s data, http://www.econ.yale.edu/~shiller/data.htm. How could you trade on the insights that come out of this regression? Let us consider a simple backtest. Table 10.1 shows that when the dividend yield has been high, the annualized market return in the following month has been high on average, 11.2%. During periods of low dividend yield, the subsequent market return has been lower. This can be viewed as a backtest of the strategy to invest only when the dividend yield is high (or low).


pages: 464 words: 139,088

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

Andrei Shleifer, Asian financial crisis, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, Bretton Woods, British Empire, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, centre right, collapse of Lehman Brothers, creative destruction, Credit Default Swap, crowdsourcing, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, distributed generation, Doha Development Round, Edmond Halley, Fall of the Berlin Wall, falling living standards, fiat currency, financial innovation, financial intermediation, floating exchange rates, forward guidance, Fractional reserve banking, Francis Fukuyama: the end of history, full employment, German hyperinflation, Hyman Minsky, inflation targeting, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, labour market flexibility, large denomination, liquidity trap, Long Term Capital Management, manufacturing employment, market clearing, Martin Wolf, Mexican peso crisis / tequila crisis, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, Nick Leeson, North Sea oil, Northern Rock, oil shale / tar sands, oil shock, open economy, paradox of thrift, Paul Samuelson, Ponzi scheme, price mechanism, price stability, purchasing power parity, quantitative easing, rent-seeking, reserve currency, Richard Thaler, rising living standards, Robert Shiller, Robert Shiller, Satoshi Nakamoto, savings glut, secular stagnation, seigniorage, stem cell, Steve Jobs, The Great Moderation, the payments system, Thomas Malthus, too big to fail, transaction costs, Tyler Cowen: Great Stagnation, yield curve, Yom Kippur War, zero-sum game

Places that boast of deep and liquid markets, the financial equivalent of an infinity pool, should be aware that their depth is variable, with a long shallow end that is sometimes drained. In the 1980s, economists debated with some passion whether the stock market was ‘rational’ or ‘irrational’. Three participants in the debate were subsequently awarded Nobel Prizes in Economic Science.43 One of them, Robert Shiller, argued that it was impossible to explain the volatility of stock prices by reference to the volatility of the dividend stream that is the return to stocks. Others argued that expectations of large surprises in the distant future, not captured in the data for dividends in any observable sample, justifies the volatility apparent in stock markets. The issue can never be resolved, for the simple reason that in a world of radical uncertainty it is impossible to know what the future holds and therefore whether or not any particular valuation is rational, only whether it seems to embody a wise or a foolish judgement.

Since such a large proportion of the existing stock of financial instruments uses LIBOR as the reference rate, a switch to an alternative would raise yet another prisoner’s dilemma: no one firm on its own could change the benchmark for derivative contracts. A much-needed change will take coordinated action among market participants, prodded by regulators and central banks. 43 The three were Eugene Fama, Robert Merton and Robert Shiller. 44 Schumpeter (1942). 45 Keynes (1936), p. 156. 46 See Tuckett (2012), who argues, ‘given that the prices of financial assets cannot be set by fundamentals – which are unknowable – they are set by stories about fundamentals – specifically the stories which market consensus at any one moment judges true. And because which stories are most popular and judged true can change very much quicker than fundamentals, asset valuations can change very rapidly indeed.’ 47 A microsecond is one millionth of a second.


pages: 376 words: 109,092

Paper Promises by Philip Coggan

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accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, balance sheet recession, bank run, banking crisis, barriers to entry, Berlin Wall, Bernie Madoff, Black Swan, Bretton Woods, British Empire, call centre, capital controls, Carmen Reinhart, carried interest, Celtic Tiger, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, delayed gratification, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, falling living standards, fear of failure, financial innovation, financial repression, fixed income, floating exchange rates, full employment, German hyperinflation, global reserve currency, hiring and firing, Hyman Minsky, income inequality, inflation targeting, Isaac Newton, John Meriwether, joint-stock company, Kenneth Rogoff, labour market flexibility, light touch regulation, Long Term Capital Management, manufacturing employment, market bubble, market clearing, Martin Wolf, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Myron Scholes, negative equity, Nick Leeson, Northern Rock, oil shale / tar sands, paradox of thrift, peak oil, pension reform, Plutocrats, plutocrats, Ponzi scheme, price stability, principal–agent problem, purchasing power parity, quantitative easing, QWERTY keyboard, railway mania, regulatory arbitrage, reserve currency, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, 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, time value of money, too big to fail, trade route, tulip mania, value at risk, Washington Consensus, women in the workforce, zero-sum game

The aim is to even out any fluctuations in the economic cycle. The higher the ratio, the greater the optimism of investors; they are willing to pay a high price, relative to past earnings, in the belief that future earnings will grow rapidly. (Just as banks are willing to lend a higher proportion of a house’s value when they think asset prices are rising.) The graph below shows the data for the US market, compiled by Professor Robert Shiller at Yale University.15 For years, many people had regarded the 1929 boom as the height of investor folly. Back then, they were willing to pay a ratio of nearly thirty-five. In effect, had profits stayed unchanged, investors would have had to wait until 1964 to get their money back. But in 2000, even that valuation was surpassed. Investors were paying forty-four times the cyclically adjusted profits of American companies.


pages: 283 words: 73,093

Social Democratic America by Lane Kenworthy

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affirmative action, Affordable Care Act / Obamacare, barriers to entry, basic income, Celtic Tiger, centre right, clean water, collective bargaining, corporate governance, David Brooks, desegregation, Edward Glaeser, endogenous growth, full employment, Gini coefficient, hiring and firing, Home mortgage interest deduction, illegal immigration, income inequality, invisible hand, Kenneth Arrow, labor-force participation, manufacturing employment, market bubble, minimum wage unemployment, new economy, postindustrial economy, purchasing power parity, race to the bottom, rent-seeking, rising living standards, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, school choice, shareholder value, sharing economy, Skype, Steve Jobs, too big to fail, Tyler Cowen: Great Stagnation, union organizing, universal basic income, War on Poverty, working poor, zero day

A good candidate here is green jobs; see Apollo Alliance 2008; Block 2011. 64. The Bureau of Labor Statistics projects that in 2020 approximately one third of US jobs will be in occupations with a median wage of $25,000 or less. See Bureau of Labor Statistics 2012a. 65. For similar sentiment, see Gans 2011. 66. Baumol 2012; Carlin 2012. 67. My suggestion is similar in spirit to the idea of “inequality insurance” proposed by Robert Shiller; see Shiller 2003, ch. 11. See also Reich 2010. 68. Average compensation tends to rise in sync with GDP per capita. See Pessoa and Van Reenen 2012. 69. Note that to be effective, a rising earnings subsidy will need to be coupled with a rising minimum wage. Otherwise, the subsidy may lead to reductions in low-end wage levels, which will offset the improvement in income achieved by the subsidy.


pages: 330 words: 77,729

Big Three in Economics: Adam Smith, Karl Marx, and John Maynard Keynes by Mark Skousen

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Albert Einstein, banking crisis, Berlin Wall, Bretton Woods, business climate, creative destruction, David Ricardo: comparative advantage, delayed gratification, experimental economics, financial independence, Financial Instability Hypothesis, full employment, Hernando de Soto, housing crisis, Hyman Minsky, inflation targeting, invisible hand, Isaac Newton, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, Joseph Schumpeter, Kenneth Arrow, laissez-faire capitalism, liberation theology, liquidity trap, means of production, microcredit, minimum wage unemployment, money market fund, open economy, paradox of thrift, Pareto efficiency, Paul Samuelson, price stability, pushing on a string, rent control, Richard Thaler, rising living standards, road to serfdom, Robert Shiller, Robert Shiller, rolodex, Ronald Coase, Ronald Reagan, school choice, secular stagnation, Simon Kuznets, The Chicago School, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, Tobin tax, unorthodox policies, Vilfredo Pareto, zero-sum game

Imperfect information exists in labor, products, money, trade, and capital markets.1 Serious unemployment 1. Neo-Keynesians have contributed extensively to the new field of "behavioral economics," which questions the efficiency/rational expectations model of the Chicago school, and proposes ways to counter the tendency of individuals to make financial mistakes, such as undersaving, over-consuming, and undeipeiforming the stock market averages. See, for example, Richard Thaler (2004) andRobert Shiller (2005). However, not all behavioral economists are Keynesian. See Jeremy Siegel (2005). could exist even without minimum wage laws or labor unions, he contends. During the Great Depression, "had there been more wage and price flexibility, matters might have been even worse," he states (2001, 477). According to Stiglitz, involuntary unemployment is still a problem! Gary Becker, Milton Friedman, and other Chicago economists may claim that the competitive marketplace discourages discrimination, unemployment, and poverty, but Stiglitz's hometown of Gary, Indiana, "even in its heyday ... was marred by poverty, periodic unemployment, and massive racial discrimination" (2001, 473).


pages: 265 words: 74,941

The Great Reset: How the Post-Crash Economy Will Change the Way We Live and Work by Richard Florida

banking crisis, big-box store, blue-collar work, car-free, carbon footprint, collapse of Lehman Brothers, congestion charging, creative destruction, deskilling, edge city, Edward Glaeser, falling living standards, financial innovation, Ford paid five dollars a day, high net worth, Home mortgage interest deduction, housing crisis, if you build it, they will come, income inequality, indoor plumbing, interchangeable parts, invention of the telephone, Jane Jacobs, Joseph Schumpeter, knowledge economy, labour mobility, low skilled workers, manufacturing employment, McMansion, Menlo Park, Nate Silver, New Economic Geography, new economy, New Urbanism, oil shock, Own Your Own Home, pattern recognition, peak oil, Ponzi scheme, post-industrial society, postindustrial economy, reserve currency, Richard Florida, Robert Shiller, Robert Shiller, secular stagnation, Silicon Valley, Silicon Valley startup, sovereign wealth fund, the built environment, The Wealth of Nations by Adam Smith, Thomas L Friedman, total factor productivity, urban decay, urban planning, urban renewal, white flight, young professional, Zipcar

Now, instead of making money on their homes, millions of people have lost a bundle. And millions more are stuck with homes whose mortgages exceed their value. According to one study, 30 percent of people age forty-five to fifty-four and 18 percent of those between fifty-five and sixty-four were underwater in their homes in 2009.3 Except for some exceptional boom periods, housing has never been a good financial investment. Yale University’s Robert Shiller, the world’s leading student of bubbles, housing and otherwise, found that from “1890 to 1990, the rate of return on residential real estate was just about zero after inflation.”4 Even if a house isn’t underwater, chances are good that its owners are house poor in the traditional sense: too much of their income is being sucked up by house payments and house-related expenses. The rule of thumb—at least this is what our parents told us—used to be that you should spend 25 to 30 percent of your household income on housing.

Investment: A History by Norton Reamer, Jesse Downing

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activist fund / activist shareholder / activist investor, Albert Einstein, algorithmic trading, asset allocation, backtesting, banking crisis, Berlin Wall, Bernie Madoff, break the buck, Brownian motion, buttonwood tree, California gold rush, capital asset pricing model, Carmen Reinhart, carried interest, colonial rule, credit crunch, Credit Default Swap, Daniel Kahneman / Amos Tversky, debt deflation, discounted cash flows, diversified portfolio, equity premium, estate planning, Eugene Fama: efficient market hypothesis, Fall of the Berlin Wall, family office, Fellow of the Royal Society, financial innovation, fixed income, Gordon Gekko, Henri Poincaré, high net worth, index fund, information asymmetry, interest rate swap, invention of the telegraph, James Hargreaves, James Watt: steam engine, joint-stock company, Kenneth Rogoff, labor-force participation, land tenure, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, means of production, Menlo Park, merger arbitrage, money market fund, moral hazard, mortgage debt, Myron Scholes, negative equity, Network effects, new economy, Nick Leeson, Own Your Own Home, Paul Samuelson, pension reform, Ponzi scheme, price mechanism, principal–agent problem, profit maximization, quantitative easing, RAND corporation, random walk, Renaissance Technologies, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sand Hill Road, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spinning jenny, statistical arbitrage, survivorship bias, technology bubble, The Wealth of Nations by Adam Smith, time value of money, too big to fail, transaction costs, underbanked, Vanguard fund, working poor, yield curve

Progress in Managing Cyclical Crises 215 To sustain some of this feverish activity, market makers propagated the myth that there was no history of any appreciable national price decline in housing. Declines were thought to be local or regional and usually of limited extent and duration. The view was promoted that any broad investment in housing, or the financing to support it, would basically be immune to substantial economic cycle exposure. Of course, the signs were there. Robert Shiller, the Yale economist, posited in advance of the cataclysm that the boom in real estate values might be driven by these psychological factors. After all, one could not explain the rises in housing prices by decomposition of increases in rents or construction costs.37 The practical manifestation of this was the boom in new construction, the growth in the phenomenon of flipping homes, and the increased tapping of built-up equity by homeowners.

William Seyfried, “Monetary Policy and Housing Bubbles: A Multinational Perspective,” Research in Business and Economics Journal 2 (March 2010), http://www.aabri.com/manuscripts/09351.pdf, 1–2. 36. Kathryn J. Byun, “The US Housing Bubble and Bust: Impacts on Employment,” Monthly Labor Review (Bureau of Labor Statistics, US Department of Labor), December 2010, http://www.bls.gov/opub /mlr/2010/12/art1full.pdf, 7. 37. Robert J. Shiller, “Understanding Recent Trends in House Prices and Home Ownership” (working paper 13553, National Bureau of Economic Research, Cambridge, MA, October 2007), http://www.nber.org /papers/w13553.pdf, 3–7. 38. Walter Bagehot, Lombard Street: A Description of the Money Market (London: King, 1873). 39. Board of Governors of the Federal Reserve System, “Ben S. Bernanke,” accessed January 2015, http://www.federalreservehistory.org/People /DetailView/12; Phillip Y.


pages: 350 words: 109,220

In FED We Trust: Ben Bernanke's War on the Great Panic by David Wessel

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Asian financial crisis, asset-backed security, bank run, banking crisis, banks create money, Berlin Wall, Black Swan, break the buck, central bank independence, credit crunch, Credit Default Swap, crony capitalism, debt deflation, Fall of the Berlin Wall, financial innovation, financial intermediation, fixed income, full employment, George Akerlof, housing crisis, inflation targeting, information asymmetry, London Interbank Offered Rate, Long Term Capital Management, market bubble, money market fund, moral hazard, mortgage debt, new economy, Northern Rock, price stability, quantitative easing, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, savings glut, Socratic dialogue, too big to fail

The Fed agreed to put up $180 billion, giving the TALF a total of $200 billion in loans at very sweet terms to offer hedge funds and other big investors to buy securitized consumer loans. The beauty of it was that the Treasury needed only $20 billion from its $700 billion congressionally authorized TARP to get $200 billion into the economy. “TALF shows us there are two sides to creative finance,” wrote Nobel Prize winner George Akerlof along with Robert Shiller, the Yale economist who had predicted the housing bust. “It may have gotten us into this crisis. But its genius may also get us out of it.” The Fed and the Treasury offered investors an additional carrot to borrow this money to buy auto or credit card loans packaged into securities. If the ultimate consumer didn’t pay back the loans, then the big-money investors wouldn’t have to pay back the Fed.

Bernanke, “The Crisis and the Policy Response,” Federal Reserve Board, January 13, 2009. http://www.federalreserve.gov/newsevents/speech/ bernanke20090113a.htm 254 “What justification is there” John B. Taylor, “The Need to Return to a Monetary Framework,” January 2009. http://www.stanford.edu/∼johntayl/NABE%20Business%20Economics%20Article%20-%20Taylor.pdf 255 “TALF shows us” George A. Akerlof and Robert J. Shiller, Animal Spirits (Princeton, N.J.: Princeton University Press, 2009), 92. 256 “Will we face challenges” Charles I. Plosser, “The Economic Outlook and Some Challenges Facing the Federal Reserve,” Federal Reserve Bank of Philadelphia, January 14, 2009. http://www.philadelphiafed.org/publications/ speeches/plosser/2009/01-14-09_university-of- delaware.cfm 257 “In a committee such as the FOMC” Richard W.

All About Asset Allocation, Second Edition by Richard Ferri

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activist fund / activist shareholder / activist investor, asset allocation, asset-backed security, barriers to entry, Bernie Madoff, capital controls, commoditize, commodity trading advisor, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, equity premium, estate planning, financial independence, fixed income, full employment, high net worth, Home mortgage interest deduction, implied volatility, index fund, intangible asset, Long Term Capital Management, Mason jar, money market fund, mortgage tax deduction, passive income, pattern recognition, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, selection bias, Sharpe ratio, survivorship bias, too big to fail, transaction costs, Vanguard fund, yield curve

Figure 11-9 represents the S&P 500 earnings and dividend growth since 1950. A common measure of stock value is the price/earnings ratio, more commonly referred to as the P/E ratio. Many investors track the market P/E ratio in an attempt to determine when stocks are cheap and when they are expensive. Figure 11-10 illustrates the P/E ratio from 1950 to 2009 using a 10-year earnings average from Professor Robert Shiller ’s database that is available to be public at www.econ.yale.edu/~shiller/data.htm. There have been several periods when the ratio was high, although none quite match the speculative premium on stocks that existed in the late 1990s. There are a couple of items that P/E ratio watchers should consider: 1. P/E multiples increase or decrease with changes in the inflation rate. If inflation increases, the present value of Realistic Market Expectations FIGURE 237 11-10 Price /Earnings Ratio (P/E) using a 10-Year Earnings Average 10% 50 10-year CPI (left scale) 10-year P/E (right scale) 9% 45 8% 40 7% 35 6% 30 5% 25 4% 20 3% 15 2% 10 1% 5 0% 1949 1959 1969 1979 1989 1999 0 2009 future earnings diminishes, and that causes the stock market to go down and the P/E ratio to go down.

BEHAVIORAL FINANCE Behavioral finance is an academic field that attempts to understand and explain how psychology influences an investor’s decisionmaking process. A fledgling field of study in the early 1960s, behavioral finance has grown to be an important area of research at How Behavior Affects Asset Allocation Decisions 273 several influential institutions. Professors recognized as experts in the field include Daniel Kahneman (Princeton), Meir Statman (Santa Clara), Richard Thaler (University of Chicago), Robert J. Shiller (Yale), and Amos Tversky. Tversky is frequently cited as the forefather of the field. He died in 1996. The following list touches on a few observations made by behavioral finance researchers. Unfortunately, the list only scratches the surface. Much more information about this fascinating field is available on the Internet and in your local library: ● ● ● ● ● ● ● ● ● People tend to be more optimistic about stocks after the market goes up and more pessimistic after it goes down.


pages: 159 words: 45,073

GDP: A Brief but Affectionate History by Diane Coyle

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Asian financial crisis, Berlin Wall, big-box store, Bretton Woods, BRICs, clean water, computer age, conceptual framework, crowdsourcing, Diane Coyle, double entry bookkeeping, en.wikipedia.org, endogenous growth, Erik Brynjolfsson, Fall of the Berlin Wall, falling living standards, financial intermediation, global supply chain, happiness index / gross national happiness, income inequality, income per capita, informal economy, John von Neumann, Kevin Kelly, Long Term Capital Management, mutually assured destruction, Nathan Meyer Rothschild: antibiotics, new economy, Occupy movement, purchasing power parity, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, Silicon Valley, Simon Kuznets, The Wealth of Nations by Adam Smith, Thorstein Veblen, University of East Anglia, working-age population

Baumol, The Free-Market Innovation Machine (Princeton, NJ: Princeton University Press, 2002). 14. Mark Bils and Peter J. Klenow, “The Acceleration in Variety Growth,” American Economic Review 91, no. 2 (2001): 274–280. 15. Diane Coyle, The Weightless World (Oxford: Capstone, 1996). CHAPTER 5: OUR TIMES: THE GREAT CRASH 1. James Glassman and Kevin Hassett, Dow 36,000 (New York: Three Rivers Press, 1999). 2. Robert Shiller, Irrational Exuberance (Princeton, NJ: Princeton University Press, 2000). 3. See John Kay, Obliquity (London: Profile Books, 2010). 4. Kenneth Pomeranz, The Great Divergence: China, Europe, and the Making of the Modern World Economy (Princeton, NJ: Princeton University Press, 2000). 5. “Has China Already Passed the U.S. as the World’s Largest Economy?” WashintonBlog, 5 April 2012, http://www.washingtonsblog.com/2012/04/has-china-already-passed-the-u-s-as-the-worlds-largest-economy.html. 6.


pages: 1,242 words: 317,903

The Man Who Knew: The Life and Times of Alan Greenspan by Sebastian Mallaby

airline deregulation, airport security, Andrei Shleifer, anti-communist, Asian financial crisis, balance sheet recession, bank run, barriers to entry, Benoit Mandelbrot, Bretton Woods, central bank independence, centralized clearinghouse, collateralized debt obligation, conceptual framework, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, energy security, equity premium, fiat currency, financial deregulation, financial innovation, fixed income, Flash crash, forward guidance, full employment, Hyman Minsky, inflation targeting, information asymmetry, interest rate swap, inventory management, invisible hand, Kenneth Rogoff, Kitchen Debate, laissez-faire capitalism, Long Term Capital Management, low skilled workers, market bubble, market clearing, Martin Wolf, money market fund, moral hazard, mortgage debt, Myron Scholes, new economy, Nixon shock, Northern Rock, paper trading, paradox of thrift, Paul Samuelson, Plutocrats, plutocrats, popular capitalism, price stability, RAND corporation, rent-seeking, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, Saturday Night Live, savings glut, secular stagnation, short selling, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, unorthodox policies, upwardly mobile, WikiLeaks, women in the workforce, Y2K, yield curve, zero-sum game

He had a feeling that the chairman was nodding in agreement. After the three Wall Streeters were done, the microphone was passed to the two academics in the group: John Campbell of Harvard and Robert Shiller of Yale. The professors presented a series of charts comparing stock prices to dividends. According to this means of valuing equities, the market was wildly overvalued. If the Fed raised interest rates, the market would crater. After a morning of meetings, the experts filed into the Fed dining room. They sat down to lunch, and Cohen remarked that the food had improved since her visits to the employee cafeteria in the 1970s.50 Alluding to the question that had been debated that morning, Robert Shiller asked Greenspan when a Fed chairman had last used his bully pulpit to sound a warning about the stock market’s level. A Fed staff economist gave the answer—1965—suggesting a precise knowledge of precedent that would later seem revealing.51 When the lunch was over, Byron Wien called his colleagues at Morgan Stanley to report on the discussion.

It was Morgan Stanley’s chief bond trader. “You asshole,” screamed the trader. “You told us you had convinced Greenspan that the market wasn’t overvalued.” A little while later, Wien’s phone rang again. This time it was Morgan’s head equity trader on the line. He was not brimming with charity, either.54 When the New York Stock Exchange opened, it followed foreign markets downward. Robert Shiller was driving his child to school in New Haven when he heard the news about Greenspan’s remarks. “I wonder if I had anything to do with that,” he said to himself.55 But then, just as quickly, the market recovered. Once traders got hold of the text of Greenspan’s comments, the gap between his speech and the alarming headlines became obvious. To be sure, Greenspan had deliberately sounded a warning; he was gratified that the market had heard him.56 But a reading of his speech showed clearly that his warning had been hedged to the maximum extent; it was hardly a bold sign that he meant to clobber the market by raising interest rates.


pages: 397 words: 112,034

What's Next?: Unconventional Wisdom on the Future of the World Economy by David Hale, Lyric Hughes Hale

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affirmative action, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Berlin Wall, Black Swan, Bretton Woods, capital controls, Cass Sunstein, central bank independence, cognitive bias, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate social responsibility, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, debt deflation, declining real wages, deindustrialization, diversification, energy security, Erik Brynjolfsson, Fall of the Berlin Wall, financial innovation, floating exchange rates, full employment, Gini coefficient, global reserve currency, global village, high net worth, Home mortgage interest deduction, housing crisis, index fund, inflation targeting, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, Just-in-time delivery, Kenneth Rogoff, labour market flexibility, labour mobility, Long Term Capital Management, Mahatma Gandhi, Martin Wolf, Mexican peso crisis / tequila crisis, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, mortgage tax deduction, Network effects, new economy, Nicholas Carr, oil shale / tar sands, oil shock, open economy, passive investing, payday loans, peak oil, Ponzi scheme, post-oil, price stability, private sector deleveraging, purchasing power parity, quantitative easing, race to the bottom, regulatory arbitrage, rent-seeking, reserve currency, Richard Thaler, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, sovereign wealth fund, special drawing rights, technology bubble, The Great Moderation, Thomas Kuhn: the structure of scientific revolutions, Tobin tax, too big to fail, total factor productivity, trade liberalization, Washington Consensus, Westphalian system, women in the workforce, yield curve

The disconnect between the concerns and warnings of the economists—among them Roubini Global Economics’ Nouriel Roubini and David Rosenberg, then with Merrill Lynch—and the indestructible optimism of the investment bankers and insurers was startling. This series of meetings subsequently led to a session at Davos in January 2007 aptly titled “Housing Deflation: What’s the Hissing Sound?” Among other panelists, economist Robert Shiller and then president of the central bank of Germany Axel Weber warned about the impending real estate crisis and its possible cascading effects on other asset classes. A lively discussion ensued with the few people in the room who had bothered to attend the session. Several of them argued convincingly that it “would all end up in tears.” The exuberant Davos consensus of 2007 paid little heed.


pages: 347 words: 97,721

Only Humans Need Apply: Winners and Losers in the Age of Smart Machines by Thomas H. Davenport, Julia Kirby

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AI winter, Andy Kessler, artificial general intelligence, asset allocation, Automated Insights, autonomous vehicles, basic income, Baxter: Rethink Robotics, business intelligence, business process, call centre, carbon-based life, Clayton Christensen, clockwork universe, commoditize, conceptual framework, dark matter, David Brooks, deliberate practice, deskilling, digital map, Douglas Engelbart, Edward Lloyd's coffeehouse, Elon Musk, Erik Brynjolfsson, estate planning, fixed income, follow your passion, Frank Levy and Richard Murnane: The New Division of Labor, Freestyle chess, game design, general-purpose programming language, Google Glasses, Hans Lippershey, haute cuisine, income inequality, index fund, industrial robot, information retrieval, intermodal, Internet of things, inventory management, Isaac Newton, job automation, John Markoff, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, Khan Academy, knowledge worker, labor-force participation, lifelogging, loss aversion, Mark Zuckerberg, Narrative Science, natural language processing, Norbert Wiener, nuclear winter, pattern recognition, performance metric, Peter Thiel, precariat, quantitative trading / quantitative finance, Ray Kurzweil, Richard Feynman, risk tolerance, Robert Shiller, Robert Shiller, Rodney Brooks, Second Machine Age, self-driving car, Silicon Valley, six sigma, Skype, speech recognition, spinning jenny, statistical model, Stephen Hawking, Steve Jobs, Steve Wozniak, strong AI, superintelligent machines, supply-chain management, transaction costs, Tyler Cowen: Great Stagnation, Watson beat the top human players on Jeopardy!, Works Progress Administration, Zipcar

(Perhaps the best was a 2002 analysis by Bruce Weinberg and his colleagues that looked at crime rates across an eighteen-year period in the United States.8 All the increases, they discovered, could be explained by rising unemployment and falling wages among men without college educations.) It isn’t only that people become disgruntled when they lack the income that flows from a good job. They miss having the job itself. This was what economics Nobel laureate Robert Shiller had in mind when he called advancing machine intelligence “the most important problem facing the world today.” He elaborated: It’s associated with income inequality, but it may be more than that. Since we tend to define ourselves by our intellectual talents, it’s also a question of personal identity. Who am I? Intellectual talents are being replaced by computers. That’s a frightening thing for most people.

The End of Accounting and the Path Forward for Investors and Managers (Wiley Finance) by Feng Gu

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active measures, Affordable Care Act / Obamacare, barriers to entry, business process, Claude Shannon: information theory, Clayton Christensen, commoditize, conceptual framework, corporate governance, creative destruction, Daniel Kahneman / Amos Tversky, discounted cash flows, diversified portfolio, double entry bookkeeping, Exxon Valdez, financial innovation, fixed income, hydraulic fracturing, index fund, information asymmetry, intangible asset, inventory management, Joseph Schumpeter, Kenneth Arrow, knowledge economy, moral hazard, new economy, obamacare, quantitative easing, quantitative trading / quantitative finance, QWERTY keyboard, race to the bottom, risk/return, Robert Shiller, Robert Shiller, shareholder value, Steve Jobs, The Great Moderation, value at risk

The lesson: In evaluating corporate performance and predicting the course of business, investors should use more reliable gauges than earnings, like those proposed in Part III. This lesson is particularly important to individual investors who tend to rely on a few summary measures, primarily earnings and the price-to-earnings ratio, in their investment decisions. Investors’ Fault or Accounting’s? 59 NOTES 1. Robert Shiller, one of the 2013 Nobel winners in economics, was awarded this highest recognition mainly for his research on investors’ irrationality. See his book Irrational Exuberance (Princeton University Press, 2005). 2. The tech bubble burst in 2000, as NASDAQ lost 50 percent of its value, a slide that continued through 2002. 3. Ample evidence indicates that investors learn from mistakes, thereby increasing the efficiency and rationality of capital markets.


pages: 519 words: 104,396

Priceless: The Myth of Fair Value (And How to Take Advantage of It) by William Poundstone

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availability heuristic, Cass Sunstein, collective bargaining, Daniel Kahneman / Amos Tversky, delayed gratification, Donald Trump, East Village, en.wikipedia.org, endowment effect, equal pay for equal work, experimental economics, experimental subject, feminist movement, game design, German hyperinflation, Henri Poincaré, high net worth, index card, invisible hand, John von Neumann, Kenneth Arrow, laissez-faire capitalism, Landlord’s Game, loss aversion, market bubble, mental accounting, meta analysis, meta-analysis, Nash equilibrium, new economy, Paul Samuelson, payday loans, Philip Mirowski, Potemkin village, price anchoring, price discrimination, psychological pricing, Ralph Waldo Emerson, RAND corporation, random walk, RFID, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, rolodex, Steve Jobs, The Chicago School, The Wealth of Nations by Adam Smith, ultimatum game, working poor

You can’t prove anything from that, as there could be other causes producing the same effect. Summers sketched one, a model in which stock prices have a strong arbitrary component yet adjust coherently to the day’s financial news. Summers’s idea is a scary one. It proposes that stock prices could be a collective hallucination. Once investors stop believing, it all comes tumbling down. “Who would know what the value of the Dow Jones Industrial Average should be?” asked Yale’s Robert Shiller in 1998. “Is it really ‘worth’ 6,000 today? Or 5,000 or 7,000? Or 2,000 or 10,000? There is no agreed-upon economic theory that would answer these questions.” The chart on the previous page shows the history of the price-to-earnings ratio of the stocks in the S&P Index. The S&P is a broad index computed from 500 companies presently accounting for about three-quarters of American’s total investment in domestic stocks.


pages: 831 words: 98,409

SUPERHUBS: How the Financial Elite and Their Networks Rule Our World by Sandra Navidi

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activist fund / activist shareholder / activist investor, assortative mating, bank run, barriers to entry, Bernie Sanders, Black Swan, Bretton Woods, butterfly effect, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, cognitive bias, collapse of Lehman Brothers, collateralized debt obligation, commoditize, conceptual framework, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, diversification, East Village, Elon Musk, eurozone crisis, family office, financial repression, Gini coefficient, glass ceiling, Goldman Sachs: Vampire Squid, Google bus, Gordon Gekko, haute cuisine, high net worth, hindsight bias, income inequality, index fund, intangible asset, Jaron Lanier, John Meriwether, Kenneth Arrow, Kenneth Rogoff, knowledge economy, London Whale, Long Term Capital Management, Mark Zuckerberg, mass immigration, McMansion, mittelstand, money market fund, Myron Scholes, NetJets, Network effects, offshore financial centre, old-boy network, Parag Khanna, Paul Samuelson, peer-to-peer, performance metric, Peter Thiel, Plutocrats, plutocrats, Ponzi scheme, quantitative easing, Renaissance Technologies, rent-seeking, reserve currency, risk tolerance, Robert Gordon, Robert Shiller, Robert Shiller, rolodex, Satyajit Das, shareholder value, Silicon Valley, sovereign wealth fund, Stephen Hawking, Steve Jobs, The Future of Employment, The Predators' Ball, too big to fail, women in the workforce, young professional

Equipped with my new badge, I headed for the modern Congress Centre—a big, bright, state-of-the-art concrete maze of a building—where most of the WEF’s formal activities are held. On my way, I crossed paths with Bill Gates, who gave me a friendly nod; IMF chief Christine Lagarde, who said hello; and private equity billionaire Steve Schwarzman, with whom I exchanged pleasantries. At the coat check, where I replaced my messy boots with elegant dress shoes, I ran into Larry Summers, former U.S. treasury secretary and Harvard economics professor, and Robert Shiller, Nobel laureate and one of the most influential economists in the world. Although I have attended the WEF several years in a row, I am still regularly amazed by the fact that everyone around me is famous, and that every financial titan who is regularly featured in prime-time news and on the front pages seems to have materialized simultaneously in front of me. I was familiar with many who were there, and after some meet and greet, I withdrew from the babel of languages into a quiet corner, where I scoured the database, deciding on which of the roughly 300 sessions I would attend.


pages: 467 words: 154,960

Trend Following: How Great Traders Make Millions in Up or Down Markets by Michael W. Covel

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Albert Einstein, asset allocation, Atul Gawande, backtesting, beat the dealer, Bernie Madoff, Black Swan, buy low sell high, capital asset pricing model, Clayton Christensen, commodity trading advisor, computerized trading, correlation coefficient, Daniel Kahneman / Amos Tversky, delayed gratification, deliberate practice, diversification, diversified portfolio, Edward Thorp, Elliott wave, Emanuel Derman, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, fiat currency, fixed income, game design, hindsight bias, housing crisis, index fund, Isaac Newton, John Meriwether, John Nash: game theory, linear programming, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, market fundamentalism, market microstructure, mental accounting, money market fund, Myron Scholes, Nash equilibrium, new economy, Nick Leeson, Ponzi scheme, prediction markets, random walk, Renaissance Technologies, Richard Feynman, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, South Sea Bubble, Stephen Hawking, survivorship bias, systematic trading, the scientific method, Thomas L Friedman, too big to fail, transaction costs, upwardly mobile, value at risk, Vanguard fund, volatility arbitrage, William of Occam, zero-sum game

I am also indebted to the following authors whose works continue to be treasure troves of information and insight: Morton Baratz, Peter Bernstein, Clayton Christensen, Jim Collins, Jay Forrester, Tom Friedman, Gerd Gigerenzer, Daniel Goleman, Stephen Jay Gould, Alan Greenberg, Larry Harris, Robert Koppel, Edwin Lefevere, Michael Lewis, Jesse Livermore, Roger Lowenstein, Acknowledgments Ludwig von Mises, Lois Peltz, Ayn Rand, Jack Schwager, Denise Shekerjian, Robert Shiller, Van Tharp, Edward Thorp, Peter Todd, Brenda Ueland, and Dickson Watts. This book could only have come to fruition with the editorial guidance of Jim Boyd at FT Press, as well as the able assistance and attention to detail of Dennis Higbee. I also want to thank Donna Cullen-Dolce, Lisa Iarkowski, Stephen Crane, John Pierce, and Lucy Petermark. To Paul Donnelly at Oxford University Press, I owe a special debt of gratitude for seeing potential in my initial proposal—even though he passed!


pages: 415 words: 125,089

Against the Gods: The Remarkable Story of Risk by Peter L. Bernstein

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Albert Einstein, Alvin Roth, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, Bayesian statistics, Big bang: deregulation of the City of London, Bretton Woods, buttonwood tree, capital asset pricing model, cognitive dissonance, computerized trading, Daniel Kahneman / Amos Tversky, diversified portfolio, double entry bookkeeping, Edmond Halley, Edward Lloyd's coffeehouse, endowment effect, experimental economics, fear of failure, Fellow of the Royal Society, Fermat's Last Theorem, financial deregulation, financial innovation, full employment, index fund, invention of movable type, Isaac Newton, John Nash: game theory, John von Neumann, Kenneth Arrow, linear programming, loss aversion, Louis Bachelier, mental accounting, moral hazard, Myron Scholes, Nash equilibrium, Paul Samuelson, Philip Mirowski, probability theory / Blaise Pascal / Pierre de Fermat, random walk, Richard Thaler, Robert Shiller, Robert Shiller, spectrum auction, statistical model, The Bell Curve by Richard Herrnstein and Charles Murray, The Wealth of Nations by Adam Smith, Thomas Bayes, trade route, transaction costs, tulip mania, Vanguard fund, zero-sum game

The following people also made significant contributions to my work and warrant my deepest appreciation: Kenneth Arrow, Gilbert Bassett, William Baumol, Zalmon Bernstein, Doris Bullard, Paul Davidson, Donald Dewey, David Durand, Barbara Fotinatos, James Fraser, Greg Hayt, Roger Hertog, Victor Howe, Bertrand Jacquillat, Daniel Kahneman, Mary Kentouris, Mario Laserna, Dean LeBaron, Michelle Lee, Harry Markowitz, Morton Meyers, James Norris, Todd Petzel, Paul Samuelson, Robert Shiller, Charles Smithson, Robert Solow, Meir Statman, Marta Steele, Richard Thaler, James Tinsley, Frank Trainer, Amos Tversky,* and Marina von N. Whitman. Eight people generously undertook to read the manuscript in its entirety and to give me the benefit of their expert criticisms and suggestions. Each of them, in his own way, deserves major credit for the quality of the content and style of the book, without bearing any responsibility for the shortcomings it contains.


pages: 425 words: 122,223

Capital Ideas: The Improbable Origins of Modern Wall Street by Peter L. Bernstein

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Albert Einstein, asset allocation, backtesting, Benoit Mandelbrot, Black-Scholes formula, Bonfire of the Vanities, Brownian motion, buy low sell high, capital asset pricing model, corporate raider, debt deflation, diversified portfolio, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, full employment, implied volatility, index arbitrage, index fund, interest rate swap, invisible hand, John von Neumann, Joseph Schumpeter, Kenneth Arrow, law of one price, linear programming, Louis Bachelier, mandelbrot fractal, martingale, means of production, money market fund, Myron Scholes, new economy, New Journalism, Paul Samuelson, profit maximization, Ralph Nader, RAND corporation, random walk, Richard Thaler, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, stochastic process, the market place, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, Thorstein Veblen, transaction costs, transfer pricing, zero-coupon bond, zero-sum game

This avalanche in the sheer number of orders coming into the system overwhelmed the whole communications network and explains the unanswered telephones in the brokerage offices and the darkened computer screens that intensified the chaos and fed investor panic. If you do not know what the last price was, you are incapable of making an informed decision; if you cannot reach your broker at all, you are in never-never land. A survey of investors conducted immediately after the crash by Robert Shiller of the Cowles Foundation at Yale reported that 20 percent of the respondents admitted to “difficulty concentrating, sweaty palms, tightness in the chest or rapid pulse.” More than half who had sold on October 19 said that they were “experiencing a contagion of fear.” Close to 40 percent who sold had stop-loss orders in place, orders to sell whenever a stock breaks below a specified price and a strategy that is just as “mechanical” as portfolio insurance.27 Shiller hypothesizes that all investors worry that somebody else knows something that other investors do not know.


pages: 411 words: 80,925

What's Mine Is Yours: How Collaborative Consumption Is Changing the Way We Live by Rachel Botsman, Roo Rogers

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Airbnb, barriers to entry, Bernie Madoff, bike sharing scheme, Buckminster Fuller, carbon footprint, Cass Sunstein, collaborative consumption, collaborative economy, commoditize, Community Supported Agriculture, credit crunch, crowdsourcing, dematerialisation, disintermediation, en.wikipedia.org, experimental economics, George Akerlof, global village, Hugh Fearnley-Whittingstall, information retrieval, iterative process, Kevin Kelly, Kickstarter, late fees, Mark Zuckerberg, market design, Menlo Park, Network effects, new economy, new new economy, out of africa, Parkinson's law, peer-to-peer, peer-to-peer lending, peer-to-peer rental, Ponzi scheme, pre–internet, recommendation engine, RFID, Richard Stallman, ride hailing / ride sharing, Robert Shiller, Robert Shiller, Ronald Coase, Search for Extraterrestrial Intelligence, SETI@home, Simon Kuznets, Skype, slashdot, smart grid, South of Market, San Francisco, Stewart Brand, The Nature of the Firm, The Spirit Level, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thorstein Veblen, Torches of Freedom, transaction costs, traveling salesman, ultimatum game, Victor Gruen, web of trust, women in the workforce, Zipcar

Many of the founders we spoke to during the course of writing this book expressed a desire for us to help people see the similarities between different examples of Collaborative Consumption: in other words, to show how Netflix, Zipcar, eBay, and Zopa are all connected. We hope we have risen to the challenge! More and more examples of Collaborative Consumption are popping up every day, everywhere. We have created a Collaborative Consumption icon for all to use to show they are part of this exciting groundswell. With thanks, Rachel and Roo Selected Bibliography Akerlof, George A., and Robert J. Shiller. Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism (Princeton University Press, 2009). Andersen, Kurt, and Tom Brokaw. Reset: How This Crisis Can Restore Our Values and Renew America (Random House, 2009). Anderson, Chris. The Long Tail: Why the Future of Business Is Selling Less of More (Hyperion, 2006). Atwood, Margaret. Payback: Debt and the Shadow Side of Wealth (Bloomsbury, 2008).

This is a working article written by Butts while on the Knight-Bagehot fellowship for business journalists at Columbia Journalism School and Columbia Business School, http://www.mickeybutts.com/wj_business.html. 19. Ibid. 20. Joe Nocera, A Piece of the Action: How the Middle Class Joined the Money Class, as quoted in Vanity Fair, “Rethinking the American Dream,” www.vanityfair.com/culture/features/2009/04/american-dream200904. 21. George A. Akerlof and Robert J. Shiller, Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism (Princeton University Press, 2009), 128. 22. Steve Rhode, founder of myvesta.org, found that 26 percent of his company’s clients say they never look at the statement. Quoted in Mickey Butts, “Why We Charge: What Behavioral Economics Can Tell Us.” 23. Juliet B. Schor, The Overspent American: Why We Want What We Don’t Need (HarperCollins, 1998), 72. 24.


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Investing Demystified: How to Invest Without Speculation and Sleepless Nights by Lars Kroijer

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Andrei Shleifer, asset allocation, asset-backed security, Bernie Madoff, bitcoin, Black Swan, BRICs, Carmen Reinhart, cleantech, compound rate of return, credit crunch, diversification, diversified portfolio, equity premium, estate planning, fixed income, high net worth, implied volatility, index fund, intangible asset, invisible hand, Kenneth Rogoff, market bubble, money market fund, passive investing, pattern recognition, prediction markets, risk tolerance, risk/return, Robert Shiller, Robert Shiller, selection bias, sovereign wealth fund, too big to fail, transaction costs, Vanguard fund, yield curve, zero-coupon bond

Those who perform poorly have a great excuse and those that perform well in the property market are unlikely to think it is luck and will always have other great reasons: they saw something others didn’t, knew something, understood something and heard something. Something. Just be honest with yourself as you consider your edge. It can be expensive to think you have it if you don’t. Has residential property really been that great? The best estimate of residential property performance is the Case-Shiller House Price index which represents the price changes in US residential homes. Professor Robert Shiller describes the housing index along with other interesting ideas in his excellent book Irrational Exuberance (Princeton University Press, 2005). To my knowledge there isn’t a property index that covers all forms of residential property investment across many countries that goes back many decades for us to analyse. Using the Case-Shiller index as a proxy for residential property investments since 1890 we can compare the returns of the housing market to an investment over the same time period in short-term US government bonds (see Figure 9.1).


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The Inner Lives of Markets: How People Shape Them—And They Shape Us by Tim Sullivan

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Airbnb, airport security, Al Roth, Alvin Roth, Andrei Shleifer, attribution theory, autonomous vehicles, barriers to entry, Brownian motion, centralized clearinghouse, Chuck Templeton: OpenTable, clean water, conceptual framework, constrained optimization, continuous double auction, creative destruction, deferred acceptance, Donald Trump, Edward Glaeser, experimental subject, first-price auction, framing effect, frictionless, fundamental attribution error, George Akerlof, Goldman Sachs: Vampire Squid, Gunnar Myrdal, helicopter parent, information asymmetry, Internet of things, invisible hand, Isaac Newton, iterative process, Jean Tirole, Jeff Bezos, Johann Wolfgang von Goethe, John Nash: game theory, John von Neumann, Joseph Schumpeter, Kenneth Arrow, late fees, linear programming, Lyft, market clearing, market design, market friction, medical residency, multi-sided market, mutually assured destruction, Nash equilibrium, Occupy movement, Pareto efficiency, Paul Samuelson, Peter Thiel, pets.com, pez dispenser, pre–internet, price mechanism, price stability, prisoner's dilemma, profit motive, proxy bid, RAND corporation, ride hailing / ride sharing, Robert Shiller, Robert Shiller, Ronald Coase, school choice, school vouchers, sealed-bid auction, second-price auction, second-price sealed-bid, sharing economy, Silicon Valley, spectrum auction, Steve Jobs, Tacoma Narrows Bridge, technoutopianism, telemarketer, The Market for Lemons, The Wisdom of Crowds, Thomas Malthus, Thorstein Veblen, trade route, transaction costs, two-sided market, uranium enrichment, Vickrey auction, Vilfredo Pareto, winner-take-all economy

It’s not just because customers are reluctant to complain about a seller who is donating money from their purchase price to charity; philanthropically inclined sellers also have about half as many unresolved disputes on their noncharity listings. 15. Akerlof never imagined that all consumers were aware of their own ignorance; for him the lemons model was merely a next step in a larger agenda. In Phishing for Phools: The Economics of Manipulation and Deception (Princeton, NJ: Princeton University Press, 2015), Akerlof and his coauthor Robert Shiller lay out a theory of markets where there are economic agents who are unaware of their ignorance (and hence buy too many subprime mortgages) or lack self-control (and eat too much ice cream). Such problems lead to what they call a “phishing equilibrium” where weak or ignorant consumers (“phools”) are taken advantage of by exploitative firms. Chapter 5. Building an Auction for Everything 1.


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Debunking Economics - Revised, Expanded and Integrated Edition: The Naked Emperor Dethroned? by Steve Keen

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accounting loophole / creative accounting, banking crisis, banks create money, barriers to entry, Benoit Mandelbrot, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, butterfly effect, capital asset pricing model, cellular automata, central bank independence, citizen journalism, clockwork universe, collective bargaining, complexity theory, correlation coefficient, creative destruction, credit crunch, David Ricardo: comparative advantage, debt deflation, diversification, double entry bookkeeping, en.wikipedia.org, Eugene Fama: efficient market hypothesis, experimental subject, Financial Instability Hypothesis, fixed income, Fractional reserve banking, full employment, Henri Poincaré, housing crisis, Hyman Minsky, income inequality, information asymmetry, invisible hand, iterative process, John von Neumann, laissez-faire capitalism, liquidity trap, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, market clearing, market microstructure, means of production, minimum wage unemployment, money market fund, open economy, Pareto efficiency, Paul Samuelson, place-making, Ponzi scheme, profit maximization, quantitative easing, RAND corporation, random walk, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Coase, Schrödinger's Cat, scientific mainstream, seigniorage, six sigma, South Sea Bubble, stochastic process, The Great Moderation, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, total factor productivity, tulip mania, wage slave, zero-sum game

the actual prediction must have been made by the analyst and available in the public domain, rather than being asserted by others. the prediction had to have some timing attached to it. (Bezemer 2009: 7) Bezemer came up with twelve names: myself and Dean Baker, Wynne Godley, Fred Harrison, Michael Hudson, Eric Janszen, Jakob Brøchner Madsen and Jens Kjaer Sørensen, Kurt Richebächer, Nouriel Roubini, Peter Schiff, and Robert Shiller. He also identified four common aspects of our work: 1 a concern with financial assets as distinct from real-sector assets, 2 with the credit flows that finance both forms of wealth, 3 with the debt growth accompanying growth in financial wealth, and 4 with the accounting relation between the financial and real economy. (Ibid.: 8) TABLE 2.1 Anticipations of the housing crisis and recession If you have never studied economics before, this list may surprise you: don’t all economists consider these obviously important economic issues?

Given the poor response of the economy to the stimulus and QE1, I think it’s reasonable to argue that it’s time Obama – and politicians in general – looked elsewhere for their economic advice. From tranquility to breakdown To a neoclassical economist, the most striking aspect of the Great Recession was the speed with which apparent tranquility gave way to sudden breakdown. With notable, noble exceptions like Nouriel Roubini, Robert Shiller, Joe Stiglitz and Paul Krugman, economists paid little attention to the obvious Bonfire of the Vanities taking place in asset markets, so in a sense they didn’t see the warning signs, which were obvious to many others, that this would all end in tears. My model, in contrast, is one in which the Great Moderation and the Great Recession are merely different phases in the same process of debt-financed speculation, which causes a period of initial volatility to give way to damped oscillations as rising debt transfers income from workers to bankers, and then total breakdown occurs when debt reaches a level at which capitalists become insolvent.


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Money Changes Everything: How Finance Made Civilization Possible by William N. Goetzmann

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Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, banking crisis, Benoit Mandelbrot, Black Swan, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, Cass Sunstein, collective bargaining, colonial exploitation, compound rate of return, conceptual framework, corporate governance, Credit Default Swap, David Ricardo: comparative advantage, debt deflation, delayed gratification, Detroit bankruptcy, disintermediation, diversified portfolio, double entry bookkeeping, Edmond Halley, en.wikipedia.org, equity premium, financial independence, financial innovation, financial intermediation, fixed income, frictionless, frictionless market, full employment, high net worth, income inequality, index fund, invention of the steam engine, invention of writing, invisible hand, James Watt: steam engine, joint-stock company, joint-stock limited liability company, laissez-faire capitalism, Louis Bachelier, mandelbrot fractal, market bubble, means of production, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, new economy, passive investing, Paul Lévy, Ponzi scheme, price stability, principal–agent problem, profit maximization, profit motive, quantitative trading / quantitative finance, random walk, Richard Thaler, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, spice trade, stochastic process, the scientific method, The Wealth of Nations by Adam Smith, Thomas Malthus, time value of money, too big to fail, trade liberalization, trade route, transatlantic slave trade, transatlantic slave trade, tulip mania, wage slave

Many thanks to Johanna Palacio for project management and her excellent work on the images for the book. I owe a great debt to Yuan Chen for her thoughtful editing of the sections of the book pertaining to China. Over the years, Ulla Kasten has helped me with access to the Yale Babylonian Collection. I also thank the many scholars who gave me advice and pointed me in the right direction: Ben Foster, Marc Van De Mieroop, Elisabeth Köll, Robert Shiller, Timothy Young, Catherine Labio, Jonathan Spence, Steven Pincus, and Naomi Lamoreaux. I thank William Fitzhugh and Harvey Weiss for including me in their pathbreaking archaeological expeditions early in my career. And I thank my friend William S. Reese for introducing me to many of the extraordinary documents in financial history that have become part of the narrative of this book. I particularly acknowledge the support of the Yale School of Management over the years.

For example, we would not understand the birth of finance in the ancient Near East without Professor Denise Schmandt-Besserat of the University of Texas, who discovered the origins of cuneiform writing—along with the origins of financial contracts. We owe a lot to the Shanghai financier and monetary historian Peng Xinwei 彭信威, who devoted his life to Chinese financial history before disappearing in the Cultural Revolution. We might never understand the first inflation-indexed security if not for economist Robert Shiller’s personal mission to help people insure themselves against everyday economic risks. A third perspective is empirical: the world of things and places. Technology requires actual tools and locations. For finance, this means coins, documents, correspondence, and places where these things were made and exchanged. Objects like coins and stock certificates functioned as tools, because they solved such problems as the storing and conveyance of value and the transmission of value through time.


pages: 515 words: 142,354

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

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bank run, banking crisis, barriers to entry, battle of ideas, Berlin Wall, Bretton Woods, capital controls, 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, 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, labour market flexibility, labour mobility, light touch regulation, 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 Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, secular stagnation, Silicon Valley, sovereign wealth fund, the payments system, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, transfer pricing, trickle-down economics, Washington Consensus, working-age population

These include Citigroup, Deutsche Bank, JPMorgan, Rabobank, Royal Bank of Scotland, and UBS. 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. This diversified portfolio approach to campaign giving has worked well for the banks, generating large bailouts under both Democratic and Republic administrations.

His remarks were partially directed at what many saw as the bubble in Japanese stock markets and led to an almost immediate decrease in the Tokyo stock market by 3 percent, with follow-on effects around the world. The phrase “irrational exuberance” has now entered into the standard lexicon, and though widely attributed to Greenspan, he may have gotten the term from Nobel Prize–winning economist Robert Shiller in a private conversation. See the blog post at http://ritholtz.com/2013/01/did-greenspan-steal-the-phrase-irrational-exuberance/. See also my more extensive discussion in my book The Roaring Nineties: A New History of the World’s Most Prosperous Decade (New York: W. W. Norton, 2003). 10 Compensation was typically not based on long-term results. Particularly harmful were stock options, which encouraged them to report results and to take actions which increased stock prices in the short run, with little regard for the long-run consequences.


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Extreme Money: Masters of the Universe and the Cult of Risk by Satyajit Das

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affirmative action, Albert Einstein, algorithmic trading, Andy Kessler, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Basel III, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, BRICs, British Empire, capital asset pricing model, Carmen Reinhart, carried interest, Celtic Tiger, clean water, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, debt deflation, Deng Xiaoping, deskilling, discrete time, diversification, diversified portfolio, Doomsday Clock, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, financial independence, financial innovation, financial thriller, fixed income, full employment, global reserve currency, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, happiness index / gross national happiness, haute cuisine, high net worth, Hyman Minsky, index fund, information asymmetry, interest rate swap, invention of the wheel, invisible hand, Isaac Newton, job automation, Johann Wolfgang von Goethe, John Meriwether, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, Kevin Kelly, labour market flexibility, laissez-faire capitalism, load shedding, locking in a profit, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Martin Wolf, mega-rich, merger arbitrage, Mikhail Gorbachev, Milgram experiment, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, Myron Scholes, Naomi Klein, negative equity, Network effects, new economy, Nick Leeson, Nixon shock, Northern Rock, nuclear winter, oil shock, Own Your Own Home, Paul Samuelson, pets.com, Philip Mirowski, Plutocrats, plutocrats, Ponzi scheme, price anchoring, price stability, profit maximization, quantitative easing, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Ray Kurzweil, regulatory arbitrage, rent control, rent-seeking, reserve currency, Richard Feynman, Richard Thaler, Right to Buy, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Ronald Reagan: Tear down this wall, Satyajit Das, savings glut, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, Slavoj Žižek, South Sea Bubble, special economic zone, statistical model, Stephen Hawking, Steve Jobs, survivorship bias, The Chicago School, The Great Moderation, the market place, the medium is the message, The Myth of the Rational Market, The Nature of the Firm, the new new thing, The Predators' Ball, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, trickle-down economics, Turing test, Upton Sinclair, value at risk, Yogi Berra, zero-coupon bond, zero-sum game

Showtime A 2006 book Traders, Guns & Money, pointing out the dangers and risks of derivatives, attracts occasional media interest. My naturally pessimistic view of the world proves useful, coinciding with the times. People are forgiving if things turn out better than predictions. In 2009, an Asian stockbroking firm invites me to speak at investment conferences in Tokyo and Hong Kong. I am part of the chorus, support for the mega-stars. In Japan, celebrity anti-exuberance advocate9 Robert Shiller in the course of a short speech, manages to mention his forthcoming book at least a dozen times. In Hong Kong, the world’s first and only celebrity economic historian10 Niall Ferguson gives a keynote address on Chimerica, the relationship between China and America. Well-known for his books and Channel 4 series, Ferguson was named by Time magazine in 2004 as one of the 100 most influential people in the world.

Stern (eds) (2004) Japan’s Lost Decade: Origins, Consequences and Prospects for Recovery, Blackwell Publishing, Oxford. Michael Schuman (2009) The Miracle: The Epic Story of Asia’s Quest for Wealth, Harper Business, New York. Jack D. Schwager (1992) The New Market Wizards: Conversations with America’s Top Traders, John Wiley, New Jersey. Fred Schwed Jr (2006) Where Are The Customers’ Yachts? Or A Good Hard Look at Wall Street, John Wiley, New Jersey. Robert Shiller (2005) Irrational Exuberance, Currency Doubleday, New York. Georg Simmel (1990) The Philosophy of Money, Routledge, London. Robert Skidelsky (2003) John Maynard Keynes 1883–1946: Economist, Philosopher, Statesman, Penguin Books, London. Robert Skidelsky (2009) Keynes: The Return of the Master, Public Affairs, New York. Robert Slater (2009) Soros: The World’s Most Influential Investor, McGraw Hill, New Jersey.


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A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation by Richard Bookstaber

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affirmative action, Albert Einstein, asset allocation, backtesting, beat the dealer, Black Swan, Black-Scholes formula, Bonfire of the Vanities, butterfly effect, commoditize, commodity trading advisor, computer age, computerized trading, disintermediation, diversification, double entry bookkeeping, Edward Lorenz: Chaos theory, Edward Thorp, family office, financial innovation, fixed income, frictionless, frictionless market, George Akerlof, implied volatility, index arbitrage, intangible asset, Jeff Bezos, John Meriwether, London Interbank Offered Rate, Long Term Capital Management, loose coupling, margin call, market bubble, market design, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, Myron Scholes, new economy, Nick Leeson, oil shock, Paul Samuelson, Pierre-Simon Laplace, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk tolerance, risk/return, Robert Shiller, Robert Shiller, rolodex, Saturday Night Live, selection bias, shareholder value, short selling, Silicon Valley, statistical arbitrage, The Market for Lemons, time value of money, too big to fail, transaction costs, tulip mania, uranium enrichment, William Langewiesche, yield curve, zero-coupon bond, zero-sum game

For a moment during the Internet bubble, Warren Buffett, a worldclass investor, looked like Warren Befuddled. So did hedge fund masters such as Julian Robertson, whose Tiger Management fund was beaten to the ground by his doggedly rational addiction to value. George Soros, who broke the Bank of England, was broken the same way—fighting the equity crowds clamoring to buy more stock. His book Irrational Exuberance (Princeton University Press, 2000) earned Robert Shiller notoriety for his call that we were in the middle of a bubble, but in fact many investment professionals recognized it for what it was, the chorus getting louder as the bubble swelled. However, it is one thing to say the market has run amuck; it is another thing to trade against it. One of the most surprising fallouts of the Internet bubble was the closing, in rapid succession, of both Robertson’s and Soros’s long-admired funds.


pages: 478 words: 126,416

Other People's Money: Masters of the Universe or Servants of the People? by John Kay

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Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, call centre, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, cognitive dissonance, corporate governance, Credit Default Swap, cross-subsidies, dematerialisation, diversification, diversified portfolio, Edward Lloyd's coffeehouse, Elon Musk, Eugene Fama: efficient market hypothesis, eurozone crisis, financial innovation, financial intermediation, financial thriller, fixed income, Flash crash, forward guidance, Fractional reserve banking, full employment, George Akerlof, German hyperinflation, Goldman Sachs: Vampire Squid, Growth in a Time of Debt, income inequality, index fund, inflation targeting, information asymmetry, intangible asset, interest rate derivative, interest rate swap, invention of the wheel, Irish property bubble, Isaac Newton, John Meriwether, light touch regulation, London Whale, Long Term Capital Management, loose coupling, low cost carrier, M-Pesa, market design, millennium bug, mittelstand, money market fund, moral hazard, mortgage debt, Myron Scholes, new economy, Nick Leeson, Northern Rock, obamacare, Occupy movement, offshore financial centre, oil shock, passive investing, Paul Samuelson, peer-to-peer lending, performance metric, Peter Thiel, Piper Alpha, Ponzi scheme, price mechanism, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, railway mania, Ralph Waldo Emerson, random walk, regulatory arbitrage, Renaissance Technologies, rent control, risk tolerance, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, Schrödinger's Cat, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, sovereign wealth fund, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, Steve Wozniak, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Tobin tax, too big to fail, transaction costs, tulip mania, Upton Sinclair, Vanguard fund, Washington Consensus, We are the 99%, Yom Kippur War

People who traded mortgage-backed securities knew about securities, but very little about mortgages, and less about houses and home-buyers. People who traded shares knew about stock markets, but not about companies and their products. People who traded interest rate derivatives knew about derivatives, but not about politics and government finance. The forces that led to these extensive failures in credit markets in 2007–8 had been evident earlier elsewhere. Robert Shiller received the Nobel Prize in economics for providing in the early 1980s the first careful demonstration of a proposition that seems intuitively obvious to anyone who watches stock markets: volatility is far greater than can be explained by changes in the fundamental value of securities. The ‘explanations’ provided nightly by market commentators and newspaper headlines are little more than rationalisation of the noise generated by this market volatility.3 Equity markets experienced more and more activity in secondary markets, while primary issuance had become less and less important.4 Intermediaries in these markets knew less and less about the companies in which funds were invested, and expertise rested in knowing what ‘the market thinks’.


pages: 342 words: 99,390

The greatest trade ever: the behind-the-scenes story of how John Paulson defied Wall Street and made financial history by Gregory Zuckerman

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1960s counterculture, banking crisis, collapse of Lehman Brothers, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, financial innovation, fixed income, index fund, Isaac Newton, Long Term Capital Management, margin call, Mark Zuckerberg, Menlo Park, merger arbitrage, mortgage debt, mortgage tax deduction, Ponzi scheme, Renaissance Technologies, rent control, Robert Shiller, Robert Shiller, rolodex, short selling, Silicon Valley, statistical arbitrage, Steve Ballmer, Steve Wozniak, technology bubble, zero-sum game

He was sure he had discovered proof of a housing bubble, and he was determined to profit from it. It was fortuitous that Paulson was a merger pro, and not a veteran of the mortgage, housing, or bond markets. He wasn’'t fully aware of the long-ignored arguments of housing bears and how many investors were refusing to buy into real estate. Just as important, he wasn’'t deterred by the dismal track record of those who already had bet against housing. In 2004, Professor Robert Shiller of Yale University produced data showing that U.S. residential real estate prices rose by only 66 percent between 1890 and 2004, or by just 0.4 percent a year. He contrasted that meager gain with the heady rise of 52 percent, or 6.2 percent a year, between 1997 and 2004. Shiller presented a series of lectures on the topic and included the charts and figures in an updated version of his best-selling book, Irrational Exuberance, in February 2005, trying to demonstrate how overpriced real estate had become.


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The Clash of the Cultures by John C. Bogle

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asset allocation, collateralized debt obligation, commoditize, corporate governance, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, estate planning, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, Flash crash, Hyman Minsky, income inequality, index fund, interest rate swap, invention of the wheel, market bubble, market clearing, money market fund, mortgage debt, new economy, Occupy movement, passive investing, Paul Samuelson, Ponzi scheme, principal–agent problem, profit motive, random walk, rent-seeking, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, statistical arbitrage, survivorship bias, The Wealth of Nations by Adam Smith, transaction costs, Vanguard fund, William of Occam, zero-sum game

As shown in Exhibit 2.4, during the 1970s the fundamentals of investment, measured by earnings growth and dividend yields on the S&P 500 Index, provided a return of 13.4 percent per year, and the total stock market return was but 5.9 percent annually. (The reduction in valuation of −7.5 percent per year reflected a drop in the earnings ratio from 15.8 to 7.3 times.) Exhibit 2.4 Stock Returns: A Tin Decade, Two Golden Decades, Then Another Tin Decade Source: Robert Shiller, www.econ.yale.edu/~shiller/data.htm. During the 1980s, by contrast, the fundamental return of 9.6 percent came hand-in-hand with an annual valuation increase of 7.7 percent, as P/E ratios more than doubled, from 7.3 to 15.2 times, bringing the total annual return to 17.3 percent. Incredibly—and bereft of historic precedent—the same sort of scenario continued during the 1990s. That two-decade-long steady, almost-clockwork-like rise in valuations couldn’t continue.


pages: 342 words: 94,762

Wait: The Art and Science of Delay by Frank Partnoy

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algorithmic trading, Atul Gawande, Bernie Madoff, Black Swan, blood diamonds, Cass Sunstein, Checklist Manifesto, cognitive bias, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, Daniel Kahneman / Amos Tversky, delayed gratification, Flash crash, Frederick Winslow Taylor, George Akerlof, Google Earth, Hernando de Soto, High speed trading, impulse control, income inequality, information asymmetry, Isaac Newton, Long Term Capital Management, Menlo Park, mental accounting, meta analysis, meta-analysis, Nick Leeson, paper trading, Paul Graham, payday loans, Ralph Nader, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, six sigma, Spread Networks laid a new fibre optics cable between New York and Chicago, statistical model, Steve Jobs, The Market for Lemons, the scientific method, The Wealth of Nations by Adam Smith, upwardly mobile, Walter Mischel

Alicia Whitaker, “Magic and Self-Loathing in Berkeley,” Huffington Post Books, March 22, 2010, available at: http://www.huffingtonpost.com/alicia-whitaker/magic-and-self-loathing-i_b_507965.html. Chapter 11 1. The authors of this study analyzed Cramer’s recommendations from June 2005 and February 2009. Joseph Engelberg, Caroline Sasseville, and Jared Williams, “Market Madness? The Case of Mad Money,” Management Science 58(2, 2012): 351–364. 2. See Robert J. Shiller, Irrational Exuberance (Crown Business, 2006); George A. Akerlof and Robert J. Shiller, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism (Princeton University Press, 2010); Jason Zweig, Your Money and Your Brain: How the New Science of Neuroeconomics Can Make You Rich (Simon & Schuster, 2007); Hersh Shefrin, Beyond Greed and Fear: Finance and the Psychology of Investing(Oxford University Press, 2000); Edward Chancellor, Devil Take the Hindmost: A History of Financial Speculation (Plume, 2000); Gur Huberman and Tomer Regev, “Speculating on a Cure for Cancer: A Non-Event That Made Stock Prices Soar,” Journal of Finance 56(2001): 387–396.


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I Will Teach You To Be Rich by Sethi, Ramit

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Albert Einstein, asset allocation, buy low sell high, diversification, diversified portfolio, index fund, late fees, money market fund, mortgage debt, mortgage tax deduction, prediction markets, random walk, risk tolerance, Robert Shiller, Robert Shiller, shareholder value, Silicon Valley, survivorship bias, the rule of 72, Vanguard fund

As an investment, real estate provides mediocre returns at best. First, there’s the problem of risk. If your house is your biggest investment, how diversified is your portfolio? If you pay $2,000 per month to a mortgage, are you investing $6,000 elsewhere to balance your risk? Of course not. Second, the facts show that real estate offers a very poor return for individual investors. Yale economist Robert Shiller found that “from 1890 through 1990, the return on residential real estate was just about zero after inflation.” I know this sounds crazy, but it’s true. We fool ourselves into thinking we’re making money when we’re simply not. For example, if someone buys a house for $250,000 and sells it for $400,000 twenty years later, they think, “Great! I made $150,000!” But actually, they’ve forgotten to factor in important costs like property taxes, maintenance, and the opportunity cost of not having that money in the stock market.


pages: 357 words: 110,017

Money: The Unauthorized Biography by Felix Martin

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bank run, banking crisis, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, Bretton Woods, British Empire, call centre, capital asset pricing model, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, creative destruction, credit crunch, David Graeber, en.wikipedia.org, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, fixed income, Fractional reserve banking, full employment, Goldman Sachs: Vampire Squid, Hyman Minsky, inflation targeting, invention of writing, invisible hand, Irish bank strikes, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, mobile money, moral hazard, mortgage debt, new economy, Northern Rock, Occupy movement, Plutocrats, plutocrats, private military company, Republic of Letters, Richard Feynman, Robert Shiller, Robert Shiller, Scientific racism, seigniorage, Silicon Valley, smart transportation, South Sea Bubble, supply-chain management, The Wealth of Nations by Adam Smith, too big to fail

Sovereign money remains just as we know it today at the heart of the system: a safe and liquid promise to pay under all circumstances. Law’s idea was to rid money-users of even this last resort of risk aversion. At the heart of his new financial world was to be not sovereign debt, but sovereign equity. Once again, it is an idea that sounds incredible to modern ears—but it is one that has its influential advocates today. The U.S. economist Robert Shiller—a modern Projector, as well as one of the world’s most distinguished academic economists—has for many years urged sovereigns to share with investors the risk to the public finances inherent in uncertain economic growth by issuing bonds that pay interest linked to GDP.24 Shiller’s proposals urge a gradual shift towards such innovative financial instruments. In the midst of the greatest economic and fiscal crisis France had ever seen, Law lacked the luxury of time.


pages: 580 words: 168,476

The Price of Inequality: How Today's Divided Society Endangers Our Future by Joseph E. Stiglitz

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affirmative action, Affordable Care Act / Obamacare, airline deregulation, Andrei Shleifer, banking crisis, barriers to entry, Basel III, battle of ideas, Berlin Wall, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, collapse of Lehman Brothers, collective bargaining, colonial rule, corporate governance, Credit Default Swap, Daniel Kahneman / Amos Tversky, Dava Sobel, declining real wages, deskilling, Exxon Valdez, Fall of the Berlin Wall, financial deregulation, financial innovation, Flash crash, framing effect, full employment, George Akerlof, Gini coefficient, income inequality, income per capita, indoor plumbing, inflation targeting, information asymmetry, invisible hand, jobless men, John Harrison: Longitude, John Markoff, John Maynard Keynes: Economic Possibilities for our Grandchildren, Kenneth Arrow, Kenneth Rogoff, labour market flexibility, London Interbank Offered Rate, lone genius, low skilled workers, Marc Andreessen, Mark Zuckerberg, market bubble, market fundamentalism, mass incarceration, medical bankruptcy, microcredit, moral hazard, mortgage tax deduction, negative equity, obamacare, offshore financial centre, paper trading, Pareto efficiency, patent troll, Paul Samuelson, payday loans, price stability, profit maximization, profit motive, purchasing power parity, race to the bottom, rent-seeking, reserve currency, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, Simon Kuznets, spectrum auction, Steve Jobs, technology bubble, The Chicago School, The Fortune at the Bottom of the Pyramid, The Myth of the Rational Market, The Spirit Level, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, transaction costs, trickle-down economics, ultimatum game, uranium enrichment, very high income, We are the 99%, wealth creators, women in the workforce, zero-sum game

But even if there were a bubble, government couldn’t be sure whether there was one until after it broke; and even if it could tell, the only instrument at its disposal was the blunt instrument of interest rates. It was better just to let the bubble run its course, since cleaning up the mess afterward would be cheaper than distorting the economy to prevent a bubble from surfacing. If the leaders of the Fed hadn’t been so wedded to the notion that there were no bubbles, it would have been obvious to them (as it was to economists like Robert Shiller, of Yale, one of the country’s leading experts on housing),54 that the unprecedented rise in housing prices relative to incomes almost surely represented a bubble. In addition, the Fed didn’t have to rely on interest rate changes to dampen the bubble—it could have increased down payment requirements or tightened lending standards. Congress had given the Fed authority to do so in 1994. The Fed in its allegiance to market fundamentalism had tied its own hands.

See the Boskin report, “Toward a More Accurate Measure of the Cost of Living,” December 4, 1996, available at http://www.ssa.gov/history/reports/boskinrpt.html. 53. Countries in which there is persistent high and variable unemployment typically put in clauses that provide for automatic adjustments in wages to changes in the cost of living (called COLA, cost of living adjustment). 54. See, e.g., Robert J. Shiller, Irrational Exuberance, 2nd ed. (Princeton: Prince-ton University Press, 2005. For S&P/Case-Shiller Home Price Indices see http://www.standardandpoors.com/indices/sp-case-shiller-home-price-indices/en/us/?indexId=spusa-cashpidff--p-us--- (accessed March 5 2012). 55. That requires that the deceleration of inflation from an increase in unemployment is weaker than the acceleration of inflation from a decrease in unemployment.


Adaptive Markets: Financial Evolution at the Speed of Thought by Andrew W. Lo

Albert Einstein, Alfred Russel Wallace, algorithmic trading, Andrei Shleifer, Arthur Eddington, Asian financial crisis, asset allocation, asset-backed security, backtesting, bank run, barriers to entry, Berlin Wall, Bernie Madoff, bitcoin, Bonfire of the Vanities, bonus culture, break the buck, Brownian motion, business process, butterfly effect, capital asset pricing model, Captain Sullenberger Hudson, Carmen Reinhart, Chance favours the prepared mind, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, corporate governance, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, Daniel Kahneman / Amos Tversky, delayed gratification, Diane Coyle, diversification, diversified portfolio, double helix, easy for humans, difficult for computers, Ernest Rutherford, Eugene Fama: efficient market hypothesis, experimental economics, experimental subject, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, Fractional reserve banking, framing effect, Gordon Gekko, greed is good, Hans Rosling, Henri Poincaré, high net worth, housing crisis, incomplete markets, index fund, interest rate derivative, invention of the telegraph, Isaac Newton, James Watt: steam engine, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Pasteur, mandelbrot fractal, margin call, Mark Zuckerberg, market fundamentalism, martingale, merger arbitrage, meta analysis, meta-analysis, Milgram experiment, money market fund, moral hazard, Myron Scholes, Nick Leeson, old-boy network, out of africa, p-value, paper trading, passive investing, Paul Lévy, Paul Samuelson, Ponzi scheme, predatory finance, prediction markets, price discovery process, profit maximization, profit motive, quantitative hedge fund, quantitative trading / quantitative finance, RAND corporation, random walk, randomized controlled trial, Renaissance Technologies, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, Robert Shiller, Robert Shiller, short selling, sovereign wealth fund, statistical arbitrage, Steven Pinker, stochastic process, survivorship bias, The Great Moderation, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Malthus, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, Triangle Shirtwaist Factory, ultimatum game, Upton Sinclair, US Airways Flight 1549, Walter Mischel, Watson beat the top human players on Jeopardy!, WikiLeaks, Yogi Berra, zero-sum game

But Paulson was one of only a small handful of people to succeed with that short, fighting a hostile financial environment every step of the way. Unlike other investors who suspected the housing bubble was near its top, Paulson had the resources, skills, connections, and good fortune to see his bet through to completion. But what if we wanted not to profit from the catastrophe, but to prevent it? Unfortunately, the record of such attempts looks rather bleak. In January 2005, the Yale economist Robert Shiller made his beliefs clear. Shiller was (and is) one of the world’s leading experts on housing prices. The index of home prices he constructed with Karl Case is the most important measurement we have of how housing prices change over time. He stated, “There is no hope of explaining home prices solely in terms of population, building costs or interest rates. None of these can explain the ‘rocket taking off ’ effect starting around 1998. . . .


pages: 389 words: 109,207

Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street by William Poundstone

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Albert Einstein, anti-communist, asset allocation, beat the dealer, Benoit Mandelbrot, Black-Scholes formula, Brownian motion, buy low sell high, capital asset pricing model, Claude Shannon: information theory, computer age, correlation coefficient, diversified portfolio, Edward Thorp, en.wikipedia.org, Eugene Fama: efficient market hypothesis, high net worth, index fund, interest rate swap, Isaac Newton, Johann Wolfgang von Goethe, John Meriwether, John von Neumann, Kenneth Arrow, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Myron Scholes, New Journalism, Norbert Wiener, offshore financial centre, Paul Samuelson, publish or perish, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Rubik’s Cube, short selling, speech recognition, statistical arbitrage, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, traveling salesman, value at risk, zero-coupon bond, zero-sum game

IEEE Information Theory Society Newsletter, Summer 1998, 16–21. Reid, Ed, and Ovid Demaris (1963). The Green Felt Jungle. New York: Trident Press. Roberts, Stanley (1978). “Welcome, Dr. Thorp.” Gambling Times, Aug. 1978, 11–14. Rogers, Everett M. (n.d.). “Claude Shannon’s Cryptography Research During World War II and the Mathematical Theory of Communication.” Roll, Richard (1988). “R2.” Journal of Finance 43:541–66. ———, and Robert J. Shiller (1992). “Comments: Symposium on Volatility in U.S. and Japanese Stock Markets.” Journal of Applied Corporate Finance 5:25–29. Rotando, Louis M., and Edward O. Thorp (1992). “The Kelly Criterion and the Stock Market.” American Mathematical Monthly, Dec. 1992, 922–31. Rubinstein, Mark (1975). “The Strong Case for the Generalized Logarithmic Utility Model as the Premier Model of Financial Markets.”


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