A ‘Myth of the Rational Market’ review in Barron’s

Myth of the Rational Market is the subject of the lead book review in this week's Barron's. Glenn C. Altschuler, a professor of American Studies at Cornell, describes the book in some depth and calls it a "lucid, lively and learned account." Unfortunately, unless you're a Barron's subscriber, you can only read the first little bit online.

I found out about the review because Barry Ritholtz, who apparently reads his Barron's online early Saturday morning, e-mailed me about it. When I read the e-mail I was eating breakfast at the Square Diner on TriBeCa. I rushed off to find a paper Barron's, and quickly discovered that this was not a trivial assignment in TriBeCa. After 10-15 minutes of running around, I finally found a newsstand next to the Chambers Street subway station, where I blew $15 on three copies.

SmartMoney says ‘Myth of the Rational Market’ is ‘rewarding and readable’

Another mini-review, this time by Robert J. Hughes as one of SmartMoney's Staff Summer Reading Picks. An excerpt:

What makes Fox's book so rewarding and so readable is his way with the
telling anecdote: Example: a blistering takedown of the industry that Lawrence Summers gave way back in 1984, concerning "ketchup economists." Fox demonstrates clearly not only the illusory nature of monetary success, but also the illusion of superiority that wealth brings.

My book demonstrated the illusory nature of monetary success? Hmmm, certainly wasn't my intention. But I'll take it.

Update: On another summer reading list, St. Louis Post-Dispatch book editor Jane Henderson includes Myth as one of her 15 nonfiction picks because it "makes business history thrilling." Wonder where she got that idea?

Top summer reading, a slurry of names, and the demolition of neoclassical economics

On Popmatters (because if financial theory isn't a pop matter I don't know what is), Rob Horning writes a review/essay about Myth of the Rational Market that's generally positive (and extremely erudite) but complains about the "slurry of names" and my "stubbornly neutral" narrative stance. That last bit is something of an exaggeration, but Horning is definitely onto something. I made a conscious decision to keep lots of people's names in the story and to shy from polemics because I figured that would give the book a better shot of getting onto business school reading lists. We'll see if that works.

Meanwhile, Gene Rebeck of Twin Cities Business puts Myth of the Rational Market atop his summer reading list. He's written a review for Delta's inflight magazine that will appear in June, but for now he writes:

Here’s a brisk, smart look at how some (usually) brilliant types came
to believe that the market could be made predictable, or at least
manageable—and how their efforts often made things worse.

Finally, Salon's Andrew Leonard notes in passing that neoclassical economics "is utterly demolished in Justin Fox's soon-to-be-published The Myth of the Rational Market." Wow. I had no idea.

The trouble with shareholder value

I wrote a mini-essay for Fortune "adapted" from my book, about shareholder value. The actual magazine in which it will appear hasn't been printed yet, but the piece went up online on Monday. It was mainly an excuse to call up my friend Al Rappaport, who coined the term "shareholder value" in a 1981 Harvard Business Review article but never embraced it in quite the way that some if his more fanatic academic peers did:

"I don't know how many times I kept saying long term, long term,
long term," explains Rappaport, who is now 77 and living in
semiretirement in Southern California, but still pens the occasional
Harvard Business Review article and has a new book in the works. "To
me, shareholder value was not about an immediate boost to stock price."

that is exactly what it came to be about in the 1990s. CEOs professing
to be disciples of shareholder value fell over themselves trying to
please the stock market. They obsessed over meeting quarterly earnings
targets. And in doing so they made their companies less valuable.

The piece got more attention than I expected. SmartBrief excerpted it.  Felix Salmon argued that most investors are too myopic to ever think about Rappaport's long-term—a point Rappaport himself made in a great 2005 Financial Analysts Journal article (pdf!). And Matthew Yglesias, citing Chapter 12 of Keynes's General Theory, wrote that:

The problem, to state it concisely, is that it doesn’t appear to be the
case that “investing for the long term” is the best way to make money
over the long term.

You know, somebody ought to write a book about this. Seriously.

Publishers Weekly gives ‘Myth of the Rational Market’ a rave review

Okay, this is the kind of thing I was looking for (or at least hoping for). In the May 18 Publishers Weekly (nine items down), a starred review that begins:

At the core of the current financial crisis has been the widely held assumption that markets behave rationally. Fox, Time
magazine editor-at-large, isn’t the first to bring scrutiny—or
censure—to the conceit, but his analysis is singularly compelling, and
the rare business history that reads like a thriller. …

And ends:

A must-read for anyone interested in the markets, our economy or
government, this dense but spellbinding work brings modern finance and
economics to life.

I felt kinda lightheaded after reading this. It was sort of my dream of how reviewers might see the book. But I wasn't entirely confident that the book merited such an endorsement—I'm way too close to it, and way too aware of the sections that fell short of what I hoped to accomplish with them.

The review also says the book is being published in July by Collins, when in fact it's being published in June by HarperBusiness (the Collins label has been shut down). Not that I'm complaining.

The first review

University of Wisconsin economist Menzie Chinn discussed Myth of the Rational Market on Econbrowser a few weeks ago (and said nice things about it), but today we've gotten the very first bona fide review of the book. It's in Library Journal (seven reviews down) and it's pretty positive, with a slightly aggravating twist at the end.

Reviewer Robbie Allen (of St. Johns River Community College in Palatka, Fla.) describes the book reasonably well, and writes that "Fox argues convincingly" that the efficient market hypothesis "has been eclipsed." But then he concludes, "The style here is journalistic, with personal stories that make
the book entertaining, but ultimately this is a history of academic
thought—complete with endnotes—and is best suited for students of
finance or people interested in financial theory."

Well, maybe in Palatka that's who it's best suited for. I certainly wrote the book with students of finance and people interested in financial theory in mind. But I also tried really really hard (and mostly succeeded, I think) in making it accessible to lay readers. A couple years ago I doubted whether many lay readers would ever think of buying such a book, but nowadays there's a pretty big audience of people interested in how financial markets (mal)function. Right?

A ‘Myth of the Rational Market’ Q&A

I put this Q&A together at the behest of my PR commander-in-chief, Rimjhim Dey (she asked the questions):

1.    What is the myth of the rational market?

Most simply, it’s the belief that financial markets can be relied upon to get things right. In the context of my book, it refers to the academic theory most commonly known as the efficient market hypothesis—although I often refer to it as rational market theory because that’s shorter and, for those of us who aren’t finance professors, clearer.

2.    What is main takeaway of your book?

That financial markets possess many wonderful traits, but that rationality is not always among them. And that relying on markets to be right all the time can be a very dangerous thing to do.

3.    Does your book explain the current financial crisis or any aspect of it?

Yes. Financial decision-making and financial regulation had been restructured over the past couple of decades around the notion that market prices are correct. If market prices and formulas built around market prices said one thing, the thinking went, then who was a Federal Reserve chairman or investment bank CEO to say they were wrong? It was a suspension of judgment on a mass scale, and it turned out really badly.

4.    How is The Myth of Rational Market any different from other books on economic history?  What is its unique appeal?

I don’t know of any other book that tells the story of the rise and fall of the idea that financial markets are always right. So that’s unique. Beyond that, I’ve tried really hard to make the book exhaustive without being exhausting. It’s written for the lay reader, but also meant to withstand the scrutiny (I hope) of the academic reader.

5.    What are some of the practical lessons of the book and do they have any application to economic recovery?

The most important practical lesson of the book in the context of the current economic situation is that financial markets don’t know everything. They know a lot, and the signals they send shouldn’t be completely ignored. But when the market decrees that a collateralized debt obligation is worth a certain amount, or that a trader at Lehman Brothers should be paid a certain amount, or that a speech by the Treasury Secretary is no good, it often gets things entirely backwards. Our society (and our financial markets) cannot survive and thrive if all decisions are left to the market.

Oh, and one another practical lesson: Stocks are a much better long-run investment when they’re cheap by historical standards (as measured by price-to-earnings or price-to-book ratio) than when they’re expensive.

6.    Although rational market theory was at first controversial, why did it become so widely accepted as standard practice?

First of all, because the facts seemed to back it up. For example: Finance scholars argued in the mid-1960s that the superstar mutual fund managers of the day were beating the market only by taking crazy risks that would eventually backfire. Within a couple of years, most of those stars had flamed out. More broadly, rational market theory offered straightforward answers—some of them correct—to a lot of questions that had long plagued investors, corporate managers and regulators.

7.    In recent decades, you note the theory traveled beyond the stock market to apply to other securities and especially to what came to be known as derivatives. Do you think this played a major role in the current economic crisis?

Yes it did. Although it’s not perfectly rational all the time, the stock market does process information quickly and handles even really bad news in a mostly orderly fashion. The same can usually be said for the organized exchanges in derivatives such as stock options and commodity futures. The off-exchange markets for mortgage securities and over-the-counter derivatives never developed the rules and contingency plans characteristic of well-established exchanges, yet were still expected to perform the same functions. When hit by adversity in the summer of 2007, many of these markets stopped functioning entirely. That, as much as anything else, was what turned a financial problem into a crisis.

8.    What can today’s investors learn from studying rational market theory?

The market isn’t rational, but neither am I. Over the course of researching and writing this book, I actually moved more and more of my investment portfolio into index funds. It wasn’t because I think nobody can beat the indexes, or that currently prevailing market prices are by definition right. But index funds charge the lowest fees, and I’ve become increasingly  dubious that in my spare time I can pick stocks or investment managers that will beat the market after fees.

For those with more time and perseverance than I possess, the big lesson from the fall of rational market theory is that value investing works—but it works in large part because it’s very hard to stick to.

9.    What do you see as the future of Wall Street?

We’ll have a long period of rethinking and relative sobriety, and then make all the same mistakes (or at least similar ones) again in 50 years or so.

10.     How did you come upon the idea of writing this book? And, how did you conduct the research?

The particular thing that got me started was encountering a book in 2002 by a finance professor, Peter Bossaerts of Caltech, that said the efficient market hypothesis had outlived its usefulness. What interested me was that Bossaerts sounded almost wistful about it—he wasn’t an efficient-market critic, just a realist. I knew there was a debate about the efficient market. This was the first hint I got that it was more or less over.

It led to a 2002 Fortune article titled “Is the Market Rational? No, say the experts. But neither are you, so don’t go thinking you can outsmart it.” Which in turn led to a book contract, six months spent reading through old academic journals at the New York Public Library and Columbia Business School Library and interviewing economists and finance scholars across the country, then years of thinking, writing, and much more reading and interviewing. Oh, and lots of staring blankly at a computer screen.


Rimjhim Dey
Publisez PR
rdey(insert ‘at’ symbol here)publisez.com
Land. 1.718.622.7570
Mobile. 1.917.514.3359

The Lavin Agency

Plain old me
justinmfox(insert ‘at’ symbol here)gmail.com