Talking efficient markets with Robert Kleinschmidt, Jerry Senser and Consuelo Mack

I hadn't realized that my appearance on Consuelo Mack WealthTrack in October was available in embeddable form. Thanks to Prieur du Plessis for showing me the way:


There's also a transcript where you can read semi-coherent utterances such as this one (it's better on TV):

JUSTIN FOX: It's funny, even though my book is critical of this whole idea coming out of academic finance, I spent enough time talking to all these finance professors that I immediately think to myself, "yeah, but do those guys really know where these stocks are headed?" But my thought is yeah, I should hope some people do because that's what makes, it's the work of Jerry and Robert that makes markets more efficient over time. My thinking is more power to them because I'm no good at that.

Fall speaking schedule

I just updated my upcoming events page for the first time in a while, and realized that I have enough stuff coming up in the next couple of months to merit a post. First, I'll be on the Consuelo Mack WealthTrack show on PBS this coming weekend. (Check your local listings!) Then there's this New-York-centric line-up of speaking events:

Columbia Business School, 6:30-8:30, William & June Warren Hall, 1125 Amsterdam Avenue, Feldberg Space. Register online.

Museum of American Finance, Oct. 29, 2009, 5:30-7, 48 Wall Street, New York ($15 for non-members).

New York Salon,
Nov. 9, 2009, 7-8:30, Barnes & Noble Lincoln Triangle, Broadway and
66th, New York. Tickets required (but they're free); e-mail

Drucker Business Forum, Dec. 3, 2009, Los Angeles. Details to come.

New York Society of Security Analysts, Dec. 9, 2009, 5:30-7:45, 1177 Avenue of the Americas, 2nd Floor, New York ($25 for non-members).

Ryan Lizza puts Myth of the Rational Market in the New Yorker, and other news

In that other blog I write, I have whined a teensy little bit about Paul Krugman and The Economist failing to throw in a mention of my book in their recent pieces on what went wrong with economics. So it was great to see, in Ryan Lizza’s epic account of economic decisionmaking in the Obama White House in this week’s New Yorker, a largely unnecessary reference to The Myth of the Rational Market:

Summers told me that, as a graduate student, he first studied claims, made famous by economists at the University of Chicago, that financial markets are always rational and self-correcting. He said, “I encountered a sentence that was much quoted: ‘The efficient-market hypothesis is the best established fact in social sciences.’ Any sentence like that is a red flag to an ambitious academic.” Summers produced a body of work that undermined the efficient-market hypothesis, or E.M.H. A memorable paper on the subject, which he wrote in the early eighties but never published, began, “THERE ARE IDIOTS. Look around.” According to Justin Fox’s recent book, “The Myth of the Rational Market,” that paper persuaded Fischer Black, one of the leading theorists of E.M.H., to essentially abandon his belief in the hypothesis.

I don’t know that I’d say Fischer Black abandoned his belief in the efficient market hypothesis. He just loosened it a lot. But I’m thrilled that Lizza, whom I’ve never met, saw fit to bring up the book. We have reached the point in Myth‘s sales trajectory where little mentions here and there seem essential to keeping it from fading into, if not oblivion, some place I’d rather not see it go. So little things, like a short review in the October Harvard Business Review that doesn’t appear to be available online to non-subscribers, or a rave in the Las Vegas Business Press, or a brief mention in the New Yorker, start mattering a lot.

In that vein, I guess I ought to mention that I’ll be on Leonard Lopate’s radio show on WNYC on Thursday, Oct. 8, and on Consuelo Mack’s WealthTrack on a PBS station near you next week.

Roger Lowenstein reviews Myth of the Rational Market in the Washington Post

The review that was meant to run in the June issue of Conde Nast Portfolio—which was shut down after the May issue—has found its way to the Sunday Washington Post (and a Friday evening online posting). The gist:

Fox, a business columnist for Time,
spins a fascinating historical narrative, beginning with economist
Irving Fisher's paean to markets in, alas, 1929. Postwar economists
such as Paul Samuelson
noticed that most investment pros do not beat the averages. This led to
the one positive contribution of the efficient-market hypothesis: Jack Bogle's
invention of index funds, which mimic the performance of the stock
market as a whole and keep ordinary people from wasting their money
trying to beat it.

Fox recognizes that true believers in the market's efficiency
suffered from a "blinkered" mindset and "tunnel vision." Yet I think he
lets them off too easily. He laments (as if it were necessary) the lack
of any alternative "grand new theory" and finds that the debate has
resulted in a "muddle." Fox concludes, "If you do come up with an idea
for beating the market, you need a model that explains why everybody
else isn't already doing the same thing." Not necessarily. Markets
aren't physics. Maybe no one model explains them.

I have it on reasonably good authority that sometime soon a review will appear in another major newspaper from another very prominent student of the market, and he will say that it's a good book and all but I'm too hard on the true believers in the market's efficiency. Sigh.

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.

Brad DeLong plugs my (as-yet-nonexistent) book

At the request of bossman Josh Tyrangiel, I’ve been trying to keep to an at-least-twice-a-weekday posting schedule over at the Curious Capitalist. Which means I haven’t had much leftover verbiage for this blog. But yesterday, in the midst of a back-and-forth debate/discussion of what the heck “neoconservative” means, UC Berkeley economist/superblogger Brad DeLong decided to announce to his readers that I have a book coming out, then reproduce most of the 2002 article that got this whole saga started. Which was most kind of him, and also reminded me that perhaps I’d better get back to work on the thing.

I’ve been waiting to get comments from my overtaxed editor before proceeding, but I already have a pretty good idea of what he’s going to say (“make it shorter, dude–and less confusing”) and a long list of people I need to check facts/stories with. So maybe I ought to get cracking on that instead of writing Curious Capitalist posts in the middle of the night, huh?

First Time column

My very first "Curious Capitalist" column is in the current issue of Time. It’s the issue that was supposed to hit newsstands last Friday, although an awful lot of newsstands haven’t figured out yet that Time now comes out on Fridays. Last Friday night with the in-laws it took three stops before we finally found a copy (at the Reston Barnes & Noble). Today at the Raleigh-Durham airport the Hudson News still had last week’s Time on display.

Anyway, the column is about hedge funds and their inevitable decline (as a group) into mediocrity. It stars Ed Thorp, about whom I offer some more detail in a blog post. And it continues what’s becoming a theme for me: That despite all my jabbering about financial markets not being efficient, I still tend to believe that, over time,  markets are actually pretty efficient. Oh well.