May 11, 2010

A movie about the real Shakespeare, Anonymous, is now being filmed, and will be released in 2011. The director is Roland Emmerich. Vanessa Redgrave plays Elizabeth. This is the first major film to present the Oxford Theory, but it remains to be seen whether it will be as persuasive as the Frontline documentary.

1. The Big Short:
Booms, Busts, and Black Swans

A. Michael Lewis

I just finished one of the hottest books in the U.S., The Big Short: Inside the Doomsday Machine, by Michael Lewis. It’s about the economic crisis of 2008 — more specifically, it’s about a handful of investors who bet against the market, who bought “short positions,” hence the title Big Short. Since the market crashed dramatically, those who bet against it succeeded dramatically. They were, for the most part, outsiders, contrarians by nature, disinclined to “go with the flow.”

Michael Lewis writes well, writes with zest. He’s more interested in people than numbers, more a humanist than an economist. Several of his books have been bestsellers, such as a football book, The Blind Side, a baseball book, Moneyball, and a book about his days as a young Wall Street trader, Liar’s Poker. One might compare Lewis to another author of non-fiction bestsellers, Malcolm Gladwell. I discovered Lewis and his book on Brian Lamb’s interview show, and for a week or two, I was fascinated, obsessed, with economics, especially the 2008 crisis. (Phlit is a record of my obsessions.)

Perhaps one reason I was drawn to The Big Short is that I myself am an outsider and a contrarian. One of my favorite theories is the contrarian view of Shakespeare — The Oxford Theory. The epigraph to The Big Short is a Tolstoy quote that could serve as an epigraph to an Oxfordian book:

The most difficult subjects can be explained to the most slow-witted man if he has not formed any idea of them already; but the simplest thing cannot be made clear to the most intelligent man if he is firmly persuaded that he knows already, without a shadow of doubt, what is laid before him.

English professors will be the last to see the truth about Shakespeare, since they’re firmly persuaded that they know about Shakespeare already. Those who worked on Wall Street were slow to recognize that subprime mortgage bonds had little or no value. Outsiders, like Michael Burry, were more apt to see the truth, and bet against those bonds — like the child in the Andersen story who said, “The emperor has no clothes!” Everyone else was trading these worthless bonds, and making a fortune doing so.

First they’d sell the mortgages, then they’d sell a pool of mortgages as a bond, then a pool of bonds as a so-called CDO, then insurance on the CDO. So lots of people made lots of money, and the original mortgage risk was magnified, and magnified again. There were huge profits but also huge risks. Billions of dollars of mortgages metastasized into trillions of dollars of bonds and CDO’s. People placed bets on whether a CDO would fail — like gamblers in a Las Vegas casino.

As long as housing prices were rising, the profits rolled in, and the risks were ignored. “I can go with the flow. If everybody’s in the same boat, how risky can it be?” It was similar to a Ponzi scheme: as long as new money kept coming in, it seemed like a good business. But the product at the bottom of it all had little value: a mortgage sold to a risky, subprime borrower. One is reminded of the Tulip Mania in 17th-century Holland: something of little value was sold and re-sold, lots of people made money, and then it all came crashing down.

Society rewards people who get along, who fit in, but in some cases, the contrarian is needed. Lewis describes how the contrarian Michael Burry never fit in; he had Asperger Syndrome, which is said to be on the “autism spectrum,” and makes it difficult to get along with people. But Burry’s problem enabled him to concentrate well, and stand apart from the crowd, instead of pretending that the emperor had clothes on.

Since the CDO’s were complicated, most people didn’t understand them — even those who bought them, even Wall Street CEO’s. Burry dug into them, dug until he knew what mortgages were at the bottom of this tower, and finally realized that the tower had a foundation of sand, and was bound to collapse eventually. Other people didn’t try to understand the CDO’s; it was enough that they were profitable.

Why would anyone buy a CDO that they didn’t understand? The ratings agencies (Moody’s and Standard & Poor’s) gave most CDO’s a Triple-A rating, so people thought they were safe investments. Why did the ratings agencies give Triple-A ratings to CDO’s that didn’t deserve it? The agencies didn’t understand the CDO’s themselves, and they were being paid by investment banks who wanted Triple-A ratings. If the bank couldn’t get a Triple-A rating from one agency, they’d go to another. The agencies were making huge profits by handing out Triple-A ratings. The agencies were part of this Ponzi scheme, this tower of tulips.

The role of the agencies in the 2008 crisis might be compared to the role of the Harvard English Department in the Shakespeare matter. How can the CDO be unsound if Moody’s has given it a Triple-A rating? How can the Stratford man be illiterate if the Harvard English Department says he wrote Hamlet and Macbeth? How can the CDO be unsound if all the major banks are giving it their seal of approval? How can the Stratford man be illiterate if all the major universities, on every continent, say that he wrote Hamlet and Macbeth? How can everyone (almost everyone) be wrong?

The origins of the 2008 crisis stretch all the way back to the 1980s, and the first lonely voices of warning were raised in the 1980s, too. Before 1980, the big Wall Street banks were privately-held partnerships. In 1981, Lewis says, Salomon Brothers became “Wall Street’s first public corporation.” This decision was made by the Salomon CEO, John Gutfreund. According to Lewis, going public meant a greater willingness to take risks; you were no longer risking your money, you were risking the shareholders’ money. Going public also meant focusing on short-term gains, quarterly profits. Perhaps one reason that partners wanted to go public is that, in a litigious society, they wanted to be free of personal liability.

[Update: Lewis’ book was turned into a movie called The Big Short (2015). I recommend it.]

B. Kaufman and Buffett

Inside Salomon, one man disagreed with Gutfreund’s high-flying approach: the widely-respected Henry Kaufman. “Amid Salomon’s push toward high risk and high leverage, in pursuit of high returns, Kaufman claims that ‘Gutfreund practiced a permissive style of leadership that allowed too many abuses to go unchecked.’”1 Kaufman resigned, and started his own company.

About ten years ago, Kaufman wrote On Money and Markets: A Wall Street Memoir, in which he discussed the evolution of finance.

The most far-reaching aspect of this evolution, says Kaufman, is the securitization of credit — the conversion of nonmarketable assets, such as credit-card receivables or mortgage obligations, into marketable assets that can be priced to market and traded. The trend has created a bewildering array of derivative instruments that have fueled what Kaufman believes to be a dangerous explosion of credit. He says that economic conditions have favored the growth of these derivatives but that no one knows how they will perform in an economic downturn or what their broader economic consequences will be.2

Thus, Kaufman warned against the very derivatives that caused the 2008 crisis, and he urged greater regulation of these derivatives.

Another widely-respected investor also disagreed with Gutfreund’s style, and also warned against derivatives: Warren Buffett. It was Buffett’s criticism of Gutfreund’s fast-and-loose style that led to Gutfreund’s departure from Salomon in 1991. In 2003, Buffett warned against derivatives:

Such highly complex financial instruments are time bombs and “financial weapons of mass destruction” that could harm not only their buyers and sellers, but the whole economic system.3

So two of the most respected figures in the financial world, Kaufman and Buffett, issued warnings far in advance, in plain language, but the subprime bubble kept inflating, as if it had a life of its own, as if nothing could stop its momentum. One is reminded of how Whitman and Twain warned against the Stratford Myth, but their warnings went unheeded.

Kaufman felt that better regulation was needed. In his memoirs, Kaufman “devotes considerable thought to the urgent need for regulatory and supervisory reform at home and abroad, as financial innovation and global integration outpace an already obsolete regulatory structure.”

Kaufman also warned against relying on computer models, which tend to be based on data from yesterday, rather than on today’s situation. “Kaufman always tempered his forecasts with intuition and good judgment, believing that elegant econometric models too often depend on historical data that miss key aspects in the evolution of finance.”4 Lewis says that computer models deceived people about the risks of subprime mortgages, since the models were based on rates-of-default that didn’t apply in today’s world.5

Not only did the subprime crisis have its roots in the 1980s, it resembled some of the financial crises of the 1980s, such as the Savings & Loan crisis. Both crises involved real estate speculation; debt reached excessive levels in order to finance real estate purchases. But while the subprime crisis involved homeowners and residential real estate, the Savings & Loan crisis involved businesses and commercial real estate.

The Junk Bond scandal of the 1980s also reminds one of the subprime scandal, since both involved new forms of bonds, bonds that were poorly understood and poorly regulated. But while junk bonds were known to be risky (and paid high yields to offset that risk), subprime mortgage bonds had Triple-A ratings, and were thought to be safe.

Alan Greenspan, former Fed chairman, failed to restrain the credit bubble and the real estate bubble. Greenspan was a disciple of Ayn Rand, and a believer in free, lightly-regulated markets. During the Clinton administration, Greenspan clashed with Brooksley Born, who advocated more regulation, especially of the “dark market” (derivatives and other products that were traded off exchanges). The 2008 crisis seems to be an argument for regulation, an argument against free markets.

Greenspan failed to foresee the subprime debacle. He approved of subprime lending; in a 2005 speech, he said, “Where once more marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risks posed by individual applicants and to price that risk appropriately.”6

C. Nassim Taleb

Like Kaufman, Nassim Taleb warned against relying on computer models. Taleb has become well-known for his bestselling books, such as The Black Swan: The Impact of the Highly Improbable. Taleb thinks that people often assume that the future will resemble the past, people make the mistake of predicting the future based on the past. Taleb thinks that unforeseen events, like the 9/11 attacks, have a major impact on the markets, and on history in general; he calls such events “black swans.” He notes that, for many centuries, people believed that all swans were white, but when Europeans explored Australia, they found black swans.

Taleb insists that our knowledge is limited, and that we can’t predict the future; if we attempt to predict the future with the help of computer models, models that use data from the past, we’ll be led astray. He says that the complexity of modern life deceives us with a veneer of stability, but actually exposes us to black swans, unforeseen calamities. Although Taleb is an investor, and a very successful one, he often writes in a philosophical vein; he says that only four pages of Black Swan deal with investing.

One of Taleb’s favorite philosophers is the skeptic, David Hume. According to Hume, “No amount of observations of white swans can allow the inference that all swans are white, but the observation of a single black swan is sufficient to refute that conclusion.” This reasoning might lead us to be receptive to the occult (I don’t know, however, if Taleb or Hume were receptive to the occult). This reasoning might lead us to conclude that anything is possible, including occult phenomena like ghosts, reincarnation, premonitions, etc. This reasoning might lead us to say, “Our knowledge is limited, so we shouldn’t presume to set boundaries around nature, we shouldn’t presume to know what’s possible and what’s not.”

Taleb invests in options that lose a little money if the market is stable, and make a huge profit if the market collapses. Most investors, on the other hand, make a little money when the market is stable, then lose a lot when it collapses. Taleb’s options turned a handsome profit during the 2008 crisis, and also turned a profit in past crises, like the crash of 1987.

Taleb laughs at those who, instead of buying such options, sell them. He laughs at the scholars who think they can predict the future, and gauge probabilities, until a “black swan event” upsets their calculations. Taleb foresaw the collapse of the hedge fund Long-Term Capital Management, which used the formulas of famous economists to gauge probabilities, and sold options instead of buying them. In 1998, when Russia defaulted on its bonds, the markets swooned, and Long-Term Capital Management collapsed. A black swan event had ruined the computer models, and embarrassed the Nobel Prize-winning economists.

Michael Lewis tells the story of Cornwall Capital Management. Like Taleb, Cornwall bought options, and enjoyed huge profits. Some of these options paid off if a company’s stock went dramatically higher, others paid off if a stock went dramatically lower. Cornwall would lose a little money if the stock didn’t move dramatically in either direction. After a series of brilliant successes, Cornwall decided they might have discovered a “serious flaw” in the market: “The model used by Wall Street to price trillions of dollars’ worth of derivatives [derivatives = what I’m calling “options”] thought of the financial world as an orderly continuous process. But the world was not continuous; it changed discontinuously, and often by accident.”7 So Cornwall’s view of the world was much like Taleb’s, though Lewis doesn’t mention Taleb.

The Cornwall-Taleb worldview is relevant to history, as well as to the financial world. Taleb is well aware of this, and devotes many pages of The Black Swan to discussing history. In an interview with Charlie Rose, Taleb described World War I as a black swan. Historical changes, as well as market changes, are discontinuous, reflecting sudden, improbable events. One of the biggest changes in the history of the planet was caused by an asteroid striking the earth 65 million years ago, causing the extinction of dinosaurs, and permitting the rise of mammals like us; one might call this event “the mother of all black swans.”

If today resembles yesterday, and tomorrow resembles today, we fall into the trap of thinking that the world is stable, and change is gradual. Doubtless, those who lived in Roman times came to believe that Roman rule would last forever, and doubtless those who lived under the French monarchy came to believe that it would last forever. Political revolutions, like market revolutions, take most people by surprise, but Taleb is ready for them. If the U.S. political system is overturned by a revolution, Taleb will be less surprised than most.

In an earlier issue, we discussed 19th-century geologists, who debated whether the earth developed by gradual change, or by catastrophes. Taleb would side with catastrophists, like Cuvier, and would reject gradualism (also called uniformitarianism), which was championed by Hutton and Lyell.

In a recent issue, I discussed Tibetan sages who believe that death can come anytime, hence they don’t provide for tomorrow. Like Taleb, the Tibetan sages are ready for calamity, they don’t believe in the permanence of the present situation.

I can think of three objections to Taleb’s investing strategy:

  1. If his books are persuasive, and more people invest this way, it will become less profitable; more buyers of options will lead to higher prices, and slimmer profits.
  2. If an asteroid strikes (or any major “black swan”), your options will pay off, but there won’t be anyone around to pay you, and you won’t be around to collect (Lewis’s contrarians often worried that they would win their bets, but not get paid).
  3. If the black swan event is such that Taleb does get paid, other investors may make money, too, when the market rebounds, as it’s doing now, and as it did after the 1987 crash. So if you wait patiently, you can survive a crash, enjoy the rebound, make money in the long run, and perhaps laugh at Taleb.

Perhaps Taleb’s strategy only looks good immediately after a crash. The key question is, what’s the best strategy in the long term? In the long term, the stock market seems to move higher, so the “long investor,” who bets for the market, may be wiser than the “short investor” like Taleb, who bets against it. Warren Buffett would be an example of a “long investor” who has been more successful than Taleb. And if we’re visited by a calamity so dire that even the best long investors are permanently ruined, then the short investor may not be able to collect his winnings.

Perhaps there is no “best strategy,” perhaps different investors have different styles, just as different novelists take different approaches. Though we may admire Proust’s work, we wouldn’t measure other novelists by how closely they resemble Proust; as the old saying goes, “different strokes for different folks.”

Another prominent economist, Nouriel Roubini, also predicted the 2008 crisis. Roubini is now one of the most respected, most sought-after economists in the world. While Taleb is of Lebanese extraction, Roubini is Iranian-Jewish. One might call Roubini a citizen of the world, a cosmopolitan. He travels frequently, believing that we can’t understand foreign countries just by reading and web-surfing. “You have to see it, smell it and live it,” he says. Roubini spent years working on emerging markets, and studying their booms and busts; this helped him to predict the 2008 meltdown. He criticizes the Democrats for resisting spending cuts, and he criticizes the Republicans for resisting tax increases. Most of his writings are for specialists, not for a general audience. Recently, though, he published Crisis Economics: A Crash Course in the Future of Finance, which seems to be for a general audience. Responding to Taleb, Roubini calls the first chapter of his book “White Swans,” and argues that financial crises can be anticipated and averted. Crisis Economics has a co-author, Stephen Mihm, who is apparently a journalist. This raises the question, Did Roubini really write this book, or just talk to Mihm?

Mohamed El-Erian is another highly-respected economist of foreign extraction. The son of an Egyptian diplomat, El-Erian attended private school in England, then earned degrees from both Oxford and Cambridge. Like Roubini, El-Erian worked at the IMF. Later, he managed Harvard’s $35 billion endowment, and also worked for the world’s largest bond fund, PIMCO. In 2008, he published When Markets Collide: Investment Strategies for the Age of Global Economic Change, which won an award as the best business book of the year.

Raghuram Rajan is another prominent economist who worked at the IMF. Born in India, Rajan anticipated the 2008 crisis, and issued a warning in 2005 at a FederalReserve conference; Rajan said that “incentive structures in the banking profession were leading to reckless credit expansion.”7A His warning was dismissed; Larry Summers, for example, called it “misguided.” Rajan is currently a professor at the University of Chicago.

Rajan argues that politicians helped create the 2008 crisis by insisting that lenders make loans to low-income borrowers. Politicians were distressed by growing income inequality, and tried to distribute wealth by lavishly extending credit. Welfare had a bad name, credit had a good name, so politicians put brakes on welfare, and opened the floodgates of credit.

The trends that shook the world economy came out of Fannie Mae and Freddie Mac, out of the Federal Housing Administration, and out of their “regulator,” the U.S. Department of Housing and Urban Development. By 2000, HUD required that low-income loans make up 50 percent of Fannie and Freddie’s portfolios. Out of “compassionate conservatism,” perhaps, the Bush administration raised that mandate to 56 percent.... By 2008, “the FHA and various other government programs were exposed to about $2.7 trillion in subprime and Alt-A loans, approximately 59 percent of total loans to these categories.”7B

Perhaps the root problem was the transition from an industrial economy to an information-and-service economy, a transition that caused a decline in high-paying jobs, and a rise of income inequality. Politicians, scrambling to address the problem of income inequality, pushed lenders to extend credit excessively. If we look at the 2008 crisis from Rajan’s perspective, the crisis demonstrates not simply the failure of free markets, and the need for more government regulation, but also the danger of government meddling in the marketplace, meddling that was driven by a desire to share wealth more widely.

Rajan’s latest book is Fault Lines: How Hidden Fractures Still Threaten the World Economy. His writing has been called “clear as a bell, even to nonspecialists.”

D. Business Books

Like many contemporary writers and journalists, Lewis violates one of my Ten Commandments of Literature: Thou shalt preserve a certain dignity, a certain courtesy. For example, he tells us that, “The focal point of [Steve Eisman’s] soft, expressive, not unkind face was his mouth, mainly because it was usually at least half open, even while he ate.”8 Sure, there’s a place for vivid description and gritty detail, but I think Lewis sometimes steps over the line.

On the whole, though, I enjoyed The Big Short, which offers a quick, readable introduction to the contemporary financial scene. If you want a more comprehensive account of the 2008 crisis, consider Andrew Ross Sorkin’s Too Big To Fail. Sorkin’s book was made into a movie of the same name, but the subject seems better suited for a documentary. (Another movie about the 2008 crisis is Margin Call.) Sorkin is the Boy Wonder of business journalism. Now 33, he’s been writing for the New York Times since he was in high school.

Also consider Roger Lowenstein’s The End of Wall Street. Lowenstein is best known for When Genius Failed: The Rise and Fall of Long-Term Capital Management.8B In a few months, Joe Nocera, another New York Times writer, is going to publish All the Devils Are Here: The Hidden History of the Financial Crisis. I enjoy Nocera’s writing, and I’m planning to read his book, Good Guys and Bad Guys: Behind The Scenes With The Saints and Scoundrels of American Business (and Everything In Between). Consider also a book by Charles R. Morris called The Two Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash. Morris also wrote The Sages: Warren Buffett, George Soros, Paul Volcker, and the Maelstrom of Markets, and The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould, and J. P. Morgan Invented the American Supereconomy.9

One of the most popular business books of recent years is Barbarians at the Gate: The Fall of RJR Nabisco, by Bryan Burrough and John Helyar. Another popular book, on a similar theme, is Predators’ Ball: The Inside Story of Drexel Burnham and the Rise of the Junk Bond Raiders. One of the most popular business writers of the last half-century is Robert Sobel; among his numerous books are The Entrepreneurs: Explorations Within the American Business Tradition and The Age of Giant Corporations: A Microeconomic History of American Business, 1914-1970.

Another popular writer from Sobel’s generation was John Brooks, author of The Takeover Game, Once in Golconda, The Go-Go Years, etc. According to Joe Nocera, “[Brooks] was a wonderful writer. He was that rarest of birds, a gifted storyteller, with an enviable talent for summing up a character with a single, pithy anecdote or sentence.” Once in Golconda deals with the Whitney embezzlement case, which was also the basis for The Embezzler, a novel by Louis Auchincloss.

George Goodman, who used the pseudonym Adam Smith, wrote both fiction and non-fiction about Wall Street. Alexander Dana Noyes wrote some well-known business books, such as Forty Years of American Finance and Market Place: Reminiscences of a Financial Editor.

A renowned business writer from an earlier generation is Edwin Lefèvre, author of a roman à clef called Reminiscences of a Stock Operator. Alan Greenspan called Lefèvre’s book “a font of investing wisdom.” (In December 2009, John Wiley & Sons published an Annotated Edition in hardcover, ISBN 0-470-48159-5, that bridges the gap between Lefèvre's fictionalized account and the actual exploits, personalities, and locations that populate the book.)

Fortune magazine compiled a list of the 75 best business books; Fortune calls its list “The Smartest Books We Know.”

If you want an overview of economics, consider Economics Explained, by Robert Heilbroner and Lester Thurow.10

E. John Kenneth Galbraith

I read a 110-page book by Galbraith called A Short History of Financial Euphoria. It surveys manics and panics, including the tulip bubble in Holland, the Crash of 1929, and the 1987 decline. It’s a readable and interesting book, though the style is wordy. Since it was written in 1993, it doesn’t discuss the Internet bubble or the subprime crisis.

Many speculative frenzies center on something new, such as the Internet; investors feel that this new field offers vast opportunity. Tulips, for example, were new in Holland in the 17th century, having come from the Levant in the late 16th century (they grow wild in the Levant). Though the Internet bubble has burst, the Internet is still very much with us. Likewise, Galbraith points out that Holland is still renowned for its tulips, and tourists flock to Holland in the tulip season. In the U.S., railroads produced speculative bubbles, but after the bubble burst, railroads remained important.

Another example of something new producing a speculative frenzy is the South Sea Bubble, which occurred in England in the early 1700s. Investors were attracted by the promise of riches in far-off lands, and by the novelty of owning stock; Jonathan Swift and Alexander Pope were among those who invested. In imitation of the South Sea Company, numerous other joint-stock companies and get-rich-quick schemes sprung up, including “the immortal enterprise ‘for carrying on an undertaking of great advantage, but nobody to know what it is.’”11 One thinks of the 2008 crisis, with its CDOs that investors bought on faith rather than understanding. Galbraith quotes a book called Extraordinary Popular Delusions and the Madness of Crowds, written in 1841 by Charles Mackay; “It remains to this day,” says Galbraith, “one of the most engaging and colorful accounts of speculative aberration.”12

Galbraith says that manics and panics have occurred regularly in U.S. history. What we would call recessions or depressions occurred in 1819, 1837, 1857, and 1873. Many speculative fevers, like those in our time, involved real estate. A common feature of these episodes is excessive debt supported by scanty real assets. Then as now, banks tried to leverage a modest amount of assets into a large amount of investments and profits. “A group of Michigan banks,” Galbraith says, “joined to cooperate in the ownership of the same reserves [“reserves” probably means gold coins]. These were transferred from one institution to the next in advance of the examiner as he made his rounds.”13 To avoid a “run on the bank,” the banks made a run on the examiner!

One of the chief debates in U.S. history was the debate between the advocates of hard money, and a gold standard, and the advocates of soft money. Hard money was generally popular in the Northeast, soft money in the South and West. One function of a National Bank was to ensure that soft money wasn’t too soft, wasn’t just worthless paper, unsupported by precious metal. So the idea of a National Bank was popular in the Northeast, unpopular in the South and West; Andrew Jackson was a prominent critic of the National Bank.

Another prominent critic of hard money was William Jennings Bryan who, in a famous speech, said that he wouldn’t allow his opponents to “crucify mankind upon a cross of gold.” The basis of money isn’t always precious metal. Before the American Revolution, southern colonies used a “tobacco standard.” In feudal Japan, a “rice standard” was used. Since 1971, money hasn’t had a gold standard or any other material standard, a situation that some economists lament.

Whenever a bubble bursts, people look for a scapegoat, but Galbraith says that the real cause of a bubble is the speculative fever itself, which is part of capitalism, part of human nature. And if bubbles are inevitable, so are bubble-burstings. Galbraith ends his book with this sentence: “Thus it has been for centuries; thus in the long future it will also be.”

If we know that another bubble is coming, one might suppose that we can avoid it, avoid being caught up in the speculative frenzy. But during the Internet bubble, it seemed to me that it was an opportunity, an economic revolution, not a bubble. Likewise, during the housing bubble of 2000-2005, Ben Bernanke said it wasn’t a bubble, it was a response to rising incomes, a declining supply of land, etc., etc. It’s easy to predict a bubble in the future, but it isn’t easy to recognize a bubble when you’re in it.

Perhaps the cause of crashes is the simple fact that prices can’t rise forever, and as soon as they stop rising, they fall. Like arrows, prices either rise or fall, they don’t stay steady. Shortly before the 1929 crash, a prominent economics professor, Irving Fisher, said “stock prices have reached what looks like a permanently high plateau.”14 But if prices were on a plateau, they weren’t rising, so why should people buy stocks? A few people began selling, and soon there was a rush for the exits, a panic.

Another book that surveys the history of bubbles and crashes is This Time Is Different: Eight Centuries of Financial Folly, by Ken Rogoff and Carmen Reinhart. Like Roubini and El-Erian, Rogoff worked at the IMF; he’s now a Harvard professor. His reputation seems to be as high as Roubini’s and El-Erian’s. This Time Is Different discusses the 2008 crisis, and compares it to other crises. This book is more comprehensive, more detailed, more quantitative than Galbraith’s rapid survey.

Galbraith died in 2006, at the age of 98. From about 1950 to 1980, he was a prominent economist, a public intellectual. He was a leading Left economist, as Milton Friedman was a leading Right economist. Galbraith served in several Democratic administrations, and may have inspired the Kennedy-Johnson War on Poverty. Galbraith wrote numerous books, including

  • The Great Crash, 1929
  • Money: Whence It Came, Where It Went
He also made a 15-hour documentary on economics (Milton Friedman parried this thrust with a documentary of his own). Like John Maynard Keynes, Galbraith was more literary, less mathematical, than today’s economists; Galbraith wrote several novels, including A Tenured Professor.

2. Selling Philosophy

My books are now available through Amazon as e-books:

I couldn’t make my late wife’s book into an e-book because Amazon doesn’t currently support Chinese. An e-book can be read on Amazon’s Kindle, Apple’s iPad or iPod, or any computer. One drawback of Kindle is that it doesn’t have color; if it supported color, that would allow it to show photos, maps, paintings, etc.

The e-book format makes it easier and cheaper to self-publish. With a traditional book, you have to charge at least $12 to cover your printing and shipping costs, but you can charge $1 for an e-book ($1 is Amazon’s minimum price). To get started, visit Amazon’s Digital Text Platform. You can upload a Word file (doc files work better than docx). Amazon’s software doesn’t do paragraph-separation well, but hopefully they’ll fix that bug. Amazon can also print an old-fashioned book, through their subsidiary, CreateSpace.

© L. James Hammond 2010
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1. “He’s Not Just ‘Dr. Doom’, Businessweek Online, June 5, 2000 issue.

A writer who has been compared to Michael Lewis is Mark Bowden. Bowden was inspired by author/journalist Tom Wolfe. Bowden became famous with his book Black Hawk Down: A Story of Modern War (about U.S. involvement in Somalia). He also wrote The Finish: The Killing of Osama Bin Laden and Killing Pablo: The Hunt for the World’s Greatest Outlaw (about the drug lord Pablo Escobar). back

2. Ibid. Lewis mentions Jim Grant of Grant’s Interest Rate Observer: “[Grant] had been prophesying doom ever since the great debt cycle began, in the mid-1980s.”(Ch. 7, p. 177) Apparently, Wikipedia doesn’t have an article on Grant, but some information about him is available on his own site. Grant has written several books, including Mr. Market Miscalculates (a collection of Grant’s speeches and articles, published in 2008), Money of the Mind: Borrowing and Lending in America From the Civil War to Michael Milken, and Bernard M. Baruch: The Adventures of a Wall Street Legend. Grant is known for criticizing Fed policy, and advocating a gold standard. He writes well, and has a sharp wit. back
3. BBC News: Business, 4 March, 2003. Another stock-market sage who foresaw the crisis is John Templeton. In 2005, Templeton predicted
Financial Chaos probably in many nations in the next five years.... The dangers are more numerous and larger than ever before in my lifetime. Quite likely, in the early months of 2005, the peak of prosperity is behind us.... Over tenfold more persons hopelessly indebted leads to multiplying bankruptcies not only for them but for many businesses.... Voters are likely to enact rescue subsidies, which transfer the debts to governments.
4. “He’s Not Just ‘Dr. Doom’, Businessweek Online, June 5, 2000 issue back
5. See, for example, ch. 4, p. 98 (hardcover, 2010). One of the contrarians whom Lewis profiles, Steve Eisman, had nothing but contempt for these models: “Just throw your model in the garbage can. The models are all backward-looking. The models don’t have any idea of what this world has become.”(Ch. 7, p. 175) back
6. Quoted in “Anatomy of a Meltdown: Ben Bernanke and the financial crisis,” by John Cassidy, New Yorker, December 1, 2008. The economist Paul Krugman drew a parallel between subprime borrowers in the U.S., and “peripheral economies” in Europe:
“You still hear people talking about the global economic crisis of 2008 as if it were something made in America. But Europe deserves equal billing. This was, if you like, a North Atlantic crisis, with not much to choose between the messes of the Old World and the New. We had our subprime borrowers, who either chose to take on or were misled into taking on mortgages too big for their incomes; they had their peripheral economies [Greece, Ireland, Spain, etc.], which similarly borrowed much more than they could really afford to pay back. In both cases, real estate bubbles temporarily masked the underlying unsustainability of the borrowing: as long as housing prices kept rising, borrowers could always pay back previous loans with more money borrowed against their properties. Sooner or later, however, the music would stop. Both sides of the Atlantic were accidents waiting to happen.”(New York Times Magazine, “Can Europe Be Saved?,” Jan. 12, 2011) back
7. Ch. 5, p. 116 back
7A. “Easy Credit, Hard Landing: The financial insights of Raghuram Rajan,” by Christopher Caldwell, Weekly Standard, July 26, 2010 back
7B. ibid back
8. Ch. 1, p. 4 back
8B. In the world of investing, genius doesn’t always fail. The Medallion Fund at Renaissance Technologies has achieved impressive results, over a long period, through superior quantitative analysis. Renaissance Technologies was founded in 1982 by math whiz Jim Simons. Renaissance’s analysts once found a correlation between sunny weather and rising stock markets.

Another successful fund is the Boston-based Baupost Group, run by Seth Klarman. Klarman is described as a “value investor,” rather than a quantitative analyst. “He has lost money in only three of the past 34 years.... His writings are so coveted and followed by Wall Street that a used copy of a book he wrote several decades ago about investing starts at $795 on Amazon, and a new copy sells for as much as $3,500.” Warren Buffett, often critical of hedge managers, has spoken highly of Klarman. As of early February, 2017, Klarman is warning against “the euphoria that has buoyed the stock market since Mr. Trump took office, describing ‘perilously high valuations.’” back

9. Many other books have been written about the 2008 crisis:
  • In Fed We Trust: Ben Bernanke’s War on the Great Panic, by David Wessel
  • Freefall: America, Free Markets, and the Sinking of the World Economy, by Joseph E. Stiglitz (I mentioned Stiglitz’s book on globalization in the last issue)
  • The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to Do about It, by Robert J. Shiller (renowned Yale economist)
  • How Markets Fail: The Logic of Economic Calamities, by John Cassidy (Cassidy is a New Yorker writer, and author of dot.con: How America Lost Its Mind and Money in the Internet Era)
  • A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman, by Lawrence G. McDonald and Patrick Robinson
  • The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History, by Gregory Zuckerman (a Wall Street Journal writer)
  • Fool’s Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe, by Gillian Tett (Tett is a Financial Times reporter who foresaw the 2008 crisis. In 2015, she published a book called The Silo Effect: The Peril of Expertise and the Promise of Breaking Down Barriers)
10. Economics Explained was first published in 1982; the fourth edition (latest edition?) was published in 1998. Heilbroner is best known for his book on famous economists, The Worldly Philosophers. His friend Peter Bernstein also wrote some well-regarded books on economics, such as Against the Gods: The Remarkable Story of Risk. Charles Geisst is a prolific business writer; among his works are Wall Street: A History and The Last Partnerships: Inside the Great Wall Street Money Dynasties. William Cohan is the author of The Last Tycoons: The Secret History of Lazard Frères & Co., which won an award as the best business book of 2007. Cohan has also written studies of two other Wall Street firms, Bear Stearns and Goldman Sachs. back
11. Ch. 4, p. 49 back
12. “Notes on Sources,” Ch. 3 back
13. Ch. 5, p. 63 back
14. Ch. 6, p. 80 back