The world’s experts on all topics are huddling in Washington, D.C. One chap proclaims that he is the world’s ranking expert on goldfish. Inquires a layman, “Okay, how do you tell a male goldfish from a female goldfish?”
Says the expert, “I can tell you as an expert that the male goldfish eats male worms and the female goldfish eats female worms.” The layman then harrumphs, “Alright, how do you tell a male worm from a female worm?”
Shouts the expert, “Hey, I’m an expert on goldfish! I never said I was an expert on worms!”
Purported experts are in the news these days. Late last month, in nominating Ben Bernanke to a second term as head of the Federal Reserve, the president gushed that the economist was “an expert.” It gave me the shivers, but I’ll get into that later.
First, some local examples of experts at work. The Motley Fool recently looked at the predictions of self-professed experts (securities analysts) on the future of San Diego’s telecom superstar, Qualcomm. Fourteen analysts estimated long-term yearly earnings growth. The estimates ranged from 7 to 22 percent. Big spread. The price targets on the stock were from $30 to $63. Qualcomm was selling at $47 then; this means that by following the experts, you could experience anything from a loss of 36 percent to a gain of 34 percent.
One of today’s most contentious donnybrooks among economics experts is whether markets are rational. The so-called efficient market hypothesis is at the center of this battle. The idea is that the decisions of millions of rational investors, all trying to outsmart one another, provide the best judge of a stock’s or bond’s value. Prices on exchanges instantly and accurately reflect the best available information on the assets. Ergo, you can’t beat the market.
San Diegan Harry Markowitz, when a graduate student at the University of Chicago in the 1950s, basically started the efficient market hypothesis going as he applied mathematical concepts to the subject of risk. (Faculty member Milton Friedman, later to become one of the most eminent economists of the 20th Century, cracked that he wasn’t sure stock market theory belonged in the study of economics.) Markowitz, now an adjunct professor at the Rady School of Management at the University of California San Diego, was soon joined by other economists, and the theory of rational markets evolved into a near religion. Markowitz won a Nobel Prize.
Almost all the experts preached the theory, but it has come under fire because of the one-day crashes in 1987 and 2008, the dot-com/tech collapse of 2000–2002, and the current bear market, along with the real estate bubble and implosion. A new book by Justin Fox, The Myth of the Rational Market, tears apart the academics who stumped for the theory, sometimes making big bucks in the process. After the 1987 crash, Yale economist Robert Shiller, who has an excellent track record in forecasting the economy, called the efficient market hypothesis “one of the most remarkable errors in the history of economic thought.”
So which expert d’ya believe?
The British royalty demands performance from its experts. Last November, Queen Elizabeth visited the London School of Economics to inquire why none of its experts had anticipated the financial devastation. Chastened, a group of Britain’s most eminent economists wrote her a letter, confessing that they were guilty of “wishful thinking combined with hubris.” Figuratively bowing to the queen, they stated, “In summary, your majesty, the failure to foresee the timing, extent, and severity of the crisis and to head it off, while it had many causes, was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole.”
Of course, the same sins are attributable to America’s self-pronounced experts. Bernanke is now lauded for keeping us out of another Great Depression by flooding the system with liquidity: keeping interest rates inordinately low, bailing out financial institutions, in effect dumping money out of airplanes. But Bernanke took his post in 2006 and did not foresee the tsunami. He couldn’t see any housing bubble. In March of 2007 he said that the subprime mortgage problems were contained. Prior to the week of September 15, 2008, Bernanke again assured Americans that housing problems were limited and under control. Then he suddenly turned tail and declared that Treasury Secretary Henry Paulson’s $700 billion bailout for the banking industry was critically necessary to save the world economy. Among the newspapers denouncing opponents of the bailout was the Union-Tribune.
Alan Greenspan, Bernanke’s predecessor, proclaimed that central bankers can’t foresee or forestall bubbles. During the Clinton administration, Greenspan, Arthur Levitt, Robert Rubin, and Lawrence Summers led the effort to repeal the Glass-Steagall Act of 1933, which for decades had separated bankers and brokers and kept runaway greed at least partly in check. Then the same foursome made sure that derivatives, those extremely complex financial instruments that now threaten to bring down the whole financial system, be nonregulated.
Oh yes. Greenspan and Summers, along with the late Ken Lay of the late Enron, lectured then–California governor Gray Davis about the cause of the state’s 2000 energy crisis. It was excessive regulation, Greenspan, Summers, and Lay claimed, reminding the governor of their expertise. Summers is now President Obama’s key economics advisor.
And Greenspan? You can say this for him: he admitted his mistakes — well, sort of. Last year, he told a House committee, “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.” He had put too much faith in the ability of markets to self-correct. And quite frankly, he had never understood the tyranny of greed or the omnipresence of crooks. He had not learned the lesson that most of us learn from our mothers: “Don’t do it just because everybody else is doing it.” That’s how derivatives became a multitrillion-dollar nightmare. Banks were making money in this extremely risky business. “If others are doing it, we must too, so our profits can keep pace,” said the experts who ran the financial institutions.