Archive for October, 2007|Monthly archive page

Whatever Happened to the Efficient Market Hypothesis?

The Wall Street Journal has a front page story today about the lack of transparency in securities. Remember, one of the great accomplishments of the market is to provide accurate information to allow for something akin to perfect efficiency. Milton Friedman would tell us that there will be inefficient speculators, but the market will ruthlessly purged them, leaving only the great ones who can guide the economy efficiently.

Financialization and securitization was supposed to distribute risk even more efficiently. Unlike most fairytales, I suspect this one will not have a happy ending. Well, here is the article.

Pulliam, Susan, Randall Smith and Michael Siconolfi. 2007. “U.S. Investors Face An Age of Murky Pricing: Values of Securities Tougher to Pin Down.” Wall Street Journal (12 October): p. A 1.

“Since the invention of the ticker tape 140 years ago, America has been able to boast of having the world’s most transparent financial markets. The tape and its electronic descendants ensured that crystal-clear prices for stocks and many other securities were readily available to everyone, encouraging millions to entrust their money to the markets. These days, after a decade of frantic growth in mortgage-backed securities and other complex investments traded off exchanges, that clarity is gone. Large parts of American financial markets have become a hall of mirrors.”

“The hazards of this new age of uncertainty became clear at Dillon Read in March, when rising defaults by homeowners were hammering the value of mortgage securities. John Niblo, a hedge-fund manager at the firm, acted fast. He twice slashed his fund’s valuation of securities tied to “subprime” mortgages, knocking them down by about 20%, or nearly $100 million, say traders familiar with the matter. But managers at UBS AG, Dillon Read’s parent company, were irate. The Swiss banking giant was carrying similar securities on its books at a far higher price, the traders say. In conference calls, the UBS managers grilled Mr. Niblo on his move. “I’m marking to where I could reasonably sell them,” Mr. Niblo responded during one call, according to the traders familiar with the conversations.”

“Today, “way less than half” of all securities trade on exchanges with readily available price information, according to Goldman Sachs Group Inc. analyst Daniel Harris. More and more securities are priced by dealers who don’t publish quotes. As a result, money managers can no longer gauge with certainty the value of some assets in mutual funds, hedge funds and other investment vehicles — a process known as marking to market. An official at the Securities and Exchange Commission said recently that some bond mutual funds might be using outdated or unrealistic prices to value their portfolios.”

“Billionaire investor Warren Buffett advocates more transparency in pricing. “Some marks can be pretty imaginative,” he says. “They call it ‘marking to market,’ but it’s really marking to myth.” He says that before funds publish financial statements, they should sell 5% of hard-to-value positions to gauge values.”

“Some Wall Streeters have a motive to inflate marks: Their bonuses often are tied to the value of their holdings. A Lipper & Co. hedge-fund manager, Edward Strafaci, earned bonuses of $3.9 million between 1998 and 2001 based on improperly marked convertible bonds, according to the SEC. Mr. Strafaci overstated the value of the bonds he managed, despite warnings from his traders, according to a civil complaint charging securities fraud. The value of a $722 million Lipper hedge fund later was cut in half, and Mr. Strafaci pleaded guilty to criminal securities fraud.”

Very Nice Interview about The Confiscation of American Prosperity

I just uploaded a copy of the first interview about my new book on our local NPR station.

A Tangled Web of the Old and the New Economy

Franklin, H. Bruce. 2007. The Most Important Fish in the Sea (Washington, DC: Island Press) tells the gruesome tale of the depredation of world’s supply of menhaden, a fish that represents the basic feedstock for the carnivorous fish and which keep the overgrowth of algae in check. A single corporation, Omega, owned by Malcolm Glazer is the chief destroyer. Omega got the business from Zapata Oil, a company founded by Bush the First back in 1953. By 1961, Bush sold his stake in the company. By 1998, Zapata became one of the most ridiculous examples of the excess of the world. Continue reading

A Different Cost of Securitization

This article shows how securitization has enriched middlemen, while impoverishing lenders.  The difference between mortgage rates and Treasury rates is now more than a half percentage point higher than in 1972-8.


Silva, Lauren and Martin Hutchinson. 2007. “The Cost of Complexity.” Wall Street Journal (6 September): p. C 14.


“Well, one defense of all the complexity would be that it saved home buyers money — but that doesn’t seem to be the case.  It looks like borrowers now pay more for this financial technology.  Between 1972 and 1978, in the days when banks offered mortgages to their customers and held the loans, the average mortgage interest rate was 1.07 percentage points higher than Treasury bonds, according to Fed figures.  Between 2000 and 2006, when most mortgages were securitized, the spread was 1.59. The figures don’t include more expensive subprime loans.  One-half percentage point is a big number in debt markets.”


“While home buyers may wonder if they are getting their money’s worth, financial institutions probably have no so such qualms about the change in the home-lending business over the past 30 years. Mortgage securitization, despite the slide in the subprime sector, has made Wall Street a lot of money.”

Watch This

The Saturday/Sunday Wall Street Journal for October 6-7 has a special 11 page advertising section for collecting and investing in luxury watches. According to

Frank, Robert. 2007. Richistan: A Journey Through the American Wealth Boom and the Lives of the New Rich (New York: Crown): p. 143: A top of the line Franck Muller watch costs $736,000.

It must be very difficult for somebody earning tens of millions of dollars to figure out what to do with it.

Absurd Interpretation of Fairness

This article condemns Radiohead for ripping off consumers by allowing them to pay what they think is appropriate to download the group’s new album.  Apparently, some consumer might pay Radiohead money that should rightfully go to the major labels.  Read this and laugh.

“Will Radiohead leave fans high and dry?  It may sound preposterous to accuse the British rockers of gouging their followers.  The band is letting them decide how much to pay for a downloaded version of new album “In Rainbows.” But early indications suggest that Radiohead’s loyal followers are paying too much for the band’s seventh disc.”

“According to a poll conducted by United Kingdom music magazine NME, the average fan appears to be willing to pay $10 for a digital copy.  Now, that may not sound like a blow out. It’s the going price for most records on Apple’s iTunes. And that price, in turn, looks to be about right for a digitally downloaded album.”

“Consider the economics of the average CD.  It retails for about $16 and costs about $6.40 to manufacture, distribute and sell in a store, research outfit Almighty Institute of Music Retail says.  These costs are essentially zero when music is sold online.  That’s why iTunes can charge roughly $10 for a downloaded album.”

“Radiohead’s fitter, happier approach slices out even more cost.  The band pulled the ripcord on EMI, so it doesn’t have to share profits or help pay the label’s overhead. As a well-known band it’s also able to take the knives out on marketing and promotion costs, cutting these by as much as two-thirds.  Subtract these expenses and Radiohead may be able to distribute an album for as little as $3.40 a copy.”

“Now, fans may be delighted to pay $10 because they think the album is

so good and Radiohead deserves the extra cash.  But Radiohead prides

itself on its anticorporate and anti-materialistic ethos.  To avoid letting down fans, it might be more productive to adopt a no-surprises policy and fix a simple, fair charge for its record.”

Cyran, Robert, Rob Cox and Mike Verdi. 2007. “What Price a Download? Given the Option to Name Their Own Price for Album, Radiohead Fans Overspend.” (3 October): p. C 14.

Nice discussion of my new book

David Warsh, longtime reporter with the Boston Globe, covering economics rather than the economy, discussed my new book, comparing it favorably to recent works by Krugman and Chait.

Quick Thoughts on Carbon Sequestration

Carbon sequestration is an excessively expensive and probably technically impossible method of capturing significant amounts of carbon. Planting trees is another popular suggestion for sequestering carbon, but a more traditional method has not been mentioned to the best of my knowledge.

Building up the soil is a simple low-tech technique for sequestering carbon. For centuries, careful farmers have realized how to build up the fertility of the soil, not really thinking in terms of carbon sequestration.

Commercial US agriculture is largely based on “robbery agriculture,” as the great German chemist of the century and a half ago, Justus von Liebig, put it. When I published my book, Farming for Profit and a Hungry World, 30 years ago, I discovered that US agriculture was eroding about 30 pounds of soil for every pound of food it delivered to an US table. At the same time, my research for the book found that US agriculture was burning about 10 calories of fuel for every calorie of food that it was delivering to a US table. Continue reading

Shameless Self-Promotion: My New Book

My new book, The Confiscation of American Prosperity, will appear tomorrow.

This book resembles a crime story in four parts. The first part, The Plunder, uses the example of the regressive redistribution of income in the United States since 1970 — a redistribution that quantitatively dwarfs the Russian or the Chinese Revolutions — to give a sense of the extent of the right wing revolution, which has remade all branches of government, the legal system, and perhaps most of all, the way people understand their condition in society. In the process, I show how the official statistics fail to capture the scope of this revolution, using examples such as corporate jets for executives and excessive fees and interest rates charged to the poor.

The second part, The Plot, tells the story of the right wing takeover in the United States from the perspective of political economy.

The third and most extensive part, Retribution, explains how this right wing revolution is laying the foundation for the next Great Depression, a cataclysm that will cost everyone dearly, even intended beneficiaries of the revolution.

The final part, The Impotence of the Economics Profession, tells the story of the missing cop on the beat the economics profession — showing how we economists have nurtured a trained incapacity for doing what should be our most important work, warning about dangerous tendencies in the economy and pointing to a better way. Continue reading

Military Contractors for Peace

Adam Smith argued that greed generates positive outcomes.  According the New York Times, contractors’ greed undermined the military’s effort to militarize space.

“President Ronald Reagan issued a call on March 23, 1983, to make enemy missiles “impotent and obsolete.” His research effort, scorned by critics as “Star Wars,” after the movie, cost taxpayers more than $100 billion.  John D. G. Rather, a laser expert who was an official at a military contractor during that era, said corporate greed undermined the effort from the start. “It became a tug of war,” he recalled, “where everybody and their brother wanted a piece of the action”.”

Broad, William J. 2007. “From the Start, the Space Race Was an Arms Race.” New York Times (25 September): p. D 1.