January 15, 2010

The Efficient Markets Hypothesis

The weak form of the U. of Chicago School's Efficient Markets Hypothesis states that the price of financial instruments will reflect publicly available information. (The strong form of the EMH states that nobody can make profits off insider trading, but that's self-evidently stupid).

The weak form is basically true: if Alcoa, say, announces a better than expected quarterly profit, Alcoa's stock price will very rapidly reflect that, as will its bond prices, and so forth. It’s not like the market doesn’t get around to reading the newspapers until the weekend or whatever. There are professional arbitrageurs who make sure that all markets stay in sync.

But that’s pretty trivial.

What has always been missing from discussions of the Efficient Markets Hypothesis is the question of the quality of the interpretation of the publicly available information. In 1999, for instance, the markets interpreted the information available about Pets.com as indicating that it would generate a lot of positive cash flow over the years, and thus its stock was worth a lot of money.

Well, their interpretation was wrong.

In 2006, the markets interpreted the publicly available information to come to the interpretation that those subprime borrowers in the Sand States would, on the whole, pay back their borrowings.

Now, subprimes were less of a pure failure of interpretation of available information than Pets.com, since with subprime there was a lot of fraud and fiduciary negligence all up and down the line, from the borrowers to the investment banks.

But the basic problem for the Efficient Markets Hypothesis was the same: the markets misinterpreted the information available. There was plenty of information available to point out that the people borrowing a half million dollars with zero down payments in California in 2006 were unlikely to ever be able to earn enough money to pay it back, nor were they likely to be able to unload their hot potato to an even Greater Fool, because who wants to pay a huge amount of money to live in a neighborhood full of poor deadbeats?

Now, the misinterpretation of Pets.com's prospects in 1999 was largely a simple example of popular delusions and the madness of crowds. In contrast, the misinterpretation of subprime-based financial instruments in the 2000s was promoted by decades of governmental pressure to demonize and punish anyone engaging in skeptical interpretations of the ability of minorities to pay back mortgages.

My published articles are archived at iSteve.com -- Steve Sailer

53 comments:

bjdouble said...

The EMH always struck me as a philosophical argument. Basically the EMH is a form of Leibnizian Panglossianism . . . The market is the best possible market because it's the only market we've got, it couldn't have been otherwise. It's a religious argument.

jody said...

i don't think the stock market is efficient at all. that is not to say it is random and wild and completely detached from reality, but i've seen stock price movements which directly contradict the weak version of the efficient markets hypothesis.

my dad has been an executive for eaton for over 10 years, and there have been a few times when eaton delivered the best financial results in company history, and the stock went DOWN. he used to hold thousands of shares, so it was illuminating to see how NOT connected to reality the price of a stock can be.

it is a big mistake to think the DOW is connected to reality or a good measure of how things are actually going. that's even more true today, now that the dow jones "industrial" average is hardly industrial at all. when american industrial companies fail, they're simply removed from the "industrial" average and replaced with random businesses. GM went bankrupt and was dropped. so, how does the DOW measure anything? the biggest, most important manufacturer in the united states has a value of zero. shouldn't the DOW be allowed to drop like a rock?

furthermore, an american company's stock can rise when it fires american workers, shuts down a big plant in the US, moves operations to some other country, and hires thousands of foreigners. in no way does this stock price rise measure a positive contribution to what is actually happening on the ground in the US. it's 180 degrees in the other direction.

Anonymous said...

Prof. Schiller at Yale has a new book out (or coming out) called "Animal Spirits" which discusses this in some depth.

Anonymous said...

The efficient markets hypothesis is so imprecisely defined as to be meaningless. What does it mean that a price "reflects" all available information? Does it mean that the price is the "right" price? What is the "right" price anyway? Can it be defined or measured?(no) Or does "reflects all available information" mean simply that you can't beat the market (except by chance)?

Financial economists typically operationalize the efficient markets hypothesis in terms of the latter with the implication that when the latter is true then the price is also "right," However, this is such an elementary logical gaffe that it boggles one's mind the degree to which the emperor has no clothes.

Whiskey said...

Steve, you and I both went to B-School. We both know that the EMH is mostly believed to exist in weak form, ala Burton Malkiel's "Random Walk Down Wall Street," and the implications are that technical analysis is useless, and that is difficult to impossible to profit long-term from market inefficiencies. One of my professors was a senior financial modeler at one of the big trading firms. They'd constantly look for short-term market inefficiencies to do program trades and take arbitrage profits, and constantly look for the exits as their strategies were copied and profits vanishing. Sometimes it would only take days before other firms copied them.

I knew people at Countrywide (EVPs). They believed, sincerely, that by cutting up aggregate income from crummy, subprime loans and selling them out in pieces, risk could be alleviated. Believe me this was a classic bubble market: 1980's Stocks, early 1990's comic books (I recall one issue of Harbingers running for $100 at a comic book store, and selling too), the dot-com craze, "flip that house" and subprime, Iceland, DUBAI, and probably, China next.

Weak EMH is not inconsistent with bubbles and tulip-mania. Everyone knew subprime was crappy, hell it is why they labeled it subprime. They all thought they could allay the risk, just like Pets.com thought they were sitting on an "internet land rush" not realizing that anyone can set up a website.

Look at Dubai. TONS of international investors including UBS, Deustche Bank, HSBC, and others who do business over there and should know better, got haircuts, often considerable.

Why? Because they wrongly assumed that if Dubai would get in trouble, the big brother at Abu Dhabi, would bail them out with endless amounts of oil money (Dubai has no oil money). Big mistake -- Abu Dhabi took care of it's own and left foreigners out to dry. Duh. A UAE Prince was acquitted of torture of various people by a UAE court (covered in the FT, not most other places).

Look at China. Everyone assumed that losses to forced-partners (everyone must take on a local SOE partner in China) and IP would be offset by "magical" ability to sell to rising consumer wealth in China. Google found that was not so and China set its hackers on them, not just to screw Human Rights people but to steal their internal code for Google Docs and Android and everything else.

Almost no one is making money in China. Except Chinese companies.

CP said...

Are you posting this because of that laughable interview with Fama that just came out?

The one where he says that the crash validates his non-falsifiable efficient market hypothesis?

Anonymous said...

"In 1999, for instance, the markets interpreted the information available about Pets.com as indicating that it would generate a lot of positive cash flow over the years, and thus its stock was worth a lot of money."

This is not necessarily true. People buy securities for various reasons. Some bought subprime mortgages and Pets.com shares in the hope they would give a positive cash flow, as you stated. Others bought it because they heard people involved in those trades made lots of money. Still others bought it knowing full well they were overvalued, yet they believed they could buy it and sell it later to a bigger sucker. There are plenty of other reasons.

My point is we can't know with certainty why the price of a particular security rises rapidly, since there is one piece of information that investors cannot know: what other investors are thinking. That, coupled with easy credit, which makes speculation cheap, will tend to cause bubbles, since investors not only buy based on solid facts, but on the opinions of other investors.

-Victor

sj071 said...

'In contrast, the misinterpretation of subprime-based financial instruments in the 2000s was promoted by decades of governmental pressure to demonize and punish anyone engaging in skeptical interpretations of the ability of minorities to pay back mortgages.'

Lol..Steve hearts Banksters.

David Davenport said...

The weak form is basically true

Is it?

anony-mouse said...

Then why didn't Steve and friends not make a killing since they had the right interpretation?

Truth said...

"Then why didn't Steve and friends not make a killing since they had the right interpretation?"

Steve has no money. Therefore, he has no money to invest.

Plus, even if he did have money to invest, I am sure he does not have the technical know-how to exploit his correct interpretation of the facts.

However, that does not mean that others did not make a killing effectively shorting subprime loans.

Some people made a killing by setting up hedge funds that bought CDS for pools of mortgage backed securities that contained a lot of subprime loans.

Dutch Boy said...

"Voodoo Economics" - department of redundancy department!

AC said...

If nobody believed that high house prices made sense, then they would have not have gotten so high. For a bubble to form, there has to be some plausible evidence that would persuade many reasonable people that there is a high probability that we are not in a bubble.

I would not trust anyone who would say "With probability 1, we are in a bubble." That person has way too much confidence in their own analysis. Markets can go wrong. But nobody can be 100 percent certain that they are smarter than the market. Nobody acts as if they are 100 percent certain that they are smarter than the market. Did your favorite prognisticator make a billion dollars betting on the Case-Shiller index? Why not? Because he was not as sure then as he is sure now that he was right.

Mercer said...

"Then why didn't Steve and friends not make a killing since they had the right interpretation?"

At least he didn't lose money by buying a bigger house or getting a home equity loan.

Dean Baker did make money by selling his condo in 2004 and renting for five years before buying a house.

Jehu said...

Anony-mouse,

The difficulty with using HBD knowledge to make money is that pretty much everyone, liberal and conservative, acts in economic life as if they believed wholeheartedly in HBD. Sure they profess love of diversity, but that doesn't factor into their decisions about where to live, where to send their kids to school, etc.
But, I'll give you one financial recommendation absolutely free.
Humans are irrationally risk averse. On average, they feel the pain of losing X dollars twice as much as they feel pleasure for gaining X dollars. This means that they are systemically biased to overreact to bad news in the stock markets. A straightforward elaboration of this will get you to value investing a la Graham and Buffet, which is a long term proven strategy for beating the market.

Mercer said...

" In 1999, for instance, the markets interpreted the information available about Pets.com as indicating that it would generate a lot of positive cash flow over the years"

I remember reading at the time that some people didn't care about a company's earnings prospects. They only cared about "eyeballs" (internet page views).



"decades of governmental pressure to demonize and punish anyone engaging in skeptical interpretations of the ability of minorities to pay back mortgages."

I think the idea that every American family should own their house goes back at least 200 years. To argue against it is considered not only racist it is disputing the American Dream. Anyone who didn't strive to become a homeowner was considered a loser and Un-American.

Vernunft said...

The post was thoughtful but the comments - afraid of math, guys?

Whiskey said...

The weak form says you cannot over the long term make market inefficiency trades and make money. You can short term. It says Technical Traders are basically modern voodoo-ists. [I am sympathetic to that view.]

It does not discount fundamental analysis, ala Warren Buffett-type investments. Note: he's made bad bets that cost him plenty.

But it means that stuff like the carry-trade does not go on forever. Borrowing from low interest rate nations like the US and Japan and Germany, to invest in High Interest rate nations like Brazil, Russia, and China. Eventually something goes boom.

Nino said...

But is also goes further than that. I'm a Californian and a number of my friends and I knew that when these subprime ARMs reset there was going to be a bloodbath. We talked about it more than a few times. Hence, we did not put our money into the markets that would be directly affected by a housing collapse and instead put our money elsewhere. If anywhere at all.

Thus, the markets in question would not really be reacting to the "marketplace at large" but only those players for that line of investment. IOW the markets would not consider the effects of people who interpreted correctly b/c it would have no way to keep track of them. And it would have no way to measure how many people were betting against the housing market simply by putting their money into a myriad of other investments.

Unless one were to devise a survey and get it into the hands of many people. Surprised they don't have them. B/c if people could read that "25% of investors are thinking the housing markets will crash once ARMs reset for low income borrowers and so they are investing in X,Y, and Z," and it were widely published, then maybe we would be onto something positive. At least people couldn't say they had no idea, and the market might work more efficiently. Right?

Steve Sailer said...

What we want is for both the bulls and the bears in any market to compete with each other. In the minority mortgage lending market, however, the government conducted a Great Bear Hunt for decades, demonizing Bears as racist. So we ended up with a whole bunch of Bulls in the business like Angelo Mozilo and Kerry Killinger and not many Bears.

Jehu said...

Nino,
Short selling is very risky precisely because the market can remain irrational far longer than you can remain solvent. Most value investors generally don't make that a centerpiece of their strategy for that reason. On the other hand, if a business is sustainably throwing off an increasing amount of cash to its investors, eventually its stock price will reflect its value.
Now, if you happen to be a real estate developer, there's money to be made in predicting where the next round of white/asian flight will go---unfortunately, said developers grok the implications of HBD quite well indeed.

Anonymous said...

Steve, the problem with your whole "interpretation" thing is that you're wrongly assuming that the EFM is necessarily a "fundamental" argument i.e. that securities must reflect some kind of Platonic "fundamental" value.

Anonymous said...

What we want is for both the bulls and the bears in any market to compete with each other. In the minority mortgage lending market, however, the government conducted a Great Bear Hunt for decades, demonizing Bears as racist. So we ended up with a whole bunch of Bulls in the business like Angelo Mozilo and Kerry Killinger and not many Bears.

Steve, it's not just unique to the "minority mortgage lending market." The entire financial system is backstopped by the government, and even when it formally wasn't, like before the recent crisis, all the large financial houses knew that it was. Risk was and is incentivized and subsidized across all markets throughout the financial system.

You'd have to drastically dismantle the entire financial regulatory, legal, and political apparatus and regime in order to have "both the bulls and the bears in any market to compete with each other" in our financial system.

Anonymous said...

Strong evidence for the weak EMH is the lack of professional fund managers consistently beating the market average. We'll see how well John Paulson, who made $15B buying CDSes on mortgage bonds, holds up over the next few years; I suspect he will have subpar returns.

Get outta here, Warren. It can be argued that once he reached a certain point, he was being offered deals that others were not because he was Warren Buffet. Goldman got more than some cash when Warren bought a pile of preferred stock with a 10% yield near the height of the crash.

William B Swift said...

Efficient Markets Hypothesis reflects ALL information, not just public, since any purchase or sale in a market, even that based entirely on private information is reflected in the price. And if someone has private information but does not act on it, by buying or selling, then it does not affect the market price.

Two, collapses and delayed effects are PART of the EMH. No one has ever claimed that markets instantly reflect all possible information.

Three, the biggest claim is obviously true, that there is NOTHING that produces more accurate prices and hence more efficient exchanges than the market. It's not some magic wand, just there is no humanly better alternative.

Ali said...

The markets are efficient. Prices eventually do catch up with reality athough nobody can predict when. That's why professional money managers are unlikely to beat the market over a sustained period of time. No one knows how long a certain trend will go on for. It's also why Graham-Dodd investing is the only type that really works i.e. buy something that's likely to make money even though everyone hates it right now. Unfortunately thismeans missing out on joining the herd during boom times which is psychologically difficult. It also means being willing to say no far many more times than yes.

Anonymous said...

Steve,
Basically economics is just a load of of over-intellectualising bollocks - with no actual 'meat' to any of the theory.
Don't make the mistake of thinking that because a lot of eggheaded professors with strings of letters after their names pompously talk in riddles and show-off all sorts of math that they are actually serious people - THEY ARE NOT.
It's not something profound and useful like Newtonian mechanics - it's just hot air based on more hot air , utter pseudo-intellectua trash the lot of it.All it does is keep a lot of second-rate men in jobs and lets them be pompous - all these fools do is use the mock-subject to justify their own tiny-minded political beliefs.
As the great mathematician Stanislaw Ulam said - 'there's not a single proposition in 'economics' that is both true and non-trivial'.
Always, just remember that quote made by one of the true great minds of the 2oth century.

Pat Shuff said...

Once upon a time in a place overrun with monkeys, a man appeared and announced to the villagers that he would buy monkeys for $10 each. The villagers, seeing that there were many monkeys around, went out to the forest, and started catching them. The man bought thousands at $10 and as supply started to diminish, they became harder to catch, so the villagers stopped their effort. The man then announced that he would now pay $20 for each one. This renewed the efforts of the villagers and they started catching monkeys again. But soon the supply diminished even further and they were ever harder to catch, so people started going back to their farms and forgot about monkey catching. The man increased his price to $25 each and the supply of monkeys became so sparse that it was an effort to even see a monkey, much less catch one. The man now announced that he would buy monkeys for $50! However, since he had to go to the city on some business, his assistant would now buy on his behalf. While the man was away the assistant told the villagers, "Look at all these monkeys in the big cage that the man has bought. I will sell them to you at $35 each and when the man returns from the city, you can sell them to him for $50 each." The villagers rounded up all their savings and bought all the monkeys. They never saw the man nor his assistant again and once again there were monkeys everywhere. Now you have a better understanding of how Wall Street works.

Anonymous said...

God in heaven, you people are naive.

I keep telling you - over and over and over again - what happened in 2008, and yet you carry on as though we still had free markets in this country.

Heck, I don't even want to invest the time and effort in typing it all up [once more], because there's about a 0.667 probability that Komment Kontrol wouldn't approve it anyway.

PS: Perhaps Komment Kontrol will allow me to point you in the direction of the latest shenanigans on the part of Cass Sunstein and the Psychological Warfare Team - it is very, very difficult to overemphasize quite how evil these people really are.

Anonymous said...

Maybe we could throw a bone to all the anti-anti-semites at iSteve, and let them know that there is more than one Orientalistic criminal conspiracy in town:


Talent on Loan From Allah: Per Usual, Muslims Dominate Medicare Fraud Indictment
January 14, 2010, - 2:01 pm
By Debbie Schlussel
debbieschlussel.com

...READ the Indictment. As you’ll note, at least five of the indicted are Muslim, and two of the three ringleaders, Muhammad Shahab and Hassan Akhtar, are from the Religion of Peace and Medicare Fraud, too...

It should be noted that Arcapita a/k/a First Islamic Investment Bank, headquartered in the Gulf and owned by a bunch of Gulf state sheikhs, bought America’s largest home healthcare company, a few years ago. At the time, company officials contacted me, worried that the new owners would encourage Medicare fraud. It’s a common practice in that community to bilk every possible U.S. government entitlement...



You know, you read stories like that, and you watch what Goldman-Sachs [et al] pulled off in 2008, and you think about how the Chicoms behave, and you look at all the Nigerian spam in your email, and, at the end of the day, it's very difficult not to entertain the idea that entire ethnicities [and maybe even entire races? or entire continents of races?] are little more than vast, extended, [loosely or not-so-loosely] organized criminal syndicates.

Henry Canaday said...

1) Which market do you mean?

2) What calculations do investors in this market make?

3) What information do they require?

4) What information did they have?

-------------

1) Consider the market for equity in the investment banks that bought mortgage-backed securities (MBSs).

2) Investors in non-financial companies traditionally try to project future earnings, based on past earnings, future economic scenarios and company-specific factors, and then convert these into present asset values. For financial firms that own secured assets, I think investors start with book values, and then try to estimate default rates and costs.
To do this, they assess credit-worthiness of borrowers, likely future asset values and the worth of other protections, such as private or public insurance of assets. Future asset values affect default rates, because borrowers are more likely to default if they are paying more for an asset than it is worth. And future values determine losses on defaults.

3) Investors need to estimate future values, not just in general, but matched against the mortgages most likely to default. That is, they needed to recognize not just that there was a housing bubble, but how large it was in particular markets. And they needed to estimate these asset-specific losses not just for the whole mortgage sector, but for individual investment banks.

Moreover, investment in MBSs was highly leveraged, up to 30:1 in some cases. So a 3-percent over-estimate of the target variable, the post-default value of the assets, could mean a complete mistake about whether the equity value of these assets was positive or negative.

4) Investors could reasonably be assumed to have a fair knowledge of the general excess of housing prices and the riskier nature of loans. I don’t think anyone, except perhaps those inside particular banks, knew how these factors affected particular assets and the equity value of each bank. The possibility of a 2- to 3- percent error in asset values, and thus a huge and disastrous mistake in estimating equity value of a particular firm, was thus very real. I think you are right that lack of, or fear of, candor about re-payment prospects by some ethnic groups hampered investors’ ability to make better estimates. But, given the nature of the market, it did not take much imperfection in estimating to set up the crisis.

Apparently, investors did not do too bad a job of estimating the value of investment banks in 2006. The oil price sure of early 2008 sucked huge and unexpected sums out of consumer pockets. Most of the investment banks are repaying most of the bail-out money now, even after the crisis-induced deep recession, indicating that illiquidity, no just over-valued assets, was the problem. But the impact of even a small investor mistake -- small measured as a fraction of asset values -- was immense.

Truth(er) said...

As the great mathematician Stanislaw Ulam said - 'there's not a single proposition in 'economics' that is both true and non-trivial'.

I see. So supply exceeding demand resulting in lower prices is not a true or non-trivial proposition?

Glib statements by people outside of a field really don't add up to much.

liberalbiorealism said...

Well, Steve, it's good to see an admission from you that there's something rotten in Chicago besides the Democratic machine.

But can you say the really hard word for someone on the right to utter here: R..e..g..u..l..a..t..i..o..n?

If the efficient market hypothesis is false in crucial cases, especially when it comes to our critical banking industry in particular, why isn't more governmental regulation the clear answer, to minimize risk of economic failure?

I gather that Richard Posner, at least, seems to be drawing such conclusions (certainly he's now rejected many of the previous pronouncements of the Chicago School, and has gone all Keynesian on their ass).

So called HBD isn't the only place where science and fact don't conform to our fondest wishes. The real world truths of economics too upset many a fine and elegant and simple model of human behavior.

In the end we must take the facts where the facts will take us.

Dennis Mangan said...

Read Buffett's "The Superinvestors of Graham-and-Doddsville" (http://www.tilsonfunds.com/superinvestors.html), in which he skewers the EMH.

It's pretty well established that value and momentum are two strategies that beat the market, and both essentially for the same reason: human bias. Momentum means that people take time to fully understand the implications of information; value means that people are often too pessimistic about a company's prospects, and then the earnings of these companies mean revert, i.e. go back up.

There are a host of reasons why professional money managers, on the whole, don't beat the market: institutional restraints, managing too much money, afraid to deviate too far from an index in one's holdings. Decent managers who lag the index for more than a very short time get fired.

John Seiler said...

That's all true, but don't forget that both disasters (the dot-com boom/bust and the housing boom/bust) were compounded by monetary policy. The recent housing fiasco obviously was made much worse by artificially low interest rates combined with debasing the dollar. Gold has gone from $350 an ounce (on average, 1981-2001) to $1130 today.

But the dot-com boom/bust was made worse by the opposite: DEflation. After 1996, Greenspan dropped the dollar to $255 an ounce (from the $350 average) for a couple of years. Which had this effect: it first made commodities much cheaper; remember $10/barrel oil and 95-cent gas? So investors moved their money into manufacturing and services. But those dropped in price, too, so money went into high-tech -- until that whole sector dropped in price from the deflation. Most dot-coms like Pets.com were overvalued anyway, but the monetary mistakes made everything much worse.

Will we ever re-learn the old lesson that only gold is real money? And that economic and business calculations are made much easier using a common, stable unit of account - gold -- instead of wildly fluctuating and manipulated paper currencies?

David Davenport said...

... the problem with your whole "interpretation" thing is that you're wrongly assuming that the EFM is necessarily a "fundamental" argument i.e. that securities must reflect some kind of Platonic "fundamental" value.

But if curent market prices do not reflect fundamental values in the Graham and Dodd, non-Platonic sense, how can one claim that current market prices are efficient?



Two, collapses and delayed effects are PART of the EMH. No one has ever claimed that markets instantly reflect all possible information.

But if the markets are vulnerable to sudden, volatile rises or falls in the near future, how can one assert that market prices are correct at any present point in time?

...

It's not some magic wand, just there is no humanly better alternative.

There are alternatives. One alternative is to be skeptical of the Gospel of efficient investment markets.

Nino said...

Dear Jehu:

I was not talking about people actively betting against the housing market, vis a vis short selling or something similar, but they who passively bet against the market by simply not investing in it and putting their money elsewhere. We have no way, that I know, to record this flight from the market unless, like you say, it is a direct bet against it. I know in my case, for example, I was confident the housing market would collapse but I did not want to be bothered with actually betting against it; I just avoided it and avoided equities tied up in it. If people asked me why I was not investing in banks or in the likes of Home Depot, I said b/c I had a bad feeling about the whole housing thing and that it was built on sand. And the thing is, most educated people I know felt the SAME way. They had seen how ridiculously easy it could be in buying a house, getting a loan, how people were throwing money at them for a piece of their equity, etc. I don't see how Wall Street could not have known, unless Californians were just more aware of the situation b/c we were in the middle of it.

albertosaurus said...

As it happens I have also been thinking about economics. I have just started reading a popular economics book A Farewell to Alms by Gregory Clark. Mr. Clark is a neo-Malthusian.

This leads me ponder the earthquake in Haiti rather than the subprime mortgage issue (yesterday's news). The short form of Clark's argument is that before 1800 man was in a state of nature such that like the wildebeest when conditions were favorable nature just produced more wildebeest it did not increase the average welfare of the individual animals. Animal welfare remained constant.

It is easy to see that the economy of Haiti has not developed beyond that of England and Northern Europe in 1800. They are still caught in what Clark calls The Malthusian Trap. Therefore sending aid to them has increased their population of paupers. It has failed to increase the well being of individuals.

When you also remember the survey that done in Haiti a few years ago where the Haitians were asked if they wanted to emigrate to the United States, you start to worry. One hundred percent of Haitians wanted to leave Haiti and come to the US.

Clark like several other economic historians notes the rise in peasant incomes in the second half of the fourteenth century when the Black Plague had thinned the populations of Northern Europe. He goes a bit further than most in that he seems to approve of natural disasters. If he is correct then the earthquake in Haiti is in at least one way a "good" thing.

Certainly if we, for example, sent the bombers in with neutron bombs in their bellys and eliminated the present nearly 100% black population, Haiti would probably be repopulated by colonists from The Dominican Republic and its per capita GNP would soar. The right half of the island has a per capita GNP of over $9,000 while the left half's is less than $800.

So it isn't true we lack the technology to raise living standards in poor countries. It's just that we don't care to do it with genocide.

We want to help Haitians become rich like us. Experience shows however that we have only one remedy that is effective for such societies - open borders.

Expect the Obama administration to generously let in a few hundred thousand Haitian refugees and institute new policies that allow a steady stream of Haitians into our country. VDare will continue to have a mission.

William B Swift said...

There was a post last week on the EMH on Overcoming Bias http://www.overcomingbias.com/2010/01/how-to-complain-re-emh.html.

I corrected and slightly expanded on my earlier post on my blog http://williambswift.blogspot.com/2010/01/efficient-markets-hypothesis.html

Dax said...

Off topic, but here's a post by Whiskey predicting that Fox News and the Wall Street Journal will go "harder left" than MSNBC following Rupert Murdoch's demise.

Looks like Whiskey's M.O., which I'm sure many readers have already caught on to, is to make a ridiculous prediction and if it turns out to be true, well then you look like some kind of genius. And if it's wrong, well then you just ignore it and go on making more ridiculous predictions.

Anonymous said...

However, that does not mean that others did not make a killing effectively shorting subprime loans.

Indeed. See Zuckerman, "The Greatest Trade Ever."

Anonymous said...

"It is easy to see that the economy of Haiti has not developed beyond that of England and Northern Europe in 1800. They are still caught in what Clark calls The Malthusian Trap."

The population of England was fairly stable in the centuries before 1800, then doubled in the next 70 years.

"The right half of the island has a per capita GNP of over $9,000 while the left half's is less than $800."

Indeed the DR is much more prosperous than Haiti. It also has roughly the same population. Maybe Haiti is a bit less roomy, but that hardly accounts for the huge difference in prosperity. Where is Malthus in all this?

Anonymous said...

OT: Any thoughts on the Haiti disaster Steve-O? There are many reports that they are very, very angry at the world for not helping fast enough, reports of aid workers having stones thrown at them, bodies being piled up as roadblocks to protest the slowness of aid (?????????), doctors being evacuated from hospitals because of nearby violent riots, and of course looting and violence. Contrast with China earthquake; seems right up your ally.

Anonymous said...

Talking about Haiti, why is the Dominican Republic absent in all of this?
Didn't the eartquake have any effect on that 2/3rds of Hispaniola? Aren't thre sufficient backhoes in DR?, Surely DR has enough emergency provisions to donate to its western neighbor, it's strange but the way it's presented on news programs you'd think that DR is a separate island

jody said...

"The markets are efficient. Prices eventually do catch up with reality athough nobody can predict when."

certainly a matter of degree, then. i hardly think "efficient" is an apt description for a system which can take 3 years to catch up to reality. i often talk about the efficiency of the basketball labor market versus the staggering inefficiency of the american football labor market. the NBA is a paragon of efficiency compared to the NFL. what about compared to the NYSE? even with guaranteed contracts, which the NBA has gone through great lengths to improve, the NBA also seems to be much more efficient than the NYSE, in which the value of a stock changes daily. even with the ability to change the value of something every day, it can take hundreds of sessions to correctly price a stock.

the NBA even protects itself from "bad IPOs". it spells out the exact salary for every drafted rookie. there are no negotiations. there are no hold outs. after being drafted, there is no way for a player to do ANYTHING other than play basketball in the NBA for 2 years for the exact amount of dollars as determined by the league, not by the team or an agent. if the player does not like the team which drafted them, they can walk. but they can't do A SINGLE THING about the number of zeros on the paycheck. then all 30 drafted players play basketball for 2 years, and at the end of 2 years, the good players get raises, and the busts get cut. this saves any team that drafted a bust with a high pick TENS of millions of dollars.

the NBA even now protects itself from "bad IPOs" by prohibiting unproven 18 year olds from entering the league, saving themselves hundreds of millions of dollars in wasted money on athletes that cannot play and sit on the bench while collecting guaranteed contracts. this is no different at all from any big, established company refusing to hire unproven entry level employees at executive level salaries.

the NFL, by comparison, is wildly inefficient. both in the highly divergent salaries that two equally capable players will get, but also in it's ironclad adherence to a strict, "blacks only" policy for hiring most labor. the number 128 black player at his position is not, and never will be, better than the number 1 white player. the pittsburgh steelers found this out in 2009. the staff that runs the steelers absolutely, positively WOULD RATHER LOSE GAMES, WOULD RATHER NOT MAKE THE PLAYOFFS, than put a white player better than tyrone carter on the field.

do not be fooled. the staff of almost every NFL team would LITERALLY rather have a losing record than let a very good white athlete play every snap of every game at a "blacks only" position.

Anonymous said...

"OT: Any thoughts on the Haiti disaster Steve-O?"

Looks like a lot of dumb white are just lining up the host Haitian refugees or adopt Haitian babies in America. I guess they were won over by feel-good nonsense such as BLIND SIDE. Those adorable babies will likely grow up to be a whole bunch of Cornel Wests or Tommy Hearnses.

David said...

>For a bubble to form, there has to be some plausible evidence that would persuade many reasonable people that there is a high probability that we are not in a bubble.<

I stopped reading at "many reasonable people." Such as fans of "Flip that Flop"? Bubbles or manias are caused precisely by a failure of reasonableness in many people - known to be such even at the time (on the guilty edge of their awareness) not simply in hindsight. Everyone goes along because his neighbor is doing it, and the rationalization is "THEY must know something, and anyway we had better get ours while the gettin' is good." Many reasonable people? Bosh! The reasonable people knew the housing market was BS back in 2000 at least, and most kept on stretching the rubber band - until it snapped.

AmericanGoy said...

This is complete bull poopie here, Steve-o.

"What has always been missing from discussions of the Efficient Markets Hypothesis is the"...

fact that this theory does not have room in it for rampant cheating, inside information, dark pool trading which hide trades from the world, and the now wildly popular front running of all trades by such scum as goldman sachs, blackrock and others.

"In 2006, the markets interpreted the publicly available information to come to the interpretation that those subprime borrowers in the Sand States would, on the whole, pay back their borrowings."

That is absolutely NOT what happened.

The markets had nothing to do with it.

It was a peculiar set of circumstances which resulted in banks making tremendous profits on all loans for homeowners, due to lax accounting and weird incentive structure.

It got to the point where lending to people with no jobs, no money and no hope of paying back was profitable (in the book ledgers, or spreadsheets if you will) resulting in huge bonuses.


And here comes the main point.

Everything in this country in the business world is extremely short term - hours, days, month, at most a quarter.


The CEO's and other assorted scum at the top have the philosophy of "Get mine before it all comes crashing down", and the result is what we see around us today - rampant cronyism, cheating, huge bonuses as a reward for destroying a country, etc.

AmericanGoy said...

"i don't think the stock market is efficient at all."

Correct, it is not.

It has very little to do with what is happening in the real economy, the world politics or people's mood.

"that is not to say it is random and wild and completely detached from reality, but i've seen stock price movements which directly contradict the weak version of the efficient markets hypothesis."

Right - most of the trading is done now by computer programs, which are in an arms race to frton run stupid idiots still trading on their home PC's and each other by a hundreth of a second...

Felix said...

one problem is that the Market is "self-referential". Investors reach decisions on the basis of what the others are deciding

re Steve's comment on "the madness of crowds". Gladwell's faith in how the masses can things out is correct in some cases but doesn't apply to complex reasoning

to use Gladwell's example, overall a group will guess the number of jellybeans in a jar better than an individual. But in skilled tasks, a chess master will defeat a group of amateurs, and Buffet will out-perform the run of investors

Anonymous said...

"Decent managers who lag the index for more than a very short time get fired", but the problem is that 80% or more of them lag the market every year, and very few of the remaining 20% beat the market in following years.

It may be possible to make one-time trades like Paulson did with CDSes on the housing market, but picking a money manager who consistently beats the market is highly problematic. Even though he recognized that housing was over-valued, he was still lucky that the bubble burst while he was still short.

rob said...

Anon who asked "Where is Malthus in all this?"

England's populations was stable absent infanticide, birth control, a "stop at two" culture, and family planning. The average woman gave birth to more than two children, yet the population was stable. How does that happen? The death rate is high. That's a Malthusian situation. In Malthusian conditions, increases in birth rates are matched by increases in death rates, and vice-versa. If something changes and total wealth increases, per capita wealth does not increase for long because the birth rate goes up or the death rate goes down, and the extra wealth results in population growth: the average person is not any better off, there're just more people.

During industrialization, the British increased wealth/income faster than before. Early on, the rate of wealth grew was about the same as the net birth rate, and population went up. Eventually, wealth increased faster than population growth, and per capita income increased.

In Haiti, any increase in production is quickly converted to more Hatians. We see the same thing in Africa. Since independence, populations have skyrocketed, but per capita income has decreased some. Increased income (from aid or wherever else) has not increased living standards, just the numnber of living.

Indeed the DR is much more prosperous than Haiti. It also has roughly the same population. Maybe Haiti is a bit less roomy, but that hardly accounts for the huge difference in prosperity. Where is Malthus in all this?

This is where Malthus and HBD collide. Haitians are less capable of producing wealth. When the resources are roughly equal, equal population sizes result in huge per capita income differences.

Chris said...

What do you think about the EMH and specific events? Take for example Steve Jobs leaving Apple and AAPL shares falling and gaining back $15 billion of market value in a day or two. I thought this was an interesting take on EMH and special situations: http://www.bestonlinebrokerage.com/steve-jobs-apple-departure-and-the-efficient-market-hypothesis/