By Justin Fox

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

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

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

How electorates and markets change their minds

I spent election night 1994 shuttling between the Montgomery campaign headquarters of Jim Folsom Jr. and Fob James, the candidates for governor of Alabama that year. Incumbent Democrat Folsom was a decent if unimpressive man. Republican James, who had been the Democratic governor about a decade before, was a know-it-all-who-didn't-really-know-anything jerk. James won, Folsom lost, and I was kind of sad about that.

Then I got in my car and began the drive back home to Birmingham. I switched the radio to AM to listen to election news, and began taking advantage of that wonderful property of AM in the middle of the night to listen to election news from all over the country. The story was similar on pretty every much station I tuned to. Democrats who had been in office for decades were being turned out everywhere.

My personal politics are all over the place, but I nonetheless found the news thrilling. The House of Representatives, in the hands of the same ossified party since the mid-1950s, had been given new bosses.

Last Tuesday night's turnaround was less historic and dramatic, but I found it similarly exciting. I'm always very dubious of claims that election results represent "the will of the people," given how conflicted and ill-defined and malleable that will tends to be. But every once in a while the electorate expresses in pretty clear terms its dissatisfaction with the way things are going. And therein lies the beauty of a functioning democracy--a nation can change course, can change its mind, without violence or other disruption.

Financial markets are capable of changing their minds, too. When they do it on a micro-level, differentiating between individual companies or securities (or even individual political candidates in something like the Iowa Electronic Markets), it's a cleaner, more efficient process than an election. But when markets really need to change course, when investors' expectations about the future are suddenly dashed in an across-the-board way (like in the U.S. in 1929-1931, or Asia in the late 1990s) the result can be a really big mess. There are a few things, it turns out, that politicians actually handle better than free markets do.

Here Is New York

Mrs. By Justin Fox, whom some of you know as Allison Downing, is deeply involved in the fundraising operation at Manhattan's P.S. 163, the fine educational establishment where The Boy attends second grade.

One of the many P.S. 163 fundraising efforts involves selling books in front of the school on Fridays, when the 97th Street sidewalk is also host to a wonderful farmers' market. Friday of the week before last was an especially beautiful day. Many books were sold. And the niece of a recently deceased resident of a nearby apartment building stopped by, wondering if she could offload some of his books. She was in from Illinois, and was more than a little daunted by the prospect of clearing out her uncle's cluttered apartment in a city with which she was entirely unfamiliar.

By the end of the day, several loads of books had been hauled down to the sale, and another P.S. 163 parent had effectively become co-executor of the man's estate. Allison was up in the apartment a week later, helping clear things out. While there, she found a first-edition copy of E.B. White's Here Is New York, a book I've been meaning to give to her ever since we first moved here in 1996, but which has a nasty habit of disappearing from stores around Christmastime.

Writes White:

The oft-quoted thumbnail sketch of New York is, of course: "It's a wonderful place, but I'd hate to live there." I have an idea that people from villages and small towns, people accustomed to the convenience and friendliness of neighborhood over-the-fence living, are unaware that life in New York follows the neighborhood pattern. The city is literally a composite of tens of thousands of tiny neighborhood units.

We've been living in this particular tiny neighborhood unit for a bit less than three years now. At the farmer's market last Friday I saw at least three people I know (not counting the people selling stuff, whom I feel like I know although I'm sure we customers are all just a blur to them), and talked one of them into buying a couple of porgies (it's a kind of fish) to be baked later in a bed of kosher salt. Allison sold books much of the day, when she wasn't helping clean out that apartment. Over the weekend we went to The Boy's soccer game in Central Park, which I coached, attended a college football game (Columbia vs. Princeton) where we met up with friends, went to two (!) church services, had lunch with friends, and went out for a drinks with other friends who also happen to be our neighbors. That we didn't have anybody over for dinner was mainly a product of Saturday night being our 11th wedding anniversary.

I'm familiar with the whole "Bowling Alone" argument, that we Americans have been loosening the bonds that tie us together and thus squandering precious social capital, or something like that. But I think that's a trend that played itself out a few years back, a product of suburbanization, both spouses going to work (which isn't a bad thing in itself, but leaves less time for bowling leagues), idiotic urban "redevelopment" efforts, and the economic pressures that have left American livelihoods less secure (even if, on average, far more bounteous) than they were before the 1970s. New York in 2006 seems headed in the opposite direction. I don't bowl, but if I did, I don't think I'd be able to get away with doing it alone.

This is what happens when you mess with FASB

I've been meaning for a while to write a tongue-in-cheek post about how the real reason Joe Lieberman lost to Ned Lamont was his wrong-headed stance on stock-option expensing in the 1990s.

When the Connecticut-based Financial Accounting Standards Board proposed in the early 1990s that options grants be counted as a cost and subtracted from earnings, Lieberman led the successful charge in Washington to bully FASB into backing down. Among his most vocal partners in accounting crime was California's Barbara Boxer, although I'm a little bit more sympathetic to her stance because it was pretty much impossible to find anyone in her (Northern) part of the state in the 1990s who wasn't brainwashed into thinking that options had magical economic powers and expensing would kill the magic. Only after the corporate scandals of the early '00s was FASB finally able to push through with options expensing (and even then Congress might have thwarted it if not for the resolute stance of, of all people, Alabama Republican Richard Shelby, chairman of the Senate Finance Committee).

It turns out, though, that I'd been beaten to the punch. Jack Ciesielski today alerted readers of his often-entertaining accounting blog to an Aug. 9 post by economist Dean Baker on the topic.

Wrote Baker:

There may not have been a single person in the state of Connecticut who voted against Senator Lieberman yesterday because of his harassment of FASB. Other issues loomed larger. But those who think that honest accounting is essential to the working of the economy might believe that some justice was done in this election.

It turns out Baker wasn't even the first to bring this up. On Aug. 6, a Daily Kos poster named Treebeard offered a detailed account of Lieberman's role in the options travesty. So maybe the issue did swing a few votes (although I guess any Connecticutter reading Kos was already voting Lamont). In any case, watch out, Barbara Boxer. The accounting purists may be coming to get you.

Germans chanting "U-S-A!"

I had hopes of blogging during my World Cup visit to Germany a week-and-a-half ago, but the demands of looking after a seven-year-old on the road, plus the fact that I forgot my laptop and thus had to share computer time with a 13-year-old in possession of gaming software, got in the way of that. And then I got sick after my return.

So it's now a little late to weigh in on the U.S.-Italy match in Kaiserslautern, except to say this. Much has been made of the fact that the U.S. fans outshouted the Italian ones, and that this cheering advantage may have played a role in the result (it certainly seemed to reflect the referee's calls over the last 20-30 minutes of the game). This was a great thing, one of the few bright spots of this World Cup for the U.S. But it wasn't because there were more dyed-in-the-wool U.S. supporters on hand than Italian ones. It was because the neutrals--the Germans, that is--turned on the ref and the diving Italians toward the end of the first half.

The Germans with tickets to the World Cup matches not featuring their country's team have endearingly adopted a policy of rooting for the underdogs, and in particular for the teams least likely to bring tens of thousands of supporters. At the Netherlands-Ivory Coast match we attended, lots of the Germans had gone so far as to buy Ivory Coast shirts. With U.S.-Italy, things were of course more complicated. We were the soccer underdog, but are the overdog in so many other ways that the Germans weren't going to be comfortable dressing up in red-white-and-blue. Some, like the fellow pictured here, split the difference. Others dressed as disinterested civilians.

But once the game got going, and the Italian team played as it is wont (defensively, cynically, etc.), sentiment shifted toward the Americans. We were sitting in a section that seemed to be filled mostly with locals, supporters of the team that usually occupies the stadium, FC Kaiserslautern. And at some point around the middle of the game, they all began chanting "U-S-A! U-S-A!" They did get bored with that after a while, and began chanting "Deutschland!" and singing "Wir fahren nach Berlin" (We're going to Berlin) instead. But they kept cheering U.S. attacks and whistling derisively at the Italians.

It may not be much to be able to claim that your country's soccer team is more beloved (outside of Italy) than Italy's is. But these days we Americans ought to take whatever we can get.

Okay, so maybe we're not ready for globalization

After Monday's debacle against the Czech Republic, I seriously considered writing another fortune.com column using the World Cup to make exactly the opposite point as last week's plea for U.S. optimism in the face of globalization.

Landon Donovan was too much of a wimp to stick it out at Bayer Leverkusen and learn how to be tough rather than just talented, I could have written. DaMarcus Beasley's lack of worldliness is dooming him to second-rate status at PSV and has halted his development as a soccer player. We Americans can't hack it in a world that doesn't revolve around us. Those Czechs, meanwhile, all have to go abroad and learn new languages if they're to get anywhere in the sport. They're the ones who are ready for globalization. Or something like that. That's the great thing about opinion journalism. Starting with a given set of facts, you can make almost any point you want.

Back in the saddle

I just did my first bit of Fortune work in a month. It's a web column on the World Cup and U.S. economic competitiveness. Kind of a stretch, I know. But I needed to make some use of all those hours I spend reading soccer news online every day, right?

I've been off working on my book. I had initially thought I might post comments about whatever chapter or subject I was working on each day, but that didn't happen. I got into full I Am a Book Writer and I Cannot Be Interrupted mode. Not that it got me to finish the thing. I've still got some big empty spots to fill toward the end. But I'm getting there. And maybe, now that I'm back to the daily interruptions of life at Fortune, I'll actually get around to discussing the book occasionally here. Which was the whole idea of this blog in the first place.

More Hubbard, more video

That's right, another video of Columbia Business School student Michael O'Rorke impersonating the school's dean impersonating a pop star! Could life possibly get better?!? This one is a take-off on Vanilla Ice's "Ice Ice Baby," and it's not nearly as well done as "Every Breath You Take." But it does feature a cameo by Dean Glenn Hubbard himself at the end.

A reader on the Upper West Side wonders if I shouldn't be working on my book instead. (I'm taking off the month of May to polish up my manuscript.) She has a point. But posting Glenn Hubbard videos doesn't take any time. Watching them does.

More Glenn Hubbard

He's not just the star of parody videos. The man also participated in a Q&A at Fortune with London Business School Dean and Clinton administration economic-policy bigwig Laura Tyson a few weeks ago, and now I have finally gotten around to posting an abridged transcript at fortune.com. I also wrote a little summary to go with it, the gist of which is that Republican Hubbard and Democrat Tyson agreed that income inequality is becoming one of the big issues of the day. Not so much inequality per se as the fact that even while the economy has been growing and unemployment low, most Americans have been at best treading water because most of the gains from globalization and rising productivity have been lining the pockets of the already-affluent. (Don't know that Hubbard would put it exactly that way.)

For a quarter century, starting in the mid-1970s, the biggest economic-policy challenge facing the U.S. was slow productivity growth. And so, after some initial hesitation, politicians responded with pro-productivity changes like deregulation, tax cuts, and reduced trade barriers. Now we've got the higher productivity growth, and it only makes sense that we should start to pay more attention to other matters, like how the proceeds of that higher productivity are distributed. So far this is an issue that George Bush has almost entirely ignored. Now even a still-pretty-loyal former Bush administration economist is saying that's a mistake. This seems to me a signal that we might be on the verge of a pretty major shift in economic policy, maybe not quite on par with the New Deal and Reagan revolution, but still a big deal. The big question is whether we can figure out a way to address inequality without destroying productivity growth in the process with things like tariffs and high taxes on capital.

Keep NPR in the radio, where it belongs

I've got a new piece (column? article? screed?) up on CNNMoney.com. It's the account of a breakfast chat yesterday with former Congressional Budget Office director Douglas Holtz-Eakin, who has this endearing (if politically ill-advised) habit of telling things like he sees them.

The piece/column/article/screed is more or less self-explanatory, so no need to elaborate here. But there's one thing I feel the need to share that I didn't get to on CNNMoney. NPR's Robert Siegel ably moderated the discussion, and I cannot tell you how disconcerting it is to hear this voice that's been coming to me in disembodied form for a quarter century suddenly emanate from the mouth of an actual human being. It was beautiful to hear—Siegel's voice is mellifluous, but not in a fake radio way. It exudes trustworthiness. Yet it seemed somehow wrong to be a first-hand witness of its production. I didn't have nightmares about it or anything. But I will in the future think twice about attending events hosted by NPR personalities.