journal and he said that kernel are rarer said that he was very worried about making that private agreement. but then he was congratulated by his superior officers for disobeying their orders and what it was about in my opinion is that aaron burr was working with the french at this time, french revolutionaries. and the french revolutionaries were in mexico and they were in on a french connected prop. so you see wilkinson did us all a favor by busting aaron burr. ..
justine fox business and economics columnist for "time magazine" is rick nellius triple straightly kinetic origins basic principles of the stock market and people who have won and lost fortunes. the world of bair institute in san francisco's the host of this event. it is about an hour. >> i thought i would start by attempting to answer a question which is just what happened? what just happened over the past six, i guess nine months by now, and i have, i was thinking about it for awhile this afternoon and they came up with to sentence answer. the first, my answer markets around the world stopped working last fall, and this had a dramatic effect on the real economy, a bad effect. i am not saying there were in tons of other factors at work. there was a very strange mortgage market we developed in the u.s. with so much support for the concept of homeownership
some time over the past decade or so it falls into basically government support for lax lending standards. i am not going to argue that the government response to the initial problems with the financial markets that began almost exactly two years ago this week words disjointed and inconsistent and in some cases probably made things worse. but, you still can't deny even if you think it is all the government's fault that financial markets stopped working last fall and i end of the camp and there was no way to prove this, but it seems like the more reasonable explanation that without the government intervention we had last fall, however clunky and unfair-- goldman sachs friendly it was, has left a substantially better off than we would have been if the government hadn't stepped in last fall.
so, that is the basic starting point here. financial markets failed. they seized up, stopped working, went kaput, whatever fur do you want to use and here's the interesting thing. the dominic academic theories for the past 50 years of how markets work and how economies work don't really leave any room for that possibility. there is really no theory in the textbooks that you get in finance classes in business school or for the most part in economic textbooks that explains why suddenly market stopped working in nobody wants to trade with each other. everything seems to be on the verge of breaking them. i will say there are lots of professors and ph.d. students who are studying these things that have their theories but in terms of the dominant paradigm, that this does not happen. you don't have bubbles and you don't have crashes, they are not part of the discussion.
so, this is what i am calling "the myth of the rational market" and i got a very long e-mailed today from a finance professor at uc-berkeley and made an excellent point that i never defined in the book exactly what they mean by rational market. so i am going to make kind of an attempt here and basically it is not any formal definition. in the end what that term is, it was the book title that we peck that seem to work. it was initially going to be, i think my agent and i have this noncommittal title, arguing the markets and that would not have gone anywhere. my publisher came up with "the myth of the rational market" in two years ago it is a project that was working on for awhile. no, i thought as the market we are working on not individual investments a let one level it is a marketing device. is not a brand new theory of the world but the same time i am
very convinced from the years i spent studying this and also watching the reactions of regulators and lots of other people in the events for the past couple of years that there was this widespread belief that financial markets basically got things right. they didn't need to be exactly right all the time that they were right. they could be relied on and they could behave in this call only reasonable manner most of the time. and so, the question is where did that idea come from because there has been an awful lot of episodes over history of markets not doing that, of breaking down and going back to the dutch in there to lips many years ago and it went on through the english and their self the financial bubble, the french and the mississippi bubble in by the 1800's these bubbles in crashes were happening almost every ten years ago. when famous economists came up with the whole theory of having something to do with sunspots and that's what was causing
financial crises in right around when he died in the 1870's it was on this 11 year cycle with the sunspots and after that it one of the cyclone never quite came back. so, we have had these bubbles and crashes all of this time so why did we come up with this theory of how markets work that didn't have any room for it? and that is what a lot of my book is about. what it is, i think in a lot of ways is that people's ideas are products of their times, and in the 1950's and 1960's memories of the 1929 crash and the subsequent-- the market kept crashing for several years after that in the crash was starting to fade. markets actually debate pre-conley in those days and it just seemed for certain purposes and it is for certain purposes perfectly valid to just assume
okay, markets can be thought of as these rationally functioning into these. another really big reason why this came along and the idea that markets work pretty well, not just financial markets but all markets for products and services and everything else, that is been part of economics since the beginning and it is a valid idea. making decisions quickly and figuring out what we should make more of and what we should make less of but this new, at the same time more careful but also more dogmatic version of this theory of markets grew up after world war ii and they think a lot of the reason was that during world war ii, economics was changed into a much more mathematical and statistically oriented discipline partly because economist for eve-- involved in the war effort in these remarkable plays using
statistics to help beat the bad guys. one of my favorite stories and learned in the course of the book is there was this organization called the statistical research group at columbia university and it was this amazing group of young statisticians and economists including the father of one of our audience members here and including paul wolfowitz's dad as well in including milton friedman. one of the questions that they dealt with was with artillery shells and i am no gunneries x barrasso up there any your the one to correct me on the details, but use for them to determine how many pieces they break into. if you score them into a few pieces whatever, if you hit your target you hit with more and the cause more damage but if you scored into lots of little pieces you cause less damage but you are more likely to hit. these calculations of what is the optimal level of fracturing
you want in your artillery cells were done at columbia and friedman would go down to washington and meet up with generals-- not generals, lower officers from the artillery officers from the army who were in the midst of fighting the battle of the bolt. they would come back and giftifies from milton friedman on how to manage their ammunition. experience like that can't help but make you more confident in your abilities and statistics then mouth can do for you. there was this dramatic developments immediately after the war were economics in the u.s. went from this still largely literary pursuits were people would talk about what had happened in the past do something that was very much dominated by a mathematical model and then when you are looking at the real world by statistical mindset. and so it was sort of natural
that in the '50s chart reading in the stock market was very fashionable. it was the next little guy's way to get them on making money on wall street and basically if you knew how to read the chart you could predict the future and make money without having any inside sources or spending lots of money doing research. to some of these finance professors and economists they could immediately see that most of these chart patterns could just as easily have been generated by totally random process these. so, there became this whole academic movement centered around mit and the university of chicago in the '60s to prove, you can't really prove it but to explore the randomness of markets and people would talk about the random walk hypothesis and basically the future, the best possible prediction of what the market is going to do in the future is a totally random
process. there is no secret to what it is going to do and this is pretty sensible. it is not absolutely true it turns out that a pretty sensible idea and it mit were first took hold it was-- of the mit professors thought the markets were hard to predict but they were mit professors and they were really smart so they would find ways to beat the market by using their advance knowledge of-- pauls samuelson the txdot there was part of this game. the university of chicago, they did the same research but people weren't interested in finding ways to beat the market and make money because whole of randomness line of research collided with this kind of libertarian revival that was happening in chicago led by milton friedman and it became much more a project to show that financial markets worked really well and didn't need, and didn't
regulation to the extent that it was thought in basically the new best, so it is out of chicago in the late '60s that sort of the most famous part of this whole rational market idea, the theory called the efficient market hypothesis came. a lot of people who claim to believe in the efficient market hypothesis say you just don't know if the market is too high or too low. that is part of it but it was also very much meant as this attempt to find a way of showing that the price is prevailing in the market for right and the markets were right. if you just look at the way things develop in the 1970's this idea that markets for right combined with the new thoughts about, we have got to give some advice to the world these professors were thinking, kira decided that they could not predict where prices were going to go but they could tell you something about the riskiness of
any particular investment, so you got this sort of grand unified theory of the world in which there was no point in trying to beat the market but you could buy properly balancing the risks come up with kind of the right portfolio and the right approach to this. so, basically this was the rational market. this is this market, where there is, where prices are basically right in there it's a simple, straightforward way to dealing with the market which is the name it got was modern portfolio but it is this mix of quantified risk and prices are right. lots of practical ideas came out of this. the first ones were new ways of measuring whether say a mutual fund manager was beating the market or taking excessive risks. things had names like shirk gracious and alpha and there's still a big deal especially
institutional investing. index funds came out of this whole movement and there are a lot of good reasons why index funds are a good idea but the particular, they would not have happened in the 1970's if there hadn't been as bleak and the rational market. the whole option pricing theory and the world of derivatives there are other ways you can get to it besides the leavings markets are rational but it came from the whole idea that the prices prevailing in the market are right and therefore you can build theories based on these prices. some of the less wonky and more philosophical ideas were first of all running a corporation should be about increasing shareholder value, which you could measure easily by whether stock prices are going up or not. financial deregulation came up for other reasons than the idea of a rational market but clearly if markets are right and it made sense to let them free to a certain extent.
most of all there was this financialization of american life that began in the '70s and again it began in many cases for reasons just because the old ways weren't working very well but we went from having a savings account that the s&l to having a money-market account run tmh will fund company and it went from having pensions to in many cases have been for one case where you were completely exposed to market risk. >> ideas really started permeating. what is interesting is starting in the 1980's when really in terms of politics in general popular beliefs, this idea that the market could be trusted was really starting to reach its peak. back on campus, some young professor trying to make a name for themselves started pointing out all of these problems with this whole elegant view of a perfectly rational market world, and some of these people are
pretty famous now, robert schiller a professor at yale who is done an excellent new book called called animal spirits. he sort of made the point that prices and the stock market choosing to jump around a lot more than any of the fundamental data of bout corporation so markets are more volatile it seems to make sense. larry summers with no running our economy from the white house, he basically made the point that okay, it is impossible to tell in a rationally random market which is what all the chicagoans and some of the mit people believe then from irrational one. there was no way of using the data to find out. later on some of the same people who came up of these rational market ideas in the first place showing over the time sheet stocks do better than others. and other research showed those-- there was momentum and
stock prices, basically like the market did the first day-- until it stops. and then the '87 crash happened and that was an interesting event and that it just absolutely did not fit any of the risk models that any of these financial investors could come up with an even more interestingly you could argue that it was partly caused by risk-management dreamed up by a couple of professors at you see early-- berkley. it was this idea to reduce the risk of investing that basically involve them making deals with pension funds and other money managers to sell off their stocks really quickly once prices started dropping. that can work for one individual investor or a small part of the market but what happened is this became so fashionable that prices started dropping in october of '87, and suddenly all
of these people were out getting their portfolio insurance programs on the market, selling stocks to avoid losses which then caused more selling and more selling and no one can prove this but was probably the main factor why it downward ticking market turned into this on press and the then when they crashed. there were obviously a lot of problems with this whole idea of financial markets as the things we should allow to rule our world, but then the 1990's happened and everything worked out really well. the '87 crash turned out that to cause any big economic damage. the berlin wall fell so it was clear capitalism seem to work a lot better than communism and even more than that though if you look around the world there are certain countries that allow financial markets in capitalist countries like the u.s. and the other anglo-saxon countries for the most part given exalted role
to the financial markets. the other countries, germany and japan but the banks in charge and in the late '80s there were lots of people in the u.s. were thinking we need each system like the germans are the japanese but in the mid 90's the u.s. was doing vastly better so it seemed like even though the theories were taking a beating back on campus in terms of popular view of the role of markets i think it really reached its apex in the late 90's. i know i've bought into it pretty much, this idea that the markets will take care of it, the financial markets will take care of it. you can see it in the way discourse changes. the one clear thing is up until about the mid 90's if you talk about how big a corporation was, how laporte nick corporation was too early to talk about either its overall sales or earnings. those are both clearly incomplete measures but partly because they are incomplete but partly because of this infatuation with the financial markets, it is made this which
and basically all people talked about with a market cap. how much the stock of the corporations were in that became the ultimate measure. then 1999 happen then it was pretty clear to a lot of people that including a lot of finance professors that pat.com was not more important then delta airlines, although considerably delta has gone bankrupt a couple of times since then. maybe it was perfectly valid but the tech bubble was something that just could not be explained very well by any theory that market prices were based on a rational assessment of future earnings power. eugene fama who authored the original -- maid this value did him that basically there's lots of uncertainty with these internet stocks. it is entirely possible one or two of them will become the next
microsoft and therefore it makes sense to assign hydeville use to all of them. that makes sense with these sort of start up level companies and clearly google, google was not out there as the company during the bubble so it was not there yet but that is clear. knit companies can come along. the problem was even the big companies were valued at these levels. sysco was a classic example. it required them to keep doubling in size every year for the next 20 years. so that caused a lot of questions among finance professors and economists about this idea that they didn't have to-- bubble for not really an issue, that markets could be relied on to get price is right but the aftermath was not that bad in large part because the fed came in pretty aggressively and kept the subsequent downturn from turning into a very deep one, and it was kind of amazing.
as housing prices rose, you heard a lot of the same arguments made to justify the higher prices that you heard for tech stocks in the early 90's. and also interestingly the loudest voice saying they were all crazy was robert schiller who published a book in march 2000, the moment the stock market started to decline called irrational exuberance making the point that yes stock markets have the habit of calling on these waves of optimism and pessimism. he put out a second edition with a whole new chapter in real estate in 2005 making the same point but the response from most of the economics profession and finance academic send alan greenspan was that markets know what they are doing. yes there is some new stuff happening in the housing market that we have all of these great new derivative instruments that are going to spread the risk and take care of everything. and then it all fell apart and greenspan made his famous
admission last fall. he has backtracked a little since then now that the world is less scary than it was november, where he said my world view did not work anymore and intellectual edifice and he was specifically referring to derivatives has collapsed he said. so, and i'm going to go to questions in a minute here but i wrote this but. is not a polemic, it is not an argument. it is the story of the rise and fall of this idea but obviously i sort of feel compelled to say so what do we do now? i don't have particularly good answers but financial markets are not perfectly rational. we should allow them to determine everything that our society does. the problem as governments are made up of people too in people who don't have some of the same
checks that participants in financial markets to. financial markets are better at eventually changing their minds when they get things wrong so it is not as simple as saying we need government to play a bigger role and regulate more. one really obvious thing is that financial market bubbles that are built on debt are a lot more dangerous than ones that aren't. the tech stock bubble was mostly people putting their own money at risk with no contractual obligation to get it back. the housing market was people lending money with the expectation that they would get it back in when they don't give repaed it is a much bigger deal than that some text baucus from $200 a share to zero so clearly there is something about leverage that is dangerous and there has got to be some better way to not get rid of it. obviously that has fueled our economy for hundreds of years, but realize that when it is
growing really fast that something might be wrong and i think there were a lot of people out there that the decree with that now. it does mean they will get it right in the future or 50 years before something like this happens again so all of the ones who come to this realization now will be long gone by then. the other issue is just that markets are flawed, governments are flawed, individuals are flawed, we are flawed that all of these institutions have strengthened that think a society works better when you don't put one completely in charge. it is pretty clear that entirely government-run economy is the disaster. it is less clear, and although we have an nixed one already buchass technology and there's something positive about the mix even if the government policies are not optimal, even if people behave rationally, it is nice to have different forces of not everything determined by the
prices prevailing on wall street. and with that not very conclusive conclusion i am going to come sit down and we are going to go to questions. [applause] >> thank you. this is now the part of the program where it is time for us to take questions from the audience. if you have a question please note it on the blue crab-- cards that should've been on your seat or the jaish and seek and you should able to have those cards to a council member to bring up. let me start with the clarifying question. previous market downturn to recall penikas. with the insulin be called the panic of 2008? >> on my blog i had a contest. i think it was before last fall, what we should call this crisis. and the problem was, first it is the two years because it started at some level in 2007 although i
guess it went to such a new level in 2008 that we should call it that. actually my favorite name for then there is no way is going to catch on, it is this blogger duncan blackledge khalsa xing guo which is this game, i am looking at my son back there. he was playing it in the cream-my green room. is this game for you stack up a bunch of blocks really high and then you start pulling them out until you see when it is going to collapse. that is not going to catch on so the panic of 08 is okay. i don't think it is a bad name for it, but it is not absolutely clear which is kind of interesting about this crisis may be because people think something is still going to happen this year. >> so, there are a couple of questions that relate to milton friedman's terese and is summed up this with this question. aires there is essentially dead with john maynard keynes back in
faux? >> keynes is definitely back in vogue. i don't think, because friedman came from a diff-- bunch of different places. others milton friedman the milan-- and all he is our game because friedman and i had this conversation with him before he died in his apartment, just over that side of town in ways. he lived on the 17th floor, had plastic over all of the furniture. well, at least in the living room. he didn't in his study. i think he sat on a real chair. he never believed markets were perfect. he also believed that one thing that had gotten shortchanged in the new deal years and afterwards was this idea that economic liberty, the frieden to start a business and to take risks is a form of liberty and an important part of liberty too and i think those ideas survived
really strongly. i also think friedman's monetary policy, what he wanted to do which was to replace the federal reserve with this spigot that spewed out money at this fixed rate over time that is never really worked in part because it is hard to measure how much money there is out there. it is very unclear what the rate measure is but the basic idea that monetary policy is very important in preventing both the rampant inflation and rampant deflationary, that is what the fed has been trying for the past two years and it seems to have succeeded. whereas, keynes did not disagree with any of that. he thought central-bank should be trying to prevent deflationary. he thought it least in the case you had in the 30's when things got bad then you needed more than just printing more money. you needed government going out in spending and i think that is working too but i guess my
thought is i don't think there's this huge dichotomy between keynes and friedman. i think there is a huge dichotomy between keynes and even friedman and this sort of super extreme version of macroeconomics called rational expectations that arose at chicago, basically round when milton friedman moved out to the area and the 1970's and i think that whole theory is in big trouble. i don't think all of friedman's monetary theories are. >> terrific. there are a couple of questions that look to our ability to learn from the current environment, and so the way to think about this is have we learned anything, and in the ten or 20 years forward from today are we going to essentially repeat the same mistakes, the same kinds of thinking and
reasoning as today? >> i don't think they will be the same and i think definitely there has been a short-term learning on an individual level that's that can be dangerous and they think that is probably the biggest learning so far and it would be nice if that became sort of institutionalized as well, and my problem is i don't have the definition of how you define how much debt is too much or when people are getting over and that it but i do think any time of the past 25 years fee of have this dramatic increase in especially consumer indebtedness since the early '80s, that any time anybody worried about it, and there were many books and magazine articles written over the years worried about this horrible phenomenon of rising debt, there would always be some economists to come out and say it is what the market has determined, it is going to be fined. clearly at some point that
stopped being right. it probably was right until 1984 and that is when-- in terms of other learnings, it is really hard to tell because it seemed like about six months ago that this was such a shocking occurrence and everything was going to change and nothing was going to work the same and it does not feel like that anywhere. wall street is that making money and people are back to screaming at obama about health care reform. we have gone quickly back to where we were beforehand, so i would think that even without any change in regulation and government behavior that just the fact that there will still be lots of people of rounds and acted in the financial markets from the next ten or 15 years will keep it from happening for ten or 15 years but after that i don't know. >> you just touched on this, given the increasing number of
people who are participating in the financial markets and the increasing role it has in their savings in such, can you speak to the world that psychology plays in the markets know, in particular with the rise of behavioral economist points of view? >> when i first heard working on this book i thought it would be this really simple story of kind of the rise and fall of this rational view of how markets work, and its replacement by behavioral economics since the ideas coming more out of psychology. as i got into it i realized it wasn't what happened at all. that basically all of these lessons about human behavior that have been studied and learned since the early '70s, the people who are seen as having started this whole line of thought for danny kahneman and amos twersky who ended up teaching in the area won the
nobel. twersky had died so he couldn't. these ideas are incredibly useful in looking at individual behavior and how you want to design a four wind cape program and it's been a really influential. 401(k)'s had changed a lot of the past five years to reflect the realization that how do you structure them has this huge impact on how people behave and there's a lot to be said for picking these defaults that the more of less okay in steering people into that, the amount of money they will save, how the money is allotted in give people the chance to change that if they want. it is a huge impact on both what individuals can learn about their own investing and the flaws that all this have in money in the future and the combination. but, in figuring out how markets work it is interesting that it has been, the impact has been,
there aren't any great behavioral theories that explain what just happened. there aren't any super great don behavioral theories that explain it either but it is not like somebody has come along and said using the lessons of cognitive psychology i can explain everything that has happened. i think there's a chapter polymerized chapter of his book that claims to do that but i don't think he really manages it. >> so on that very point many people may be wondering at this point in the conversation do we actually need a unified theory to explain the market's and what would be the downside of not having won and we have seen the down side of something that may not be perfectly accurate. >> i think it is healthier to not have a grand unified theory. the problem is if you don't have a new one, but maybe that is okay and i would think a much
more sort of loosely understood then loosely defined version of this whole rational market paradigm wouldn't be the worst thing in the world. but it does seem that what makes markets work actually is diversity of opinion and so if you don't have lots of people with different models of how they think the world works, then i think, i think it is everybody agreeing that we need to buy houses in california, that causes markets to go crazy. disagreement actually makes markets work better so i am fine with their not being a grand very but i think that is one of the reasons that some ideas that don't work very well in sort of stayed in the textbooks and elsewhere because there grand theory is that going to replace them. >> on the topic of grand theories can you give your opinion of all the government spending that has been allocated
to help the u.s. economy and some of the thinking that maybe driving obama's current financial agenda? >> obviously the initial big government action was to throw a bunch of money up the financial system so money would keep coming at the atm's and you can never tell if we really were at risk of this complete financial breakdown burbanks stopped giving people money but that was the fear and that is why they acted like that ended didn't happen so it was probably hugely inefficient use of money but it did seem to work. the second part is stimulus and the idea behind stimuluses just when everybody is feeling blue and not wanting to spend, that is somebody will to it and the only one left in a time when every buddies animal spirits are downtrodden quitting the government, that can keep the economy going in a way and that
is another thing as far as rational expectations as macroeconomics goes, stimulus can work but he watched what has happened over the past few months and it seems to be working well. obviously with cars for clunkers, all of these people are rushing out to buy cars now. it simply went expires there will be a drop-off in car sales but if in the meantime you have got money flowing for the economy and you have got to carmakers starting to to look for new models and you have gotten people starting to spend on other things that maybe it works. there's not really in need deeply sophisticated economic theory behind all of this stimulus the. is basically that world war ii, the u.s. government spent wesley more money than it's again. it was the most dramatic economic stimulus ever as far as i know and it worked. that is basically all economists can say.
jacinta orkin walport tewes let's try again on a slightly smaller scale. >> looking at college economics classes what you think the dominant theories of the day will be that will drive those studies? >> i mean as it stands now i think they will be pretty similar to the ones we have got now. the one area, and there are people who have been talking this up for 20 years, it is that their insights coming mostly out of physics but also other sciences about complexity and evolutionary dynamics and non-linear equations that somehow could lead to a better understanding of how problems work. i am all for that. is just it hasn't happened yet as far as i know all that i got this long comment on my blog the
other day from a professor in peking this as i was totally unfair in shortchanging the work being done in the evolutionary dynamics of maybe there will be more of that but i am betting a lot of these really basic economic theories, the stuff that is taught in economics 101, it does not date back to the '50s. it dates back 300 years but also the bulk of it was formulated in the late 1800's and there are valuable insights in it. i guess the question is how strictly you apply it and again this is something i've heard from-- all models are wrong in some models are useful. it is sort of determining what is used to wonder what circumstances so i would love it is presented in a way that is more, if you are these theories, we stick with them for these reasons but they don't describe everything that happens in the world. >> just to follow-up are there
any specific theories you feel have been truly justified being thrown out the door at this point in time? >> i mean the clearest one and i don't know that anyone ever stated this as a theory. it just was very convenient to do, is to assume that risk in financial markets works on a bell curve, that basically you have this sort of scattered graph of lots of potentially dense than most of them will cluster toward the mean and then you sort of-- you will have a few sort of extreme events but you won't have super extreme events. if on an average day the stock market only moves 1%, you want so they have a the where it moves 25% like it did in october of '87, and that is wrong. it is a wrong way of doing it. even people who use this stuff
know it is wrong but it still gets used because it is unique. when somebody calculates this sharp racial of the mutual fund which is this crystal ware performance measure they are using bill curve measures of risk in the morningstar ratings are based on, i don't know if it is the sharpes ratio exactly but they are very convenient and very useful and therefore the keep getting used even though as far as financial markets go completely wrong. >> there is some interest in how to think about the derivatives market. can you talk about whether you feel derivatives and other second quarter financial instruments generally make the financial markets more stable or unstable, and it is the recent volatility that we have seen, and you spoke about it in your-- are these normal if you have it
long enough time horizon in which to view them? the that is one of the great things about the whole resch market world few. over a long enough time ricin id is absolutely right. on average markets are correct over hundreds of years, or even scores of years. as orice derivatives, i think the only answer i can give is i don't know. i don't know if derivatives make markets more volatile or less volatile and the story i tell in my book is about holbrooke burking, who is this professor at stanford four years and years at the food research institute at stanford in he did some of the earliest research into futures markets and the randomness of futures markets and how a vision they were but he was always interested in this questions, and do future markets if the underlying markets more or less volatile? he got this test case in the early '60s when congress banned
future trading in onions. there had been and onion futures market. i guess what happened was in the 30's when they started some of the big futures markets renteria products and eggs as well as wheat and in the 30's with all of these new deal dairy support program suddenly the chicago-- lost a bunch of business so they had to come up with new heckert culture products so they said we will do on in future training-- at that point the markets were become this was the chicago mercantile chain, small dominated by a small number of traders so the couple of the traders decided to corner the onion market, so you have this incredible onion bubble and then they collapse. all these onion farmers who should have just taken advantage of the bubble until they could sell and say okay i will deliver my onions at that insane price.
they all started joining the market and buying futures themselves so all of these onion farmers would-- so they got congress to ban it. if you could just look at onion prices before and after this market, then you could learn something, so initially when the legislation first came in, they thought let's look back a new markets before and after they had the onion futures trading in the first place and sort of inconclusive. then the first test of the '60s seem to show much less volatility before the ban and after the bansal is seen to give evidence that things worked better with futures trading. somebody else did a study with the whole decade of data and that it was the least volatile onion price ever so that is basically what research into whether-- are inconclusive.
they don't seem to run the world but the same time it is not clear that they make it all that much better, so the theory behind wide derivatives, especially the explosion of different the kind we have had over the past quarter-century would make the world safer is basically there's this kind of the perfect mathematical economic theory of the perfect market, which a couple of-- dubreau who ended up the it came up with this and in the '50s sort of in vision that you would have the invisible hand would work perfectly even in an uncertain world if you had securities markets that basically covered every possible future outcome, so the argument that people made and it was a student of sarah fossett winonah to be derivatives there is at
mit said that means the more new derivatives we can come up with the better off and more stable our world will be. i don't know that it has really worked that way. it seems i guess in some perfect theoretical world that is true but in the real world where any time you come up with a new financial product lots of people don't understand it and its use it, you may be creating lots of new volatility of the same time so i wish i had an answer on derivatives, but i think sort of the confident pronouncements alan greenspan in particular use to make over the past decade about how much they allowed us to decrease the riskiness overall, those have not panned out. >> on a related note, there has been a lot in the press recently about the growth in the use of the exchange traded funds and then things that are called in verse funds that take positions
on those markets. you also have, so you have a lot of new product innovation in this space which you alluded to, for example with the onion market and then you also have a lot of technology, the flesh trading and the very quick trading by and large institutional firms. can you talk about how the role of product innovation in technology innovation are driving the markets and whether very can keep pace with both? >> first of all i should point out that futures trading in onions is still banned so don't try it. [laughter] the thing about all of these innovation in the financial markets is clearly it is a good thing over the long run. the issue seems to be that a new financial product needs to be tested for one cycle, when market cycle before you know it
is worth anything or not, so the issue is always that there's just this, since the early '70s there has been this incredible boom in transformation and a bunch of innovations have turned out to be either completely useless or may be designed wrong. so i guess the fear with all of these things, i just wrote my column this week. i wrote it next to the pool at my parents' house, so if you have problems with that that is probably why, but they wrote my column about this high-frequency trading and when you start looking at the reason it is happening is because we now have this very competitive environment where there lots of different exchanges competing with new york stock exchange and nasdaq and they'll need volume to make money. these new traders come along to make new trades every millisecond and that generates tons of volumes of the exchanges are catering them to try to get these people to trade even more with them.
it is clearly a much better system than when there was one exchange, basically the new york stock exchange up to the early '70s that dominated everything in charged huge commissions and the specialist on the exchange, made tons of money using their private information that other people could not get that and now the transaction costs to buy and sell stocks were dramatically lower so from that science innovation has been great. the note-- the question is is there something about this that is just going to go off the rails in the next couple of years when you are starting to make market decisions more quickly than any human could even hope to keep up with? and nobody knows the answer. i talked to this guy who was one of the pioneers of the electronic trading but sort of checked out about ten years ago and he is totally freaked out by a. it is kind of funny so maybe this fear of the unknown but i also think financial innovation
and increased speed in financial transactions is a mixed blessing. >> so let me build on that with a pretty clear-cut question. how fearful are you about the survival of the market capitalist system, especially given what you are now talking about, about the pace and nature of the innovation? >> i mean, i am not that fearful. i think we will puzzle it out one way or another and we don't-- we are going to have financial bubble send crashes and that is okay. it is just the thing we should structure of our society in a way that we have to a certain extent. we are surviving this crisis but it is easier for me to say because they still have my job. there has been a lot of collateral damage the probably did not have to happen. i guess it is just in the category of i don't know what the alternative is for the right
now china is very fashionable and it probably should be among other emerging market countries because there's something to be said when you were playing catch-up for just sort of identifying what worked for other people and what technologies are in other countries, but it is much harder when you are one of the world's richest and most developed economies for any government official or anybody else to sort of say this is the path everybody's going to take and therefore we should allocate resources this way. clearly right now we are doing more of that then we have been a while especially with alternative energy and there is a lot to be said for that just because we look at, there seems to be real costs to our current energy system in the energy uses-- usage that it would be nice if somebody step then and assign them to the right people. so i think we can always find smarter ways to intervene here
and there in a market economy but no i don't think market capitalism is headed for a bust. >> okay. i would like to shift course in little bit and talk about your column. i am curious, if you could share with us, when you think pre-and post all of the events that we are talking about now, all hat-- how have fractions change on the part of people who are reading your column and how has the nature of what you cover change and how does that play out in the real time, everyday interactions get from readers online? >> the big thing that is changed his eyes seemed to write about financial stuff 90% of the time despite the fact there wrote this book about financial things. i never really thought of myself as a financial writer and one eye for started writing my column i really wanted to arrange into different areas. i keep saying next month, that
is what i will get back to not writing about banks in the more. in terms of the reactions, one of the things that is really interesting is, the bike column in the magazine, it is opinionated but mostly in explanatory column. i am not trying to raise hell. maybe this kind of one of the reasons is that is the kind of person i am but also when i got to time my column was often the only economic coverage and an issue of the magazine and it seemed inappropriate to at the polemic. nowadays there's a lot of other economic coverage in their too and sometimes i wonder if i should pick more fights. i don't get huge amounts of reaction from my column and i think it is because of that. i'm just trying to explain that in not telling people how to think. on the blood, i get a lot of reaction but actually i have this loyal group of ten are 15 people probably because we make this line in process absurdly
difficult. i actually like it that way because i will read some story on yahoo! finance and will have 500 comets than 497 of them will be totally idiotic where is the comments on my blog are mostly pretty smart. i engaged with them and we argue back and forth. i guess the interesting thing has been a lot of real questioning since last fall about are we going about this whole financial rescue and financial reregulation in the right way? i don't know what the answer is. i get a lot of-- i would say most of the pushback and get on my blog is from people who think we are being way to kind to wall street but i have no idea that is representative. so, i love the feedback because it forces me to be clear. sometimes it corrects mistakes and sometimes it forces me to be clear in my arguments but i have no idea if it represents
anything more than that, ten f-15 regular commenters on my blog. >> on the subject of feedback and you also talked about the feedback you are getting from economists to your book and the general public to your book. >> i have started just in the last couple of weeks to get very long e mills from finance professors that have started to arrive. and i sort of cringed at this prospect because i really wanted when i wrote the book to have a bunch of time between when i finished the manuscript and when i was moving on to show it to a bunch of finance scholars. it did not happen then suddenly i finally got to the point where i was happy with the manuscript and the publisher was like, we have to get going with this thing. the couple of professors never got around to reading it. for the most part, there are factual errors here and there that luckily nowadays book publishers don't like to print
many copies said one so they keep coming up with new printings and each one as it little bit more correct. let me see it this one has any of the fixes in it. no, this is there were original edition with all the typos. [laughter] i mean, one reaction is he sure neglected this particular line of research and my response to that is always yeah, you are bright sorry and in many cases i am sure my decision will occur stupid 20 years from now but in the end i was trying to be as fair as possible and represent reality as well as possible. when your of looking at academic arguments that it happen in the past and are 15 years there is no way to tell what is going to last and what is not so you pick the people who seem to be the most compelling characters that fit into the narrative flow of the best. in general everybody is pretty appreciative because they think from the title, most of the
orthodox finance professors expected to be this total broadside against them because they are people out there, george soros is one of them and another money manager who blamed everything that's happened over the past few years on the efficient market hypothesis they say and i don't go that far and i try to tell the story. in general the e-mails are nice book, but a you have got the name of my paper, you that's something wrong about the paper wrote in 1977, or you miss this line of reasoning, or you failed to ever say what he meant by the rational market. >> so, for the last question what i would like to do is where both of those audience we talked about, the academic audience in your book and