Must-Read: Robert Shiller: Fraud, Fools, and Financial Markets
Must-Read: The fact that the sources of win-win value in finance are subtle and second-order–having to do with liquidity, patience, diversification, and incentive alignment–makes phishing for phools much more profitable relative to building relationships with customers and suppliers than in “normal” industries. I am pleased that the… I was going to say Nobel Prize-caliber minds, but looking again at the Economics prize recipients I realize that is not a compliment… extremely-sharp minds of Shiller and Akerlof are thinking of this:
: Fraud, Fools, and Financial Markets: “Because we can be manipulated or deceived or even just passively tempted…
…free markets also persuade us to buy things that are good neither for us nor for society… an important codicil to Smith’s vision… one that George Akerlof and I explore in our new book, Phishing for Phools: The Economics of Manipulation and Deception…. Routine phishing can affect any market, but our most important observations concern financial markets…. Borrowers are lured into unsuitable mortgages; firms are stripped of their assets; accountants mislead investors; financial advisers spin narratives of riches from nowhere; and the media promote extravagant claims. But the losers in the downturns are not just those who have been duped. A chain of additional losses occurs when the inflated assets have been purchased with borrowed money. In that case, bankruptcies and fear of bankruptcy spawn an epidemic of further bankruptcies, reinforcing fear. Then credit dries up and the economy collapses. This vicious downward spiral for business confidence typically features phishes–for example, the victims of Bernard Madoff’s Ponzi scheme–discovered only after the period of irrational exuberance has ended….
We found out many years ago, to the world’s great regret, what happens when a financial epidemic is allowed to run its course. Our analysis indicates that not only are there endemic and natural forces that make the financial system highly volatile; but also that swift, effective intervention is needed in the face of financial collapse. We need to give free rein to fiscal and monetary authorities to take aggressive steps when financial turmoil turns into financial crisis. One Dark Age is one too many.