Justin Fox's new book: 'Myth of the Rational Market'

by Bruce WebbOver at TPM Justin Fox is launching a discussion of his new book The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street which feeds right into some discussions we have had at this time at Angry Bear. So I propose to give his set-up at this time and then suggest people comment in either otherwise together places. (But) a couple of apparent certainties that emerged from academic finances and finance in the 1960s and 1970s have been showed by experience to be mighty uncertain. One was the contention that financial market prices were in some fundamental sense correct, otherwise at smallest amount fluctuated in a reasonably narrow band around their fundamental values. The other--and the two don't have to be linked, though they frequently were--was that it was comparatively easy to model the actions of markets and manage the risks thereof.If you believed these two things, then the spectacular growth in power of financial markets (at the expense of government, of corporations, of commercial banks) over the past three otherwise four decades was great news. I am pretty sure, in fact, that rational-market economic theories fueled this rise--although it's awfully difficult to sort out cause and effect.Now that this financialized economy has proved to be very fragile, we are due for an comprehensive period of rethinking--of financial economics, of regulation, of taxes, of how we think about economic growth (clearly, growth fueled purely by rising asset prices isn't such a great thing). I am of the view that it's not as simple as, say, putting the regulators back in charge, given that there's negative reason to think financial regulators are additional likely to be rational and right than financial markets are. But obviously we can do better. Got any ideas?(My TPM Cafe comment is reproduced under the fold.)My take:Well we might start by recognizing that market participants are intent on maximizing their own interest and where possible will exploit irregular information to attain that end. Moreover if not restrained they will also exploit power imbalances.I think we would all be well served by having all economists study the way markets in fact operated back in the Gilded Age. What happens to a market when insider trading is not only not against the law but appreciated as a most excellent business practice? The old saying "What the market will bear" implies a lot additional than a simple affair of supply and demand location price, not when the seller has the ability to control supply and influence demand.And then after mastering the methods of Cornelius Vanderbilt they could move on back and study the history of wage location in industrializing England from 1790 to say 1848. I am currently re-reading E.P. Thompson's 'Making of the English Working Class' and can say that the reality of the wage market in those years bears negative similarity to the sanitized market models establish in book books. The notion that some Invisible Hand was busy adjusting compensation to marginal productivity is belied by facts on the ground, wage suppression was a national policy backed as essential by the use of State force (see Peterloo Massacre).I firmly believe that much of the problem with the traditional liberal economic model is that it was formalized in a time and a place where political democracy based on worldwide suffrage was not only not the standard but conceived to be a positive danger to society at large. Give all workers and (shudder) women the vote and who knows what might happen. Well now we know, it gave Britain the Labour Party and the U.S. the New Deal and with them reverberations that shook old ideas about how markets have to work to the core.Caplan's book 'Myth of the Rational Voter' whose title I assume is at smallest amount an ironic inspiration to that of the book under discussion is I think at root the product of frustration. Don't the proles understand that everything was better back when the world was run by J.P. Morgan and a handful of associates?It is negative wonder that together the political and economic right look back at the McKinley Era for their ideal. No income tax, negative worldwide suffrage in England, negative popular vote of Senators in the U.S., negative insider trading rules, negative restrictions on wage suppression. Now that is freedom!!Prof. Thoma told me a a small number of years ago that "Economics does not handle even-handedness well". And after giving that some long thought I figured out why. Because traditional finances does not handle popular democracy well. That is for some people in England everything was downhill after the Reform Act of 1832 with ultimate disaster delivered with Representation of the People Act of 1918, while in the U.S. it was the changes introduced with the 16th, 17th and 19th Amendments.Damn democracy! Always screwing with this satisfactorily designed business plan!
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