These three book reviews are for books that I scanned, and did not read in depth.

Quantitative Equity Investing

The first book: Quantitative Equity Investing, is a book for practitioners with strong math skills, not average investors.  It reviews basic econometrics and factor analysis, and then applies these tools in an effort to sort out anomalies in investment markets, tease out important factors driving markets, and find workable trading strategies, considering execution costs, slippage, etc.  It has a brief section on algorithmic and high frequency trading.

On the whole, I didn’t find anything that new or amazing in the book.  Though there were a few things in the book that I hadn’t seen before, they were trivial things that I looked at and said, “Oh, yeah, of course.”

The book is generic in the way that it deals with the topic.  It is no going to give you ideas to pursue, but only tools that you can use if you have ideas tht you want to analyze, and turn into strategies.

Who would benefit from this book?

You have to have a very strong math background, including the type of Matrix Algebra that one would use in graduate-level Econometrics.  To that end, this book would be most useful to grad students wanting an introduction to how to apply their math skills to the markets.

The book is available here: Quantitative Equity Investing: Techniques and Strategies (The Frank J. Fabozzi Series)

The New Science of Asset Allocation

This book uses Modern Portfolio Theory in order to analyze asset allocation decisions.  Those that have read me for a while know that I think that is a flawed paradigm, in need of replacement.  For those that want a reasonable understanding of that paradigm in a short space, the book does that very well.

That said, the book has its virtues.  The chapter on the “Myths of Asset Allocation” shows that the authors have some depth of insight into the foibles and misunderstandings that surround asset allocation.  The book also goes into the importance of qualitative analysis of managers, looking up from the numbers so that you can avoid allocating money to the next Madoff.  It also describes the use of derivatives in order to control risk exposures.

Each chapter ends with a short summary of the takeaways from the chapter, which serves to reinforce the points of the book.

Though the book has the word “new” in the title, I did not find much new in it.  If one is looking for novel implementation methods for asset allocation, best to look elsewhere.

Who would benefit from this book?

This is not a book for average investors.  It is for professionals who want to brush up their asset allocation skills, and young professionals wanting insight into asset allocation.

The book is available here: The New Science of Asset Allocation: Risk Management in a Multi-Asset World (Wiley Finance)

The Economics of Food: How Feeding and Fueling the Planet Affects Food Prices

To me, this was the most interesting book of the three, but I feel it was mistitled.  A better title would have been: “Fueled: The Effects of  Using Food for Fuel” or something like that, because the central question of the book is to what degree has using crops to produce biomass for fuel production (usually ethanol) affected the costs of food and fuel.

I found the book is very even-handed, to a fault.  It argues that the use of crops for fuel production had little impact on food costs, and that there were many other factors that made food prices rise when ethanol production was going gangbusters.  Weather, domestic and foreign demand and many other factors had a role in moving food prices, not just ethanol.

After reviewing the book, I have a better sense of the complexity of the question, and that it will not admit easy answers.

Who would benefit from this book?

Anyone who wants a basic understanding of food economics, and how that is impacted by a wide number of factors including using crops for the production of fuel would benefit from this book.  The book is well written, and seemingly balanced.

The book is available here: The Economics of Food: How Feeding and Fueling the Planet Affects Food Prices

Full disclosure: The publishers sent me copies of these books, hoping that I would review them.  I review about 80% of the books that get sent to me.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

I really enjoyed the book Fortune’s Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street (review forthcoming), so when I learned the William Poundstone had written a new book, I went out and bought it.

This book, Priceless: The Myth of Fair Value (and How to Take Advantage of It), covers rationality in decision making, and how markets and marketers take advantage of the deficiencies in rationality in average people.

There are many in the investment community that admire behavioral finance, and many who say that it might be true, but where are the big profits to be made from it?

This book doesn’t cover behavioral finance per se, but it does cover its analogue in pricing and marketing.  In a negotiation, the first person to put a price on the table tends to push the final price agreed to closer to his price.  Leaving aside no-haggle dealerships, why do car dealers post high prices for vehicles?  Because only a minority does the research to understand what the minimum price is that a dealer will accept.  The rest pay more, often a lot more.  Personally, I do a lot of research before I buy a car, and it helps me spot dealer errors in pricing.

The book is replete with examples of how there is no “fair” way to price things out.  What are the proper damages for a jury settlement?  The attorney for the plaintiff is incented to come up with the highest believable amount for the jury, because they will render a verdict less than that.  Make the ceiling as high as possible, and the plaintiff will get more.

We call placing the first price on the table “anchoring,” because it pulls the final result toward itself.  The book is filled with experiments dealing with anchoring.

The book also spends a lot of time on the “ultimatum game,” where a person gets $10, and must offer some of it to a second person, but if the second person turns him down, the first person gets nothing.  The main lesson here is that pride is stronger than greed.  Yes, it can be construed as a question of fairness, but when someone gives up money to deny money to someone else, it is not fairness but envy.  Why pay to make someone else worse off?  To teach him a lesson?  What an expensive lesson.

Much of this book was a walk down memory lane for me.  I discovered Kahneman and Tversky in the Fall of 1982, and I found their ideas to be more cogent than much of the “individuals maximize utility” cant that was commonly heard from most professors teaching microeconomics.  People are far more complex than homo oeconomicus.  Small surprise that most tests of microeconomics as a system are not confirmed by the data.

Kahneman and Tversky showed via a wide array of examples that the decisions people make are affected by the way they are presented to them.  People can be manipulated in limited ways in order to affect the decisions that they make.

The book deals with many marketing tricks, particularly the powerful word, “free,”  and how it dupes people into buying something to get something for free.  For another example, why companies sell really expensive items that few will want, because people will buy the next most expensive item with greater probability, versus less expensive items of the same class.

Other topics covered include:

• The virtue of complex billing
• Why nines work well in pricing.
• Alcohol, and its value in bargaining
• How changing symbols can affect willingness to deal.
• Why to keep a ‘neutral’ friend with you in bargaining.
• And much more.

I really enjoyed the book.  It won’t be of as much value to investors, but it will be of great value to consumers.  Learn how marketers trick you.

If you want to buy the book, you can buy it here:  Priceless: The Myth of Fair Value (and How to Take Advantage of It)

Who would benefit from this book

Most people would benefit from the book.  We all need to understand our thinking biases better, so that we make smarter purchases, and avoid wasting money.  If the ideas of the book are applied well, you could pay for the book many times over in a year.

Full disclosure: I bought my copy with my own money.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

That said, I needed to make changes and had been delaying doing so.  I have modified my blogroll to reflect who I regularly read.  For the most part, I feature those that say more, but say it less frequently.

I will modify my leftbar to make it shorter, so that the site loads faster.  I will categorize my book reviews, and place the least recent of them on a separate page.

Though I like long post blogging, I will do more short posts.  My site will load a lot faster, so for those that visit the site directly, it should not be as much of a pain.

I expect to have this complete over the next month.  Much as this episode was a pain for me, I kept a good attitude about it, and am looking forward to the better blog that may result from the changes.

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In order to write tonight’s essay, I scanned Kartik Athreya’s letter, and used OCR to turn it into a tractable file.  I had to correct OCR errors, but I left his spelling and grammar errors alone.  The formatting is slightly different, and fits on three pages, not the original four.

In many ways, economics and finance are about competition.  Writing about economics and finance is tough.  There are many facets to write about; there are feedback loops galore.  So, why do some writers in the blogosphere gain followers, and others don’t?

Tough question.  Being an engaging writer helps in the intermediate-run, and being a scandalmonger helps in the short-run.  In the long-run, all that matters is that the writer is right frequently, makes sense to readers, and has the humility to admit errors.  The economics and finance blogosphere is highly competitive, and talent tends to prevail over long periods of time.  Blogging is more of a meritocracy than peer-reviewed journals.  It more closely resembles “perfect competition.”

There is another aspect to blogging that is different from writing for economic journals: we have more of a slant toward positive economics than normative economics.  Ethics plays a larger role in what bloggers write about than what timid Ph.D. economists will write about.

Just as Law is too important to be left to lawyers, with all of their self-protecting biases, even so Economics is too important to be left to economists with Ph.Ds.  The economics guild protects its own in much the same way as described in Thomas Kuhn’s The Structure of Scientific Revolutions. Bad paradigms survive until a significant number of young scientists displace the paradigm, and replace it with a new one that explains things better.

Economics needs a better paradigm, and I do not mean better mathematical formulas.  For decades economists have been playing sterile math games assuming what they define as rational behavior which is not rational.

Simple example: when I was much younger, I was traveling with the two senior members of my Ph. D. dissertation committee, and I asked them, “But what if consumers don’t maximize?  What if they conserve on maximization, because maximization takes a lot of effort, and take the first ‘good enough’ solution?”  Their answer was the intellectual equivalent of a shrug.  Without maximization, mathematical economics falls apart.  Besides, Milton Friedman taught us that the realism of assumptions doesn’t matter.

I disagree.  It matters a great deal.  If we can’t get optimization to work, all of the implications of a model will fail; there is no way to get correct significant estimates of an optimization model, if people merely satisfice.  And most of us know that we are under time and knowledge constraints, and do not optimize.

The same issues apply to the Microeconomic theory of the firm.  But now let us consider Macroeconomics, which is even squishier.  Academic macroeconomists did not distinguish themselves regarding the recent economic crisis.  Few predicted it, versus a greater number of economist in the business world that did predict it.  Think about it: what should we say about macroeconomic models that claim that the financing structure of the economy is neutral?  That it does not matter how much is financed by debt versus equity?

As I said to Dr. Carmen Reinhart when I met her, “We need more economists that are students of history, and fewer that can do the pretty math for the ideal world that does not exist.”  She seemed to agree.

Get in contact with real data.  Abandon theories that don’t make sense when applied to the real world.  Work in the markets; see if you can make money.  Be practical and adjust.  If businesses can’t lever up infinitely, why should we assume that governments can do so?  Because they can tax or inflate it away?  Ah, but each comes with a cost.

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With respect to Athreya’s letter, I would tell him to grow up, and genuinely compete with those who blog on economics and finance.  Though I am not a Ph.D., I did pass my comprehensive exams and oral exams from UC-Davis, an institution far more prominent than the University of Iowa, at least as far as applied economics goes.  That my dissertation committee left me, and that I could not set up a new committee killed my Ph. D.  It did force me to become an actuary, (my wife-to-be and I wanted to marry and start our family) and learn a lot of practical things about markets and funding structures that most economists will never bother with, to their practical detriment.

In my days at Johns Hopkins and UC-Davis, the longer that I studied, the more I learned that economics waves its hands at the problems that come whenever detailed studies attempt to test the main theories.  The results aren’t pretty; far better to have ad hoc theories that work over a limited range, than theories that proceed from basic principles, but do not work.

Yes, economics is hard.  Much harder than most economists think.  They need to abandon Keynesian, Chicago, and Neoclassical thinking, and aim for something that fits the data more closely.  That may not be the Austrian School, but it will be closer to that than the Neoclassical School.

We need an economic paradigm that is willing to tell the politicians that their actions will do no good, and will likely do harm; that central banks can’t create prosperity.  Governments exist to enforce justice, not goose the economy.

When we are in the bust phase of the economy, there are no good solutions, except to take the pain, realize the losses, and come to a quick end through a painful “big bang.”  This is the solution our central bank and politicians are fighting.  The “Japan solution” that is being followed refinances assets that are in oversupply at progressively lower rates, allowing bad assets to survive, and encouraging unproductive investment.  Real progress comes from accepting that there is no easy solution, and allowing the economy to liquidate bad investments without hindrance from the government or central bank.

The solution comes in preventing booms from getting out of hand, and always letting recessions be hard enough to liquidate bad investments.    We can’t do that now in the midst of the bust, but after the bad debts of our economy are liquidated, much as the Depression ended in 1941 when Debt/GDP reached 1.4x due to compromises and payoffs, and not due to the government or Fed, there can be real growth again, because less-indebted consumers and businesses are ready to act.

To Mr. Athreya, I would say that he has insufficiently embraced the complexity of the economy.  It is so complex that reducing it to mathematics does not work well.  But in a spirit of friendship, I invite him to visit me in Maryland and have lunch or dinner with me, at my expense.  Maybe I will tell him the story of when I got to question the head of the Richmond Fed.

That’s all for now.  There is more to say, but I am tired, and might not continue the essay so well.

Now, if you’ve read me for a while, you know that I think that the boom-bust cycle can’t be repealed, but it can be modified.  You can either get a bunch of moderate booms and busts, where the busts are allowed to burn out naturally, or you can try to suppress the busts (wrong strategy, try suppressing the booms), leading to anemic booms, declining marginal productivity of capital, and when bust suppression no longer works, you get a colossal bust, like the Great Depression or now.

There’s no free lunch in macroeconomics.  Academic economists foolishly look for ways to optimize economic performance.  They end up overinterpreting limited data, and given the biases of politicians that employ economists, suggest intervention where none is needed.

All that said, I enjoyed the presentations.  I felt the discussions were worth the two-plus hours that I spent on the matter, as well as the people that I met.

Preventing the Next Bubble

Bill Foster (U.S. House of Representatives (D-Ill.)) led off, suggesting that if you can make LTV ratios in residential lending countercyclical, you can  eliminate booms and busts.  He wants to put that into law next year.

He is an engineer by training, and like most engineers and physicists, they adopt a mechanistic model to control the economy.  My father-in-law, an eminent physicist, often suggests the same to me.  I tell him that economics is more similar to ecology than physics.  People hate having their freedom restrained, and so when arbitrary rules are imposed, even smart rules, they look for means of escape.  But his proposal misses many items:

• Mortgage insurers will undo the tightening, and I can’t see a way to outlaw mortgage insurance.
• Fraud issues still exist — appraisal and application fraud will undo some of the constraint, as will seller financing.
• Monetary policy will be hindered by the countercyclical restraints on mortgage lending, and the Fed will loosen more aggressively as a result.  (Yes, I am looking 20 or so years out here, to when monetary policy normalizes.)

In my opinion, any proposal for preventing bubbles that does not limit the Fed is not a real proposal.  That said, the Fed had the ability during the housing bubble to constrain mortgage underwriting, and did not do it.  Why should a new law change matters?’

The next presentation was from Jay Brinkmann, of the Mortgage Bankers Association.  His presentation dug into reasons why demand for housing was unsustainable.  Whether it was weak underwriting, tight spreads, teaser rates, fraud, or incompetent credit models, there were a lot of reasons for failure.

But the politics of fixing things is tough.  Who wants to oppose the CRA, Realtors and Builders?  I would note that really tough credit busts occur with secured lending, because lenders ge deluded by the seeming value of the collateral.

Next was Allan Mendelowitz, of the Federal Housing Finance Board.  His presentation discussed how one could fight a mortgage bubble.  I noted four ways to fight:

• Raise underwriting standards.
• Decrease the abilities of the GSEs to lend.
• Remove/decrease tax subsidies to home ownership, particularly those that allow for limited capital gains tax on house sales.
• Raise down payments.

I was most impressed with Mark Zandi of Moody’s.  He didn’t just look at the housing market, but at bubbles generally.  He noted three ways to discern a bubble.

• High turnover rates
• Rise in prices
• Increased leverage

He had three solutions:

• Modify Fed policy to incorporate asset signals, such that when high yield spreads are tight, Fed policy should tighten.  (His rules were more complex than that.)
• Make Risk Based Capital more cyclical
• Genuinely regulate underwriting standards.

I thought Zandi’s ideas were the most comprehensive — after all it is unlikely that the next bubble will be in residential housing.  Why focus on the last war?  Why not aim for a generic solution?

John H. Makin, of  AEI and Caxton Associates, gave the simplest presentation.  Bubbles will always exist.  Central banks will not see them.  Booms militate against those who want to dampen them, because there are many who look for rewards without work.

A number of the presenters pointed to China and Israel, both of which are trying to run countercyclical mortgage policies.  The jury is out here.  Hopefully we can learn from their successes or mistakes.

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I had my disagreements with the presenters.  Rep. Foster think that we lost $17.5 trillion of wealth from the bust.  My view is that we never had that wealth.  That is the nature of bubbles and busts.  Asset values can get pushed ahead by cheap credit.  Once the cheap credit was gone, so was a lot of the “wealth.”

I believe that the way things are financed can help detect bubbles.  It is almost always initially profitable to borrow short and lend long.  Most bubbles have a lot of people buying long-dated assets and financing a lot shorter than the assets useful lifetimes.

Also, bubbles usually start with a good idea, where money can be made at a low level of leverage.  But as prices get pushed up leverage levels rise for new entrants wanting to make money.  As prices are pushed up further, new buyers use cheap short term finance to acquire assets.  This is a sign that a bubble is nearing its end.  Another such sign that a bubble is nearing its reversal is that new owners rely on capital gains to stay afloat.  Owners have to continually feed the asset in order to hold it.  Few can do that, so when you see that, the bubble is nearly complete.  Sell with both hands.

Another disagreement that I had was that none of the speakers was willing to finger the Fed as a major culprit, given their overly loose monetary policy over the last 25 years.

I learned from one of the best, that with bank lending there is quality, quantity, and price.  In good markets, you can get two of the three.  In bad markets, you can get one of three.  In the most recent crisis, lenders ignored that, and assumed that current profits indicated good business.

But, in the finance business, there are “yield hogs.”  Yield hogs take for granted the stability of the financial system, and assume that they can ear an above average yield by taking more risk.

In general that does not work.  Yield hogs take losses.

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So, I am not optimistic about preventing bubbles.  But, I can predict them on occasion, as I have described above:

Wrecking Ball Looms for Big Housing Spec
Real Estate’s Top Looms

The way assets are financed tells us a lot about their owners.  Are they here for the long haul or not?  Long term holders augur for positive price action, whereas stock renters argue for negative price action.

1) Researchers would learn of ideas that don’t work and would avoid them.

2) Researchers would conclude that your process does not work, but they have a better way to proceed and act on it.

3) Academics would get credit for doing honest research, and not twisting research through falsifying data or tweaking formulas in order to get significant coefficients.

It is almost as valuable to know that something doesn’t work, than to know that is does work.  How much time could be saved, and new avenues acted on, through journals that record failed research.  Who knows, but that it might improve honesty among scientists, if they get credit for publishing failed research that is honest, versus falsifying data or engaging in a specification search in order to tweak coefficients to make them significant.

This would be a big improvement for every academic discipline worth writing about, where data and fair results matter.  Let it happen then.  I am willing to set up online journals for failed research.  Let the submissions begin.

So it is with Ayres and Nalebuff.  I have rarely been impressed with what they write.  Like Freakonomics, they write about stuff that is sensational, and challenge the conventional wisdom.  Yo, the conventional wisdom is right most but not all of the time.  Anyone that focuses on where the conventional wisdom is wrong will commit a lot of errors in an effort to be novel.

Now, Abnormal Returns and Sentiment’s Edge have made their polite comments, but now it is time for my less polite comments. I have five main critiques of their paper, which stems from the lack of practical experience in the markets for these two professors.

1) History is an accident.  It is fortunate that they are analyzing the US, rather than nations whose markets got wiped out during a war.  It is not impossible that the US could face a similar crisis in its future.  Try the same analyses with Argentina or Peru.  Will it work?

2) Even in the US stocks don’t outperform bonds by that much.  My estimate of the equity premium is around 1%.  Yes, the economics profession says the equity premium is higher, but they use a wrong metric; they should use dollar-weighted returns, not time-weighted returns.  The estimate of 4% equity returns over margin rates, which are higher than bond yields, is hooey.

3) Average people aren’t capable of managing portfolios that are 100% equities, much less levered equities.  It is well known that people invested in equity funds tend to buy and sell at the wrong times.  It would be far worse with leveraged portfolios.

4) Leveraged ETFs tend to underperform over time, have you noticed?  This is a mathematical necessity.  Through options and swaps, which have larger bid-ask spreads, maintaining the leverage is at low cost is tough.  If the advantage over margin rates were true, there would be real advantages to leverage.

5) What if everyone did it?  The paper is a typical, “If you had done this in the past, you would have done a lot better.”  Duh, and I can do better versions of that than the authors.  Going back to point one, history is an accident, and cannot be relied on.  Point two, their math is wrong.  Point three, average people can’t implement it.  Point four, those who try to do this don’t do as well as you might expect.

The last point is that everyone can’t do this.  Can you imagine what would happen if everyone aged 25-41 suddenly invested into equity exposure equal to twice their assets?  Stock prices would shoot up, and would offer little future returns to holders.  Stocks aren’t magic, and over the very long haul, they tend to return what the GDP does plus a few percent.

Think of Alan Greenspan encouraging people to finance using ARMs at the worst time possible.  The authors here encourage young people to speculate on equities with leverage at a time when the market is somewhat overvalued.  If this were a good idea, you would have seen many people doing it already, and it is not a common practice.  Don’t listen to academics that have little practical experience for investment advice.

One final note: when I wrote at RealMoney, I took a contrarian view that for average investors, no one should be fully invested.  Even the great Ben Graham never exceeded 75% invested.  My view is that average people must limit their risks or they will not be able to sustain their investment plans.  A 50/50 or 60/40 balanced fund approach is best for the average person — they will never get scared enough to abandon it.

Leverage is for experts only, and I have never used leverage.  Only use leverage if you are more of an expert than me.  (I write this not out of pride, but out of my experience where so many have gotten burned by taking too much risk.)

Rather than looking at correlations one at a time, multiple regression looks at them all at once, and tries to analyze which are the biggest factors.  Now unlike CXO, I used interest rate variables that have credit risk.  Why?  Corporations face credit risk, and they fund themselves with risky paper, unlike the US Treasury.  So, my two interest rate variables are the Moody’s Corporate Baa Average, which contains only long bonds, and the 30-day A2/P2 commercial paper yield as calculated by the Fed [H15s030Y].  These better measure funding costs for corporations.

All of these variables are highly significant.  Two go the way one would suspect, and one doesn’t.  Like REITs, performance is positively related to the market as a whole, and negatively related to Baa yields.

But, A2/P2 yields are positively related to returns.  Fascinating, and a reason why we should always use the long and short end of the yield curve for analyses.  They don’t measure the same thing.  Short-term liquidity is different from long-term borrowing rates.

Why are short-term rates positively related to returns?

1. They are a measure of confidence in the economic system.
2. Inflation drives both short-term rates and utility profit margins.

At least, I think that is the case.  As I often say, be skeptical about statistical arguments about the market, particularly when there is little economic reasoning behind the discussion.

With that, I simply say that yes, higher long-term interest rates do affect utility stock prices.  And higher short term rates will indicate inflation, and drive utility prices higher.  Beyond that utilities go higher as the market does, but the beta is low.

Are Utilities Like Bonds or Like Stocks?  They are like both of them.  Learn to enjoy that, unless the regulatory regime changes.

I did not ask for this book, but I am glad the publisher sent it to me for free.  There is a lot of concern over inflation in the present era, but not a lot of structured thought about what drives inflation.

This book takes the long term perspective, and looks at the wide array of monetary arrangements, and analyzes which arrangements produced more or less price inflation.  The author shows that there is generally an inflationary bias in all currencies.  Currencies that are backed by precious metals tend to experience less inflation, but many governments using such currencies debase the metals or clip the coins.  That said, it does restrain inflation, because inflating a  metallic-based currency takes a lot of work.

To have significant inflation, one must have unbacked paper money.  The same is true of defaults in bonds.  In order to have a crisis, much debt must be issued relative to the assets and earning power of the companies.  The debt is not backed by sufficient repayment capacity, and thus there are some defaults.

A fiat currency in and of itself, is not sufficient to create hyperinflation.  Hyperinflation only happens when the government finances itself by printing money with abandon.

The book further distinguishes itself by explaining situations where foreign currencies come in to act as shadow currencies inside nations.  Further, the book describes how inflationary situations end.  One constant is that people quickly analyze where purchasing is declining, and seek stability through metals or relatively stable fiat currencies.

One strength of the book is that at the end of each chapter, the author summarizes all of the main points.  I recommend this book.

Quibbles

The book is not dry, but it has a distinctly academic feel.  Not everyone will take to the book easily.

Who would benefit from this book?

Economists would benefit from the book, and also those that like reading about the history of inflation.  Few things truly change in History; the names may change, but we make the same mistakes.

For those who want to buy the book, you can buy it here: Monetary Regimes And Inflation: History, Economic And Political Relationships.

Full disclosure: Though I get books for free from publishers, I burn time to read books in full, and write reviews that are balanced.  Those entering Amazon through my site and buying anything will end up sending me a small commission, but they will not pay more in order to do that.

Many of you have heard of the blog Naked Capitalism, and its pseudonymous writer, Yves Smith.  Well, she has written what I regard as an ambitious book, ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism.  It is ambitious for several reasons:

• It tries to be comprehensive about all aspects of the crisis.
• It digs deeper than most, analyzing flaws in economic and financial theories that underpinned the errors of the crisis.
• It looks at the political angle of how laws and regulations were subverted, while alleging conspiracy probably too much, when ordinary greed in the open and stupidity could cover the causes of the crisis.

There is a tension between capitalism and democracy.  We don’t like to talk about it, but it is there.  Property rights are human rights, and should be protected.  Governments often determine that certain contracts are not valid on public policy grounds.  (I.e., gambling, prostitution, arson, assassins, etc.)

Democracies also do not like rivals for power.  If business gets too big, to the point where it is influencing the decisions of the government, democracy fights back.  I write this as one who would err on the side of property rights rather than democracy.  Property rights are a direct descendant of the eighth commandment, “You shall not steal,” whereas the form of government of any nation is a thing of relative indifference.  Many nations have different ways of ruling themselves.  It is not yet proven that democracy is the best form of government.  Personally, I think it is more prone to corruption than most governmental forms.  But it has the advantage of motivating the people.

I draw the line when businesses use political power to exclude rivals.  It is one thing to be really clever, and dominate your market, like Google.  It is another to have a natural monopoly like the old AT&T, before technology obsoleted them.  But it stinks to have a system where major financials, who have nothing of patentable value, hold the nation hostage, saying “Bail us out or the financial system fails.”

I argued against the bailouts, as did Yves, but the government caved under the asymmetry of “Heads we win, Tails you lose.”  It came up tails for all of us.

Yves digs deeper than many critics.  She questions the assumptions of the economics profession,with its gloss of pseudo-science.  She pokes at the questionable assumptions underlying much of finance theory.   She looks at those who got it right regarding the crisis, and were marginalized as a result.  Where I differ is that there isn’t necessarily a conspiracy behind unwillingness to listen to discordant theories.  Academic guilds ignore researchers who question their closely held beliefs, regardless of the truth of the matter.  They know that it couldn’t be true, and the outsider doesn’t really understand their discipline.  I do not charge them with ill intentions, but stupidity.

What I really appreciated about the book was its willingness to challenge academic economics and finance.  She did it well, but left little in her wake as to what to look to as a substitute.  The willingness of economics to engage in pretend games with high level math is ridiculous.  If we restarted economics from scratch today, whether mathematical or not, it would not look like much of the sterile games that are played in leading economic journals.  Ask the question: how many benefit outside the economics profession from what is written in economic journals.  Answer: precious few.

I have many more things to say about this book, but this review is long enough as it is.  Let me say that there are few books that I have marked up as much as this one.

Quibbles

I do not go in for conspiracy theories.  Usually, most evil can be performed outside of darkness; people still don’t notice for the most part.

Yves should have spent more time on the enablers of the crisis — yield hogs.  You can’t buy protection on a company that you think will die, unless there is a yield hog out there that wants extra income that they think they are getting for free.  AIG was the largest of them, but by no means the only one.

She complains a bit much about “free markets.”  Aside from trading with the enemy, why should trade be constrained?  Why should I try to take away the property rights of my neighbor?  Beyond that, suppose you are right.  Where would you draw the lines?  It is one thing to criticize, and quite another to propose new policy.  Personally, I make an effort that when I suggest that something be demolished, that I recommend something else to take its place.  It is easy to be a critic, but hard to be a builder.

Who would benefit from this book:

Most people would benefit from the book, if they read it realizing that the things that happened do not require that parties conspired to make this happen.  Those who would especially benefit include economics and finance professors; they need the criticism.

If you want to buy the book, you can buy it here: ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism.

Full disclosure: The publisher sent me the book for free.  I spent several hours reading it in full.  If you enter Amazon through my site and buy anything, I get a small commission (6-7% typically).  But, your costs don’t rise versus going to Amazon directly.  I have avoided doing a “tip jar” because I would rather people benefit from the books I review, while allowing Amazon to pay me indirectly.

One more note, I disagree with Volcker and Sarkozy regarding supporting Greece, versus the Euro.  If Greece defaulted, Greece would lose the low cost funding of the Euro.  The Eurozone would lose a country, but the Euro would retain its strength, and marginal nations prone to cheating would come into line.  Tough love is the best policy; don’t bail others out if you care about the union as a whole.

On to tonight’s rule: Unless there is a natural purchaser of an exposure that one is trying to hedge, someone must speculate to a degree to allow you to hedge.  If the speculator is undercapitalized, risks to the financial system rise.

This rule is pretty simple.  There are few places in the financial markets where there are naturally offsetting exposures that have not been remedied by an institution created for that very purpose, such as a bank.  In most cases with derivatives, the one that wants to reduce exposure relies on a speculator.  There are rare cases where the risk of one is the benefit of another, but situations like that tend to create new firms to internalize the trade.

The trouble occurs when the speculator can’t make good on his obligations.  As with many speculators, he overcommits.  He is short of funds because many trades are going against him at the same time.  It is in these cases that those who hedge learn to evaluate counterparties for their riskiness.

That is why it is worth knowing who is at the end of the chain in this financial game of crack-the-whip.  The status of the ultimate speculators, and whether they can make good on promises or not is a huge thing.  After all, subprime mortgages were downplayed by many as the crisis was rising, but they were at the end of the financial game of crack-the-whip.  They were one of the main classes of marginal borrowers.

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Taking this a different way, this argues against the academics that look for complete markets in the sense of Arrow-Debreu.  There are trades that no one wants to take at any price that a seller could live with.  There are securities that can be created that no one wants to buy, at prices that are unprofitable to the securitizer.    Complexity is a minus.  We can create securities that are the financial equivalent of toxic waste, but no one should pay much for them.  It is the price of creating safe securities.

No surprise: people pay a lot more for certainty, even if it is seeming certainty.  We see it in corporate bond spreads.  High quality borrowers borrow cheaply.  Low quality borrowers pay up. So what else is new?

What is new is the low-ish spreads for going down in quality.  This one could go either way; spreads are wide against history, but might be narrow against current difficulties.  The rebound has been rather sharp.

Note: this is reposted because of a system glitch.