+ THE MYTH OF THE RATIONAL MARKET
A History of Risk, Reward, and Delusion on Wall Street by Justin Fox

+THE SAGES
Warren Buffett, George Soros, Paul Volcker, and the Maelstrom of Markets by Charles R. Morris

Yesterday, Paul Krugman reviewed them. His piece is worth reading::

School for Scoundrels

Last October, Alan Greenspan — who had spent years assuring investors that all was well with the American financial system — declared himself to be in a state of “shocked disbelief.” After all, the best and brightest had assured him our financial system was sound: “In recent decades, a vast risk management and pricing system has evolved, combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. . . . The whole intellectual edifice, however, collapsed in the summer of last year.”

Justin Fox’s “Myth of the Rational Market” brilliantly tells the story of how that edifice was built — and why so few were willing to acknowledge that it was a house built on sand.

Do we really need yet another book about the financial crisis? Yes, we do — because this one is different. Instead of focusing on the errors and abuses of the bankers, Fox, the business and economics columnist for Time magazine, tells the story of the professors who enabled those abuses under the banner of the financial theory known as the efficient-market hypothesis. Fox’s book is not an idle exercise in intellectual history, which makes it a must-read for anyone who wants to understand the mess we’re in. Wall Street bought the ideas of the efficient-market theorists, in many cases literally: professors were lavishly paid to design complex financial strategies. And these strategies played a crucial role in the catastrophe that has now overtaken the world economy.

This journey to disaster began with a beautiful idea. Until 1952, finance theory, such as it was, consisted of a set of wise observations and rules of thumb, without any overarching framework. But in that year Harry Markowitz, a graduate student at the University of Chicago, gave finance theory a new, hard-edged clarity by equating the concept of risk — previously a vague term for potential losses — with the mathematical concept of variance.

Markowitz’s model told investors what they should do, rather than predicting what they actually do. But by the mid-1960s other theorists had taken the next step, analyzing financial markets on the assumption that investors actually behaved the way Markowitz’s model said they should. The result was an intellectually elegant theory of stock prices — the so-called Capital Asset Pricing Model, or CAPM (pronounced “cap-em”). CAPM is a deeply seductive theory, and it’s hard to overemphasize how thoroughly it took over thinking about finance, not just in business schools but on Wall Street.

Markowitz would eventually share a Nobel in economic science with William Sharpe, who played a key role in developing CAPM, and Merton Miller, another central figure in the development of modern financial theory. Long before then, however, the innovative idea had hardened into a dogma.

One of the great things about Fox’s writing is that he brings to it a real understanding of the sociology of the academic world. Above all, he gets the way in which one’s career, reputation, even sense of self-worth can end up being defined by a particular intellectual approach, so that supporters of the approach start to resemble fervent political activists — or members of a cult. In the case of finance theory, it happened especially fast: by the early 1960s Miller began a class at the University of Chicago’s business school by drawing a line down the middle of the blackboard. On one side he wrote M&M, for “Modigliani-Miller” — that is, the new, mathematicized, CAPM approach to finance. On the other he wrote T — for “Them,” meaning the old, informal approach.

In this sense, efficient-market acolytes were like any other academic movement. But unlike, say, deconstructionist literary theorists, finance professors had an enormous impact on the business world — and, not incidentally, some of them made a lot of money in the process.

This may seem strange, since CAPM and the broader work it inspired were based on the assumption that investors make mathematically optimal investment decisions with the information at their disposal. As a result, Eugene Fama, of Chicago’s business school, wrote, “actual market prices are, on the basis of all available information, best estimates of intrinsic values.” Fama called a market with this virtue an “efficient market” — and argued that the data showed that real-world financial markets are, in fact, efficient, or very nearly so. But if the markets are already getting it right, who needs finance professors?

In fact, however, Wall Street was eager to hire “rocket scientists,” especially after Fischer Black and Myron Scholes, working at M.I.T.’s Sloan School, came up with a formula that seemingly solved the puzzle of how to value options — contracts that give investors the right to buy or sell assets at predetermined prices. The quintessential collaboration between big money and academic superstars was the hedge fund Long-Term Capital Management, whose partners included Scholes and Robert Merton, with whom Scholes shared another finance Nobel. L.T.C.M. eventually imploded, nearly taking the world economy down with it. But efficient-markets theory retained its hold on financial thought.

All along, there were critical voices. Robert Shiller, who has become famous for predicting both the Internet crash and the housing bust, first made his mark by casting statistical doubt on the evidence for efficient markets. Lawrence Summers, now a senior official in the Obama administration, began a paper on financial markets thus: “THERE ARE IDIOTS. Look around.” And a whole counter culture emerged in the form of “behavioral finance,” which argued that investors are irrational in predictable ways. But the sheer scope and sweep of the efficient markets hypothesis — not to mention the fact that so many people devoted their careers to it — allowed it to brush off most of these challenges.

Of course, there have always been men of affairs wise enough to see past the current dogma. In “The Sages,” Charles R. Morris profiles three of them: George Soros, Warren Buffett and Paul Volcker.

Morris, the author of “The Trillion Dollar Meltdown,” doesn’t have much patience with economic theory, and it shows; I almost gave up on the book after Morris managed, in the space of just a few pages, to thoroughly misrepresent the ideas of both John Maynard Keynes and Milton Friedman. But the book comes to life with its personal profiles, especially the surprisingly endearing portrait of Warren Buffett as a young man.

Do the lives of the sages carry useful lessons for the rest of us? Soros doesn’t really seem to have a method, except that of being smarter than anyone else. Buffett does have a method — figure out what a company is really worth, and buy it if you can get it cheap — but it’s not a method that would work for anyone without his gifts. And Volcker’s main asset is his implacable integrity, which most mortals would find hard to match.

Indeed, I came away from reading these books wondering if their shared under lying premise — that the current crisis will put an end to Panglossian views of financial markets — is right. Fox points out that academic belief in the perfection of financial markets survived the 1987 stock market crash and the bursting of the Internet bubble. Why should the reaction to the latest catastrophe be any different? In fact, what I hear from my finance professor friends is that there’s a lot less soul-searching under way than you might expect. And Wall Street’s appetite for complex strategies that sound clever — and can be sold to credulous investors — survived L.T.C.M.’s debacle; why can’t it survive this crisis, too?

My guess is that the myth of the rational market — a myth that is beautiful, comforting and, above all, lucrative — isn’t going away anytime soon.

Ben Stein gets fired from the New York Times. Many people weren't big fans. He once wrote a book called "Yes, You Can Time the Market!” and then wrote this:

I’m writing this on Aug. 13, 2007… the stock market is cheap on a price-earnings basis, profits are fabulous… and in the long run, both here and abroad, stocks are a lovely place to be.

More than three months into the deepest recession in living memory, that “as a matter of definition, we simply cannot be” in a recession at all.

He got canned because he became a shill for FreeScore, another one of those misleading, rip-off operations that purport to get you your credit score for free.

.. To activate your trial membership in FreeScore, you will be charged/debited a $1.00 refundable processing fee and then you can immediately take advantage of the exciting savings FreeScore has to offer! After your 7-day FREE trial period it's just $29.95 per month for FreeScore. Remember, you can call FreeScore toll-free at 1-800-316-8824 within the first 7 days to cancel, and you will not be charged/debited. Also, remember to ask for a refund of your $1 processing fee. To ensure continuous service, at the end of your trial period your membership will be automatically charged/debited each month at the then-current membership fee on or about that same date to the credit card you provide today or from the checking account associated with the debit card you provide today. If for any reason you are dissatisfied, call our toll-free number to cancel, and you'll no longer be charged/debited.

For fun, I called the toll-free number. It's a machine -- as if I expected anything else.

There is no moral to this story, except financial writers are people -- occasionally dumb, occasionally smart. Reader beware.

My son bought a new printer for his new business. It's the Brother MFC 7440N.

It's an all-in-one laser printer, copier, fax, scanner. He paid $200. CNET thinks the thing is uninspiring. For CNET's review, click here. But my son loves it because it does everything perfectly fine -- except print beautiful pictures -- "not great on pictures." He doesn't care pictures. It's a business machine. What he does love is that it comes with great software. Setup was a "breeze" and the drivers and management program don't take over your computer like the Epson / Cannon / HP software do.

I remember the good old days when you paid $2500 for just a laser printer.

Windows 7 is meant to be a nice operating system. But getting it onto your computer is a whole other thing -- also called a nightmare.

In contrast, you never have this insanity when upgrading your Apple Mac operating system to the newest OS You simply load the CD, run it and it works perfectly on top of your present, older OS. You don't have to copy your files, wipe out your hard disk, reformat it, load Windows 7 and then re-load all your software and hardware drivers -- some of which may work, but a lot won't. The contrast between insane Microsoft and sane Apple is mind-blowing. But then so is the price of their shares.

P.S. I will not upgrade to Windows 7 from my present Windows XP. My philosophy is simple, "If it works, why mess with it?"

Why are we still there? We went to Afghanistan eight years ago because Osama was there. He's no longer there. Now we're wasting our precious soldiers and our scarce resources by fighting an enemy that poses zero threat to the U.S. -- the Taliban. This morning's Wall Street Journal (not a left-wing newspaper) carries this story:

Taliban Now Winning;
U.S. Commander in Afghanistan Warns of Rising Casualties

The Taliban have gained the upper hand in Afghanistan, the top American commander there said, forcing the U.S. to change its strategy in the eight-year-old conflict by increasing the number of troops in heavily populated areas like the volatile southern city of Kandahar, the insurgency's spiritual home.

Gen. Stanley McChrystal warned that means U.S. casualties, already running at record levels, will remain high for months to come. ...

The militants are mounting sophisticated attacks that combine roadside bombs with ambushes by small teams of heavily armed militants, causing significant numbers of U.S. fatalities, he said. July was the bloodiest month of the war for American and British forces, and 12 more American troops have already been killed in August. ...

The Obama administration is in the midst of an Afghan buildup that will push U.S. troop levels here to a record 68,000 by year end. There are roughly an additional 30,000 troops from North Atlantic Treaty Organization countries and other allies.

The U.S. war effort in Afghanistan is costing American taxpayers about $4 billion a month. ..

It's time to tell Washington that this War should be stopped NOW. My points:

1. It's been 8 years. That's longer than World War II.

2. It's unwinnable. But, if we did win, what would we gain? An assured supply of opium and heroin?

3. Though I don't like them, the Taliban pose us no threat.

4. Our soldiers' lives are precious. Nothing about this war is worth the life of a single additional American soldier.

The preacher and his son
An old country preacher had a teenage son, and it was getting time the boy should give some thought to choosing a profession. Like many young men his age, the boy didn't really know what he wanted to do, and he didn't seem too concerned about it. One day, while the boy was away at school, his father decided to try an experiment. He went into the boy's room and placed on his study table four objects:

2. A silver dollar.

3. A bottle of whisky, and

4. A Playboy magazine.

'I'll just hide behind the door,' the old preacher said to himself. 'When he comes home from school today, I'll see which object he picks up.

If it's the Bible, he's going to be a preacher like me, and what a blessing that would be! If he picks up the dollar, he's going to be a business man, and that would be okay, too. But if he picks up the bottle, he's going to be a no-good drunken bum, and Lord, what a shame that would be. And worst of all if he picks up that magazine he's going to be a skirt-chasing womanizer.'

The old man waited anxiously, and soon heard his son's footsteps as he entered the house whistling and headed for his room. The boy tossed his books on the bed, and as he turned to leave the room he spotted the objects on the table. With curiosity in his eye, he walked over to inspect them.

Finally, he picked up the Bible and placed it under his arm. He picked up the silver dollar and dropped into his pocket. He uncorked the bottle and took a big drink, while he admired this month's centerfold.

'Lord have mercy,' the old preacher disgustedly whispered. 'He's gonna run for Congress.'

This is funny, no matter your politics
Barack Obama was out jogging along the parkway one morning when he tripped, fell over the bridge railing, and landed in the creek below.

Before the Secret Service guys could get to him, three kids who were fishing pulled him out of the water. He was so grateful he offered the kids whatever they wanted.

The first kid said, "I want to go to Disneyland." "No problem," Barack said, "I'll take you there on my special airplane."

The second kid said, "I want a new pair of Nike Air Jordan shoes." "I'll get them for you and even have Michael sign them," Barack said.

The third kid said, "I want a motorized wheelchair with a built-in TV and stereo headset!" Barack was a little perplexed by this and said, "But you don't look like you're handicapped."

The kid said, "I will be after my dad finds out I saved your ass from drowning!"

This column is about my personal search for the perfect investment. I don't give investment advice. For that you have to be registered with regulatory authorities, which I am not. I am a reporter and an investor. I make my daily column -- Monday through Friday -- freely available for three reasons: Writing is good for sorting things out in my brain. Second, the column is research for a book I'm writing called "In Search of the Perfect Investment." Third, I encourage my readers to send me their ideas, concerns and experiences. That way we can all learn together. My email address is . You can't click on my email address. You have to re-type it . This protects me from software scanning the Internet for email addresses to spam. I have no role in choosing the Google ads on this site. Thus I cannot endorse, though some look interesting. If you click on a link, Google may send me money. Please note I'm not suggesting you do. That money, if there is any, may help pay Michael's business school tuition. Read more about Google AdSense, click here and here.