Random Wall Street Walking

There was a popular book in 1973 – A Random Walk Down Wall Street. (by Burton Malkiel, now in its 9th edition, 2007) – that pooh-pooh’ed the idea that one investor’s stock picks could always be better than another investor’s stock picks. The punch line is that you could randomly throw darts at the Wall Street Journal financial pages and do just as well as anyone else investing in the stock market. I first read it in 1980, while taking Investment 101 in business school at night and editing economic research documents for the Federal Reserve Bank of San Francisco during the day. I had a very memorable argument with John P. Judd, then senior research economist and more recently special advisor to the Bank president and CEO Janet Yellen.

John thought the Wall Street brokers were crazy for thinking they could make more than average returns on investment. I thought the Federal Reserve was crazy for thinking they could control the money supply. John was already a PhD economist; I was still working on my Bachelor degree in business administration.

Twenty years later I also have a PhD in economics, but there are still two camps pulling in different directions in their dangerous tug-of-war on the economy. There are the double-dip pessimists led by Yale Economist Bob Shiller and most recently discouraged by Paul Ferrell of MarketWatch. And there are the “Mad Money” optimists who believe that Jim Cramer will tell them everything they need to know to get and stay rich, while Ben Bernanke consoles them with sound bites like “increased optimism among consumers … should aid the recovery.”

At the heart of the problem is the same, original argument I had with John Judd – “is there a way to beat the averages” – except that this time around Wall Street is in bed with the Federal Reserve. You can no longer tell the crazies apart.

Which brings me back to the Random Walk. If Wall Street has their way, they will inflate the market just enough to induce you to put your money back in. Don’t forget the Weenie Roast of 2008. If the government – either Congress or Treasury or the Federal Reserve – has their way, they will let it crash again, too. Don’t forget that it was only Wall Street that got bailed out the last time. I think the chances are 50-50 either way.

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I don't know if I agree with

I don't know if I agree with you on this one. I've read Malkiel's book too. A nice well written tome but I think it misses the point. There are indeed investors who have managed produce consistent yields and do so over decades. The people around Warren Buffet/Ben Graham, people like Seth Klarman, Charlie Munger and a very few others have managed to generate consistent returns for decades with Buffet doing so for more than half a century.
I think that the world was bailed out in 2008. It was the fault of the deregulated financial system but letting it completely disintegrate really was not an option. The Fed really has to set up a framework that keeps funds flowing but limits the excesses of the eighties, nineties and noughties. But I don't have a PhD in economics.

RE: I don't know if I agree with

Hi, Kirk and thanks for your comment.

The fact that you can point to specific individuals – name names – is evidence that “you can’t beat the averages”. In fact, in order to have an average – a normal bell-shaped curve, if you will – you have to have some “tails”.

But perhaps I was too clever with the "street walking" reference. My point all along has been that professional investors – including Warren Buffett – need individuals to come back to Wall Street. Their investment schemes require a continued inflow of new money – either yours or the government's.

Maybe you could clarify for me what "framework" you are referring to that you believe will prevent the Fall of 2008 from recurring tomorrow? The system that supports settlement failures and selling more financial products than there are assets has not been changed. I'm interested in any new information you have.


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I would probably not be

I would probably not be teaching American culture at an obscure German university if I knew what the framework should be exactly. I think it has to work along the lines of what Hayak said in the Road to Serfdom. The government has to provide a means to allow competition to thrive. I think breaking up some of the banks up the way they did Standard Oil might be a decent start. I think it would be a shame to punish players like Jamie Dimon for their fiduciary caution but for the good of the whole the power of these banks needs to be reined in. The truth is that even though reinstating Glass Steagall would not have necessarily prevented 2008, something needs to be done. I cannot tell you what that is.

RE: I would probably not be

Hi, Kirk,
When you wrote that you thought the Fed's framework could prevent financial crises, I thought maybe you heard about some changes. Since the autumn of 2008, things have been moving very rapidly and I find it impossible to stay in front of it. The legislation is written very fast, changed faster and -- from what I can tell -- even changed after it's passed. Makes it hard for the ordinary citizen or even the informed researcher to keep up with the final outcomes.

In my view, it is not the size of the firms but the size of the risks that are the real problem. The transaction settlement system (US, UK for sure, likely others) permits dealers to sell more stocks and bonds than exist without any incentive to deliver on time. This is the core of the problem -- both in theory and in practice. For example, the 17 primary dealers reporting to the New York Federal Reserve Bank failed to deliver $2.5 trillion worth of US Treasury securities for 7 weeks in late 2008 -- no fines, no sanctions; worst of all, no press coverage. What this means is that supply is infinite -- there is no limit to how many bonds can be sold because no one is enforcing delivery.

Until I see something in regulatory reform that fixes the fundamental hole in the system, I won't have anything positive to say about it.

Thanks for the dialogue! Some of the new best work I've seen on securities trade settlement is being done at Goethe-University Frankfurt.

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