Efficient market hypothesis is dead – for now

I have to report the sad passing of the efficient market hypothesis. The theory was officially declared dead yesterday at the World Economic Forum in Davos. There were no mourners.

The announcement was made at a brainstorming session that involved many of the world’s top economists, politicians and business leaders … together with a few bankers wearing dark glasses and false beards.

Asked which policy assumption had most contributed to the global financial crisis, the most popular answer by far was the belief that markets are self-correcting. (Nassim Nicholas Taleb, author of The Black Swan, said it was that markets “robustify” themselves, which amounts to the same thing … I think.)

In recent years, the belief in efficient markets has dominated economic policy and financial regulation in the Anglo-Saxon world and increasingly across the globe. Its death, if confirmed, is a momentous event. At the very least, it will cause anguish among countless MBA graduates who have paid good money, worked long hours and consumed large quantities of cold pizza to learn about something nobody now believes in.

The efficient market theory (or more precisely, the closely related efficient banks theory) has already been given a bit of a kicking by one of its greatest supporters, Alan Greenspan. The former Federal Reserve chairman has said that the big mistake he made was assuming that banks’ self-interest would prevent them doing anything that would threaten their own survival.

It was a good thing Mr Greenspan wasn’t at Davos yesterday. He would have been set upon. When it comes to the sins of bankers and regulators, the mood among Davos types is just as ugly as it is among the general population.

John Neill, chief executive of Unipart, was given one of the day’s biggest rounds of applause when he declared that bankers who were involved in developing toxic products that caused massive damage to the global economy should be punished. If you knowingly make other kinds of toxic products, you go to jail. Why should bankers be different, he asked.

Regulators also came in for a battering. But the Davos consensus on what needs to be done was concerning. Asked what the top priority should be in terms of financial regulation for the forthcoming G20 meeting, half the delegates at the session said it was addressing the lack of an international regulatory framework.

This echoes the oft-repeated call by politicians, including Gordon Brown, for better international regulatory co-ordination.

Yet, as Lord Turner, chairman of the Financial Services Authority, told me yesterday, international standards and better co-ordination would have made little difference to the course of the credit crisis. It would not have improved the Federal Reserve’s regulation of Citigroup or the FSA’s regulation of Northern Rock.

Moreover, coming up with an international regulatory framework will be extremely difficult. Unlike in trade, for example, there is no treaty-based international organisation in which such a framework can be hammered out.

It will take a very long time. So long, in fact, that it is unlikely to be finished before the efficient market hypothesis rises again from the dead. As it surely will.

 

David Wighton: Business Editor’s Davos commentary.

 

From The Times - January 29, 2009

http://business.timesonline.co.uk/tol/business/columnists/article5607960.ece

Filed under: Business , davos, efficient, market

How bad is the crisis going to get?

36 hours in September changed the world. When investment bank Lehman Brothers collapsed, the credit crunch became a global financial crisis.

But how bad is that crisis? Was it wrong to let Lehman fail? Or was Lehman just a symptom not the cause of the chaos in the global economy?

Tough questions, and the World Economic Forum had lined up five top experts (including two Nobel prize winners) to find answers.

The economists among them were Crunch Cassandras; two or three years ago they had predicted that our financial system was headed for a huge liquidity crisis – Nouriel Roubini, Nassim Taleb and economic historian Niall Ferguson.

A pity then, a participant said, that two years ago nobody had thought of inviting them to speak at the forum.

Little wonder that this session was hugely oversubscribed, with 150 people on the waiting list and probably more than that crowding into one of the cavernous dining rooms that are the hallmark of Davos hotels.

Under Davos rules this was a closed session, to encourage frank debate. So with a few exceptions I am not allowed to attribute quotes to individual speakers.

But I can report what was said, and this session was an intellectually stimulating eye opener – and utterly depressing (at least economically).

Depression 2.0?

The biggest question, of course, is how bad is it going to get, and nobody – neither on the panel nor in the audience – dared to provide any cheer.

There was talk of “Depression Lite” and “Depression 2.0″, although the experts also pointed out that it was unlikely to get as bad as the 1930s.

Back then, the US economy shrank on average 14% a year, prices fell at 8% a year and unemployment peaked at 25%.

The sharp rate cuts and fiscal stimulus packages around the world would prevent a repeat, everybody agreed.

Still, warned one of the experts, the world would have to brace itself for “a best case scenario” of at least a year of recession and a “lost decade” of low growth – and most people were still in denial about this prospect.

Nouriel Roubini warned of a credit crunch two years ago.

Root causes

But what caused the crisis? A popular theory is that Washington is to blame for the “global cardiac arrest”, because it allowed Lehman to fail.

The panellists rejected this suggestion as “tosh” and “a myth”.

 

This crisis, several economists said, started two years earlier and was “bound” to lead to a financial meltdown – whether it was a bank like Washington Mutual or the likes of Lehman and other parts of the lightly regulated shadow banking system of investment banks, hedge funds and broker dealers.

 

“How could banks be so stupid?,” several panellists asked, and allow things go so wrong so quickly?

The root causes for the economic crisis were too much debt, a culture of short-term rewards for long-term risk-taking and fatally flawed mathematical risk models. And plain old greed.

“Derivatives trading is all about how to make a bonus and how to screw your client,” said Nassim Taleb, a former derivatives trader and author of “The Black Swan,” a book about expecting the unexpected.

The result was a mountain range of “troubled assets” (one of the great euphemisms of the crisis, one expert said) that resulted in billion dollar losses and the need to bail out financial institutions like Fannie Mae, Freddie Mac and AIG even before Lehman collapsed.

Into the hurricane

Morgan Stanley, one expert ventured, was saved only because its share price bounced back when rumours emerged of Washington’s $700bn bail-out package.

Two thirds of the world’s hedge funds would collapse, suggested another. Financial institutions took on debt worth 40 times their assets – and failed to understand how risky this was. Bank’s risk models, a prominent participant revealed, were based on one year’s worth of data.

It was, another expert said, as if a pilot was assuming that he would never fly into a hurricane, because he hadn’t come across one during the past year.

Bankers had no memory, another panellist said, they had forgotten about the Asian crisis in the late 1990s, the collapse of the LTCM hedge fund, and much more.

But it is too easy to single out the bankers – a banker said.

Where were the regulators, rating agencies, corporate boards and central bankers?

What about the borrowers, who did not read contracts and had to know they could not afford these mortgages?

And what about the shareholders and investors, who did not question the business models of the companies they owned? 

 

 

By Tim Weber 
Business editor, BBC News website, in Davos.

http://news.bbc.co.uk/2/hi/business/davos/7859179.stm

Filed under: Business , Bad, Crisis, economic

Do You Want An Internship? It’ll Cost You

Faced with a dismal market for college summer internships, a growing number of anxious parents are pitching in to help — by buying their kids a foot in the door.

Some are paying for-profit companies to place their college students in internships that are mostly unpaid. Others are hiring marketing consultants to create direct-mail campaigns promoting their children’s workplace potential. Still other parents are buying internships outright in online charity auctions.

 

Even as the economy slows, internship-placement programs are seeing demand rise by 15% to 25% over a year ago. Critics of the programs say they deepen the divide between the haves and have-nots by giving students from more affluent families an advantage. But parents say the fees are a small price for giving their children a toehold in a treacherous job market. And operators of the programs claim they actually broaden access to internships by opening them to students who lack personal or political connections to big employers.

The whole idea of paying cash so your kid can work is sometimes jarring at first to parents accustomed to finding jobs the old-fashioned way — by pounding the pavement. Susan and Raymond Sommer of tiny St. Libory, Ill., were dismayed when their daughter Megan, then a junior at a Kentucky university, asked them to spend $8,000 so she could get an unpaid sports-marketing internship last summer in New York City. Paying to work “was something people don’t do around here,” says Ms. Sommer, a retired concrete-company office worker; her husband, a retired electrical superintendent, objected that if “you work for a company, you should be getting paid.”

But Megan, then 20, had already applied for 25 summer internships and hadn’t received any replies. The Sommers gave in, and Ms. Sommer says they’re glad they did. After working last summer for a sports-memorabilia auction concern, Megan has come “out of her shell. It really made her grow as an individual,” Ms. Sommer says. Megan agrees, saying the internship helped her focus her post-graduation career plans.

The program they used, University of Dreams, Los Gatos, Calif., is one of a handful of for-profit internship companies that have sprung up in the past few years. After screening out some applicants — the company won’t say how many — University of Dreams helps students polish their résumés, arranges interviews with employers that offer internships, such as fashion house Donna Karan International or public-relations shop Ruder Finn, and also provides on-campus housing and after-hours social and educational programming for the students during their eight-week internships. The company guarantees an internship placement or refunds students’ fees, which range from $5,000 to $9,500.

Other parents are paying consultants to mount the equivalent of a direct-mail campaign on behalf of their children. Sheila Miller, Albuquerque, says her daughter, Amber, couldn’t find the internship she needed to complete her degree in emergency-management planning at a Texas university; 18 months after completing her course work, Ms. Miller says, Amber was stalled working a $10-an-hour retail job that wasn’t paying the rent.

To jump-start their daughter’s career, Ms. Miller and her husband dipped into the remainder of Amber’s college fund late last year to send her to Fast Track Internships, a Highland Village, Texas, consultant founded in 2005. For $799, the firm helped her polish Amber’s résumé and cover letter, identify 133 target employers and mail them all letters and résumés. Amber soon received 15 calls from employers and last week took an unpaid internship with a city police department, writing their emergency-response plan. “She’s just thrilled,” Ms. Miller says.

Other parents are purchasing internships outright in charity auctions. CharityFolks.com, a fundraising Web site, saw a sharp rise in internships offered for sale last year at such employers as Rolling Stone, Elle magazine and Atlantic Records, says Chief Executive Kelly Fiore. Another site, CharityBuzz.com, says a one-week internship at a music-production company sold last month for $12,000.

Ms. Fiore sees internships as one way to help charities fight “an otherwise staggering downturn” in donations. Mindful of the trend, hard-pressed nonprofits are pounding the pavement to drum up internships to sell. Gina Philips, Los Angeles, a consultant to the Alzheimer’s Association, says demand from wealthy parents has led employers in the entertainment industry to create internships that otherwise wouldn’t exist, just to help raise money.

Some critics say the programs distort students’ job-seeking experience by easing the rigor of the job search. “The type of students corporate America wants are the students who can find their own internships,” says Claudia Tattanelli, CEO of Universum North America, Philadelphia, which consults with employers on recruiting. The vast majority get internships through campus career-services offices or Web sites such as MonsterTrak.com.

Others question the value of the unpaid internships the programs often provide. Another novel internship program, Brill Street & Co., Chicago, founded in 2006, places students only in paid positions and derives its profit by taking a percentage of their paychecks. Nancy Lerner, co-founder, says this is the only way to ensure applicants will get “quality work assignments.” Brill’s applicants have doubled in the past year to about 150 a week.

While career counselors warn that unpaid interns often do little more than pour coffee or run errands, several employers and interns I interviewed said the work was worthwhile. Ruder Finn, New York, has found 29 of its 36 unpaid interns since 2003 through University of Dreams and has hired at least two of them into permanent jobs, says Cathleen Graham, a Ruder human-resources executive.

The internship programs also contend they actually broaden access for students — allowing firms to recruit from lesser-known schools and distant cities. “It’s a huge misconception to say this is a program for rich kids,” says Eric Lochtefeld, CEO of University of Dreams, which operates programs in six U.S. and five overseas cities. “The average student comes from the middle class, and their parents dig deep” to pay for it. His company has begun funding scholarships and grants for low-income applicants.

Mike Esterday of Nashville, Tenn., whose daughter got photography and marketing internships in London and Hong Kong through University of Dreams, says, “it would be really tough to get anything of this caliber, unless you know somebody.”

While some fault parents for “buying your kids an ‘in,’ ” says CharityFolks’ Ms. Fiore, “I happen to feel that a foot in the door is fair, because it’s talent that’s going to seal your fate. It’s your drive and what you do once you’re given the opportunity” that determines how far kids finally get.

Criticism aside, parents see the education and experience their children gain as priceless. Teresa Hayes, Evanston, Ill., plans to pay $3,400 to the Washington Internship Program, which guarantees placement and helps secure housing for students, to secure a Capitol Hill internship this summer for her daughter Leah Barnes, 19, a Stanford University sophomore. Ms. Hayes regards this as just another of many opportunities she has provided her child, from foreign-exchange programs to teen-leadership conferences.

“People say, ‘you’re nuts, are you kidding me? You’re spending thousands of dollars on your kids,’ ” says Ms. Hayes, a pharmaceutical sales representative, who is also paying college tuition for Leah’s younger sister. But Leah “worked so hard. Whatever she wants to do, I want her to have the background to do it intelligently.” Leah, who hopes for a career in international law, says she is grateful and excited.

Without such programs, says Linda Bayer, executive director of the Washington Internship Program, the capital would be “the playground of the children of the rich, whether they were capable or not” — because snaring internships would largely be based on personal connections. But with programs such as hers, “there’s no distinction here between the uber-rich and someone whose parents are schoolteachers.” Her placements are running about 25% ahead of a year ago.

 

By SUE SHELLENBARGER (sue.shellenbarger@wsj.com)

Work & Family JANUARY 28, 2009  - http://online.wsj.com

Filed under: Business , cost, Crisis, internship