- Joined
- Jan 3, 2009
- Messages
- 2,605
- Points
- 0
Wall Street's ivory tower gives bad ideas
People, pundits and politicians looking for financial-crisis culprits should turn their sights to the professors who bear so much responsibility for it.
To borrow a phrase from professor Burton Malkiel, a random walk down Wall Street reveals that some of its biggest disasters have come from ideas hatched in the ivory tower.
The next one may come from Lord John Maynard Keynes, now in fashion as the U.S. government goes on a spending binge.
“Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back,” said Professor Keynes, who died in 1946.
“Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”
I'll wager that his ideas will in time be blamed for the brewing disaster that's sure to follow the explosion in federal deficit spending during and after the financial meltdown. But that's for a future column.
Let's start with Edward Altman, a professor at New York University's Stern School of Business. He published a paper in 1985 showing that the default rate for bonds rated below the investment grade of BBB- (high-yield or junk bonds) was comparable to that of investment-grade issues. Michael Milken, the junk-bond king at Drexel Burnham Lambert, latched on to the same idea and began arranging bond issues to finance the corporate buyout boom of the 1980s.
S&L Crisis
Both men held the view that investors could boost their returns without increasing risk. This view played itself out in the savings-and-loan industry collapse in the late 1980s, fueled partly by their investments in high-yield bonds. Among the most notable was Lincoln Savings & Loan Association, headed by Charles Keating, who invested heavily in Milken junk bonds that played a major role in the lender's failure. The Lincoln debacle also entangled five U.S. senators, the so-called Keating Five, in a political influence-peddling scandal.
Another 1980s disaster with roots in academia was portfolio insurance, which used a computer model to dynamically hedge equity portfolios, selling stock-index futures contracts as prices fell. The firm Leland O'Brien Rubinstein Associates Inc., headed by three academics, pioneered the strategy, which was blamed for contributing to the Oct. 19, 1987, stock-market crash.
Though other forces played a part in that crash, the New York Stock Exchange invoked portfolio insurance when it adopted so-called circuit breakers, which halted trading if the indexes fell by a specified amount.
People, pundits and politicians looking for financial-crisis culprits should turn their sights to the professors who bear so much responsibility for it.
To borrow a phrase from professor Burton Malkiel, a random walk down Wall Street reveals that some of its biggest disasters have come from ideas hatched in the ivory tower.
The next one may come from Lord John Maynard Keynes, now in fashion as the U.S. government goes on a spending binge.
“Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back,” said Professor Keynes, who died in 1946.
“Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”
I'll wager that his ideas will in time be blamed for the brewing disaster that's sure to follow the explosion in federal deficit spending during and after the financial meltdown. But that's for a future column.
Let's start with Edward Altman, a professor at New York University's Stern School of Business. He published a paper in 1985 showing that the default rate for bonds rated below the investment grade of BBB- (high-yield or junk bonds) was comparable to that of investment-grade issues. Michael Milken, the junk-bond king at Drexel Burnham Lambert, latched on to the same idea and began arranging bond issues to finance the corporate buyout boom of the 1980s.
S&L Crisis
Both men held the view that investors could boost their returns without increasing risk. This view played itself out in the savings-and-loan industry collapse in the late 1980s, fueled partly by their investments in high-yield bonds. Among the most notable was Lincoln Savings & Loan Association, headed by Charles Keating, who invested heavily in Milken junk bonds that played a major role in the lender's failure. The Lincoln debacle also entangled five U.S. senators, the so-called Keating Five, in a political influence-peddling scandal.
Another 1980s disaster with roots in academia was portfolio insurance, which used a computer model to dynamically hedge equity portfolios, selling stock-index futures contracts as prices fell. The firm Leland O'Brien Rubinstein Associates Inc., headed by three academics, pioneered the strategy, which was blamed for contributing to the Oct. 19, 1987, stock-market crash.
Though other forces played a part in that crash, the New York Stock Exchange invoked portfolio insurance when it adopted so-called circuit breakers, which halted trading if the indexes fell by a specified amount.
