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ECONNED: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism

I am going to do something I never do: Recommend a book I have yet to read. Harry Markopolos’ No One Would Listen: A True Financial Thriller.

I met Harry several times — a quiet, studious guy. Very serious. The sort of guy you want doing your taxes.

That he discovered the Madoff fraud isn’t very surprising; That he could not get anyone to listen is amazing.

I spoke with two people who are each halfway thru the book — one I cannot reveal, because she will be reviewing it for a major media outlet (Hi C!)  But she grabbed me in the hallway today to wax enthusiastic about it: “A real potboiler page turner! And surprisingly funny, too. You must read this.”

Mine should arrive by tomorrow, and I expect to finish it quickly.

Timeline of Fraud discovery below:

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Investing is such a competitive arena that no matter how good you think you are, it is important that you constantly develop new skills and improve your knowledge base. You cannot afford to simply stand still.

How can you do this? By learning as much as possible about how the markets operate, what makes the economy work, about new trading concepts and various schools of investing thought.

Don’t think of this as light reading. While digesting any investing-related material, you must do so actively, with a keenly skeptical eye. At the same time, you need to have an open mind. Doing both at once ain’t easy.

As part of my ongoing education regimen, I try to read 10 to 20 market/economic/trading-related books per year. This is on top of my regular research and media diet. If out of that list, I find three books that are truly worthwhile, it’s been a good year (this year was excellent). After 15 years of this, I’ve found quite a few books that are truly terrific, and should be of interest to any investor thirsty to learn.

Think of what follows as a course offering for those who want to improve their knowledge and skills. These were chosen for their readability, their wisdom, and their timelessness.

If this were graduate school, you would cover this reading in a year or two. But since you probably have a day job, family and other obligations, I suggest reading a book per month. Take notes — I jot down extensive notes in the margins — then a year later, go back and reread your annotations.

This is by no means a complete reading list. Many books were left off — some were simply too advanced, others obscure, rather inaccessible. And that’s not counting the pile of books I have queued up and haven’t yet read. In order to keep any bias out of the list, I purposefully excluded books written by my colleagues at TheStreet.com. The writers here have a broad body of excellent work — and none of it is included. So don’t take this list as the absolute gospel.

With that in mind, here is part one of my planned two-part introductory course in markets and investing — perfect for the Apprenticed Investor:

Introduction to Investing

Any one of these books will give you insight into investing and the markets. All three will make an essential base for future studies:

• Stock Market Wizards : Interviews with America’s Top Stock Traders by Jack D. Schwager

Schwager interviewed market legends at the height of their success. What makes the book so worthwhile are the consistent themes that evolve from currency traders, mutual fund managers, commodities traders, hedge fund managers. Regardless of what is being traded, there are related motifs that run throughout.

What results is not a “How to trade” book; instead, it is a book about “How to think about trading.”

This has become a seminal book on trading and investing. I actually re-read Market Wizards every five years — it is that good. Wizards was so well received by the financial community that the same author put out The New Market Wizards. Whether you read one or both of these books, you will have knowledge of the market from both the trader’s and the investor’s perspectives.

• The Investor’s Anthology: Original Ideas from the Industry’s Greatest Minds by Charles D. Ellis

Instead of interviewing famed investors, Ellis gathered their best writings into one collection. He ends up with a series of short chapters by luminaries of days gone by. There is something worthwhile on just about every page. This is another favorite worth rereading every few years.

• Bull: A History of the Boom and Bust, 1982-2004,  What drove the Breakneck Market — and What Every Investor Needs to Know About Financial Cycles by Maggie Mahar

The best book about the past 20 years of the market, bar none. Mahar does a terrific job weaving the long tale of how things eventually reached their penultimate top in 2000. She spares no one — the government, the Fed, Wall Street, her colleagues in the financial press — all are subject to a scathing critique for their complicity in inflating the bubble.

Bull! reads like a historical work, despite the recentness of its subject. There are a surprising number of lessons buried in these pages that will reward the careful reader. I found it both fascinating and informative.

Historical Perspectives

It’s astounding how little things have changed over the past century. Yes, information moves more quickly, and computing power has allowed for a more quantitative analysis of stocks — but human nature remains immutable.

• How I Trade and Invest in Stocks and Bonds by Richard Wycoff

This book will help you understand how your brain: processes randomness; overlooks evidence that is inapposite to prior beliefs; selectively perceives and reinterprets data; and engages in selective recall. It’s how we all create an artificial story line to help make sense of otherwise incomprehensible data.

Once you finish this book, you will never look at investing the same way.

Note: This is purely psychology writing; If you prefer a more specific investing-related analysis, consider Why Smart People Make Big Money Mistakes And How To Correct Them: Lessons From The New Science Of Behavioral Economics by the same author (with Gary Belsky).

Hard-core fans of cognitive biases and economic anomalies (and other similar type of analyses) will also appreciate Richard H. Thaler’s The Winner’s Curse. Thaler is one of the most influential researchers in the field of behavioral economics.

If you want to see how cognitive and reasoning deficits manifest themselves, then the seminal book on the subject is Extraordinary Popular Delusions & the Madness of Crowds by Charles Mackay. There have been a lot more booms and busts then you imagine. This book details how they came about and their impact throughout history. Fascinating and instructive stuff.

Once you understand how our brains fool us into occasionally doing idiotic things — funny, but it seemed perfectly reasonable at the time — then you can start looking for ways to avoid making those gaffes. Humphrey Neill’s Art of Contrary Thinking will show you the way. He explains why “When everyone thinks alike, everyone is wrong.” This intriguing thesis applies not only to markets, but to politics, academia, even sports.

What if human nature can never learn from its mistakes? What if we are doomed to repeat the aforementioned cognitive, reasoning and behavioral defects over and again? That provocative thesis is put forth by Robert R. Prechter Jr.: Prechter’s Perspective. This is the book that explains why our own nature leads to history repeating so often.

A few caveats: I am not a devotee of Elliot Wave theory (Prechter’s school of choice). Further, I hasten to add that many of Prechter’s market calls have left much to be desired. However, his overarching perspective of human nature, and of history’s cyclical tendencies, makes for utterly fascinating reading. Even though I found myself arguing with many of the premises in the book, I enjoyed this thoroughly. The cycle geeks out there will too.

In part 2 of the series we’ll look at books focused on economics, Wall Street, technical analysis, fundamentals, shorting, and miscellany.

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I did this interview with Howard Lindzon months ago — forgot all about it until he sent me the embed code for it just now.

Frederick Sheehan is the co-author of Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve.

His new book, Panderer for Power: The True Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession, was published by McGraw-Hill in November 2009. He was Director of Asset Allocation Services at John Hancock Financial Services in Boston. In this capacity, he set investment policy and asset allocation for institutional pension plans.

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On January 14, 2010, an academic economist took a rare stance. Tenured professors rarely lift the veil from numbers that governments invent. In “Don’t Like the Numbers? Change ‘Em,” Michael J. Boskin, Ph.D., formerly, an economics professor at Harvard and Yale; formerly, chairman of the Counsel of Economic Advisers in the George H.W. Bush administration; currently, T. M. Friedman Professor of Economics at Stanford University; research associate at the National Bureau of Economic Research; senior fellow at the Hoover Institution; and board member of the Exxon Mobil Corporation, Oracle Corporation and Vodafone PLC (among others), wielded his sword.

The Wall Street Journal devoted a half page to Boskin’s list of offenders. Politicians are interfering with the Gross Domestic Product calculations in France and Venezuela. They have toyed with the inflation rate in Argentina. In the U.S., the Obama administration has taken the phony numbers game “to a new level.” Here, Boskin is writing of the current adminstration’s calculations of jobs “created or saved” from its stimulus bill.

The “created or saved” job calculation is nonsense, but the very last person one would expect to decry the miscarriages is Michael J. Boskin.

In the early 1990s, Senator Patrick Moynihan from New York warned his fellow legislators about rising social security commitments. Then the worm crawled out of his hole, so to speak. Federal Reserve Chairman Alan Greenspan testified before the Senate and House Budget Committee on January 10, 1995. He told the Committee the inflation rate was probably overestimated by 0.5% to 1.5%.

If Greenspan was correct, this was a godsend. Social security payments are increased each year at an inflation rate calculated by the federal government: the change in the Consumer Price Index (CPI). If the CPI could be increased at a lower rate in the future, benefits would rise more slowly, without Congressional action. This would reduce government spending and delight politicians, who knew of the looming crisis in social security but did not want to imperil their careers by reducing benefits, or, in this case, by cutting the rate at which social security benefits were raised each year.

The Boskin Commission was duly formed. Michael Boskin was the right man for the job. He had served as chairman of the President’s Council of Economic Advisers (CEA) from 1989 to 1993, a post previously held by such government functionaries as Arthur Burns and Alan Greenspan.

Jumping to the conclusion, the Boskin Commission’s Report, as it was known (formally, the “Advisory Commission to Study the Consumer Price Index”) found that inflation was overstated by 1.1%. Several recommendations were made by the Commission to the Budget Committee. These were instituted with great efficiency by the Bureau of Labor Statistics.

The changes have lopped off far more than 1.1% in most years since 1997. From the time the changes were instituted through 2008, the compounding of an artificially low Consumer Price Index reduced payments to social security recipients by about half (according to John Williams, author of the newsletter Shadow Government Statistics).

How the CPI calculation was changed is not important here. (Chapter 12 of my book Panderer to Power is devoted to the Boskin Commission.) One adjustment may help to understand Boskin’s contribution to the impoverishment of older Americans. “Hedonic adjustments” by government number crunchers substitute imaginary prices for prices actually paid. Hedonic adjustments (purportedly, the “quality improvement” of an item) reduce the CPI. (Hedonic adjustments had been employed before the Boskin Commission, but sparingly. Afterwards, even the prices of textbooks – if they had color graphics – were adjusted for quality.)

Steve Leuthold, founder and chief investment officer of the Leuthold Group, calculated the price of a new car in the U.S. had risen from $6,847 in 1979 to $27,940 in 2004. Using hedonic adjustments, the government calculated the price of a new car had risen from $6,847 in 1979 to $11,708 in 2004.

The Boskin Commission was one scandal that economists actually denounced. Greg Mankiw, chairman of George W. Bush’s Council of Economic Advisers from 2001-2003, said at the time “the debate about the CPI was really a political debate about how, and by how much, to cut real entitlements.”

Barry Bosworth of the Brookings Institute called the revised CPI an “ ‘immaculate conception‘ version of deficit reduction in which spending is cut without Congress taking the blame.”

Jack Triplett of the Brookings Institute extended the argument: “What I liked least about the Commission Report was exactly what made it so influential – its guesstimate of 1.1 percentage points of bias….The Commission (and others that have followed) used ad hoc reasoning to come up with a number….”

Jacob Ryten, from the Canadian statistical office, wrote in the same vein: “Without the guesstimates, the Commission Report was just another dry, academic study to be perused by professionals… Conversations with Committee members suggest that some, at least, were ill at ease themselves with guesstimates…. My personal preference is to resist the seductive blandishments of politics and politicians….”

Jack Triplett chided the Report as succumbing “to the lure of political statements in its choice of language to describe the effect of CPI measurement errors on Social Security expenditures…. Professionals at any rate, should understand that improving the accuracy of the CPI is not the same thing as improving the basis for allocation to the dependent population….”

Professionals, at any rate, have seen fit to keep Michael Boskin at the summit after he succumbed to “seductive blandishments of politics and politicians.” It cannot be said that Boskin dishonored his profession, since he is still a superstar. Other professions institute bodies such as the American Bar Association and the American Medical Association that take action against negligence.

Federal Reserve Chairman Ben S. Bernanke, another pliant alumnus of the CEA, sits before the Senate claiming there is no inflation in the economy. He uses the CPI as his measure, taking the additional step of removing food and energy costs.

Near the end of his Wall Street Journal effort, Boskin wrote of the Obama job numbers: “One piece of good news: The public isn’t believing much of this out-of-control spin.” He’s probably correct, but spinning the number of jobs “created or saved” has no consequence, other than to increase the public’s distrust of government. The distortion of the CPI should have been censured by his profession, if it is that.

Frederick Sheehan is the author of Panderer for Power: The True Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession

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See his blog at aucontrarian.com.

Imagine my surprise when I come home to find a review copy of a book called:  The Big Picture: Essential Business Lessons from the Movies by Kevin Coupe and Michael Sansolo arrived in the mail today!

The authors say they “show how to use the stories in movies to solve problems in business.” I’ve only skimmed it so far, but it looks like a run through the usual business maxims, only told via films — 6 sections, about 50 movies, ranging from The Godfather (Its business, not personal) to The Producers to Jaws.

Sounds like a fun. I may have to bring this one to the beach — it looks like good hammock reading!

UPDATE: Videos here

Here are the most up-to-date collection of reviews for Bailout Nation:

USA Today: “Best books to make sense of financial crisis of 2009”
Miami Herald: “Best business books of 2009”
Marketplace Radio: The best business books of 2009
Stock Trader’s Almanac: “Investment Book of the Year”

“Succeeds in laying out all that transpired in easy-to-understand language. If you want to know how we got into this mess and what might still be coming, this is the book for you.”
-Wall Street Journal

“The author writes with the fury of an insider mortified by the behavior of his heretical peers . . . There is much to be said for the book’s irreverence. Mr. Ritholtz has written an important book about a complicated subject, and yet you could still read it at the beach. Here’s hoping that some policy makers in Washington take it with them on vacation this month.”
-New York Times

“Ritholtz makes a valuable new contribution to our understanding of how we arrived at this sorry juncture. He’s smart, sassy and often amusing. If you’re looking for an all-in-one place explanation of what went wrong and why, this is the book for you (or your confused neighbor).”
-Bloomberg

Bailout Nation’s straightforward, compelling account puts the crisis in context, explains why the US government responded so stupidly, offers solutions, and advises how to prevent a repeat. Ritholtz’s indictment of the financial and political establishment is devastatingly accurate.
-Asia Times

“Before the housing and credit bubbles popped, Barry Ritholtz, a lawyer turned blogger and money manager, was one of the voices crying in the wilderness. His caustic (and occasionally profane) blog, The Big Picture, dissected macroeconomic news and relentlessly cut through spin. His book takes a long view of the roots of the economic crisis, tracing the history of a series of ever more expensive taxpayer-funded bailouts of failed industries.”
-Newsweek

“Ritholtz’s book seeks to explain how the United States, once so proud, became “a nanny state for well-paid bankers. Ritholtz may be just the right person to explain the transition to both the disillusioned amateur and the finance junkie. He doesn’t pull his punches or bury the truth in layers of finance-speak, caveats, and disclaimers. Since he began blogging seven years ago, in-the-know readers of his popular blog, The Big Picture, have turned to Ritholtz for his prescient, refreshingly honest commentary on the economy. Anyone interested in understanding the roots of our current crisis should check out the book..”
-Freakonomics

“A comprehensive crisis scrapbook compiled by the money manager behind the popular financial blog the Big Picture in a quippy, no-nonsense voice…”
-New York Magazine

“These are some of the provocative and even dangerous questions that Barry Ritholtz takes on in Bailout Nation…Above all, Bailout Nation is about the socialization of risk and the privatization of profits.
-Forbes

Bailout Nation made another “Best of” year end list:

A look back at the best business books of 2009

I didn’t — couldn’t — read every business book published during the past year, but I was still gob-smacked by the number of books that I did read in 2009, including a few just for fun. (Imagine that!) But among those that I read and reviewed in this space, these titles represent the ones that I thought were exceptional, have lasting value and were worth my time — and yours.
A few things that may have deserved inclusion didn’t make the cut for one reason or another, and some worthy titles that came out in 2009 won’t get reviewed until January. Them’s the breaks. You may have a few choices that aren’t here either. If you’d like to share, I’m always happy to get e-mail from readers. After all, you make this all possible.

Thanks for reading!

(Books listed in chronological order by review. Date of original review follows each title. Full reviews of all books on this list are online at www.richardpachter.com)

Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy. Barry Ritholtz. Wiley. 332 pages. 6/1/09

Economist and investment guru Barry Ritholtz’s blog, The Big Picture, is a mandatory daily stop for many. This honest, unvarnished look at the forces that screwed up the U.S. economy is a worthy candidate for a time capsule so that future financial operators can avoid the same traps that we fell into. Or at least howl when history repeats itself.

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Source:
A look back at the best business books of 2009
Business Monday books columnist Richard Pachter offers his highly subjective list of favorites.
RICHARD PACHTER
Miami Herald, 12.28.09

http://www.miamiherald.com/business/v-fullstory/story/1399600.html

USA Today is out with its list of best business books for 2009 — Too Big Too Fail and Bailout Nation top the list.

“After the collapse of Lehman Bros. in September 2008, Federal Reserve Chairman Ben Bernanke, then-Treasury secretary Henry Paulson and then-New York Fed president Timothy Geithner stood on the brink of catastrophe. Their decision not to bail out Lehman set off a near panic among investors and lenders worldwide.

In response, the government implemented a $700 billion bailout and has since adopted a series of rescue measures that put U.S. taxpayers on the hook for a potential $14 trillion, author Barry Ritholtz says.

The panic and the U.S. reaction spawned a wave of books. Money Bookshelf editor Gary H. Rawlins picks some of the better ones. The selection includes books that point the finger at Wall Street firms and their CEOs, that blast the government for excessive bailouts, that assail the U.S. economic policy triumvirate for letting the inflation genie out of the bottle, and that explain arcane financial derivatives and how they acted as viral agents spreading the crisis to the global economy.

•Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System — and Themselves by Andrew Sorkin (Viking Adult, $33). Arguably the definitive history of the banking crisis, a blow-by-blow account of how decisions made on Wall Street and in Washington in the past decade led to the crash of the global financial system.

•Bailout Nation: How, Greed and Easy Money Corrupted Wall Street and Shook the World Economy by Barry Ritholtz (Wiley, $25). Explores how the U.S. evolved from a rugged independent nation to a soft Bailout Nation, where financial firms are allowed to self-regulate in good times, but are bailed out by taxpayers in bad times.

Way cool !

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Source:
Year’s best business books to make sense of financial crisis
Gary Rawlins
USA TODAY, December 21, 2009

http://www.usatoday.com/money/books/2009-12-20-years-best-business-books_N.htm

I have a long list of books waiting to be read — these half dozen, however, are at the top of my list — sitting on a shelf, patiently waiting to be read — or for my next flight:

• Carmen M. Reinhart and Kenneth Rogoff, This Time is Different: Eight Centuries of Financial Folly Doesn’t it figure: The one book I don’t have is the one I want to read the most.

• Stephen Roach, Next Asia: Opportunities and Challenges for a New Globalization: Roach up and moved to Asia a few years ago, so I am curious as to what he has to say. Recent FT columns by him, however, make it clear he believes the “supply-oriented growth model that leaves the region heavily dependent on external demand” is sub-optimal. to say the least.

• Bruce Bartlett, The New American Economy: The Failure of Reaganomics and a New Way Forward Bartlett is a fascinating character, furious at W for betraying Reagan’s policies. The book has been described as “an informed insider’s knowledge with an economic historian’s perspective.”

• David J. Leinweber, Nerds on Wall Street: Math, Machines and Wired Markets Professor Leinweber is an alpha geek, an interesting and funny guy — the book looks quirky, chock full of his personality. This one looks like fun.

• Steven Pinker, The Stuff of Thought: Language as a Window into Human Nature What language reveals about the Human framework of basic cognitive concepts.

• David Wessel, In Fed We Trust: Ben Bernanke’s War on the Great Panic Yes, it will be homework — but Wessel is a good writer, and I hope it is informative about the Fed’s inner workings.