Change or Dopamine?
When the stock market started creeping up this week, the money pundits immediately began buzzing and babbling — Is this the rebound? Did we just hit bottom? It might be time to buy. Get in now. You could be rich next year, or maybe even tomorrow.
Why are we so reactionary? MIT finance professor Andrew Lo’s research indicates that when traders feel they have made some good picks, dopamine is released into their brains creating a stupor which causes them to under-perceive dangers and risks. On the other hand, when a few bad trading choices are made, the threat of loss activates fight-or-flight mechanisms, releasing adrenaline and cortisol into the bloodstream, which can result in over-perceiving risk. Thus, tiny glimmers of hope can produce huge upswings, while a little bad news can make stock markets tank. It’s not rational, it’s psychological. Which is not to say, as our favorite cowboy deregulator Phil Gramm once did, that we’re in a “mental recession.” The recession, in fact, is fundamental. It’s the day-to-day spasms that are “mental.”
Some made millions last week, jumping in and out of stocks like cold baths. Others stood back and observed as their 401(k)s recovered a small fraction of what’s been lost.
Jon Stewart scolded CNBC “Mad Money” host Jim Cramer on the Daily Show this week for misleading viewers during the boom. Stewart showed us a 2006 interview in which Cramer boasted that, as a hedge fund manager, he manipulated futures to make money on short positions, and encouraged others to do it “because it’s legal, and it’s a very quick way to make money, and very satisfying.” The videotape also showed Cramer explaining how to spread false rumors about Apple to make some quick money.
But despite Cramer’s first-hand experience of the way traders manipulate markets and of the lies that they tell (and he told), the TV personality still stoked the irrational exuberance during the boom period. If he knew so well how the game was played and how deception reigned supreme in the markets, then why on earth did Cramer take the words of Lehman CEO Dick Fuld, and Bear Stearns CEO Jimmy Cayne, at face value?
It’s the dopamine, stupid.
Which raises the question: What has been done to limit market manipulation going forward? Unfortunately, the answer is nothing, yet. There’s been talk of re-instituting the uptick rule, first enacted by Joseph Kennedy after the crash of 1929, but withdrawn in a deregulatory, dopamine-induced frenzy a few years ago. The rule reasonably requires an uptick in share prices before investors can short a stock, and thus would curb the same kind of manipulation that dopey Jim Cramer once recommended. But the feds are dragging their feet. SEC discussions on the issue will begin in April, but it could take months to reach a resolution on this no-brainer.
Most disturbing is a movement in the banking industry and by certain commentators (including Newt Gingrich and Ben Stein) to suspend the so-called “mark-to-market” valuation rule. In fact, the industry has persuaded two federal law makers to introduce a bill that would permit a suspension of the rule.
The current rule requires banks to value assets based on their actual value as determined by how much a reasonable buyer would pay for them today. Why was this rule implemented to begin with? Remember Enron? One of the primary reasons Enron imploded was because of its creative asset valuations, whereby a given valuation was based not upon the current state of affairs, but rather on far-fetched assumptions treating future contingent events (like income streams, business deals, etc.) as certainties. The results were assets whose stated values had no basis in reality. And when the vast number of contingencies that Jeff Skilling and Andy Fastow conveniently assumed were accomplished facts, fell through, Enron was toast.
Now the banks apparently want to re-institute the loosey-goosey rule that enabled Enron to hang itself. They say the current rule forces them to value certain toxic assets at zero (because that’s about all a reasonable buyer would pay for them in today’s market), when they’re really worth more since banks intend to hold the assets for a substantial period of time. It’s kind of like saying that that, while my stock in GE is currently about $9.50 per share, I should be able to book it at, say, $20 per share because, if all goes well, that’s where it will be by the time I get around to selling it.
The astonishing thing is that the proposal to suspend the mark-to-market rule is being taken seriously. Regulators are actually considering permitting the banks to value their assets at a price the banks think they should be worth, rather than what they’re actually worth. Thus, while it is common knowledge that pervasive market manipulation was a substantial cause of our current Great Recession, regulators are contemplating whether it might be possible to manipulate our way out of the crisis by letting banks send the market false (or at least very dubious) signals regarding the value of their enterprises.
At a recent accounting conference at Pace University, the question was asked to the mark-to-market critics in the audience if they had a better way of determining market value than the current rule? Tellingly, nobody raised their hand.
As business columnist Floyd Norris notes:
Next time you hear a banker denounce mark-to-market rules, ask if he runs his business that way. Will he offer you a mortgage loan based on what you think your home should be worth, which you can repay only if you make a lot more money than anyone will pay you?
The attempts to suspend the mark-to-market rules should be rejected. All it would do is produce some short-term spikes (enabling a elite few to get more free lunches) and a lot of excess dopamine, when what we need is some cool and sober analysis of the country’s systemic economic problems; and realistic proposals, with an eye on the long-term, of how we can stop the endless cycles of bubble and bust by ensuring there are reasonable rules of the road in the finance industry.
Comments
By todd on March 14th, 2009 at 5:24 pm
The analogy of GE price with the MTM rule is a little like apples and oranges. If the loans are still being paid why should the underlying value be marked down to zero? And therefor why should the true value of a property be subject to the temporary perceived value? The reason , I would offer, that no one raised their hand is because value is subjective, why make banks vulnerable to subjective swings? The banks can’t move forward with capital ratio swings which is what the MTM brought about through unitended consequences.
Cramer has been out front in describing how the hedge funds work and how the markets work for that matter. I don’t think Cramer ever takes a CEO at face value. I have watched Cramer every night for the last few years but would never trade directly upon a specific recomendation. His picks have been proved to be wrong more than computer generated random pics. However his insights into trading equities are invalueable because because of his honesty and his ability to explain sophisticated strategies in ways that a regular guy can understand. For a comedian to scold cnbc for wooping up the markets and lying to its viewers is so laughable, more like scapegoating for his(Cramer’s) critizisms of the administrations view of the DOW average as another poll. Cramer is the first one to tell you not to believe those rumors.
Also I would propose, that many of the spasmatic minute by minute swings have little to do individual mental shifts and more to do with rationality. Computers are doing most of the trading and computers are 100% rational. The good news about the banks turning a profit for the last two months along with the news about the cure for pancreatic cancer and the stabilization of consumer sentiment were all fundamental reasons for a small bounce off the 12 year lows. The Madoff guilty plea was definitly a psycological boost. Most pundits have termed the bounce as a bear market rally with plenty of caution. After all we all know that markets do not move in a straight line.
All of the hedge funds can find their way around the uptick rule, why not let people short stocks at will? If they go low enough someone will step in and buy. So what change would you propose other than the uptick rule? Fight and flight are hardwired into the human brain so what is the rational way to set prices? The only way that I see to set prices is to slug it out on virtual trading floors. Those with the ability to trade with a strategy win , those who trade on emotion lose and don’t stay in the game for long.
By Aaron Knapp on March 16th, 2009 at 5:36 pm
Not all of the toxic junk bonds are marked down to zero. They’re marked down to whatever they’re worth at a given time, and not some future time, in some future place, at some future price conjured up by Ernst & Young and some creative CFO. These securities are mind-numbingly complex — they are bonds of bonds of bonds and bonds, sliced and diced thousands of times along the way. In light of this, your assertion “the loans are still getting paid” is a little glib.
Yea Stewart was a little zealous, but Cramer was drinking the Kool-Aid, and he’s an idiot who had no foresight and who was probably getting his palms greased by his buddies in exchange for riling the markets/.
There are rational elements, and irrational elements. Self-deception, however, is not rational.
The fact that some people might break the uptick rule is not an argument against the uptick rule. That’s an enforcement issue, which also has to be dealt with.