The study of behavioral finance has exposed many of the heuristics and biases of investors. While financial pundits are aware of this literature, they are just as susceptible as the average investor.
At "A Dash" we believe that opportunity knocks when too many rush to over-simplify.
Pundits and the Academic Stereotype
Here is a test that readers can try at home. When some financial writer or trader dismisses someone as an academic, take an extra look at the argument offered. Our experience is that those using such stereotypes do so to mask hasty arguments.
These writers reveal their own naivete' , since any sophisticated person knows better than to reason from stereotypes.
Inhabitants of the Ivory Tower
Academics come in all shapes and sizes. These include many who fit the stereotype of the ivory tower dreamer just perfectly. Our colleagues have included one who could name the leader of virtually any foreign nation. "Let's see," he said, presenting a little test for his colleagues at lunch one day in the 80's, "are we allies with the South Yemeni's or the North Yemeni's?" He was great on facts, but not as good on political and economic processes. Another was an expert in sociology and political theory, but he did not know what a linebacker was, and certainly could not name eone. Another joined us for a Packer playoff game at Lambeau Field. After the first score he inquired how many points were awarded for the kick after a touchdown. At least he knew when to cheer!
By contrast, there are professors who are quite interested in both theory and application. In science and engineering, their work is the basis for much of our progress - things like new drug discoveries, new software, advances in computing, and better manufacturing processes. In the humanities one would be surprised by the many practical questions from speech, language, and literature. Any reader who does not understand this missed some great classes.
In public policy analysis there are academics whose work is directly relevant to the study of existing policies and possible improvements.
Dismissing someone as an "academic" is a disparaging stereotype that is no more accurate than any of other, including the insults rejected by any thinking observer -- those based upon race, ethnicity, or gender.
The Natural Human Tendency
We conducted many classes that had team teaching with professors from different fields. The biggest single problem was to get each of these experts to appreciate the contributions of the others. In a seminar on environmental policy, for example, the scientists had an attitude of "zero tolerance." The economists favored incentives that encouraged pollution reduction. Political scientists looked for solutions that could garner the coalition of political support necessary for adoption.
What traders and market pundits do is much the same thing. They dismiss the relevance of knowledge they personally lack.
Why Should We Care?
In general, investors can profit from mistaken viewpoints that are widely shared in the financial community. (Yes, we know. It does not happen overnight. This is a recurring theme at "A Dash.")
In this case we believe that the financial punditry has done a poor job of anticipating and explaining Fed actions. This is partly because they dismiss the Fed members as "academics" while they are "realists."
Getting this right can be profitable.
Discovering Relevant Academics
Here is a simple lesson that any financial pundit should be able to grasp. When looking for relevant academic expertise --
....let the market do it for you.
There is a very simple rule that we learned long ago in our own (extensive) consulting work. Those who are doing something relevant are in demand -- working as consultants and sometimes moving into government. Those whose work is strictly theoretical stay in the university.
Applying this Principle to the Fed
Last week we highlighted the excellent discussion of David Merkel, who described various attributes of Fed members. He went so far as to highlight the relevance of academic research from some, getting most of the way to a conclusion.
We wrote as follows:
Some months ago when the FOMC membership was criticized as a bunch of academics we did our own check of the backgrounds. We were looking for a very specific credential which gets no respect in the financial community. Even in the astute Merkel analysis, this credential is not mentioned; in fact, it is given short shrift.
Any guesses as to what this might be?
Let us turn to the Merkel summary and find a few highlights. It is pretty easy because virtually every FOMC member has something relevant.
The key ideas are under "political" dealings. (Kudos to reader Chris who spotted the point from our earlier article). Public policy analysts distinguish between "political" and "policy formation." David would not know this, but it is not nit-picking. It is just as significant as any technical term from his own insurance experience.
The FOMC members have a range of relevant experience including the following:
- Membership and chairing the Council of Economic Advisors -- perhaps the most important role in economic policy formation;
- Under-Secretary positions at Treasury. Once again, these are the positions sought by academics who seek to have some impact on the world;
- World Bank, IMF, and other consulting;
- Experience at money management firms including Morgan Stanley;
- Associations with an wide array of policy-oriented think-tanks. These are places where research is expected to be policy-relevant.
Briefly put, nearly every member of the FOMC has extensive experience in policy formation and implementation, far from the theoretical world of the ivory tower. This experience is much more relevant that that of someone who has worked on a trading desk or (for example) run a trucking company. It is more relevant in breadth and in method.
Most Fed observers in the financial press have been slow to grasp and appreciate Fed policy. As a result, their predictions and explanations have been poor. They have been more interested in criticizing the Fed and offering their own opinions of what should be done, rather than helping investors understand what is actually happening. They have looked only at the level of the Fed funds rate and the money supply. Meanwhile, the Bernanke Fed has looked more carefully and deeply into the problem. The result is a set of policies that has (at least partially) made up for the broken "mark-to-market" accounting methods by addressing the most acute liquidity needs.