XBRL:  The Next Big Thing

Bob Jensen's Enron Quiz (with answers) --- http://www.trinity.edu/rjensen/FraudEnronQuiz.htm

Tom Selling's blog The Accounting Onion (great on theory and practice) --- http://accountingonion.typepad.com/

"Corporate Reports Now Searchable Via EDGAR," SmartPros, June 16, 2006 --- http://accounting.smartpros.com/x53502.xml

Investors and analysts can now search the full text of every SEC document filed by companies within the last two years. They'll also be able to retrieve mutual fund filings by fund or share class.

The company filing search engine enables real-time, full-text searches of filings on the entirety of the SEC's EDGAR (Electronic Document, Gathering, Analysis and Retrieval) database of company filings for the last two years. The tool can be found at http://www.sec.gov/edgar/searchedgar/webusers.htm.

SEC Chairman Christopher Cox, a strong proponent of using the Internet to post dynamic financial reports and to serve as a tool for investors and analysts made the announcement in his opening remarks at the SEC's Interactive Data Roundtable in Washington, D.C.

"This new full-text search capability will give investors and analysts instant access to the specific information they want," said Cox.

The new mutual fund search capability was made possible when the SEC recently required that filings contain a unique numerical identifier for each fund and share class. Investors will be able to find relevant filings by searching for the name of their own fund. In the past, searching for information on particular funds and particular share classes within funds was very difficult, because a single prospectus might contain information about many mutual funds and share classes.

The SEC is asking users of this Web site feature to supply feedback, including suggestions for additional functions, so that further improvements to the site can be considered and implemented.

Paul Pacter has been working hard to both maintain his international accounting site and to produce a comparison guide between international and Chinese GAAP.  He states the following on May 26, 2005 at http://www.iasplus.com/index.htm 

May 26, 2005:  Deloitte (China) has published a comparison of accounting standards in the People's Republic of China and International Financial Reporting Standards as of March 2005. The comparison is available in both English and Chinese. China has different levels of accounting standards that apply to different classes of entities. The comparison relates to the standards applicable to the largest companies (including all non-financial listed and foreign-invested enterprises) and identifies major accounting recognition and measurement differences. Click to download:

Comparison between PRC GAAP and IFRS (English) (PDF 688k)   Comparison between PRC GAAP and IFRS (Chinese) (PDF 675k)

The chronology of events leading up to European adoption if common international accounting standards --- http://www.iasplus.com/restruct/resteuro.htm

Large International Accounting Firm History --- http://en.wikipedia.org/wiki/Big_Four_auditors

Tom Selling's blog The Accounting Onion (great on theory and practice) --- http://accountingonion.typepad.com/

"Pre-Med Education Must Be Compatible with Liberal Arts Ideals," by Timothy R. Austin, Inside Higher Ed, July 31, 2008 --- http://www.insidehighered.com/views/2008/07/31/austin

Also see http://www.trinity.edu/rjensen/HigherEdControversies.htm#CatFights

Were Islamic records precursors to accounting books based on the Italian method?" by Zaid, Omar Abdullah, Accounting Historians Journal, June 20, 2009 --- http://findarticles.com/p/articles/mi_qa3657/is_200006/ai_n8887031/

Abstract:
The precise origin of the accounting records and reports outlined by Pacioli in 1494 and used in the Italian Republics is presently unknown. Historical evidence preserved in Turkey and Egypt indicates that accounting records and reports developed in the early Islamic State were similar to those used in the Italian Republics as outlined by Pacioli in 1494. Furthermore, some of the records and reports used in different parts of the Islamic State are comparable to modern-day books and reports. The religious requirement of Zakat (religious levy) and the increasing responsibilities of the Islamic State were the force behind the development of accounting records and reports by Muslims. The Islamic State was established in 622, and Zakat was imposed on Muslims in the year 2 Hijri'iah (H) (623). The enactment of Zakat necessitated the establishment of the Diwan (office where accounts are held) and the initial development of accounting records and reports. These records were further developed in Addawlatul Abbasi'iah (Abbaside Caliphate) between 132-232 H (750-847) whereby seven accounting specializations were known and practiced. Auditing played a very important role in the Islamic State and was designated as one of the accounting specializations. This paper argues that it is most likely that the commercial links between Muslim traders and their Italian counterparts influenced the development of accounting books in the Italian Republics.

The for-free IASC comparison study of IAS 39 versus FAS 133 (by Paul Pacter) at http://www.iasc.org.uk/news/cen8_142.htm

The non-free FASB comparison study of all standards entitled The IASC-U.S. Comparison Project: A Report on the Similarities and Differences between IASC Standards and U.S. GAAP
SECOND EDITION, (October 1999) at http://stores.yahoo.com/fasbpubs/publications.html 

In 1999 the Joint Working Group of the Banking Associations sharply rebuffed the IAS 39 fair value accounting in two white papers that can be downloaded from http://www.iasc.org.uk/frame/cen3_112.htm.

• Financial Instruments:  Issues Relating to Banks (strongly argues against required fair value adjustments of financial instruments).  The issue date is August 31, 1999.  
  Trinity University students may view this paper at J:\courses\acct5341\iasc\jwgbaaug.htm.  
  Others may go to the IASC download site at http://www.iasc.org.uk/pix/banksjwg.pdf.
  
  

• Accounting for financial Instruments for Banks (concludes that a modified form of historical cost is optimal for bank accounting).  The issue date is October 4, 1999
  Trinity University students may view this paper at J:\courses\acct5341\iasc\jwgfinal.htm 
  Others may go to the IASC download site at http://www.iasc.org.uk/pix/jwgfinal.pdf.

Also see the Financial Accounting Standards Board (FASB) and the International Federation of Accountants Committee (IFAC).

Side by Side: IAS 39 Compared with FASB Standards (FAS 133), by Paul Pacter, as published in Accountancy International Magazine, June 1999 --- http://www.iasc.org.uk/news/cen8_142.htm 
Also note "Comparisons of International IAS Versus FASB Standards" --- http://www.deloitte.com/dtt/cda/doc/content/pocketiasus.pdf

October 21, 2005 message from Scott Bonacker [lister@BONACKERS.COM]

I remember a thread or two asking for information on historical figures or accounting heros or something like that. I couldn't come up with the right key words to find it by searching the archives unfortunately.

When I saw this article, I thought this was someone that should be included:


"Mary T. Washington of Chicago stepped bravely beyond race and gender boundaries in 1943, becoming the first black female certified public accountant in the United States. Washington, 99 years old when she died in late July, first opened an accounting practice for African-American clients in her basement while working on her college degree.

Washington lived and led in a world not yet here, creating what her business partner later called an "underground railroad" for aspiring black CPAs.
...."

Read the rest at: 
http://www.sojo.net/index.cfm?action=magazine.article&issue=soj0511&article=051149
 

October 21, 2005 reply from Bob Jensen

Hi Scott,

Although there are probably various interesting sites such as those you mentioned, there are several sites that are of particular interest with respect to famous accounting practitioners and academics.

The OSU Accounting Hall of Fame
It should be noted that members elected to this Hall of Fame include famous accountants from around the world --- http://fisher.osu.edu/acctmis/hall/ 

U.K. Accounting Hall of Fame
Professors David Otley and Ken Peasnell of the Department of Accounting and Finance are two of the fourteen founding members of the British Accounting Association’s Hall of Fame. The ceremony took place at the British Accounting Association 2004 Annual conference at York in April 2004 --- http://www.lums.lancs.ac.uk/news/3806/ 

Michigan State Video Archive
I've not yet seen anything about other accounting Hall of Fame sites. Michigan State University has a video archive of famous accountants. These accountants were invited to campus and then taped live. I don't think any of this footage is available online, but it would be a nice thing to do now that digitization hardware is so inexpensive. Don Edwards (U. of Georgia) probably knows more about these videos than anybody else.

A few accountants who became famous in fields other than accounting are listed at http://www.educationwithattitude.com/catch/accounting.asp 

The above site missed my favorite accounting celebrity John Cleese
The Unofficial Monty Python Website --- http://www.educationwithattitude.com/catch/accounting.asp

Note especially The Accountancy Shanty (audio) at http://www.educationwithattitude.com/catch/accounting.asp 

Bob Jensen

October 23, 2005 reply from Tom Sentman [TSentman@MSN.COM]

Here is a historical figure for consideration. While not a CPA, Luca Pacioli is considered to be the father of accounting. Although he did not invent dual-entry accounting, he described the system as we know it today. I always use this question on my tests.

Visit http://acct.tamu.edu/smith/ethics/pacioli.htm  for more.

Cheers,

Tom Sentman

One of the early contributors to value theory in accounting was Theodore Limperg from Holland.

The social responsibility of the auditor: A basic theory on the auditor's function  by Theodore Limpberg ((Hard to Find, but no doubt Steve Zeff has a copy. Steve is an expert on accounting in The Netherlands). A copy no doubt is also on file at the Accounting History Libraries at the University of Mississippi (Ole Miss) --- http://www.olemiss.edu/depts/accountancy/libraries.html

Question
How does accounting for time differ from accounting for money?
Remember those Taylor and Gilbreth time and motion studies in cost accounting.
How has time accounting changed in the workplace (or should change)?

The link below was forwarded by Gregory Morrison at Trinity University

Studies have shown the alarming extent of the problem: office workers are no longer able to stay focused on one specific task for more than about three minutes, which means a great loss of productivity. The misguided notion that time is money actually costs us money.
"Time Out of Mind," by Stefan Klein, The New York Times, March 7, 2008 --- Click Here

In 1784, Benjamin Franklin composed a satire, “Essay on Daylight Saving,” proposing a law that would oblige Parisians to get up an hour earlier in summer. By putting the daylight to better use, he reasoned, they’d save a good deal of money — 96 million livres tournois — that might otherwise go to buying candles. Now this switch to daylight saving time (which occurs early Sunday in the United States) is an annual ritual in Western countries.

Even more influential has been something else Franklin said about time in the same year: time is money. He meant this only as a gentle reminder not to “sit idle” for half the day. He might be dismayed if he could see how literally, and self-destructively, we take his metaphor today. Our society is obsessed as never before with making every single minute count. People even apply the language of banking: We speak of “having” and “saving” and “investing” and “wasting” it.

But the quest to spend time the way we do money is doomed to failure, because the time we experience bears little relation to time as read on a clock. The brain creates its own time, and it is this inner time, not clock time, that guides our actions. In the space of an hour, we can accomplish a great deal — or very little.

Inner time is linked to activity. When we do nothing, and nothing happens around us, we’re unable to track time. In 1962, Michel Siffre, a French geologist, confined himself in a dark cave and discovered that he lost his sense of time. Emerging after what he had calculated were 45 days, he was startled to find that a full 61 days had elapsed.

To measure time, the brain uses circuits that are designed to monitor physical movement. Neuroscientists have observed this phenomenon using computer-assisted functional magnetic resonance imaging tomography. When subjects are asked to indicate the time it takes to view a series of pictures, heightened activity is measured in the centers that control muscular movement, primarily the cerebellum, the basal ganglia and the supplementary motor area. That explains why inner time can run faster or slower depending upon how we move our bodies — as any Tai Chi master knows.

Time seems to expand when our senses are aroused. Peter Tse, a neuropsychologist at Dartmouth, demonstrated this in an experiment in which subjects were shown a sequence of flashing dots on a computer screen. The dots were timed to occur once a second, with five black dots in a row followed by one moving, colored one. Because the colored dot appeared so infrequently, it grabbed subjects’ attention and they perceived it as lasting twice as long as the others did.

Another ingenious bit of research, conducted in Germany, demonstrated that within a brief time frame the brain can shift events forward or backward. Subjects were asked to play a video game that involved steering airplanes, but the joystick was programmed to react only after a brief delay. After playing a while, the players stopped being aware of the time lag. But when the scientists eliminated the delay, the subjects suddenly felt as though they were staring into the future. It was as though the airplanes were moving on their own before the subjects had directed them to do so.

The brain’s inclination to distort time is one reason we so often feel we have too little of it. One in three Americans feels rushed all the time, according to one survey. Even the cleverest use of time-management techniques is powerless to augment the sum of minutes in our life (some 52 million, optimistically assuming a life expectancy of 100 years), so we squeeze as much as we can into each one.

Believing time is money to lose, we perceive our shortage of time as stressful. Thus, our fight-or-flight instinct is engaged, and the regions of the brain we use to calmly and sensibly plan our time get switched off. We become fidgety, erratic and rash.

Tasks take longer. We make mistakes — which take still more time to iron out. Who among us has not been locked out of an apartment or lost a wallet when in a great hurry? The perceived lack of time becomes real: We are not stressed because we have no time, but rather, we have no time because we are stressed.

Studies have shown the alarming extent of the problem: office workers are no longer able to stay focused on one specific task for more than about three minutes, which means a great loss of productivity. The misguided notion that time is money actually costs us money.

And it costs us time. People in industrial nations lose more years from disability and premature death due to stress-related illnesses like heart disease and depression than from other ailments. In scrambling to use time to the hilt, we wind up with less of it.

Continued in article

March 12, 2008 reply from David Albrecht [albrecht@PROFALBRECHT.COM]

For those who don't remember these time and motion studies (about 100 years ago), here is a summary:  http://www.netmba.com/mgmt/scientific/

Pondering your question, I keep coming back to a humorous story I read in Reader's Digest years ago.  A person's car breaks down and a mechanic with a fine reputation is summoned.  The mechanic looks over the engine, pulls out a screwdriver, and in about three seconds tightens a screw.  The mechanic then hands the driver a bill for several hundred dollars.  The driver complains about paying so much for so little of the mechanic's time.  The mechanic replies that the itemization was $0.10 for the act of tightening the screw, and hundreds of dollars for knowing what to tighten.

At this time I refrain from saying much about the Empire Club and it's ability to charge thousands of dollars per hour for the time of its models.  I'm wondering if Governor Spitzer maintained personal financials according to GAAP, would he have reported his time involvement with Empire Club as a contingent liability.

Bob, you're retired and on pension, I'm still employed and getting paid.  The time you spend surfing, writing and sharing on AECM is unrecompensed, but mine is not.  Yet, you provide much more value to AECM than I.

David Albrecht

How Foucault, Derrida, Deleuze, & Co. Transformed the Intellectual Life of the United States
"French Theory," by Scott McLemee, Inside Higher Ed, April 17, 2008 --- http://www.insidehighered.com/views/2008/04/16/mclemee

Last week, while rushing to finish up a review of Francois Cusset’s French Theory: How Foucault, Derrida, Deleuze, & Co. Transformed the Intellectual Life of the United States (University of Minnesota Press), I heard that Stanley Fish had just published a column about the book for The New York Times. Of course the only sensible thing to do was to ignore this development entirely. The last thing you need when coming to the end of a piece of work is to go off and do some more reading. The inner voice suggesting that is procrastination disguised as conscientiousness. Better, sometimes, to trust your own candlepower — however little wax and wick you may have left.

Once my own cogitations were complete (the piece will run in the next issue of Bookforum), of course, I took a look at the Times Web site. By then, Fish’s column had drawn literally hundreds of comments. This must warm some hearts in Minnesota. Any publicity is good publicity as long as they spell your name right — so this must count as great publicity, especially since French Theory itself won’t actually be available until next month.

But in other ways it is unfortunate. Fish and his interlocutors reduce Cusset’s rich, subtle, and paradox-minded book (now arriving in translation) into one more tale of how tenured pseudoradicalism rose to power in the United States. Of course there is always an audience for that sort of thing. And it is true that Cusset – who teaches intellectual history at the Institute d’Etudes Politiques and at Reid Hall/Columbia University, in Paris – devotes some portions of the book to explaining American controversies to his French readers. But that is only one aspect of the story, and by no means the most interesting or rewarding.

When originally published five years ago, the cover of Cusset’s book bore the slightly strange words French Theory. That the title of a French book was in English is not so much lost in translation as short-circuited by it. The bit of Anglicism is very much to the point: this is a book about the process of cultural transmission, distortion, and return. The group of thinkers bearing the (American) brand name “French Theory” would not be recognized at home as engaged in a shared project, or even forming a cohesive group. Nor were they so central to cultural and political debate there, at least after the mid-1970s, as they were to become for academics in the United States. So the very existence of a phenomenon that could be called “French Theory” has to be explained.

To put it another way: the very category of “French Theory” itself is socially constructed. Explaining how that construction came to pass is Cusset’s project. He looks at the process as it unfolded at various levels of academic culture: via translations and anthologies, in certain disciplines, with particular sponsors, and so on. Along the way, he recounts the American debates over postmodernism, poststructuralism, and whatnot. But those disputes are part of his story, not the point of it. While offering an outsider’s perspective on our interminable culture wars, it is more than just a chronicle of them..

Instead, it would be much more fitting to say that French Theory is an investigation of the workings of what C. Wright Mills called the “cultural apparatus.” This term, as Mills defined it some 50 years ago, subsumes all the institutions and forms of communication through which “learning, entertainment, malarky, and information are produced and distributed ... the medium by which [people] interpret and report what they see.” The academic world is part of this “apparatus,” but the scope of the concept is much broader; it also includes the arts and letters, as well as the media, both mass and niche.

The inspiration for Cusset’s approach comes from the French sociologist Pierre Bourdieu, rather than Mills, his distant intellectual cousin from Texas. Even so, the book is in some sense more Millsian in spirit than the author himself may realize. Bourdieu preferred to analyze the culture by breaking it up into numerous distinct “fields” – with each scholarly discipline, art form, etc. constituting a separate sub-sector, following more or less its own set of rules. By contrast, Cusset, like Mills, is concerned with how the different parts of American culture intersect and reinforce one another, even while remaining distinct. (I didn’t say any of this in my review, alas. Sometimes the best ideas come as afterthoughts.)

The boilerplate account of how poststructuralism came to the United States usually begins with visit of Lacan, Derrida, and company to Johns Hopkins University for a conference in 1966 – then never really imagines any of their ideas leaving campus. By contrast, French Theory pays attention to how their work connected up with artists, musicians, writers, and sundry denizens of various countercultures. Cusset notes the affinity of “pioneers of the technological revolution” for certain concepts from the pomo toolkit: “Many among them, whether marginal academics or self-taught technicians, read Deleuze and Guattari for their logic of ‘flows’ and their expanded definition of ‘machine,’ and they studied Paul Virilio for his theory of speed and his essays on the self-destruction of technical society, and they even looked at Baudrillard’s work, in spite of his legendary technological incompetence.”

And a particularly sharp-eyed chapter titled “Students and Users” offers an analysis of how adopting a theoretical affiliation can serve as a phase in the psychodrama of late adolescence (a phase of life with no clearly marked termination point, now). To become Deleuzian or Foucauldian, or what have you, is not necessarily a step along the way to the tenure track. It can also serve as “an alternative to the conventional world of career-oriented choices and the pursuit of top grades; it arms the student, affectively and conceptually, against the prospect of alienation that looms at graduation under the cold and abstract notions of professional ambition and the job market....This relationship with knowledge is not unlike Foucault’s definition of curiosity: ‘not the curiosity that seeks to assimilate what it is proper for one to know, but that which enables one to get free of oneself’....”

Much of this will be news, not just to Cusset’s original audience in France, but to readers here as well. There is more to the book than another account of pseudo-subversive relativism and neocon hyperventilation. In other words, French Theory is not just another Fish story. It deserves a hearing — even, and perhaps especially, from people who have already made up their minds about “deconstructionism,” whatever that may be.

You can read more about Michael Foucault at http://en.wikipedia.org/wiki/Michel_Foucault

You can read about post-structuralism at http://en.wikipedia.org/wiki/Post-structuralism

You can read about post-modernism at http://en.wikipedia.org/wiki/Postmodernism

Jensen Comment
It's pretty difficult to trace these French theories to accounting research and scholarship, but the leading accounting professor trying to do so is probably my former doctoral student Ed Arrington who even moved to Europe for a while to carry on his studies in these theories --- http://www.uncg.edu/bae/acc/accfacul.htm#arrington

A Google search turns up some of his publications in this area as they relate to accounting, economics, and business. His publications also branch off into other areas since Ed has wide ranging interests and is an excellent speaker as well as a researcher and writer. His thesis was an application of the Analytic Hierarchy Process in decision modelling, but he's expanded well beyond that since he got his PhD. http://en.wikipedia.org/wiki/Analytic_Hierarchy_Process
For years my interests and publications were in AHP, although in latter years I was mostly critical of Saaty's precious and arbitrary eigenvector mathematical scaling (but I was not critical of Ed's thesis).

Selling New Equity to Pay Dividends:  Reminds Me About the South Sea Bubble of 1720 ---
http://en.wikipedia.org/wiki/South_Sea_bubble

"Fooling Some People All the Time"

"Melting into Air:  Before the financial system went bust, it went postmodern," by John Lanchester, The New Yorker, November 10, 2008 --- http://www.newyorker.com/arts/critics/atlarge/2008/11/10/081110crat_atlarge_lanchester

This is also why the financial masters of the universe tend not to write books. If you have been proved—proved—right, why bother? If you need to tell it, you can’t truly know it. The story of David Einhorn and Allied Capital is an example of a moneyman who believed, with absolute certainty, that he was in the right, who said so, and who then watched the world fail to react to his irrefutable demonstration of his own rightness. This drove him so crazy that he did what was, for a hedge-fund manager, a bizarre thing: he wrote a book about it.

The story began on May 15, 2002, when Einhorn, who runs a hedge fund called Greenlight Capital, made a speech for a children’s-cancer charity in Hackensack, New Jersey. The charity holds an annual fund-raiser at which investment luminaries give advice on specific shares. Einhorn was one of eleven speakers that day, but his speech had a twist: he recommended shorting—betting against—a firm called Allied Capital. Allied is a “business development company,” which invests in companies in their early stages. Einhorn found things not to like in Allied’s accounting practices—in particular, its way of assessing the value of its investments. The mark-to-market accounting that Einhorn favored is based on the price an asset would fetch if it were sold today, but many of Allied’s investments were in small startups that had, in effect, no market to which they could be marked. In Einhorn’s view, Allied’s way of pricing its holdings amounted to “the you-have-got-to-be-kidding-me method of accounting.” At the same time, Allied was issuing new equity, and, according to Einhorn, the revenue from this could be used to fund the dividend payments that were keeping Allied’s investors happy. To Einhorn, this looked like a potential Ponzi scheme.

The next day, Allied’s stock dipped more than twenty per cent, and a storm of controversy and counter-accusations began to rage. “Those engaging in the current misinformation campaign against Allied Capital are cynically trying to take advantage of the current post-Enron environment by tarring a great and honest company like Allied Capital with the broad brush of a Big Lie,” Allied’s C.E.O. said. Einhorn would be the first to admit that he wanted Allied’s stock to drop, which might make his motives seem impure to the general reader, but not to him. The function of hedge funds is, by his account, to expose faulty companies and make money in the process. Joseph Schumpeter described capitalism as “creative destruction”: hedge funds are destructive agents, predators targeting the weak and infirm. As Einhorn might see it, people like him are especially necessary because so many others have been asleep at the wheel. His book about his five-year battle with Allied, “Fooling Some of the People All of the Time” (Wiley; $29.95), depicts analysts, financial journalists, and the S.E.C. as being culpably complacent. The S.E.C. spent three years investigating Allied. It found that Allied violated accounting guidelines, but noted that the company had since made improvements. There were no penalties. Einhorn calls the S.E.C. judgment “the lightest of taps on the wrist with the softest of feathers.” He deeply minds this, not least because the complacency of the watchdogs prevents him from being proved right on a reasonable schedule: if they had seen things his way, Allied’s stock price would have promptly collapsed and his short selling would be hugely profitable. As it was, Greenlight shorted Allied at $26.25, only to spend the next years watching the stock drift sideways and upward; eventually, in January of 2007, it hit thirty-three dollars.

All this has a great deal of resonance now, because, on May 21st of this year, at the same charity event, Einhorn announced that Greenlight had shorted another stock, on the ground of the company’s exposure to financial derivatives based on dangerous subprime loans. The company was Lehman Brothers. There was little delay in Einhorn’s being proved right about that one: the toppling company shook the entire financial system. A global cascade of bank implosions ensued—Wachovia, Washington Mutual, and the Icelandic banking system being merely some of the highlights to date—and a global bailout of the entire system had to be put in train. The short sellers were proved right, and also came to be seen as culprits; so was mark-to-market accounting, since it caused sudden, cataclysmic drops in the book value of companies whose holdings had become illiquid. It is therefore the perfect moment for a short-selling advocate of marking to market to publish his account. One can only speculate whether Einhorn would have written his book if he had known what was going to happen next. (One of the things that have happened is that, on September 30th, Ciena Capital, an Allied portfolio company to whose fraudulent lending Einhorn dedicates many pages, went into bankruptcy; this coincided with a collapse in the value of Allied stock—finally!—to a price of around six dollars a share.) Given the esteem with which Einhorn’s profession is regarded these days, it’s a little as if the assassin of Archduke Franz Ferdinand had taken the outbreak of the First World War as the timely moment to publish a book advocating bomb-throwing—and the book had turned out to be unexpectedly persuasive.

Accounting history research led me to the following interesting tidbit about Bill Paton.
Bill was instrumental in founding the American Accounting Association.
He was born in April 1889, so go figure how old he was when the following book was published.

Professor Paton at one time was perhaps the most influential professor at the University of Michigan and in all of accounting academe. Rumor has it that at one time, due to his power of persuasion, a basic accounting course was in the core requirements at Michigan, although I never confirmed this rumor. He was notoriously influential in the AAA and notoriously conservative in his political thinking and speech making. Although his devotion was to accounting, his pride was his knowledge of economics. He regined as king and published countless articles when normative methodology reigned in accounting research. Today he probably could not get one article accepted in The Accounting Review. He lived and taught us in a bygone era.

Book Review by Harvey Hendrickson, The Accounting Review, October 1984, pp. 722-723

WILLIAM A. PATON, Words! Combining Fun and Learning (Ann Arbor: The Graduate School of Business Administration, The University of Michigan, 1984, pp. vii, 187, $12.00 paper).

This delightful paperback arrived oo late to be reviewed in the July issue and thus commemorate Mr. Paton's 95th birthday on July 19. It differs from Mr. Paton's many earlier books in at least three respects. First, it is not on accounting or related areas; a careful search indicates that the terms of these areas are rarely mentioned and when they are it is merely a passing reference. Second, it is something of a family affair in that the involvement, including "cooperation and encouragement" (p. iii), of several members (in addition to William A., Jr. who has been a co-author on many of his works) is mentioned at numerous points. Third, among potential users, it should be of interest not only to the accountant but also to nonaccountant member(s) of the family or household; this has been the case with this reviewer who has used it on several occasions to stimulate family conversationsa nd activities. A finding from these sessions is that our youngest child has encountered exercises similar to many in the book in the gifted and talented program of our public school system.

While presenting the lighter side, the a vocational or anecdotal Paton, this book also provides an insight into the breadth, versatility, and incisiveness of his thinking, his respect for and command of the English language, his lifelong commitment to learning, scholarship, and intellectual development, and his abhorrence of sloppiness in thinking and any of its other manifestations.

His opening sentence is that "words are man's greatest tool" (p. 1). He fleshes this out with a brief exploration of the importance of words in communication and the accumulation, classification, development, and expansion of knowledge. He continues with some specifics on reading, writing, speaking, and the misuse of words, and then proceeds to some 60 word games, puzzles, problems, challenges, and exercises-which should be enjoyable as well as helpful in stimulating thinking, increasing the ability to read, speak, and write. Paton adds that "[he is] convinced that playing word games at home will offset in some measure the lack of good instruction in many schools these days" (p. iii). Generously interspersed throughout the book are other anecdotes, aphorisms, and witticisms that constitute a part of the Paton lore and will give many chuckles, especially to those who know, admire, and respect this remarkable person, Outstanding Accounting Educator, and Book Reviews 723 stimulating thinking, increasing the ability to read, speak, and write. Paton adds that "[he is] convinced that playing word games at home will offset in some measure the lack of good instruction in many schools these days" (p. iii).

 Generously interspersed throughout the book are other anecdotes, aphorisms, and witticisms that constitute a part of the Paton lore and will give many chuckles, especially to those who know, admire, and respect this remarkable person, Outstanding Accounting Educator, and unforgettable character.

A nice timeline on the development of U.S. standards and the evolution of thinking about the income statement versus the balance sheet is provided at:
"The Evolution of U.S. GAAP: The Political Forces Behind Professional Standards (1930-1973)," by Stephen A. Zeff, CPA Journal, January 2005 --- http://www.nysscpa.org/cpajournal/2005/105/infocus/p18.htm
Part II covering years 1974-2003 published in February 2005 --- http://www.nysscpa.org/cpajournal/2005/205/index.htm 
The module for 1940 is as follows:

"Ideology and reality in accounting: a Marxist history of the US accounting theory debate from the late 19th century to the FASB’s conceptual framework," by R.A. Bryer, Warwick Business School ---
http://www.st-andrews.ac.uk/business/ecas/7/papers/ECAS-Bryer.pdf

Paton wrote many books and articles on many issues over his long life, but he rarely changed his mind. One writer who did effect a temporary change was Littleton, who persuaded him to give up the idea of ‘value’ in accounting, as it was the self-evident source of his problems.

A.C. Littleton

Littleton’s main contribution to the debate was his argument that accounting could achieve its primary aim of accountability and avoid the Scylla of the LTV and the Charybdis of economic value, if accounting theorists abandoned the search for a theory of value, and focused on controlled use-values, but, without one, he failed to resolve any fundamental questions of practice.

Littleton dismisses any role for Fisherian economic value in accounting. Failure to sharply distinguish between economic value and price, he says, "makes for confusion" (1929, p.148).^{( Littleton says this ‘confusion’ existed in 1929 "as it did in the lifetime of Adam Smith and David Ricardo" (1929, p.148), studiously ignoring Marx who claimed to have removed precisely these confusions.)} To remove it, Littleton points out that ‘value’ is subjective and ‘price’ is objective. "Value is a subjective estimate of an article’s relative importance; price, however, is a compromise between such subjective estimates and is measured by the quantity of money for which an article is exchanged…; a value, however, can exist in one mind alone" (Littleton, 1929, p.149). However, if price is objective value, this raises the question, an objective value of what? Littleton goes out of his way to stifle the idea that this value is a commodity’s labour value, to distance himself from any association with the LTV. It is, as he said, "easy to see how…some writers feel that profit represented a certain portion of income created by labor but retained by enterprisers or the result of a superior bargaining power on the part of proprietors" (Littleton, 1928, p.281). He naturally dismissed "the old idea that [value] was stored up labor of the past" (1929, p.149), "that cost is the basis of value", and Marx’s idea that capitalists set prices to return them at least the required return on capital, the idea that price = cost + profit:

"Much of the loose usage of ‘value’ in accountancy may perhaps be due to the generally held view that value in business has a cost base, that Price = Cost + Profit. As a matter of fact: Price – Cost = Profit. …[I]f cost is a proper basis for the inventory of a stock of unsold goods it must be for other reasons than that it express the value of the goods. As an expression of the investment in goods, cost is quite acceptable, but not as an expression of their value…[,] a record of recoverable outlay, and not a record of values. …What they are worth will depend upon future circumstances" (1929, pp.150-152).

 

Although Littleton was unwavering in defense of historical cost as the main basis of financial reporting and defended his "costs attach" theory in the Paton and Littleton (1940) monograph, Bill Paton later withdrew his strong support of the "costs attach" justification for historical cost and the importance of matching revenues earned with the costs attached to the product or service being sold. You can find various references to this effect in  Accounting History Newsletter, 1980-1989 and Accounting History, 1989-1994: A Tribute to Robert William Gibson, by Garry Carnegie, Peter W. Wolnizer (Editor):  (Taylor and Francis, 1996) --- Click Here
http://snipurl.com/patonrecant      [books_google_com]

It should be noted that Bill Paton was in an advocate of "value accounting"  clear back in his 1922 Accounting Theory, but I take this to be replacement cost rather than exit value later advocated by MacNeal in 1939 and Chambers and Sterling in the 1960s.  In his famous (prior to the 1940 Paton and Littleton monograph) Accountants Handbook (Ronald Press, 1932, Second Edition, Page 525) it is stated:

In particular the case of specialized equipment market value is usually little more than scrap value. That is, a specialized machine, bolted to the factory floor, has little value apart from the particular situation, and hence its market value, unless it is being considered as an element of the market value of the entire business as a going concern, is limited to net salvage ... buildings and equipment have a "going concern value" or "value in use" in excess of liquidation or market value.

I've long argued that exit value non-financial items has the drawback in that the balance sheet is no different for a bankrupt firm as is the balance sheet of a dynamic going concern. Who cares about exit values if there is virtually no likelihood of liquidation of assets used in delivering a product or service?

"Ideology and reality in accounting: a Marxist history of the US accounting theory debate from the late 19th century to the FASB’s conceptual framework," by R.A. Bryer, Warwick Business School ---
http://www.st-andrews.ac.uk/business/ecas/7/papers/ECAS-Bryer.pdf

On this vital issue, Paton and Littleton go out of their way to distinguish their notion that ‘costs attach’ from an anonymous "cost theory of value".32 First, they explain the function of accounting in monitoring the circuit of capital in a way that Marx himself could have written:

"When production activity effects a change in the form of raw materials by the consumption of human labour and machine-power, accounting keeps step by classifying and summarizing appropriate portions of materials cost, labor cost, and machine cost so that together they become product-costs. In other words, it is a basic concept of accounting that costs can be marshalled into new groups that possess real significance. It is as if costs had a power of cohesion when properly brought into contact" (Paton and Littleton, 1940, p.13).

Rather than say that Paton recanted his position on historical costs and the "costs attach" theory, it should be emphasized that Paton was always a "value man" who returned to his roots after after temporarily being influenced by the "cost man" Ananias Littleton. Littleton never viewed costs as a measure of value. Instead they measured sacrifices made at one historical point in time for generating future revenues. Profits measured the efficiency and effectiveness of managing purchased for generating those revenues, which is why Littleton strongly advocated the cost attachment to those resources until they were used up or otherwise disposed of in operations.

You can read about William  Andrew Paton at --- Click Here
http://fisher.osu.edu/departments/accounting-and-mis/the-accounting-hall-of-fame/membership-in-hall/william-a.-paton/
Also see http://en.wikipedia.org/wiki/William_Andrew_Paton

You can read about Ananias Charles Littleton at Click Here
http://fisher.osu.edu/departments/accounting-and-mis/the-accounting-hall-of-fame/membership-in-hall/ananias-charles-littleton/

Accounting for the Shadow Economy

Property is much more than a body of norms. It is also a huge information system that processes raw data until it is transformed into facts that can be tested for truth, and thereby destroys the main catalysts of recessions and panics -- ambiguity and opacity.
See below

A Lesson for Auditors:  Accounting for the shadow economy
"Toxic Assets Were Hidden Assets:  We can't afford to allow shadow economies to grow this big," by Hernando de Soto, The Wall Street Journal, March 25, 2009 --- http://online.wsj.com/article/SB123793811398132049.html?mod=djemEditorialPage

The Obama administration has finally come up with a plan to deal with the real cause of the credit crunch: the infamous "toxic assets" on bank balance sheets that have scared off investors and borrowers, clogging credit markets around the world. But if Treasury Secretary Timothy Geithner hopes to prevent a repeat of this global economic crisis, his rescue plan must recognize that the real problem is not the bad loans, but the debasement of the paper they are printed on.

Today's global crisis -- a loss on paper of more than $50 trillion in stocks, real estate, commodities and operational earnings within 15 months -- cannot be explained only by the default on a meager 7% of subprime mortgages (worth probably no more than $1 trillion) that triggered it. The real villain is the lack of trust in the paper on which they -- and all other assets -- are printed. If we don't restore trust in paper, the next default -- on credit cards or student loans -- will trigger another collapse in paper and bring the world economy to its knees.

If you think about it, everything of value we own travels on property paper. At the beginning of the decade there was about $100 trillion worth of property paper representing tangible goods such as land, buildings, and patents world-wide, and some $170 trillion representing ownership over such semiliquid assets as mortgages, stocks and bonds. Since then, however, aggressive financiers have manufactured what the Bank for International Settlements estimates to be $1 quadrillion worth of new derivatives (mortgage-backed securities, collateralized debt obligations, and credit default swaps) that have flooded the market.

These derivatives are the root of the credit crunch. Why? Unlike all other property paper, derivatives are not required by law to be recorded, continually tracked and tied to the assets they represent. Nobody knows precisely how many there are, where they are, and who is finally accountable for them. Thus, there is widespread fear that potential borrowers and recipients of capital with too many nonperforming derivatives will be unable to repay their loans. As trust in property paper breaks down it sets off a chain reaction, paralyzing credit and investment, which shrinks transactions and leads to a catastrophic drop in employment and in the value of everyone's property.

Ever since humans started trading, lending and investing beyond the confines of the family and the tribe, we have depended on legally authenticated written statements to get the facts about things of value. Over the past 200 years, that legal authority has matured into a global consensus on the procedures, standards and principles required to document facts in a way that everyone can easily understand and trust.

The result is a formidable property system with rules and recording mechanisms that fix on paper the facts that allow us to hold, transfer, transform and use everything we own, from stocks to screenplays. The only paper representing an asset that is not centrally recorded, standardized and easily tracked are derivatives.

Property is much more than a body of norms. It is also a huge information system that processes raw data until it is transformed into facts that can be tested for truth, and thereby destroys the main catalysts of recessions and panics -- ambiguity and opacity. To bring derivatives under the rule of law, governments should ensure that they conform to six longstanding procedures that guarantee the value and legitimacy of any kind of paper purporting to represent an asset:

- All documents and the assets and transactions they represent or are derived from must be recorded in publicly accessible registries. It is only by recording and continually updating such factual knowledge that we can detect the kind of overly creative financial and contractual instruments that plunged us into this recession.

- The law has to take into account the "externalities" or side effects of all financial transactions according to the legal principle of erga omnes ("toward all"), which was originally developed to protect third parties from the negative consequences of secret deals carried out by aristocracies accountable to no one but themselves.

- Every financial deal must be firmly tethered to the real performance of the asset from which it originated. By aligning debts to assets, we can create simple and understandable benchmarks for quickly detecting whether a financial transaction has been created to help production or to bet on the performance of distant "underlying assets."

- Governments should never forget that production always takes priority over finance. As Adam Smith and Karl Marx both recognized, finance supports wealth creation, but in itself creates no value.

- Governments can encourage assets to be leveraged, transformed, combined, recombined and repackaged into any number of tranches, provided the process intends to improve the value of the original asset. This has been the rule for awarding property since the beginning of time.

- Governments can no longer tolerate the use of opaque and confusing language in drafting financial instruments. Clarity and precision are indispensable for the creation of credit and capital through paper. Western politicians must not forget what their greatest thinkers have been saying for centuries: All obligations and commitments that stick are derived from words recorded on paper with great precision.

Above all, governments should stop clinging to the hope that the existing market will eventually sort things out. "Let the market do its work" has come to mean, "let the shadow economy do its work." But modern markets only work if the paper is reliable.

Continued in article

Question
When is $7 billion not a material bad debt exposure?

Answer
When the "bad debt" is from an "empty creditor"
Now do you understand?

"'Empty Creditors' and the Crisis How Goldman's $7 billion was 'not material," by Henry T.C. Hu, The Wall Street Journal, April 10, 2009 ---
http://online.wsj.com/article/SB123933166470307811.html

The defining moments of our financial crisis are now familiar. Last September, Lehman collapsed and AIG was teetering. Because an AIG collapse was viewed as posing unacceptable systemic risks, the Federal Reserve provided the company with an emergency $85 billion loan on Sept. 16.

But a curious incident that fateful day raises significant public policy issues. Goldman Sachs reported that its exposure to AIG was "not material." Yet on March 15 of this year, AIG disclosed that it paid $7 billion of its government loan last fall to satisfy obligations to Goldman. A "not material" statement and a $7 billion payout appear to be at odds.

Why didn't Goldman bark that September day? One explanation is that Goldman was, to use a term that I coined a few years ago, largely an "empty creditor" of AIG. More generally, the empty-creditor phenomenon helps explain otherwise-puzzling creditor behavior toward troubled debtors. Addressing the phenomenon can help us cope with its impact on individual debtors and the overall financial system.

What is an empty creditor? Consider that debt ownership conveys a package of economic rights (to receive principal and interest), contractual control rights (to enforce the terms of the agreement), and other legal rights (to participate in bankruptcy proceedings). Traditionally, law and business practice assume these components are bundled together. Another foundational assumption: Creditors generally want to keep solvent firms out of bankruptcy and to maximize their value.

These assumptions can no longer be relied on. Credit default swaps and other products now permit a creditor to avoid any actual exposure to financial risk from a shaky debt -- while still maintaining his formal contractual control rights to enforce the terms of the debt agreement, and his legal rights under bankruptcy and other laws.

Thus the "empty creditor": someone (or institution) who may have the contractual control but, by simultaneously holding credit default swaps, little or no economic exposure if the debt goes bad. Indeed, if a creditor holds enough credit default swaps, he may simultaneously have control rights and incentives to cause the debtor firm's value to fall. And if bankruptcy occurs, the empty creditor may undermine proper reorganization, especially if his interests (or non-interests) are not fully disclosed to the bankruptcy court.

Goldman Sachs was apparently an empty creditor of AIG. On March 20, David Viniar, Goldman's chief financial officer, indicated that the company had bought credit default swaps from "large financial institutions" that would pay off if AIG defaulted on its debt. A Bloomberg News story on that day quotes Mr. Viniar as saying that "[n]et-net I would think we had a gain over time" with respect to the credit default swap contracts.

Goldman asserted its contractual rights to require AIG to provide collateral on transactions between the two, notwithstanding the impact of such collateral calls on AIG. This behavior was understandable: Goldman had responsibilities to its own shareholders and, in Mr. Viniar's words, was "fully protected and didn't have to take a loss."

Nothing in the law prevents any creditor from decoupling his actual economic exposure from his debt. And I do not suggest any inappropriate behavior on the part of Goldman or any other party from such "debt decoupling." But none of the existing regulatory efforts involving credit derivatives are directed at the empty-creditor issue. Empty creditors have weaker incentives to cooperate with troubled corporations to avoid collapse and, if collapse occurs, can cause substantive and disclosure complexities in bankruptcy.

An initial, incremental, and low-cost step lies in the area of a real-time informational clearinghouse for credit default swaps and other over-the-counter (OTC) derivatives transactions and other crucial derivatives-related information. Creditors are not generally required to disclose the "emptiness" of their status, or how they achieved it. More generally, OTC derivatives contracts are individually negotiated and not required to be disclosed to any regulator, much less to the public generally. No one regulator, nor the capital markets generally, know on a real-time basis the entity-specific exposures, the ultimate resting places of the credit, market, and other risks associated with OTC derivatives.

With such a clearinghouse, the interconnectedness of market participants' exposures would have been clearer, governmental decisions about bailing out Lehman and AIG would have been better informed, and the market's disciplining forces could have played larger roles. Most important, a clearinghouse could have helped financial institutions to avoid misunderstanding their own products, and modeling and risk assessment systems -- misunderstandings that contributed to the global economic crisis.

Henry Hu is a professor at the University of Texas Law School.

Bob Jensen's threads on the credit derivatives mess of AIG are at http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout

Behavioral and Cultural Economics and Finance

"Video: Daniel Kahneman - The Psychology of Large Mistakes and Important Decisions" Simoleon Sense, July 27, 2009 ---
http://www.simoleonsense.com/daniel-kahneman-psychology-of-large-mistakes-and-decisions/

Speaker Background (Via Wikipedia)

Daniel Kahneman is an Israeli psychologist and Nobel laureate, notable for his work on the psychology of judgment and decision-making, behavioral economics and hedonic psychology.With Amos Tversky and others, Kahneman established a cognitive basis for common human errors using heuristics and biases , and developed Prospect theory . He was awarded the 2002 Nobel Memorial Prize in Economics for his work in Prospect theory. Currently, he is professor emeritus of psychology and public affairs at Princeton University’s Woodrow Wilson School.

Watch the video --- Click Here

Video 1: "Nobelist Daniel Kahneman On Behavioral Economics (Awesome)!" Simoleon Sense, June 5, 2009 ---
http://www.simoleonsense.com/video-nobelist-daniel-kahneman-on-behavioral-economics-awesome/

Introduction (Via Fora.Tv)

Nobel Prize-winning psychologist Daniel Kahneman addresses the Georgetown class of 2009 about the merits of behavioral economics.

He deconstructs the assumption that people always act rationally, and explains how to promote rational decisions in an irrational world.

Topics Covered:

1. The Economic Definition Of Rationality

2. Emphasis on Rationality in Modern Economic Theory

3. Examples of Irrational Behavior (watch this part)

4. How to encourage rational decisions

Speaker Background (Via Fora.Tv)

Daniel Kahneman - Daniel Kahneman is Eugene Higgins Professor of Psychology and Professor of Public Affairs Emeritus at Princeton University. He was educated at The Hebrew University in Jerusalem and obtained his PhD in Berkeley. He taught at The Hebrew University, at the University of British Columbia and at Berkeley, and joined the Princeton faculty in 1994, retiring in 2007. He is best known for his contributions, with his late colleague Amos Tversky, to the psychology of judgment and decision making, which inspired the development of behavioral economics in general, and of behavioral finance in particular. This work earned Kahneman the Nobel Prize in Economics in 2002 and many other honors

Video 2:  Nancy Etcoff is part of a new vanguard of cognitive researchers asking: What makes us happy? Why do we like beautiful things? And how on earth did we evolve that way?
Simoleon Sense, June 10, 2009
http://www.simoleonsense.com/science-of-happiness/ 

Video 3:  Yale's Robert Shiller (slightly over one hour of video lecture)
Behavioral Finance: The Role of Psychology --- http://www.youtube.com/watch?v=0ZLNbxWH8Lc

"Countries and Culture in Behavioral Finance," by Meir Statman ---
http://www.scu.edu/business/finance/research/upload/Countries-and-cultures-in-BF.pdf

Behavioral finance has made important contributions to the field of investing by focusing on the cognitive and emotional aspects of the investment decision-making process. Although it is tempting to say that people are the same everywhere, the collective set of common experiences that people of the same culture share will influence their cognitive and emotional approach to investing. In this article, the author discusses the many cultural differences that may influence investor behavior and how these differences may influence the recommendations of a financial advisor.

"Must Read: Why People Fall Victim To Scams," Simoleon Sense, March 18, 2009 ---
http://www.simoleonsense.com/must-read-why-people-fall-victim-to-scams/
The paper is at http://www.oft.gov.uk/shared_oft/reports/consumer_protection/oft1070.pdf

A Mountain Climbing Metaphor of Corporate Greed

"Scaling the Heights of Corporate Greed: Chafkin and Lo on Risk," by Stephen J. Dubner, Freakonomics Blog of The New York Times, August 5, 2009 ---
http://freakonomics.blogs.nytimes.com/2009/08/04/scaling-the-heights-of-corporate-greed-chafkin-and-lo-on-risk/

Scaling the Heights of Corporate Greed A Guest Post By Jeremiah H. Chafkin and Andrew W. Lo

In Laurence Gonzales’s riveting book Deep Survival, he gives a sobering account of four mountain climbers who successfully scaled the 11,249-foot peak of Mount Hood in Oregon — considered a “beginner’s” mountain — only to fall disastrously during their descent.

The climber in the top position — a veteran of much more challenging climbs — felt that belaying (the laborious process of anchoring a climber’s rope to the mountainside to arrest a fall) was an unnecessary precaution in this case, so when he lost his footing and fell, he yanked his three tethered colleagues, and five climbers below them, off the side of the snow-covered mountain. Three men died in this unfortunate incident, and the question posed by Gonzales is what leads some individuals to such tragic ends, while others faced with the same circumstances survive?

The answer, which forms the major thesis of Deep Survival, may also be the ultimate explanation for the current financial crisis:

The climbers on Mount Hood were set up for disaster not by their inexperience, but by their experience. It was the quality of their thinking, the idea that they knew, coupled with hidden characteristics of the system they had so often used. The system … was capable of displaying one type of behavior for a long time and then suddenly changing its behavior completely.

In other words, their mental model of this beginner’s mountain did not match the reality on that fateful day, resulting in their tragic accident.

The remarkably consistent performance of the U.S. residential real-estate market over the decade from 1996 to 2006 may have had the same effect, leading many experienced businessmen to conclude that such growth was likely to continue indefinitely. And despite all the protections that were available to these captains of industry — analytics that showed large potential losses in the event of a downturn in housing prices, leverage constraints imposed by regulatory capital requirements, and warning signs from the hedge-fund industry in 2005 and 2006 — they charged ahead anyway, with the single-mindedness of a well-funded expedition hell-bent on conquering a mountain. Their mental models apparently did not match reality either.

Much of neoclassical economics is based on the assumption that individuals act rationally and that markets fully reflect all available information, i.e., markets are informationally efficient. So powerful and far-reaching are the implications of this hypothesis that we sometimes forget it is meant to be an approximation to a much more complex reality. Recent advances in the cognitive neurosciences have radically altered our understanding of human decision-making, underscoring the importance of emotion, “hardwired” responses, and neural “plasticity” (the adaptability of neural pathways) in producing observed behavior (see Lo 2004, 2005). These breakthroughs show that decisions are often the result of several distinct components of the brain — some under our direct control and others that work behind the scenes and below our consciousness — that collaborate to yield a course of action best suited to achieve our immediate goals. On occasion, those immediate goals may conflict with larger and more important goals, like survival.

One illustration of this mismatch is the typical response to the following question: what is the primary objective of any mountain-climbing expedition? If, like most individuals, you answered “to get to the summit, of course,” you may be suffering from the same mental blinders as those climbers who fell from Mount Hood. A more risk-aware response might be: “to get to the summit, and then descend successfully.” Sometimes, we are so focused on one objective — to the exclusion of all else — that we neglect the obvious.

Risk-taking in corporate contexts is surprisingly similar, except that the height of the mountain is measured in units of earnings-per-share, return-on-equity, and share price. CEO’s are richly rewarded for the speed of their ascent during times of growing demand and easy money, but not necessarily for safely navigating the descent to the bottom of the business and credit cycles. While “greedy” CEO’s are easy scapegoats, the main object of everyone’s attention — the stock price — is often driven by shareholders looking for short-term profits, not long-term capital appreciation. And competition for shareholder dollars is akin to having many climbers competing to reach the same peak first. In both cases, the rewards — either bragging rights or bonuses — are proportional to the difficulty of the climb (barriers to entry) and the speed of the ascent (growth rate). A well-planned and successful descent is usually not on the list.

Now it can be argued that descending safely goes without saying, and most serious climbers are extremely well-prepared for both legs of their journey. But if it goes without saying, it sometimes goes without detailed planning, and then without doing, especially by those lucky climbers who have never experienced any setbacks or accidents. Similarly, corporate profits are rarely generated without taking some risks, yet the current culture, compensation structure, and shareholder and analyst objectives surrounding the modern corporation are all focused mainly on the race to the summit.

So what is the business equivalent of a well-crafted plan for descent? One possibility is for a corporation to appoint a chief risk officer (CRO) who reports directly to the board of directors and is solely responsible for managing the company’s enterprise risk exposures, and whose compensation depends not on corporate revenues or earnings, but on corporate stability. Any proposed material change in a corporation’s risk profile — as measured by several objective metrics that are specified in advance by senior management and the board — will require prior written authorization of the CRO; and the CRO can be terminated if a corporation’s risk profile deviates from its pre-specified risk mandate, as determined jointly on an annual basis by senior management and the board.

Such a proposal does invite conflict and debate among senior management and their directors, but this is precisely the point. By having open dialogue about the potential risks and rewards of new initiatives, senior management will have a fighting chance of avoiding the cognitive traps that can lead to disaster. Imagine if one of the four ill-fated climbers on Mount Hood had been assigned the role of the “designated skeptic” in advance, in which capacity he would be expected to raise every reasonable objection he could think of to a quick descent. We will never know if this would have been enough to have prevented their fall, but it would certainly have given them pause, and an opportunity for further reflection.

Mountains must be scaled, businesses must be built, and risks imply that occasionally, losses will be severe. But it would be even more tragic if we compounded our mistakes by failing to learn from them.

"Using Psychology To Save You From Yourself (with audio) ," by Alix Spiegel, NPR, June 12, 2009 ---
http://www.npr.org/templates/story/story.php?storyId=104803094&sc=nl&cc=es-20090628

The city of Greensboro, N.C., has experimented with a program designed for teenage mothers. To prevent these teens from having another child, the city offered each of them $1 a day for every day they were not pregnant. It turns out that the psychological power of that small daily payment is huge. A single dollar a day was enough to push the rate of teen pregnancy down, saving all the incredible costs — human and financial — that go with teen parenting.

Cass Sunstein, President Obama's pick to head the Office of Information and Regulatory Affairs, was a vocal supporter of the program, because it was an economic policy that shaped itself around human psychology. Sunstein is just one of a number of high-level appointees now working in the Obama administration who favors this kind of approach.

All are devotees of behavioral economics — a school of economic thought greatly influenced by psychological research — which argues that the human animal is hard-wired to make errors when it comes to decision-making, and therefore people need a little "nudge" to make decisions that are in their own best interests.

And that is exactly what Obama administration officials plan to do: By taking account of human psychology, they hope to save you from yourself.

This is the story of how obscure psychological research into human decision-making first revolutionized economics and now appears poised to remake the relationship between the government and its citizens.

How Behavioral Economics Came To Be

The ideas that underlie the Obama administration's approach to social policies got their start in 1955 with Daniel Kahneman. Then a young psychologist in the Israeli army, Kahneman's primary job was to try to figure out which of his fellow soldiers might make good officers. To do this, Kahneman ran the men through an unusual exercise: He organized them into groups of eight, took away all their insignia so know one knew who had a higher rank, and told them to lift an enormous telephone pole over a 6-foot wall.

Kahneman felt the exercise was incredibly revealing. "We could see who was a leader, who was taking charge," Kahneman says. "We could see who was a quitter, who gave up. And we thought that what we saw before us is how they would behave in combat."

Certain of their wisdom, Kahneman and his fellow psychologists would make recommendations after the exercise. The chosen men would go to officer school, and Kahneman would move on to the next batch of soldiers. There was only one problem: Kahneman and his colleagues were terrible at it.

Every month or so, Kahneman would get feedback from the school about his picks, and "there was absolutely no relationship between what we saw and what people saw who examined them for six months in officer training school," he says.

But here's the remarkable thing: Despite the negative feedback, Kahneman's faith in his own ability was unshaken.

"The next day after getting those statistics, we put them there in front of the wall, gave them a telephone pole, and we were just as convinced as ever that we knew what kind of officer they were going to be."

People Make Irrational Choices

Kahneman was surprised by the pure visceral power of his own certainty. He eventually coined a phrase for it: "illusion of validity."

It's a problem that afflicts us all, says Kahneman, who won the 2002 Nobel Prize in economics for his work on this subject. From stockbrokers to baseball scouts, people have a huge amount of confidence in their own judgment, even in the face of evidence that their judgment is wrong.

But that mistake is just one of many cognitive errors identified by Kahneman and his frequent collaborator, psychologist Amos Tversky. For more than a decade, the two worked together cataloging the ways the human mind systematically misjudges the world around it.

For instance, Kahneman and Tversky identified "anchoring bias." It turns out that whenever you are exposed to a number, you are influenced by that number whether you intend to be influenced or not.

This is why, for example, the minimum payments suggested on your credit card bill tend to be low. That number frames your expectation, so you pay less of the bill than you might otherwise, your interest continues to grow, and your credit card company makes more money than if you had not had your expectations influenced by the low number.

Through their research, Kahneman and Tversky identified dozens of these biases and errors in judgment, which together painted a certain picture of the human animal. Human beings, it turns out, don't always make good decisions, and frequently the choices they do make aren't in their best interest.

In the realm of academic psychology, this isn't much of a revelation — psychologists see people as flawed in all kinds of ways. So, if the ideas of Kahneman and Tversky had simply stayed in the realm of academic psychology, there wouldn't be much of a story to tell.

Continued in article

Bob Jensen's threads on the Efficient Market Hypothesis are at
http://www.trinity.edu/rjensen/theory01.htm#EMH

Media Reporting and Advising Controversies

Video (humor?):  Jon Stewart versus Jim Cramer (CNBC) on The Daily Show ---
http://www.youtube.com/watch?v=Vi6bxKAAHzQ

See the full episode --- http://www.youtube.com/watch?v=dwUXx4DR0wo

Question
What is hyperbolic discounting?

"Psychology of poverty and temptation," by Chris Blattman, September 2009 ---
http://chrisblattman.com/2009/09/15/psychology-of-poverty-and-temptation/

Some people are impulsive and impatient; they prefer a dollar or a donut today far more than a dollar or a donut tomorrow, so much so that they’re willing to give up shocking amounts of dollars and donuts tomorrow for just one today. This is one reason, some say, that we see such high interest rates for short-term borrowing, from New York to Calcutta.

Some people are not only impulsive and impatient, but inconsistently so. they care a lot about a dollar today versus tomorrow, but could care less between getting a dollar either 10 or 11 days from now. Economists call this ‘hyperbolic discounting’.

Both behaviors–impatience and time inconsistency–could be a source of persistent poverty.

Or not. Abhijit Banerjee presented a new paper here yesterday, written with MIT colleague Sendhil Mullainathan. They look at a number of seemingly unusual behaviors by the very poor–from exorbitant rates of short-term borrowing to the low take-up of small, high-return investments. Impatience cannot explain the patterns, they say. The impatience approach also requires the poor think differently than the rest of the population.

Another view: we’re all impulsive and impatient in the same way, but over a narrow range of goods that are quickly and cheaply satisfied. If you’re poor, these temptations are a big fraction of your income. If you’re even somewhat wealthy, they are not. Temptations are declining in income.

The paper runs through half a dozen perplexing patterns of behavior, and shows that these simple assumptions can explain a great deal.

This approach has a great deal in common with hyperbolic discounting, but is empirically distinct (and has very different policy implications). Parsing out and testing these subtleties strikes me as one of the most important frontiers in the study of poverty. Declining temptation, if true, could explain all sorts of odd behaviors. With more than a few Uganda and Liberia surveys on the horizon, I’m now scheming ways to test whether it’s true.

It’s a difficult paper, especially for those uninitiated in micro-economic theory. Even if that sounds like you: the subtle points are worth the slog.

For an intro to the subfield, see Senthil’s essay, Development economics through the lens of psychology. Another great resource is Stefano Dellavigna’s recent JEL article on evidence from the field. Both are ungated.

78% of former NFL players have gone bankrupt or are under financial stress because of joblessness or divorce.
Championship Rings in pawn shops, IRS vaults, Ponzi schemer stashes offshore, or in the clutches of ex-wives

What on earth did athletes learn in college?

Pros seem especially susceptible to Ponzi schemes. Some recent examples --- Click Here

10 Ways Sports Stars (multi-millionaires) Go From Riches To Rags," by Lawrence Delevingne, Business Insider, September 18, 2009 --- http://www.businessinsider.com/10-ways-sports-stars-destroy-their-finances-2009-9

 Sports Illustrated article this year showed how shockingly common financial ruin is:

• By the time they have been retired for two years, 78% of former NFL players have gone bankrupt or are under financial stress because of joblessness or divorce.
• Within five years of retirement, an estimated 60% of former NBA players are broke.
• Numerous retired MLB players have been similarly ruined.

If that's not bad enough, the recession has made things even worse. Too much money in real estate; investments in Ponzi schemes; and poor financial advising have been exposed with the down economy.

A sign of the times? More former stars are selling their championship rings for money than ever. "It's amazing that I heard the recession was over," says Timothy Robins, owner of Championshiprings.net, who buys bling from current and former pros and has seen a 36% increase in sales during the past year. "I'm getting more calls from players than ever. They're having a really hard time."

While just about everyone has lost money over the past year, athletes tend to make particularly bad financial decisions, and it's not just reckless spending.

How they lose their wealth --- Click Here
http://www.businessinsider.com/10-ways-sports-stars-destroy-their-finances-2009-9#put-cash-in-a-ponzi-scheme-1

The 10 ways sports pros blow their cash >>

Jensen Comment
The same goes for many, many movie stars like Debbie Reynolds who, very late in their lives, are "willing to work for food."

The boots in Hollywood's Boot Hill are not stuffed with savings.

Bob Jensen's helpers in personal finance ---
http://www.trinity.edu/rjensen/Bookbob1.htm#InvestmentHelpers

How to avoid losing your money to fraud ---
http://www.trinity.edu/rjensen/FraudReporting.htm

Video: Financial Reporting in Today’s Economy - Buyouts, Takeovers, Downsizing ---
http://www.simoleonsense.com/video-financial-reporting-in-todays-economy-buyouts-takeovers-downsizing/

The Jon Stewart & Jim Cramer battle made numerous rounds and yet the question still remains- should the financial media be held accountable for failing to warn citizens of the economic/financial downturn?

Introduction (Via Fora.TV)

Should financial media be held accountable for their failure to have warned the public of the current economic downturn? What steps are being taken to avoid this happening in the future?

A panel of leading financial reporters assess the global crisis and discuss the ‘perfect storm’ of events that led to it. Aspiring journalists will hear how to avoid the perils and pitfalls of the profession, and media observers can decide for themselves if the media is to blame.

About the Speaker (Via Fora.TV)

Liz Claman - Liz Claman joined FOX Business Network (FBN) as an anchor in October 2007. Her debut included an exclusive interview with Berkshire Hathaway CEO and legendary investor Warren Buffett.

Alan Murray - Alan Murray is a Deputy Managing Editor of The Wall Street Journal and Executive Editor for the Journal Online. He also has editorial responsibility for Wall Street Journal television, books, conferences, and the MarketWatch web site. Mr. Murray spent a decade as the Journal’s Washington bureau chief.

Jeff Bercovici - Jeff Bercovici joined Conde Nast Portfolio from Radar magazine, where he was part of the relaunch team for both the online and print editions.

Efficient Markets (EMH) versus Imperfect Markets

'Efficient Market Theory and the Crisis: Neither the rating agencies' mistakes nor the overleveraging by financial firms was the fault of an academic hypothesis," by Jeremy J. Siegel, The Wall Street Journal, October 27, 2009 ---
http://online.wsj.com/article/SB10001424052748703573604574491261905165886.html?mod=djemEditorialPage

Financial journalist and best-selling author Roger Lowenstein didn't mince words in a piece for the Washington Post this summer: "The upside of the current Great Recession is that it could drive a stake through the heart of the academic nostrum known as the efficient-market hypothesis." In a similar vein, the highly respected money manager and financial analyst Jeremy Grantham wrote in his quarterly letter last January: "The incredibly inaccurate efficient market theory [caused] a lethally dangerous combination of asset bubbles, lax controls, pernicious incentives and wickedly complicated instruments [that] led to our current plight."

But is the Efficient Market Hypothesis (EMH) really responsible for the current crisis? The answer is no. The EMH, originally put forth by Eugene Fama of the University of Chicago in the 1960s, states that the prices of securities reflect all known information that impacts their value. The hypothesis does not claim that the market price is always right. On the contrary, it implies that the prices in the market are mostly wrong, but at any given moment it is not at all easy to say whether they are too high or too low. The fact that the best and brightest on Wall Street made so many mistakes shows how hard it is to beat the market.

This does not mean the EMH can be used as an excuse by the CEOs of the failed financial firms or by the regulators who did not see the risks that subprime mortgage-backed securities posed to the financial stability of the economy. Regulators wrongly believed that financial firms were offsetting their credit risks, while the banks and credit rating agencies were fooled by faulty models that underestimated the risk in real estate.

After the 1982 recession, the U.S. and world economies entered into a long period where the fluctuations in variables such as gross domestic product, industrial production, and employment were significantly lower than they had been since World War II. Economists called this period the "Great Moderation" and attributed the increased stability to better monetary policy, a larger service sector and better inventory control, among other factors.

The economic response to the Great Moderation was predictable: risk premiums shrank and individuals and firms took on more leverage. Housing prices were boosted by historically low nominal and real interest rates and the development of the securitized subprime lending market.

According to data collected by Prof. Robert Shiller of Yale University, in the 61 years from 1945 through 2006 the maximum cumulative decline in the average price of homes was 2.84% in 1991. If this low volatility of home prices persisted into the future, a mortgage security composed of a nationally diversified portfolio of loans comprising the first 80% of a home's value would have never come close to defaulting. The credit quality of home buyers was secondary because it was thought that underlying collateral—the home—could always cover the principal in the event the homeowner defaulted. These models led credit agencies to rate these subprime mortgages as "investment grade."

But this assessment was faulty. From 2000 through 2006, national home prices rose by 88.7%, far more than the 17.5% gain in the consumer price index or the paltry 1% rise in median household income. Never before have home prices jumped that far ahead of prices and incomes.

This should have sent up red flags and cast doubts on using models that looked only at historical declines to judge future risk. But these flags were ignored as Wall Street was reaping large profits bundling and selling the securities while Congress was happy that more Americans could enjoy the "American Dream" of home ownership. Indeed, through government-sponsored enterprises such as Fannie Mae and Freddie Mac, Washington helped fuel the subprime boom.

Neither the rating agencies' mistakes nor the overleveraging by the financial firms in the subprime securities is the fault of the Efficient Market Hypothesis. The fact that the yields on these mortgages were high despite their investment-grade rating indicated that the market was rightly suspicious of the quality of the securities, and this should have served as a warning to prospective buyers.

With few exceptions (Goldman Sachs being one), financial firms ignored these warnings. CEOs failed to exercise their authority to monitor overall risk of the firm and instead put their faith in technicians whose narrow models could not capture the big picture. One can only wonder if the large investment banks would have taken on such risks when they were all partnerships and the lead partner had all his wealth in the firm, as they were just a few decades ago.

The misreading of these economic trends did not just reside within the private sector. Former Fed Chairman Alan Greenspan stated before congressional committees last December that he was "shocked" that the top executives of the financial firms exposed their stockholders to such risk. But had he looked at their balance sheets, he would have realized that not only did they put their own shareholders at risk, but their leveraged positions threatened the viability of the entire financial system.

As home prices continued to climb and subprime mortgages proliferated, Mr. Greenspan and current Fed Chairman Ben Bernanke were perhaps the only ones influential enough to sound an alarm and soften the oncoming crisis. But they did not. For all the deserved kudos that the central bank received for their management of the crisis after the Lehman bankruptcy, the failure to see these problems building will stand as a permanent blot on the Fed's record.

Our crisis wasn't due to blind faith in the Efficient Market Hypothesis. The fact that risk premiums were low does not mean they were nonexistent and that market prices were right. Despite the recent recession, the Great Moderation is real and our economy is inherently more stable.

But this does not mean that risks have disappeared. To use an analogy, the fact that automobiles today are safer than they were years ago does not mean that you can drive at 120 mph. A small bump on the road, perhaps insignificant at lower speeds, will easily flip the best-engineered car. Our financial firms drove too fast, our central bank failed to stop them, and the housing deflation crashed the banks and the economy.

Dr. Siegel, a professor of finance at the University of Pennsylvania's Wharton School, is the author of "Stocks for the Long Run," now in its 4th edition from McGraw-Hill.

Eugene Fama Lecture: Masters of Finance, Oct 2, 2009
Videos Fama Lecture: Masters of Finance From the American Finance Association's "Masters in Finance" video series, Eugene F. Fama presents a brief history of the efficient market theory. The lecture was recorded at the University of Chicago in October 2008 with an introduction by John Cochrane.
http://www.dimensional.com/famafrench/2009/10/fama-lecture-masters-of-finance.html#more 

Fama Video on Market Efficiency in a Volatile Market
Widely cited as the father of the efficient market hypothesis and one of its strongest advocates, Professor Eugene Fama examines his groundbreaking idea in the context of the 2008 and 2009 markets. He outlines the benefits and limitations of efficient markets for everyday investors and is interviewed by the Chairman of Dimensional Fund Advisors in Europe, David Salisbury.
http://www.dimensional.com/famafrench/2009/08/fama-on-market-efficiency-in-a-volatile-market.html#more

Jensen Comment
This does not mean the EMH and its wildly popular stepchild CAPM are not in deep keeshee (theory and practice) --- http://www.trinity.edu/rjensen/theory01.htm#EMH

Warren Buffett did a lot of almost fatal damage to the EMH
If you really want to understand the problem you’re apparently wanting to study, read about how Warren Buffett changed the whole outlook of a great econometrics/mathematics researcher (Janet Tavkoli). I’ve mentioned this fantastic book before --- Dear Mr. Buffett. What opened her eyes is how Warren Buffet built his vast, vast fortune exploiting the errors of the sophisticated mathematical model builders when valuing derivatives (especially options) where he became the writer of enormous option contracts (hundreds of millions of dollars per contract). Warren Buffet dared to go where mathematical models could not or would not venture when the real world became too complicated to model. Warren reads financial statements better than most anybody else in the world and has a fantastic ability to retain and process what he’s studied. It’s impossible to model his mind.

I finally grasped what Warren was saying. Warren has such a wide body of knowledge that he does not need to rely on “systems.” . . . Warren’s vast knowledge of corporations and their finances helps him identify derivatives opportunities, too. He only participates in derivatives markets when Wall Street gets it wrong and prices derivatives (with mathematical models) incorrectly. Warren tells everyone that he only does certain derivatives transactions when they are mispriced.

Wall Street derivatives traders construct trading models with no clear idea of what they are doing. I know investment bank modelers with advanced math and science degrees who have never read the financial statements of the corporate credits they model. This is true of some credit derivatives traders, too.
Janet Tavakoli, Dear Mr. Buffett, Page 19

October 28, 2009 reply from Paul Williams [Paul_Williams@NCSU.EDU]

Bob, et al,
I never cease to marvel at the powers of rationalization defenders of sacred institutions can muster. The above characterization of EMH was certainly not the version pedaled by its accounting disciples (notably Bill Beaver) back in the late 60s and early 70s. An accounting research industry was created based on a version of EMH that was decidedly more certain that securities were "properly priced." [Why else do studies to debunk the Briloff effect?].

Given the interpretation offered above, "Information Content Studies" make no sense. The whole idea of this methodology was that accounting data that correlated with prices implied market participants found it useful for setting prices based on publicly available data, which implied such prices were the ones that would exist in an idealized world of perfectly informed investors. Thus, this data met the test of being information and was to be preferred to other "non-information" to which the market did not react.

But now we are told that this latest version of EMH does not justify such sanguinity because "...the prices in the market are mostly wrong...", thus prices are not an indicator of the value of data, i.e., just because there is a price effect we still don't know if that data is truly "information." Think of the millions and millions of taxpayer dollars that have been wasted over the last forty years subsidizing people to search for something that is indeterminate given the methodology they are employing.

And for this the AAA awarded Seminal Contributions. Jim Boatsman had an ingenious little paper in Abacus eons ago titled, "Why Are There Tigers and Things," that cast serious doubts on the whole enterprise of "testing" market efficiency. It addressed the issue Carl Devine harped on about needing an independent definition of "information." And this is related to the logical slight of hand EMH required of surmising there is a way to know what the "true" price is since we glibly talk about over and under and mis-priced securities.

But there is no way to know this, since security prices are CREATED by the institution of the securities market. There does not exist a natural process against which market performance can be compared. "Market value," which is what a price is, is a value established by the market. The market is all there is. To paraphrase NC's current governor's favorite expression, "The price is what it is."

It isn't over or under or mis or proper or anything else, other than what a particular institution created by us at one moment in time determines it is. If we lived in a society in which mob rule settled issues of justice, it would make little sense to argue that someone the mob hung was "not guilty." Of course he was guilty, because the mob hung him!!

Paul Williams
paul_williams@ncsu.edu 
(919)515-4436

Bob Jensen's threads on the economic crisis are at http://www.trinity.edu/rjensen/2008Bailout.htm

This illustrates how difficult it is to teach, let alone do accountics, research given the unknowns about impacts of variations in methodology. How do professors who teach from a few of their chosen studies prepare students about the simplifications inherent in any one model?

It would seem that students have to be pretty sophisticated to understand the limitations of the accountics harvests.

"The Cross-Section of Expected Stock Returns: What Have We Learnt from the Past Twenty-Five Years of Research," by Avanidhar Subrahmanyam University of California, Los Angeles - Finance Area, European Financial Management, Forthcoming

Abstract:
I review the recent literature on cross-sectional predictors of stock returns. Predictive variables used emanate from informal arguments, alternative tests of risk-return models, behavioral biases, and frictions. More than fifty variables have been used to predict returns. The overall picture, however, remains murky, because more needs to be done to consider the correlational structure amongst the variables, use a comprehensive set of controls, and discern whether the results survive simple variations in methodology.

From Jim Mahar's blog on November 13. 2009 --- http://financeprofessorblog.blogspot.com/

VERY good review article on the ability of financial models (CAPM, APT, Fama-French, etc) to predict and explain cross sectional stock returns).

Super short version: While we have progressed, we have done so down different paths and there needs to be some standardization, testing for robustness, and checks for correlations across the many variables that have been used in past models.

From Introduction:

"The predictive variables are motivated principally in one of four ways. These are: • Informal Wall Street wisdom (such as “value-investing”) • Theoretical motivation based on risk-return (RR) model variants • Behavioral biases or misreaction by cognitively challenged investors • Frictions such as illiquidity or arbitrage constraints"

AN ABSOLUTE MUST FOR CLASSES.

Jensen Comment

"SEC Proposes Changes for 'Dark Pools'," SmartPros, October 21, 2009 --- http://accounting.smartpros.com/x67909.xml 

Federal regulators are proposing tighter oversight for so-called "dark pools," trading systems that don't publicly provide price quotes and compete with major stock exchanges.

The Securities and Exchange Commission voted Wednesday to propose new rules that would require more stock quotes in the "dark pool" systems to be publicly displayed. The changes could be adopted sometime after a 90-day public comment period.

The alternative trading systems, private networks matching buyers and sellers of large blocks of stocks, have grown explosively in recent years and now account for an estimated 7.2 percent of all share volume. SEC officials have identified them as a potential emerging risk to markets and investors.

The SEC initiative is the latest action by the agency seeking to bring tighter oversight to the markets amid questions about transparency and fairness on Wall Street. The SEC has floated a proposal restricting short-selling - or betting against a stock - in down markets.

Last month, the agency proposed banning "flash orders," which give traders a split-second edge in buying or selling stocks. A flash order refers to certain members of exchanges - often large institutions - buying and selling information about ongoing stock trades milliseconds before that information is made public.

Institutional investors like pension funds may use dark pools to sell big blocks of stock away from the public scrutiny of an exchange like the New York Stock Exchange or Nasdaq Stock Market that could drive the share price lower.

"Given the growth of dark pools, this lack of transparency could create a two-tiered market that deprives the public of information about stock prices," SEC Chairman Mary Schapiro said before the vote at the agency's public meeting.

Republican Commissioners Kathleen Casey and Troy Paredes, while voting to put out the proposed new rules for public comment, cautioned against rushing to overly broad regulation that could have a negative impact on market innovation and competition.

Dark pools might decide to maintain stock trading at levels below those that trigger required public display under the proposed rules, Paredes said. "Darker dark pools" could be worse than the current situation, he suggested.

When investors place an order to buy or sell a stock on an exchange, the order is normally displayed for the public to view. With some dark pools, investors can signal their interest in buying or selling a stock but that indication of interest is communicated only to a group of market participants.

That means investors who operate within the dark pool have access to information about potential trades which other investors using public quotes do not, the SEC says.

The SEC proposal would require indications of interest to be treated like other stock quotes and subject to the same disclosure rules.

Continued in article

Bob Jensen's threads on mutual fund and index fund and insurance company scandals are at
http://www.trinity.edu/rjensen/FraudRotten.htm#MutualFunds

Bob Jensen's threads on the Efficient Markets Hypothesis (EMH) are at
http://www.trinity.edu/rjensen/theory01.htm#EMH 

"Poking Holes in a Theory on Markets," Joe Nocera, The New York Times, June 5, 2009 --- http://www.nytimes.com/2009/06/06/business/06nocera.html?_r=1

Jensen Comment
We need only look at the billions lost by Warren Buffett to anecdotally note that it is very difficult for anybody but insiders (who are not allowed by law to steal from the public) to consistently exploit less sophisticated investors who rely upon price movements and whims more than detailed financial analysis. Big winners are usually big risk takers and/or just darn lucky even if market researchers find, in retrospect, instances where the EMH falters.

The above article advises that investors put their money in index funds. This bothers me a bit, however, since large numbers of investors have to be buying and selling actual shares of companies in order to set the prices upon which index fund values are derived. If everybody invested in index funds it would be like gambling on race horses who never entered the races.

Jensen Comment
I don’t like the above advice for the “average investor” because if too many investors prefer investing in index funds rather than in business debt and equity, then there will be no underlying commerce to support the index fund concept. It becomes like betting on NHL games before that season a few years ago when all NHL games were cancelled. Index funds aren’t so hot if all commerce is cancelled.

 

Pat Walters stated:
“I just want to know if the people who want to go back to historical cost for financial instruments will be the first in line to buy bank stocks when they have no clue what the value of the banks 'assets" are.  Not me.”

 

Hi Pat,

You may not be maximizing your net worth, and you aren't explaining why sophisticated investors (your CREF account investors?) may be buying bank stocks after the FASB lightened up on allowing banks more freedom to overlook the fair value stench of toxic investments with more Level 3 historical cost measurement use in FAS 157 (And Wells Fargo and other banks jumped on Level 3 as fast as its auditors would allow).

Why do some very clever investors pay a price well above what they think something is worth in an efficient market? It’s because they think the market will be inefficient at some point where they can find a fool to sell it to at a profit. It’s called a Fool’s Fooling Game, and when played well, smart fools beat the dumb fools

The Motley Fool is a very popular commercial Website about stocks, investing, and personal finance --- http://en.wikipedia.org/wiki/Motley_Fool  
Did you ever wonder about the “Fool” part of the company’s name?
The Gardner brothers considered themselves “fools” that were smarter than some foxes. Although at many times the Gardners have shown that fools can fool wannabe foxes, the Gardners brothers have at times also been out foxed.

My point here, Pat, is that people who buy Wells Fargo Bank shares just because the price went up following an accounting change (accounting change from Level 1 to Level 3 covered up the smell of Wells Fargo’s enormous toxic loan portfolio) may not be ignorant that accounting changes don’t really offset pending toxic deaths in the long run.

Some “fools” buying Wells Fargo Bank shares just think there are many fools more foolish than themselves.

Either way you look at it, investing is a bit of a fools game with fools trying to outfool one another. The premise is, however, that sophisticated fools ultimately win. That's most certainly the case with casinos.

 

In retrospect between 2001 and the credit derivatives fiasco of 2008 (where Wall Street had millions of such contracts) is that Janet M. Tavakoli’s credit derivative models in 2001 looked almost perfect but ignored the Black Swan of 2008 that some might argue helped to bring down the world of finance to the extent that so many credit derivatives were used, in a failing effort, to insure against investment failures. This, of course, was a much larger specification problem than the Euclidean difference between cylinders and cones. I wonder how Ms. Tavokoli is sleeping these days. See http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout  

Q&A: Confidence in the Bell (Gaussian)Curve --- http://en.wikipedia.org/wiki/Gaussian
Also see http://en.wikipedia.org/wiki/Normal_Distribution
Value at Risk --- http://en.wikipedia.org/wiki/Value_at_Risk
Eugene Fama --- http://en.wikipedia.org/wiki/Eugene_Fama
Kenneth French --- http://en.wikipedia.org/wiki/Kenneth_French

Question for Fama and French ---
http://www.dimensional.com/famafrench/2009/03/qa-confidence-in-the-bell-curve.html#more
It would be very enlightening if you would comment on the Nassim Nicholas Taleb ("The Black Swan") attack on the use of Gaussian (normal bell curve) mathematics as the foundation of finance. As you may know, Taleb is a fan of Mandelbrot, whose mathematics account for fat tails. He argues that the bell curve doesn't reflect reality. He is also quite critical of academics who teach modern portfolio theory because it is based on the assumption that returns are normally distributed. Doesn't all this imply that academics should start doing reality-based research?

Answer from Gene Fama (Chicago)
EFF: Half of my 1964 Ph.D. thesis is tests of market efficiency, and the other half is a detailed examination of the distribution of stock returns. Mandelbrot is right. The distribution is fat-tailed relative to the normal distribution. In other words, extreme returns occur much more often than would be expected if returns were normal.

There was lots of interest in this issue for about ten years. Then academics lost interest. The reason is that most of what we do in terms of portfolio theory and models of risk and expected return works for Mandelbrot's stable distribution class, as well as for the normal distribution (which is in fact a member of the stable class). For passive investors, none of this matters, beyond being aware that outlier returns are more common than would be expected if return distributions were normal.

For other applications, however, the difference can be critical. Risk management by financial institutions is a good example. For example, portfolio insurance, which was the rage in the early 1980s, bombed in the crash of October 1987, because this was an event that was inconceivable in their normality based return model. The normality assumption is also likely to be a serious problem in various kinds of derivatives, where lots of the price is due to the probability of extreme events. For example, news story accounts suggest that AIG blew up because its risk model for credit default swaps did not properly account for outlier events.

Answer from Kenneth French (Dartmouth)
KRF: I agree with Gene, but want to make another point that he is appropriately reluctant to make. Taleb is generally correct about the importance of outliers, but he gets carried away in his criticism of academic research. There are lots of academics who are well aware of this issue and consider it seriously when doing empirical research. Those of us who used Gene's textbook in our first finance course have been concerned with this fat-tail problem our whole careers. Most of the empirical studies in finance use simple and robust techniques that do not make precise distributional assumptions, and Gene can take much of the credit for this as well, whether through his feedback in seminars, suggestions on written work, comments in referee reports, or the advice he has given his many Ph.D. students over the years.

The possibility of extreme outcomes is certainly important for things like risk management, option pricing, and many complicated "arbitrage" strategies. Investors should also recognize the potential effect of outliers when assessing the distribution of future returns on their portfolios. None of this implies, however, that the existence of outliers undermines modern portfolio theory or asset pricing theory. And the central implications of modern portfolio theory and asset pricing—the benefits of diversification and the trade-off between risk and return—remain valid under any reasonable distribution of returns.

Who is Nassim Nicholas Taleb? --- http://en.wikipedia.org/wiki/Taleb
Many finance professors make students watch some of Taleb's videos, especially the Black Swan --- Click Here
http://video.google.com/videosearch?q=taleb+black+swan+&www_google_domain=www.google.com&emb=0&aq=f&aq=f#
Black Swan Financial Collapse Black Swan --- http://www.dailymotion.com/video/x720r3_black-swan-paradigm-financial-colla_tech
(People underestimate the probability of rare events)

"How Dragon Kings Could Trump Black Swans Power laws have a hidden structure that reveals why extreme events are more common than we'd thought," MIT's Technology Review, August 4, 2009 ---
http://www.technologyreview.com/blog/arxiv/ 

Sornette gives as an example the distribution of city sizes in France which follows a classic power law, meaning that there are many small cities and only a few large ones. On a log-log scale, this distribution gives a straight line. Except for Paris, which is an outlier, many times larger than it ought to be if it were to follow the power law.

Paris is an outlier because it has been hugely influential in the history of France and so has benefited from various positive feedback mechanisms that have ensured its outsize growth. Apparently London occupies a similarly outlying position in the distribution of cities in the UK.

Sornette goes on to identify a number of data sets showing power laws with outliers that he says are the result of positive feedback mechanisms that make them much larger than their peers. He calls these events dragon kings. What's interesting about them is that they are entirely unaccounted for by a current understanding of power laws, from which Nassim Nicholas Taleb built the idea of black swans.

The special characteristic of dragon kings is that a positive feedback mechanism creates faster-than-exponential growth making them larger than expected.

So what to make of this? Sornette makes one interesting observation. The seemingly ubiquitous existence of these dragon kings in all kinds of data sets means that extreme events are significantly more likely than power laws alone suggest.

That's important. If you've ever wondered why we've experienced not just a single 100-year financial crises in the last couple of decades but two or three, here's your answer. It also implies that you'll experience a few more before your time is up.

But Sornette goes further. He argues that dragon kings may have properties that make them not only identifiable in real time but also predictable. He puts it like this: "These processes provide clues that allow us to diagnose the maturation of a system towards a crisis."

That's much more speculative. It's one thing to identify the feedback mechanisms that cause faster-than-exponential growth (and it's not clear that Sornette can do even this) but quite another to spot the event that trigger a crash.

Sornette looks to be onto something interesting with his notion of dragon kings: outliers that exist beyond the usual realm of power laws. That could be a hugely infuential. But his contention that these outliers are in some way more easily predictable than other events smacks more of wishful thinking than good science.

Ref: arxiv.org/abs/0907.4290: Dragon-Kings, Black Swans and the Prediction of Crises

Video:  Nassim Taleb Talks About The Book “Dancing With Chance” ---
http://www.simoleonsense.com/nassim-taleb-talks-about-the-book-dancing-with-chance/
Also see http://www.cnbc.com/id/31706523

Garbage Research in Stock Pricing Correlations and Equity Premiums
Seriously that smelly kind of garbage you pay to have hauled away
A new measure of consumption -- garbage -- is more volatile and more correlated with stocks than the standard measure, NIPA consumption expenditure. A garbage-based CCAPM matches the U.S. equity premium with relative risk aversion of 17 versus 81 and evades the joint equity premium-risk-free rate puzzle. These results carry through to European data. In a cross section of size, value, and industry portfolios, garbage growth is priced and drives out NIPA expenditure growth.
Alexi Savov, University of Chicago Booth School of Business. "Asset Pricing with Garbage, SSRN, February 17, 2009 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1345470 

This is a little like the historic 0.63 correlation between stork nests and birth rates --- http://www.jstor.org/pss/2983064

Statistics Lesson:  Spanking is a cause of lower IQ?
U.S. children who were spanked had lower IQs four years later than those not spanked, researchers found. University of New Hampshire Professor Murray Straus, who is presenting the findings Friday at the 14th International Conference on Violence, Abuse and Trauma, in San Diego, called the study "groundbreaking." "The results of this research have major implications for the well being of children across the globe," Straus said in a statement. "It is time for psychologists to recognize the need to help parents end the use of corporal punishment and incorporate that objective into their teaching and clinical practice." "How often parents spanked made a difference. The more spanking the, the slower the development of the child's mental ability," Straus said. "But even small amounts of spanking made a difference."
"Study: Spanking linked to lower IQ," Breitbart, September 25, 2009 ---
http://www.breitbart.com/article.php?id=upiUPI-20090925-121520-9596&show_article=1&catnum=0
Jensen Comment
I think Straus was frequently spanked as a child. Could it be that lower IQ students get more frustrated and are inclined toward greater degrees of misbehavior?

This is a little like the historic 0.63 correlation between stork nests and birth rates --- http://www.jstor.org/pss/2983064

Summary of the Ups and Downs of the Efficient Market Hypothesis

Before reading this article you may want to consult the EMH at http://en.wikipedia.org/wiki/Efficient_market_hypothesis

"Poking Holes in a Theory on Markets," Joe Nocera, The New Yor