Richard H Thaler - Misbehaving- The Making of Behavioral Economics (epub)

these warning signals and realized that a fall in home prices was becoming
increasingly likely. Instead, surveys by Shiller showed that these were the
regions in which expectations about the future appreciation of home prices were
the most optimistic. Instead of expecting mean reversion, people were acting as
if what goes up must go up even more.
Moreover, rational lenders would have made the requirements for getting a
mortgage stricter under such circumstances, but just the opposite happened.
Mortgages were offered with little or no down payment required, and scant
attention was paid to the creditworthiness of the borrowers. These “liar loans”
fueled the booms, and policy-makers took no action to intervene.
This lesson is one of the most important to take away from the research about
market efficiency. If policy-makers simply take it as a matter of faith that prices
are always right, they will never see any need to take preventive action. But once
we grant that bubbles are possible, and the private sector appears to be feeding
the frenzy, it can make sense for policy-makers to lean against the wind in some
way.
Central banks around the world have had to take extraordinary measures to
help economies recover from the financial crisis. The same people who complain
most about these extraordinary recovery measures are also those who would
object to relatively minor steps to reduce the likelihood of another catastrophe.
That is simply irrational.
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* It was possible to find some shares to borrow if you had time on your hands. In fact, at the time, there
was a finance PhD student at the University of Chicago who was determined to make money on
3Com/Palm. He opened accounts at every discount brokerage house and spent all of his time trying to
borrow shares of Palm to sell short. Whenever he got Palm shares he would sell them short and use the
proceeds to buy the number of shares of 3Com required to hedge his bet. When the deal was finalized a few
months later, he made a tidy profit and bought a sports car that he nicknamed the Palm-mobile. The moral
of this story is that it was possible to make tens of thousands of dollars from this anomaly, but not tens of
millions.
† A similar situation arose in mid-2014 when Yahoo’s holdings of Alibaba were calculated to be worth
more than the whole of Yahoo (Jackson, 2014; Carlson, 2014).
‡ When I described this anomaly to the CEO of a large pension fund sometime in the 1990s, he said I must
be wrong because surely the smart money would just buy whichever shares were cheaper. I said, “Really? I
believe your fund owns millions of dollars of the more expensive version,” and offered to bet a fancy dinner
that I was right. He wisely didn’t bet. His fund was partly indexed to the S&P 500, which then included the
Dutch version that was selling at a premium.
§ Full disclosure: Since 1998 I have been a partner in a money management firm called Fuller and Thaler
Asset Management that invests in U.S. equities by finding situations where investors’ behavioral biases are
likely to cause mispricing. The fact that we are still in business suggests that we have either been successful
at using behavioral finance to beat the market, or have been lucky, or both.