The blunderer who is Ben

Curiouser and curiouser. In Sunday's New York Times, 'economics' columnist Ben Stein comes out against speculative portion of the CDS market.

This kind of stance is one of those bonehead simplifications of a complicated subject that appeal to people who want to think they are sophisticated without having to do a lot of wonkish reading. You know. People like ... Ben Stein.

Here's a link to his column for those of you with a subscription to the NYT.

And here is the bit that has provoked my ire:

ADD A RULE Don’t allow speculators with no insurable interest to buy credit-default swaps on bonds.

When used properly, these instruments can function as a legitimate kind of insurance. Yes, if you are a real buyer of the bonds of a given company, you should be able to buy insurance. But you shouldn’t if you are just a shark circling prey, bringing blood into the water.

Allowing speculators to buy C.D.S.’s merely to bet against a firm in difficulty just blasts the prices of bonds, kills the balance sheets of banks, insurers and hedge funds, and throws fear into the system.

First, it is absurd to try to draw a sharp distinction between the "legitimate insurance" use of a CDS and the illegitimate speculative use. Those speculators provide precious liquidity for the market. If you have GM bonds in your portfolio, and you want to buy default protection, you'll be glad that there are counterparties in the market willing to sell protection to you. And part of the reason there will be such counterparties in the market is that there are speculators to whom they can sell. The speculators, in other words, increase the size of the overall pool, making life easier for the hedgers who need to wade into it.

Second, on any CDS contract, whether hedging or speculative, there is a winner as well as a loser. If a hedge fund makes a speculative bet that GM will fail, it is because and to the extent that somnebody else -- typically, a bank or insurance company -- has made a speculative bet that it will survive for the life of the contract. Stein doesn't even explain: which side of that bet is the public policy problem? Which side is the "shark," which side is the "prey"? If the protection is sold too cheaply, the bank has taken a foolish position. But on that same presumption, the hedge fund has made a wise decision. The outcome isn't going to "killl the balance sheet" of them both.

Third, in more general terms, why shouldn't we expect that a liquid market in CDS will cause prices, i.e. spreads, to move to an equilibrium that won't represent a foolish decision on either side?

There are some necessary changes in the CDS marketplace. Central clearing and settlement would be a good idea, and some standardization of product is probably necessary to make that happen. Such developments are underway. But Stein blunders right through all of that, cognizant of none of the real issues because he just wants somebody -- the SEC? the CFTC/ Treasury? Congress? it doesn't really matter -- he just wants somebody to "add a rule".

Win Ben Stein's Cheapened Money

Ben Stein, the droning voice of Ferris Bueller's teacher, fancies himself an economist, like his father, Nixon adviser Herb Stein. When he's not a game show host, or an anti-Darwinian propagandist.

Ben has recently posted on Yahoo!Finance a column about why the US and all the other major industrial nations should print money like mad. All the dangers are on the "deflationary" side, he says. There's no danger in the other direction, from inflation/reflation. So ... let's go for it!

Hey, sort of like Zimbabwe, right? How's it working out there?

Here's Ben's column, just so you won't think I'm inventing a straw man!

And here is a fine take-down of Ben's nonsense, by the economics junkie, who rightly says that the Stein column is "so utterly wrong" that somebody had to call him out.

Good work, EJ.

Also, over at Portfolio, Felix Salmon has a semi-regular feature, his "Ben Stein Watch," in which he tilts with this windmill pretending to be a giant. I recommend that.

Now that I check, I see that this is the fourth mention of Stein's economic views I've made in the brief history of this blog. So just follow the tag if you've got the stomach for more. Thanks.

Three quick notes

1. Melnyk's astonishment

Let's just try to keep up today with three of our continuing stories. As I reported month, there was a shake-up at the Canadian pharma company Biovail. The company is doing its best to disassociate itself from its founder, Eugene Melnyk, whom it blames for a roster of legal troubles. This is tricky, because Melnyk remains the largest shareholder, with just under 12% of the equity.

And he isn't a happy camper. Indeed, in a letter to the reconstituted board of his old company, dated May 8, he professes himself astonished by the latest measures in this continuing distancing.

He is "very concerned about the circumstances surrounding the entering into of the employment agreements with senior management and the change in control provisions in those agreements. I intend to pursue this matter further."

He can pursue it on June 25, the day of the annual shareholders' meeting. The "record date" for the meeting is April 28 -- i.e. you'd need to have been a shareholder "of record" by then to be qualified to vote.

2. More from Ben Stein

You remember Ben Stein? I last wrote about him in January, when he used his New York Times column to set out a theory of "trader realism," i.e. that the whims and machinations of speculators in Manhattan or London are so important to pricing of strategic commodities that they render the fundamentals ("supply," and "demand" and other stuff and nonsense) essentially irrelevant.

This is a lunatic theory, and since then Stein has shown signs of abandoning it for a cause even dearer to his heart -- "biologist realism" linked here.

But watch out economics. Stein, like a poltergeist, is baaa-ack.

Felix Salmon does him justice.


3. The latest at CSX

The feud between railroad company CSX and activist investor TCI continues, pending some resolution at next month's meeting.

TCI has posted a white paper titled "CSX: The Case for Change," it claims that numerous opportunities for productivity improvements could add $2.2 billion to annual earnings within five years, and it complains that the incumbents ()the folks who have left those opportunities unexploited) have also awarded themselves the highest pay packages in the industry.

Yesterday, TCI sent out a "dear shareholders'" letter asking its fellow investors to go to their website and check out that white paper.

So what does "trader realism" tell us, Ben?

According to Stein, professional traders, (like judges in the "legal realism" model) start from their desired conclusion, and work backward to rig up the necessary premises.

"Traders can see masses of data any minute of any day. They can find data to support hitting the 'buy' button or the 'sell' button. They don’t act on the basis of what seems to them the real economic situation, but on what’s in it for them."

Of course, classical economists would say, traders act on what's in it for them! So does everybody in the system, at least according to the classical model Stein may think he's refuting here. The difference may be this: Stein thinks the decision whether a "sell" or a "buy" has more "in it for them" has a non-rational, even an irrational, element based on, say, the corporate politics of the broker-dealer, quirks of bonus policies, idiosyncratic personalities.

A classicist who doesn't wish to conform to stereotype too tightly can of course acknowledge that traders sometimes act in ways hard to model. Still, those who consistently act on irrational factors will lose money. They won't stay in business for long. And if there are a lot of traders, and a lot of trading going on, then the irrational aspects are factored out within the whole system, the noise is filtered out and the market conveys information efficiently.

Stein's reason for believing this model is wrong and his "trader realism" has pierced a veil? An uncheckable anecdote. A "close friend of mine, now deceased," who used to be a trader in London for a major financial house, told him a story about shorting IBM on a dare from the boss, and then geting on the phone to spread rumors, talking down the price of IBM so his short position would pay off.

That's it. After the household meatloaf, the law school memories, the trader/judge analogy, we get around to a theory based on a single recollected story from one unnamed person who has shuffled off the mortal coil. Wow! On such evidence, many people seem to believe that Elvis continues to walk about and order Slurpees at various Quickie Marts.

Those of you who wish to follow reactions to his column ... as I've noted, the blogosphere is full of them. Here are just two links to get you going:

Blodgett.

Weiss.

Blodgett is harsh, Weiss is critical-but-sympathetic.

It's a tad anachronistic, but I can't help feeling that Oscar Wilde had Stein in mind when he had a character in one of his plays warn that "even these metallic problems have their melodramatic side."

Ben Stein's "trader realism"

In The New York Times this Sunday, Ben Stein has explained market volatility in a conspiracy-theorist spirit.

Stein isn't the type of guy who stocks up on canned food and worries about the black helicopters of the UN. He's perhaps best known as an actor (having played Ferris Bueller's teacher, having hosted game shows on television etc.) but he seems to think of himself more as an economist in the line of his father, Herb Stein, who chaired the council of economic advisors under Presidents Nixon and Ford.

At any rate, Stein seems to have carved out a niche for himself somewhere in between the worlds of financial punditry and entertainment. The actor who can discourse eruditely about economics, the finance pundit who can play a role.

His column Sunday begins with a personal note -- he reminds us that he is Herb Stein's kid, and tells us that when he was a child monetarism was a subject for dinner table discussion, over the meatloaf.

From this we seque to his law school education, to his absorption of the ideas known as "legal realism," and from there at last to the point. He has decided that what economics/finance needs is the sort of veil-piercing that the realist scholars brought to the world of law.

I once wrote a book which was largely devoted to the defense of formalism against realism within jurisprudence, so I guess I'n not the audience Stein had in mind when he introduced his conspiracy theory in this roundabout way.

If you'd like to read the column itself, please do sohere. I'll describe the theory to which his effort at veil-piercing has led him tomorrow.