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Ben Stein's Intensely Silly Market Manipulation Theory

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Ben Stein was up to his usual silliness in Sunday’s New York Times, this week writing about a conspiracy theory involving traders manipulating the market in search of profit. He gives his theory a name—Financial Realism—because he bases it on something he learned about in law school called Legal Realism. According to his theory, traders have been using fear churned up by the subprime storm to push markets down in search of profits.
It’s a really radically theory of how easily markets can be manipulated. If traders could really move markets like Stein thinks, we wouldn’t already be hearing about January was a terrible month for hedge funds, and quantitative managers went through another 28 sigma event last week. And, as Gary Weiss points out, if Stein were right about this all being a result of manipulation, that would be good news. Because soon the efficiency of the markets would step in, set things right, the Fed wouldn’t have to inflate away are already meager savings and we could live forever on the big rock candy mountain.
"If the current market action is the manifestation of some sort of evil trader genius, they have executed it pretty poorly," Naked Capitalism writes. "Every major firm should have been net short, not just Goldman. The investment banks, with their sales forces and research arms, are in a much more powerful position to push rumors. If the market fall was by design, pray tell me how it benefited the Street? They have taken over $100 billion in writeoffs, and the fourth quarter results are still coming in."
After the jump, we get into it with a bit more detail with Stein again.

So where does Stein get his ideas? Maybe he’s just too old, suggest Larry Ribstein. Back when Ben was learning the secret truth about legal realism as a law and economics student at Yale, people believed some really dumb things about markets. (And even dumber things about law.) “Ben’s pre-1970 education in law and economics has, shall we say, some gaps. Among other things, he has missed 35 years of theory and data about the efficient capital markets hypothesis, which was just getting going around when Ben graduated from law school,” Ribstein writes.
But Stein’s theory is flawed from its genesis, which is his surprise that the stock markets have suffered a decline over the past several months. “The losses in the stock market since the highs of October 2007 are about 14 percent. This predicts –very roughly—a fall in corporate profits of roughly 14 percent,” Stein claims. “Yet there has never been a decline of quite that size for even one year in the postwar United States, and never more than two years of declining profits before they regained their previous peak.”
Felix Salmon points out that its surprising to see a proponent of manipulated market conspiracy theory who displays such a strong faith in the efficient markets hypothesis. “The implication seems to be that the efficient markets hypothesis held in October, and that the market was pricing in future profits correctly; and that it doesn't hold today, in the wake of all that short-selling by those nasty traders,” Salmon writes.
Even the way Stein claims to have come by his theory strikes us as doubtful. Stein lays out his theory with a story he heard from a guy who is now dead. Hint: that’s what you say when you don’t want anyone checking your facts.

Because I usually write about finance, I have come to believe in the theory of what I would call “financial realism,” or what might more accurately be called “trader realism.” Under this theory, on which I have an imaginary patent, 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.
Just as a tiny example, years ago a close friend, now deceased, was a trader in London for a big financial house. As he told it, one day I.B.M. came out with stellar numbers. The boss of the trading floor said, “O.K., the guy who’s getting the prize is the one who can make us money selling I.B.M. short.”
So the traders grabbed for their phones and started to put out any bad thoughts they could dream up about I.B.M. They called journalists, retailers, anyone. They sold huge amounts of I.B.M. short. Soon, they had I.B.M. on the run, made money on their shorts and went to Langan’s to drink champers.

Basically, we call bullshit on this uncheckable story Stein uses to illustrate an unsupportable theory.
Can Their Wish Be the Market’s Command? [New York Times]
Ben Stein on the Meshuganeh Market [Gary Weiss]
Ben Stein Tells Us It's All the Traders' Fault [Naked Capitalism]
Ben Stein on law, legal realism, economics and finance [Ideoblog]
Ben Stein Watch: January 27, 2008 [Portfolio]