Book Review: The Malign Hand of the Markets

Subtitle: The Insidious Forces on Wall Street that are Destroying Financial Markets – and What We Can Do About It

This book, written by Duke Professor of Psychology, Biology and Neurobiology John Staddon, provides a quite interesting view of the way our markets are impacted by the “malign hand” – a play on the “invisible hand” described by Adam Smith in his book “Wealth of Nations”.

Briefly, the Invisible Hand Theory describes how an unknown force allows the market to self-balance – the self-interest of the individuals making up the marketplace has a beneficial impact on the overall marketplace, even though the individuals in the marketplace are only interested in their own benefit.

But we’re not here to talk about Invisible Hand, but rather the Malign Hand.  Staddon explains that individual self-interest may have a negative impact to the overall marketplace.  One example of this is in the tragedy of the commons – where a finite amount of resources, let’s say for example fish in the sea, are harvested by a set number of fishermen.  For each additional fish caught, the fisherman makes more money.  Self-interest leads the fishermen to catch more and more fish, and for a while that means they all make more money.  After some time has passed, the number of fish available begins to dwindle, enough that none of the fishermen is making enough money to live on.

Once this has happened, preservation measures must be taken in the form of regulation, limiting all fishermen to a severely reduced catch.  This regulation drives some of the fishermen out of the market, and gradually the fishery recovers (hopefully) to a point that sustains the fewer remaining fishermen with an adequate living.

Mr. Staddon argues that the tragedy of commons, which has many faces in our financial industry, is brought on by the way our system of regulation (and de-regulation) has evolved over time.  This system results in feedback loops that end up reinforcing the wrong kinds of behavior – behavior that actual exacerbates the situation, rather than restoring balance to the market.

Many diverse disciplines are used to help explain how the reinforcement process works: biology, psychology, behavioral economics, and philosophy.  This leads to some very interesting theories on how things work in our system.  However, this does not lead to a light read – it’s pretty heavy indeed.  For those who endeavor to take it on, it’s interesting to read Staddon’s takes on how it all plays out.

Staddon isn’t a believer in Efficient Market Theory, and he takes many opportunities to poke holes in it.  Instead, he believes that the EMT only goes part-way to explaining how the market works – and that the rest of the story is left unexplained since there is inherent unpredictability in the market.  This is further enhanced (in Staddon’s explanation) by the fact that value in the marketplace is not a consistently easily-identified figure, and in order for a market to be efficient, measures must be easily and concretely identified.  Efficiency infers a ratio – and without a way to identify the figures as inputs, a ratio cannot be useful.

I found this book to be very insightful in explaining how governmental influence has not regularly been helpful.  One of the examples was particularly interesting: How the fiscal policies and excess (deficit) spending of FDR’s administration during the Great Depression actually prolonged the economic problems rather than improving them as has often been attributed.  The improvements to the economy didn’t actually come about until the US entered WWII – which continued the deficit spending, but it also put into play severe austerity measures on the populace, while at the same time putting more people to work.  Upon the end of the war, unemployment was at manageable levels and the consumer public had an intense pent-up demand to consume.  It was these factors that eventually turned around the economy.  Staddon points out that forced austerity measures aren’t readily accepted by the public, so something like this isn’t likely to be artificially employed to resolve our current economic situation.

All in all I enjoyed the book – even though it is a relatively heady read – and I recommend it to anyone who would like more insight on our economic situations, past and present.  Staddon also provides some examples of regulatory changes that could be made to help resolve current economic issues.  He’s given me a lot of fuel for future research on the topic – I suspect that there are many other sides to the arguments he’s posed.

The above book review is part of a series of reviews that I am doing in an arrangement with McGraw-Hill Professional Publishing, where MH sends me books with the only requirement being that I read the book and write a review – like it or not.  If you find the information in this review useful, let me (and McGraw-Hill) know!