NEWS

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August 10, 2009

Recession Specialist: The Myth of the Bad Bad Business School

Paul Krugman's August 6th book review is headlined, "School for Scoundrels," and you get the feeling from reading it that he's talking about one school in particular.

He reviews two books, "The Myth of the Rational Market" by Justin Fox and "The Sages" by Charles R. Morris, that deal with the financial crisis, and focuses on the subject of the former, the efficient-market hypothesis. Krugman explains that the theory, developed at Chicago's School of Business in 1952 by grad student Harry Markowitz, was a jump forward for market analysts, moving beyond risk analysis by predicting what an investor should do. The problem became that theorists began analyzing the markets based on Markowitz's model.

"The result was an intellectually elegant theory of stock prices — the so-called Capital Asset Pricing Model, or CAPM (pronounced “cap-em”). CAPM is a deeply seductive theory, and it’s hard to overemphasize how thoroughly it took over thinking about finance, not just in business schools but on Wall Street."

According to Krugman, Fox's book places the blame for last year's meltdown on this theory, its acolytes and the Business School. Two of those who are named are Chicago professors Merton Miller, who won a Nobel Prize for his work on the subject, and Eugene Fama, who coined the term "efficient market" and made it seem as though most markets were efficient. MIT makes an appearance, but the theory it produced was quickly put down, a pretender to the dark throne, the implication being that only the University of Chicago was smart yet blind enough to develop this "deeply seductive theory."

Fox's book sounds like an intelligent and important record of a dangerous idea that needs to be told so that it doesn't happen again. But, at least to the Recession Specialist's knowledge, the Booth School of Business is no longer a "School for Scoundrels," and the record should be amended to acknowledge that. In fact, University of Chicago professors have been among the most vocal critics of the system of late, and some of the most innovative in the last year as academia has struggled to adopt and adapt the new economic reality.

The University may have started the fire, Mr. Krugman, and while it did light it, it has tried to fight it.