Morningstar Advisor - February/March 2009 - 41

It would be very helpful if we recognize that the problems in the 1930s and the problems we’re facing today are a result of excessively loose credit policies in the previous decades. That’s a missing piece of analysis. George Cooper crisis, economy, and the long-term ramifications for investors. On Dec. 17, Ibbotson called from New Haven, Conn., Cooper from London, and Mandelbrot from Boston. The discussion has been edited for clarity and length. Paul Kaplan: The Fed took a dramatic step yesterday in lowering its funds rate to close to zero. What does that say about the current state of our financial system? How’d we get here? Roger Ibbotson: Obviously, it’s in really bad shape right now. I don’t think the Fed funds rate has ever been that low. We are trying to regenerate the economy and save the financial system. and, particularly, in the financial sector. This leverage was packaged and put in complex forms of derivatives, which wasn’t always transparent to investors, and sold off around the world. So this crisis is not local to the United States, but it’s a global financial crisis in both developed and emerging countries. What’s different this time is that the government is taking action. The government was paralyzed in the beginning of the 1930s, but today, it’s acting. Maybe what the government is doing is not coherent or structured enough—there seems to be a lot of one-off actions and some panic—but certainly officials are doing a tremendous amount to try to alleviate this crisis. Part of that was what happened yesterday with the Fed rate. George Cooper: What the Fed did yesterday is What was missed in that analysis was that by generating credit, Bernanke and Greenspan created a temporary boom in the economy. But once the credit needed to be repaid, you created a greater slump in the future. We are now reaping the rewards, if you like, of trying to fix the Nasdaq problem with a housing boom, which has compounded the problem into the current mega-credit cycle. I think it would be very helpful if we step back and recognize that the problems in the 1930s and the problems we’re facing today are a result of excessively loose credit policies in the previous decades. That’s a missing piece of analysis. I think we need to fix the problems with the policies being used now, but as we do that, we need to recognize that once the fix is enacted, we need to run monetary policy in a fundamentally different way. Kaplan: Dr. Mandelbrot, since the early 1960s, you’ve been building statistical models of asset returns. Your models differ very significantly from the ones that are taught in business schools. You use fat-tailed distributions, long-term memory, and so on. One of your students was Eugene Fama, who wrote his doctoral dissertation based on your research. Today, of course, Fama is very much in the mainstream of financial economics. Please describe your research. Why is it important for financial advisors to be familiar with it? Benoit Mandelbrot: While working for the IBM As I look back, it’s looking more and more like the 1930s in terms of the financial markets. We haven’t seen these large daily price movements in the market since the Great Depression. We had some really bad results in the stock market in the 1970s; we had the crash of 1987; and we were down 45% in 2000-2002. But why I go back to the 1930s here is that both crises were created by the financial market. Most of the recessions that we have had were not oriented around a breakdown of the financial system. It’s only this one and the one in the 1930s that were related to a breakdown in the financial system. In both cases, you had an overleveraged economy with a lack of transparency and a meltdown of various types of financial instruments. In the 1930s, a large number of banks failed and companies were overleveraged. We have that same sort of leverage today, not so much in companies, but both on the household level part of the necessary policy response here. They clearly have little choice, other than to use monetary policy and fiscal policy to attempt to prop up the financial markets and the economy more broadly. What worries me, though, is that we’re enacting these very aggressive policy responses without really stepping back and analyzing the problem or the reason that we got into this problem. We should go back a few years to when Ben Bernanke was giving speeches about how he could avoid a deflation problem in America by lowering interest rates and injecting liquidity into the economy; he claimed then that the deflation threat could be offset by stimulating more and more borrowing, which he and Alan Greenspan at the time did by lowering rates to 1% and triggering a boom in the housing market. Research Center in New York, I became motivated to look very carefully at cotton prices over a fairly ordinary period of five years. I observed that those prices’ changes had been always very much dominated by special events MorningstarAdvisor.com 41
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Morningstar Advisor - February/March 2009

Table of Contents for the Digital Edition of Morningstar Advisor - February/March 2009

Morningstar Advisor - February/March 2009
Contents
New on MorningstarAdvisor.com
Letter from the Editor
Contributors
Inbox
How Do You Gauge and Measure Risk?
No Skinny-Dippers Here
Heading to Shore
Investment Briefs
Weapons of Mass Destruction?
Déjà Vu All Over Again
A Failure to Gauge Risk
Five Areas to Find Opportunities
Getting a Read on Risk
Heavenly Returns
Greenspring Comes to the Rescue
How to Spot a Trustworthy REIT
Four Picks for the President
Find Succor in These Large Dividends
These Stocks Are Fiscally Fit
Mutual Fund Analyst Picks
50 Most Popular Equity ETFs
Undervalued Stocks
Most Popular Variable Annuities
New at Morningstar
You Gotta Look Sharpe
Morningstar Advisor - February/March 2009 - Intro
Morningstar Advisor - February/March 2009 - Morningstar Advisor - February/March 2009
Morningstar Advisor - February/March 2009 - Cover2
Morningstar Advisor - February/March 2009 - 1
Morningstar Advisor - February/March 2009 - 2
Morningstar Advisor - February/March 2009 - Contents
Morningstar Advisor - February/March 2009 - 4
Morningstar Advisor - February/March 2009 - 5
Morningstar Advisor - February/March 2009 - New on MorningstarAdvisor.com
Morningstar Advisor - February/March 2009 - 7
Morningstar Advisor - February/March 2009 - 8
Morningstar Advisor - February/March 2009 - Letter from the Editor
Morningstar Advisor - February/March 2009 - Contributors
Morningstar Advisor - February/March 2009 - Inbox
Morningstar Advisor - February/March 2009 - How Do You Gauge and Measure Risk?
Morningstar Advisor - February/March 2009 - 13
Morningstar Advisor - February/March 2009 - No Skinny-Dippers Here
Morningstar Advisor - February/March 2009 - 15
Morningstar Advisor - February/March 2009 - 16
Morningstar Advisor - February/March 2009 - Heading to Shore
Morningstar Advisor - February/March 2009 - 18
Morningstar Advisor - February/March 2009 - 19
Morningstar Advisor - February/March 2009 - Investment Briefs
Morningstar Advisor - February/March 2009 - 21
Morningstar Advisor - February/March 2009 - Weapons of Mass Destruction?
Morningstar Advisor - February/March 2009 - 23
Morningstar Advisor - February/March 2009 - 24
Morningstar Advisor - February/March 2009 - 25
Morningstar Advisor - February/March 2009 - 26
Morningstar Advisor - February/March 2009 - 27
Morningstar Advisor - February/March 2009 - Déjà Vu All Over Again
Morningstar Advisor - February/March 2009 - 29
Morningstar Advisor - February/March 2009 - 30
Morningstar Advisor - February/March 2009 - 31
Morningstar Advisor - February/March 2009 - 32
Morningstar Advisor - February/March 2009 - 33
Morningstar Advisor - February/March 2009 - A Failure to Gauge Risk
Morningstar Advisor - February/March 2009 - 35
Morningstar Advisor - February/March 2009 - 36
Morningstar Advisor - February/March 2009 - 37
Morningstar Advisor - February/March 2009 - Five Areas to Find Opportunities
Morningstar Advisor - February/March 2009 - 39
Morningstar Advisor - February/March 2009 - Getting a Read on Risk
Morningstar Advisor - February/March 2009 - 41
Morningstar Advisor - February/March 2009 - 42
Morningstar Advisor - February/March 2009 - 43
Morningstar Advisor - February/March 2009 - 44
Morningstar Advisor - February/March 2009 - 45
Morningstar Advisor - February/March 2009 - 46
Morningstar Advisor - February/March 2009 - 47
Morningstar Advisor - February/March 2009 - Heavenly Returns
Morningstar Advisor - February/March 2009 - 49
Morningstar Advisor - February/March 2009 - 50
Morningstar Advisor - February/March 2009 - 51
Morningstar Advisor - February/March 2009 - Greenspring Comes to the Rescue
Morningstar Advisor - February/March 2009 - 53
Morningstar Advisor - February/March 2009 - 54
Morningstar Advisor - February/March 2009 - 55
Morningstar Advisor - February/March 2009 - How to Spot a Trustworthy REIT
Morningstar Advisor - February/March 2009 - 57
Morningstar Advisor - February/March 2009 - Four Picks for the President
Morningstar Advisor - February/March 2009 - 59
Morningstar Advisor - February/March 2009 - Find Succor in These Large Dividends
Morningstar Advisor - February/March 2009 - 61
Morningstar Advisor - February/March 2009 - These Stocks Are Fiscally Fit
Morningstar Advisor - February/March 2009 - 63
Morningstar Advisor - February/March 2009 - Mutual Fund Analyst Picks
Morningstar Advisor - February/March 2009 - 65
Morningstar Advisor - February/March 2009 - 66
Morningstar Advisor - February/March 2009 - 67
Morningstar Advisor - February/March 2009 - 50 Most Popular Equity ETFs
Morningstar Advisor - February/March 2009 - 69
Morningstar Advisor - February/March 2009 - 70
Morningstar Advisor - February/March 2009 - 71
Morningstar Advisor - February/March 2009 - Undervalued Stocks
Morningstar Advisor - February/March 2009 - 73
Morningstar Advisor - February/March 2009 - 74
Morningstar Advisor - February/March 2009 - 75
Morningstar Advisor - February/March 2009 - Most Popular Variable Annuities
Morningstar Advisor - February/March 2009 - 77
Morningstar Advisor - February/March 2009 - 78
Morningstar Advisor - February/March 2009 - New at Morningstar
Morningstar Advisor - February/March 2009 - You Gotta Look Sharpe
Morningstar Advisor - February/March 2009 - Cover3
Morningstar Advisor - February/March 2009 - Cover4
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