Monday, September 14, 2009

They Called Him Mr. Bubble

by David Leonhardt in Yale Alumni Magazine:

Sometime in the mid-1980s, Robert Shiller and John Campbell '84PhD created The Chart. It wasn't especially complicated. It showed average stock prices, relative to corporate earnings, going all the way back to the late nineteenth century. Wall Street analysts produce charts along these lines all the time. The measure is called the price-earnings ratio, and it is the single most common analytical yardstick of the stock market.

The yardstick that Shiller and Campbell created, however, came with a twist -- a twist that transformed their little chart into The Chart. Today, The Chart stands as one of the signature pieces of economic research of the past generation. It is rigorous enough to have appeared in the Journal of Portfolio Management and simple enough to be understood by those of us who are behind on our Portfolio Management reading.

Anyone who heeded the central lesson of Shiller and Campbell's analysis -- as well as the lesson of a subsequent chart, created by Shiller, on the housing market -- could have avoided some of the worst pain of the financial crisis. If Alan Greenspan had taken The Chart seriously during the late 1990s, Greenspan's reputation might be in better shape today. So might the United States economy. Nouriel Roubini, the doomsday-prophesizing finance professor at New York University who has lately become a media darling, credits The Chart for much of his clairvoyance.

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