5 Tax cuts pay for themselves (supply-side economics): Sometimes bad ideas start as good ones. When tax rates are so high as to cause all manner of tax avoidance strategies — think confiscatory rates of 75 to 90 percent — reducing them makes sense and can change investor behavior for the better. Where we run into trouble is when this concept gets extrapolated to an absurd degree. Claiming that any tax cut will pay for itself by producing greater economic activity has now reached that point. No, Virginia, cutting taxes 3 percent does not lead to more revenue. Get over it.
6 The efficient-market hypothesis: This is the mother of all academic zombie ideas. The concept is that markets are “informationally efficient.” That lots of self-interested investors hunt down every last data point about any given asset class or stock. And pricing perfectly represents all of the given information available at the time. Therefore, no one can outperform the markets for long.
Except they have. Fund managers such as Peter Lynch, Warren Buffett, Ray Dalio and Jim Simons have consistently beaten markets over such long stretches that it cannot be merely by chance. Perhaps the even bigger anomaly that this concept runs into are the all-too-regular booms and busts — the massive mispricings of assets — that economic bubbles and crashes produce.
7 Markets can self-regulate: Another example of an idea that started out reasonably enough but soon after went off the rails. After 30 years of postwar economic growth, there was a credible argument that government regulations had become too costly, time-consuming and complex. With inefficiencies holding back small businesses, paring the worst of the regulatory burden should be productive.
As so often occurs, this good idea was taken to an illogical extreme. Instead of removing onerous, expensive regulations, zealots such as then-Sen. Phil Gramm (R-Tex.) argued against all regulations. Markets can regulate themselves much better than some bureaucrat or lawyer. Besides, the self-interest of companies and the efficient market would more effectively police behavior than any government agency ever could. We know how that turned out.
8 Gurus, shamans and prognosticators: Wall Street produces market wizards at a prodigious pace. It may be NYC’s single-biggest export. We love experts to tell us what is going to happen in the future. Never mind that their track record is awful, we prefer the mysticism of the television guru to actual thought.
The data about these experts should give us pause: The more confident an expert sounds, the more likely he is to be believed by TV viewers. Unfortunately, the more self-confident an expert appears, the worse his/her track record is likely to be. And forecasters who get one single big outlier correct are more likely to underperform the rest of the time.
Why is it that we are ensnared by bad ideas? A lot of the reasons have to do with our own makeup and the structure of our society.
● Fooled by randomness (a.k.a. luck): Just because something is a bad idea does not mean it cannot, through pure chance, lead to a winning investment. (It is very difficult for people to acknowledge just how lucky they got once money is made by a bad idea).