The Potent Directors Fallacy in Action

"We have written an article on the so-called 'potent directors fallacy' (as far as we are aware credit for coining the term is due to Robert Prechter) in February of 2009, where the principle is explained by inter alia examining the crash of 1929. In brief, the fallacy is the belief held by investors that someone – either the monetary authority, the treasury department, or a consortium of bankers, or nowadays e.g. the government of China – will come to their rescue when the market begins to fall. 'They' won't allow the market to decline!' 'They' won't allow a recession to occur!' 'They can't let the market go down in an election year!' All of these are often heard phrases. Even many prominent economists who should really know better are fervently holding on to this faith in the magical powers of the central planners. In 1998 famous MIT economist Rudi Dornbusch wrote that there 'will never be a recession again', as 'the Fed doesn't want one'. Seriously. In late 2007, Gregory Mankiw of Harvard was gushing in the New York Times about the 'dream team' in charge at the Fed and the treasury, which would surely keep us out of recession 'if only we let them work' (as if 'we' had a choice in the matter!). Mankiw often comes across as a pretty shameless panderer to power, which may have been the inspiration behind this inane remark, but reading his op-ed one did come away with the impression that he actually believed it. Investors appear to be hostage to similar beliefs – and this is also what explains the odd ability of certain shares to levitate in 2007 in the face of the world obviously crumbling around them. ABK's stock did not reflect the almost inescapable conclusion that the company would be bankrupt in short order. It reflected only one thing: the faith of market participants that Ben Bernanke and the merry pranksters at the Fed would save the day."

http://www.acting-man.com/?p=19178