Mandelbrot on Wall Street analysis flaws

Interesting article from Scientific American written in 1999 by Mandelbrot (father of fractals) on his opinions on how Wall Street analysis is flawed. As he states, the analysis used by Wall Street essentially eliminates the need to address rare events - in Mandelbrot's words:

The risk-reducing formulas behind portfolio theory rely on a number of demanding and ultimately unfounded premises. First, they suggest that price changes are statistically independent of one another: for example, that today’s price has no influence on the changes between the current price and tomorrow’s. As a result, predictions of future market movements become impossible. The second presumption is that all price changes are distributed in a pattern that conforms to the standard bell curve. The width of the bell shape (as measured by its sigma, or standard deviation) depicts how far price changes diverge from the mean; events at the extremes are considered extremely rare. Typhoons are, in effect, defined out of existence.

http://www.sciam.com/article.cfm?id=multifractals-explain-wall-street

Well, we just had a typhoon in the markets in October 2008 (and there have been several typhoons in the financial markets over the past several hundred years).

Ponzi schemes can work for quite a while (just ask Madoff). However, once the cat gets out of the bag all hell breaks loose and it's pretty much impossible to get the cat back into the bag - and even if you do most everyone knows that it's a cat that's in the bag (instead of a wonderful piglet). There will be very few suckers to be found again to play the con with the same scam.

The Ponzi scheme that's been run by the US government for the past decade is unwinding - the cat is out of the bag. GDP growth was a fantasy based on increasing personal (and public) debt. Also, the increased money supply that Greenspan pushed for 15 years created an asset bubble in the housing market. Other bubbles occurred at the same time - student loans, car loans, credit card debt, inflated stock prices, and others. The cats all came out of the bags at once - all the bubbles popped together - a typhoon of financial disaster. On a global scale.

The government can print lots of money (trillions it turns out) and try to get the same suckers to play the game again (spend money they don't have and go deeper into dept) but there just aren't going to be many players. Deflation is going to happen likely followed by high inflation. People are losing their jobs (maybe we will see double-digit unemployment) and these people are not going to start buying a bunch of stuff. Millions of people who have jobs are worried about losing them soon - they are going to cut back and save. Millions are deep in debt as it is - with banks cutting back on credit lines, increasing late fees, etc., these heavily indebted people aren't going to be able to spend much more. And even people with relatively safe jobs are going to have salaries and benefit cuts (elimination of 401k matches, small or no bonuses, salary freezes, etc.) and these people are going to cut back their spending too. So who is it that is going to increase their spending to keep deflation (i.e. market correction) from happening? Almost nobody.