The recent financial crisis and the frantic (and finally successful) attempt by the government and Wall Street to strong-arm the public to provide immediate relief to the very institutions that caused the crisis is striking evidence, if anyone needed it, of exactly for whose benefit the government is run: Wall Street. You can ignore all the blather about how this bailout was needed to prevent ordinary people from financial ruin. That may or may not be true. What is indubitable is that if Wall Street interests were not at stake, nothing would have been done.

As was clearly evident in the past week, while the government can drag its feet for decades, say it is too expensive, and take no action to solve urgent problems like health care, when it comes to giving away nearly a trillion dollars to the financial industry, it can act with lightning speed. And you can be sure that when this money runs out (as it surely will as Wall Street institutions get their greedy hands on it) and next financial ‘crisis’ appears, we will be asked to cough up even more, and told that otherwise the sacrifices we have already made will be ‘wasted’. This is the same argument given for continuing the war in Iraq.

Although I have written quite a bit in recent days about the crisis and the economy and think I have at least some understanding of how things work, one thing I don’t understand is how the stock market works. I understand the mechanics of it, of course, but have long given up trying to understand what makes it go up or down on any given day.

It seems to me that stock prices are only loosely based on the actual health and performance of companies and the general economy, and more on expectations of what will happen in the future. It is not based on current data but on predictions of future data. It is closer to astrology or soothsaying than science.

I can pinpoint the very event that made me give up on the whole business as being hopelessly irrational.

Emperor Hirohito of Japan (1901-1989) was the symbolic head of Japan from 1926 until his death. He was revered by his people and considered by many to be a god-king. He was quite ill during the last decade of his life and close to death on many occasions.

I was intrigued and amused by the fact that the Japanese stock market would go up and down quite dramatically based on rumors about his health, and the news organizations would solemnly report with a straight face things like, “The Japanese stock market dropped sharply today on news that Emperor Hirohito’s health had taken a turn for the worse.”

This was, of course, absurd. The emperor was very old, had been ill for a long time, and was a purely symbolic head of state and had no say whatsoever on how the government or the economy was run. It would be like the British stock indices fluctuating on rumors about the Queen of England. The reaction of the stock market seemed to me then, and still seems now, to be hopelessly irrational.

Although I do not invest directly in the stock market (although my retirement funds are presumably invested in it), I do an experiment on days when there is some fairly big news event, either political or financial. After I listen to the news, I try to predict what that news will do to the stock market that day. I find that there is little or no correlation. If anything, I am more often wrong than right, that what I see as bad news for the economy sends the stock market up, and vice versa. It is clear that I will never get rich speculating as a day trader.

A couple of years ago, Bob Garfield on the show On the Media had a droll report on how the media and financial analysts try to come up with simple explanations to explain the day-to-day gyrations of the stock market, usually based on nothing more than sheer guesswork or story-telling.

This is why I never take seriously those people who urge policies based on the stock market fluctuations. They are usually self-serving rationalizations for what they want to do.

For example, on Monday, September 29, the House of Representatives surprisingly defeated the Paulson bailout plan on a close vote. As you can see from the graph, the Dow Jones index immediately headed down, plunging 777 points, and that drop was blamed directly on the vote.

People were issuing dire warnings that it would continue that deep decline and we would all have our retirement funds disappear if Congress did not reverse itself and pass the Paulson plan immediately.

The next day the House was not in session due to a religious holiday and the Dow went up nearly 500 points. Did people conclude that sending Congress on vacation was good for the market? Of course not. They found some other fatuous reason.

Then the Senate passed a revised plan late on Wednesday evening and the market should have been happy on Thursday but it wasn’t. (It feels so absurd to ascribe human emotions to the stock market, an institution that deals impersonally with billions of transactions daily but we now take such absurdities for granted.) The stock market declined steeply all through the day, losing about 350 points, for no reason that I could see.

Tension then mounted as the House came back in session on Friday to vote on this new package. The market started the day up and kept rising, gaining about 300 points by 1:00 pm, reaching a peak of 10,766. The House voted at that time and passed the measure quite easily.

Since we were told that the House failing to pass a bailout plan on Monday was the cause of the steep decline that day, you would expect that passing it now would be an occasion for joy. What actually happened was that right after the vote, the market immediately went into a steep decline, losing 450 points to end the day with a net loss.

To me this makes no sense at all. Maybe, to use the phrase coined by MIT professor of business Dan Ariely and which is the title of his book, the market is ‘predictably irrational’, meaning that there is some method in its seeming madness and I am not expert enough to see it.

As long as the stock market was tethered to the underlying real economy, that may have been true. But I think that the present out-of-control virtual economy, generated by financial institutions that have been allowed to speculate wildly using debt-based securities that were free from regulations and oversight, has resulted in the stock market being connected to the real economy by the slenderest of threads, making rational decision-making impossible.

Maybe it is truly rational and there are people who actually understand it. I know I don’t.

POST SCRIPT: Paulson’s history

This article points out the little publicized fact that Treasury Secretary Paulson, while head of Goldman Sachs, advocated the very policies that led to the current crisis. And now he has been given a huge check from the taxpayers to ‘solve’ the very problem he helped create. Nice work if you can get away with it.

Paulson, according to a celebratory 2006 BusinessWeek article entitled “Mr. Risk Goes to Washington,” was “one of the key architects of a more daring Wall Street, where securities firms are taking greater and greater chances in their pursuit of profits.” Under Paulson’s watch, that meant “taking on more debt: $100 billion in long-term debt in 2005, compared with about $20 billion in 1999. It means placing big bets on all sorts of exotic derivatives and other securities.”

According to the International Herald Tribune, Paulson “was one of the first Wall Street leaders to recognize how drastically investment banks could enhance their profitability by betting with their own capital instead of acting as mere intermediaries.” Paulson “stubbornly assert[ed] Goldman’s right to invest in, advise on and finance deals, regardless of potential conflicts.”

In testimony in 2000 before the Securities and Exchanges Commission, Paulson as head of Goldman Sachs, argued that Wall Street should be allowed to regulate itself.

Meanwhile, Rep. Brad Sherman of California describes the horror scenarios painted for lawmakers in private sessions before the Monday vote to try and scare them into voting for the bill.