Yesterday we discussed how experts can make fundamental mistakes. Today's topic is sniffing out people who claim to be experts, but are not.

While I was in the high net worth marketing department at Merrill Lynch, my boss wanted to take control of a group that handled stock option programs for corporate executives. She was very impressed by the glib fellow who headed it, and she believed his assertion that this service brought many wealthy, profitable clients into the firm. However, this guy had failed for years to produce a convincing empirical analysis that justified his claims. He pressured me to do this for him, although it was not my responsibility. I did this only after my boss insisted.

I was suspicious of this fellow from day one. He was way too slick. He also claimed to teach economics to night students, yet he did not understand some very fundamental concepts from Economics 101. Specifically, he never heard of stock and flow variables. This man had to be a fraud.

A stock variable is a snapshot at a point in time. Like the population of the United States. Like the value of a company's inventory or of its debt. A flow variable has two dimensions, quantity and time. Like a company's revenues or its expenses. Like gross domestic product (GDP). You have to state the time period over which the measurement is made. A day? A week? A month? A quarter? A year? Without also specifying the time dimension, the quantity dimension lacks meaning.

I succeeded in analyzing the clients of the executive stock option department. The vast majority would do "exercise and sell" transactions (exercise the option to buy stock, then sell the shares immediately) and move the proceeds outside Merrill Lynch. In short, this business was adding nothing to the firm. The guy in charge was flabbergasted. Were he a real economist, he should have been able to construct the analysis that I did. But he wasn't. When I left the firm, he somehow was still hanging on. I had warned my boss about him, but she continued to be dazzled by his fast talking and breezy, self-confident style.

Attention to detail is an important ingredient of success. Be especially careful if you fancy yourself expert or experienced in a given field. That's when carelessness all too often sets in. A related issue is what to do when those inevitable mistakes of yours come to light. Do you admit them openly, try to ignore them, or make excuses? Let me give you an example from the art world.

Late in November, I visited one of my favorite small art museums, the Westmoreland Museum of American Art in Greensburg, PA, 35 miles east of Pittsburgh. It has an excellent special exhibition called "Scenic Views: Painters of the Scalp Level School Revisited" (November 9, 2008 through February 1, 2009). Scalp Level is an area near Johnstown, PA where this obscure but talented group of 19th-century American artists often gathered to paint landscapes. The director/CEO of the museum is the curator of this exhibition and the author of the associated gallery guide, wall texts and object labels. She cites one particular painting, Rocky Gorge (1869) by George Hetzel (1826-99), as being the most important produced by this group.

Rocky Gorge is owned by the museum, but the curator left it in a dark, hidden alcove where 95% of museum visitors are unlikely ever to look, rather than placing it in the exhibition gallery where its name is invoked so often. I found it only after working on a hunch and scouring every nook and cranny of the building, which I know well from prior visits.

The gallery guide, wall texts and object labels don't tell the visitor where Rocky Gorge is. There's a picture of it on the cover of the guide, but it has no caption or image credit. All this struck me as an incredible string of oversights, so I e-mailed the museum to offer my observations. (I also pointed out a major factual mistake in the guide.) I got no response for a month. Then I sent a follow-up message. This time another museum official did reply, and acknowledged that they indeed had missed the obvious.

The art critics for the two major daily newspapers in the area, the Pittsburgh Post-Gazette and the Pittsburgh Tribune-Review, reviewed the exhibition prior to its opening. However, both reviews read more like press releases than critical commentaries. The Trib was originally a Greensburg paper that expanded into Pittsburgh. Its owner, Richard Mellon Scaife, is a co-sponsor of the exhibition. I e-mailed my observations to both critics last week, and asked for their reactions.

The Post-Gazette critic told me that, since the exhibition was intended to introduce paintings that were not previously on public view, it was inappropriate to include Rocky Gorge. To see if this really reflects accepted museum practices and procedures, I consulted an expert at the Metropolitan Museum of Art in New York. He says that it does not. Instead, he believes that the curator erred. Interestingly, this critic also told me that Rocky Gorge should have been put in a more accessible place, though not inside the special exhibition gallery. However, she was silent on this matter in her review.

The Tribune-Review critic had a similar, but subtly different, response. He believed that Rocky Gorge was omitted because the curator wanted the exhibition to include only works that previously had not been displayed in public. However, he also felt that the museum should have done a better job of making this premise clear.

Lessons?

• You can't be too careful.
• Be grateful for constructive criticism that helps you fix problems.
• Don't be too proud to admit mistakes. You'll have greater credibility if you do.

If you go to see "Scenic Views" before it closes on February 1, look for Rocky Gorge by George Hetzel. The Post-Gazette critic tells me that it has been moved closer to the exhibition gallery, though not into it.

Last week's issue of The Economist has an informative article on how banks in Denmark write home mortgages. While the country is suffering from the worldwide economic contraction, and home prices are falling there, mortgages nonetheless are being written there at a pace similar that before the credit crisis. What are they doing differently from us?

First, by law, mortgages cannot exceed 80% of the value of the home.

Second, when a Danish bank writes a mortgage loan, it must also issue a bond with a maturity date and payment structure that mirrors those on the loan.

Third, the banks that issue these bonds are responsible for making the payments to the investors who buy them. That is quite unlike the American system that has caused so many problems today, in which the securitization of loans is a way for banks to dump the risk of default on the buyers of these bonds. By contrast, the Danish system forces the banks to remain careful about their loan qualification process.

Fourth, Danish borrowers can pay off their mortgages by purchasing the associated bonds. The value of the bond will fall if interest rates rise or if home values fall. In the Danish market, many people whose home values have fallen recently have found it beneficial to pay off their mortgages by purchasing the associated bonds, which now would be trading at deep discounts. American borrowers might benefit from such a system. Instead, increasing numbers of them are stuck with mortgages whose principal values now exceed the values of their homes. Meanwhile, if these mortgages have been securitized, the values of these bonds have declined, but the borrowers have no means of redeeming their own mortgages at their current market values.

The Danish system appears to have much to recommend it here. George Soros is a prominent figure promoting it worldwide, especially for emerging economies.

We've seen indications that the financial meltdown of 2007-08 will lead to a strengthening of compliance departments, as a reaction to the ill-advised, unduly risky practices that pushed so many firms to the wall. Last Monday's Wall Street Journal, however, reports that many firms are doing just the opposite, in order to cut costs. After all, compliance is a technically an overhead function that produces no revenue. This is a shortsighted view, and it has the SEC alarmed. You'd think these firms would have learned that such penny-wise, pound-foolish business practices are potentially disastrous. Indeed, I've already commented on how the undermining of the strong culture of compliance at Merrill Lynch was a major factor in that firm's near failure.

Meanwhile, as is typical in bear markets, arbitration claims are way up. That is, claims filed by clients against financial advisors or financial firms for alleged malfeasance. They've jumped 84% from the first 11 months of 2007 to the same period in 2008. The aggregate 11 month 2008 figure of 3,215 does not seem especially large in an absolute sense, given the size of the financial services industry, but the WSJ article says that dealing with this increased caseload is straining compliance staffs, and that they are likely to respond by placing increased procedural restrictions on financial advisors. Enforcing such restrictions will require increased staffing and/or technology in compliance departments, contrary to the cost-cutting trend that the article started talking about. Stay tuned.