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Nothing up my sleeve

The longer I’m alive, the more I think economists are the academic version of Gypsy palm readers: They charge you a lot of money to make stuff up about the future, then when it doesn’t work out, you go back to them for more advice. Watch Eugene Fama, founding father of the efficient-market hypothesis, scuttle sideways like a crab:

So what is your explanation of what happened?

What happened is we went through a big recession, people couldn’t make their mortgage payments, and, of course, the ones with the riskiest mortgages were the most likely not to be able to do it. As a consequence, we had a so-called credit crisis. It wasn’t really a credit crisis. It was an economic crisis.

But surely the start of the credit crisis predated the recession?

I don’t think so. How could it? People don’t walk away from their homes unless they can’t make the payments. That’s an indication that we are in a recession.

So you are saying the recession predated August 2007, when the subprime bond market froze up?

Yeah. It had to, to be showing up among people who had mortgages. Nobody who’s doing mortgage research—we have lots of them here—disagrees with that.

So what caused the recession if it wasn’t the financial crisis?

(Laughs) That’s where economics has always broken down. We don’t know what causes recessions. Now, I’m not a macroeconomist so I don’t feel bad about that. (Laughs again.)

Haha! But the really funny thing about the efficient-market hypothesis is that we know market prices are correct because they are set by markets. Got that? It’s the same reason the Bible is God’s word – because He said it is. In the Bible. Hilarious!


  1. gauche wrote:

    Well, for what it’s worth, the text of the Bible does not attempt to self-authenticate. Mr. Fama, though, is not coming across well here.

    You know how, when you learn about the crazy things people in other times thought, like bloodletting or alchemy, you think to yourself, “they must have known this didn’t actually work.”? Yeah.

    Wednesday, January 13, 2010 at 16:30 | Permalink
  2. bjorn wrote:

    Wrong. The efficient market hypothesis basically says “economists don’t know crap, so stop trying to guess. People have already priced everything they know into the market” So, if you think economists don’t know anything, than using index funds and following the efficient market hypothesis makes sense.

    If you think economists, equity analysts and the like DO know something, than you would say, the market is not efficient. My guy knows what is coming.

    So, the efficient market doesn’t say the market price IS right, it says that it is the most accurate current PERCEPTION of the right price. As evidence, it says that those who try to outguess the market usually use (which is true)…because economists don’t know much.

    Thursday, January 14, 2010 at 11:25 | Permalink
  3. pjk wrote:

    “the efficient market doesn’t say the market price IS right, it says that it is the most accurate current PERCEPTION of the right price.”

    Exactly. And if you fervently believe this impossible-to-validate piece of doctrine, then the best public policy is to leave markets completely alone because they know what they’re doing. Anything the markets do is, ipso facto, “the most accurate,” effectively allowing this theory’s adherents to beg any questioning of economic performance, or, for that matter, their theory.

    Ironically, the very fact that investment banks and hedge funds make so many billions of dollars every quarter by trading market inefficiencies suggests that this doctrine, which has been so adored by certain academics and public policy makers over the last few decades, holds little water in practice.

    Thursday, January 14, 2010 at 12:06 | Permalink

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