The Bank of Sweden Nobel Memorial Prize in Economic Science awarded a pile of money to Eugene Fama, Robert Shiller and Lars Peter Hansen. Fama teaches at the University of Chicago Booth School of Business, and made his contribution years ago in the promulgation of the efficient market hypothesis. Shiller is at Yale; his contribution was showing that the markets are loaded with irrational and inefficient activity, meaning that they aren’t efficient. It was impossible to miss the point that a profession in which people holding diametrically opposite views win a major honor must be rotten at the core.
Economists took a more polite stance. Krugman noted the issue, but says it makes sense. “Fama’s work on efficient markets was essential in setting up the benchmark against which alternatives had to be tested; Shiller did more than anyone else to codify the ways the efficient market hypothesis fails in practice.“ Krugman added that Fama has said some “foolish things” since the Great Crash.
Binyamin Appelbaum noted the contradictions in his news article in the New York Times. He seems to think Fama did something useful by showing the value of index funds as compared to stock picking, while Shiller predicted the stock market crashes of 2000 and 2008. Brad DeLong put up a bunch of the stupid things Fama has said, but had the grace not to mention that he and several others have an important paper debunking Fama’s ideas. DeLong has many good things to say about Shiller, but maybe that’s because he credits Shiller with influencing his decision to become an economist. Mark Thoma collected a bunch of testimonials, if you care.
The key thing to understand about the efficient market hypothesis is that it is a central plank in the neoliberal platform. It says that markets know all and process all information perfectly at all times. Therefore, government intervention is bound to be a disaster, interfering with evolutionary social forces beyond human understanding and slowing the transition to a better world that only markets can bring us. (See Philip Mirowski, Never Let A Serious Crisis Go To Waste, p. 343.)
Eugene Fama gave an interview to John Cassidy of the New Yorker in 2010, when Fama had had plenty of time to think about the Great Crash. Cassidy asks Fama how the efficient market hypothesis held up.
I think it did quite well in this episode. Stock prices typically decline prior to and in a state of recession. This was a particularly severe recession. Prices started to decline in advance of when people recognized that it was a recession and then continued to decline. There was nothing unusual about that. That was exactly what you would expect if markets were efficient.
It worked perfectly, says Fama. Prices in the stock market started to decline before the Great Crash, just as the efficient market hypothesis predicts. A recession started before the Great Crash, in fact, before August, 2007 he says, and before mere humans knew there was a recession, but the market knew, which is why stock prices declined. Then after mere humans figured it out, the Great Crash came. In fact, stock prices kept rising until late December 2007, and then dropped back to 2006 levels for most of 2008, before dropping precipitously in late 2008, as these two graphs show.
There was no bubble, says Fama, allowing that he doesn’t know what the word means. The whole mess is the fault of the government, specifically Fannie and Freddie. Cassidy says their contribution was negligible, which it was, so Fama retreats to this quote: “Laughs. Well, what does it take?” Cassidy says correctly that the private sector was the dominant force in mortgages. Fama retreats into absurdity:
Well, (it’s easy) to say after the fact that things were wrong. But at the time those buying them didn’t think they were wrong. It isn’t as if they were naïve investors, or anything. They were all the big institutions—not just in the United States, but around the world. What they got wrong, and I don’t know how they could have got it right, was that there was a decline in house prices around the world, not just in the U.S.
Fama doesn’t acknowledge the fraudulent nature of the entire mortgage finance sector, beginning with CNBC cheerleading for housing, moving to fraudulent and deceptive mortgage lending, false statements on loan documents, false appraisals, and ultimately fraudulent sales of RMBS backed by fraudulent bond ratings.
The interview is packed with similar condescending and arrogant nonsense. It isn’t “foolish”. Fama intentionally dumps his specially prepared load of garbage into the public discourse to confuse people, and to defend his failure and that of the entire economics profession to do anything useful.
UPDATE: John Cassidy has his own response, here. Here’s a taste:
After living through a stock-market bubble and a credit bubble in the past decade and a half, we can be quite sure that financial markets are sometimes chronically inefficient. The only outstanding question is how far this inefficiency extends.