Interview with Eugene Fama
Excerpts from the New Yorker interview with Eugene Fama:
Many people would argue that, in this case, the inefficiency was primarily in the credit markets, not the stock market—that there was a credit bubble that inflated and ultimately burst.
I don’t even know what that means. People who get credit have to get it from somewhere. Does a credit bubble mean that people save too much during that period? I don’t know what a credit bubble means. I don’t even know what a bubble means. These words have become popular. I don’t think they have any meaning.
Maybe you can convince me there can be bubbles in individual securities. It’s a tougher story to tell me there’s a bubble in a whole sector of the market, if there isn’t something artificial going on. When you start telling me there’s a bubble in all markets, I don’t even know what that means. Now we are talking about saving equals investment. You are basically telling me people are saving too much, and I don’t know what to make of that.
Is it not true that in the credit markets people were getting loans, especially home loans, which they shouldn’t have been getting?
That was government policy; that was not a failure of the market. The government decided that it wanted to expand home ownership. Fannie Mae and Freddie Mac were instructed to buy lower grade mortgages.
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.) We’ve never known. Debates go on to this day about what caused the Great Depression. Economics is not very good at explaining swings in economic activity.
The experiment we never ran is, suppose the government stepped aside and let these institutions fail. How long would it have taken to have unscrambled everything and figured everything out? My guess is that we are talking a week or two. But the problems that were generated by the government stepping in—those are going to be with us for the foreseeable future. Now, maybe it would have been horrendous if the government didn’t step in, but we’ll never know. I think we could have figured it out in a week or two.
What lessons have you learned from what happened?
Well, I think the big sobering thing is that maybe economists, like the population as a whole, got lulled into thinking that events this large couldn’t happen any more—that a recession this big couldn’t happen any more. There’ll be a lot of work trying to figure out what happened and why it happened, but we’ve been doing that with the Great Depression since it happened, and we haven’t really got to the bottom of that. So I don’t intend to pursue that. I used to do macroeconomics, but I gave (it) up long ago.
Thanks very much. Finally, before I go, what about Paul Krugman’s recent piece in the New York Times Magazine, in which he attacked Chicago economics and the efficient markets hypothesis. What did you think of it?
(Laughs) My attitude is this: if you are getting attacked by Krugman, you must be doing something right.
HT: David L. Prychitko
13 Comments:
Sounds like Fama understands the political Krugman
Towards the end the point was reached we did not believe that the past could happen again. House prices declined during the 1930s but Wall Street thought that the 30s where such an outlier that they could never happen again. Just like a volcano erupts once and goes extinct. Wall Street had the money to go and construct house price indices for at least the whole 20th century, by sending interns to the libary to get the data if need be. In fact Wall Street should now start a project to push back as far as possible with a lot of economic data, at least to 1865 and before if possible to better characterise the tail of the risk curves.
i don't know what it's going to take to finally drive a stake through the heart of these "random walk" CAPM allocators who have never actually participated in a market in a meaningful way (the horrible buy 1000 stocks and hold approach of dimensional fund doesn't count - 3rd grader could beat their numbers), but it can't come to soon.
he's right that this mess was caused by government manipulation of markets, but i'd love to hear how he justifies belief in bubbles in individual stocks but not in markets. that seems an indefensible viewpoint.
The U.S. government is to blame for the "Great Recession."
Dollars were drained out of the U.S. private sector and flowed into the U.S. government (when foreign economies sold their goods to the U.S. private sector and invested those dollars in U.S. Treasury bonds).
Meanwhile, the Fed tightened the money supply and then kept a restrictive stance too long, while U.S. budget deficits continued to shrink reaching $162 billion in 2007 (or roughly 1% of GDP).
Moreover, the U.S. government's policies of "too big to fail," Fannie Mae, etc. were major factors in contributing to systematic risk in the financial industry.
Furthermore, markets dislike uncertainty more than negative news. So, the government allowing Lehman to fail made it uncertain whether or not other major financial firms would fail.
The U.S. was on a path to a mild recession before Lehman failed, and given another tax cut (similar to early 2008).
I meant systemic risk instead of systematic risk.
You can "beat the market." You need to know what the market will do before the market knows :)
Knowing when the market knows is also important.
Seems that Eugene Fama doesn't understand anything about fractional reserve banking, if she believes that a loan must be covered by savings.
This was one of the most embarrassing interviews given by an economist that I've read in quite some time.
Fama first blames everything on Fannie/Freddie. Then when forced to confront the fact that a lot of these subprime loans were written by companies other than Fannie/Freddie, he pleads ignorance and says no one can really understand why this happened.
Then, at another point in this interview, he disagrees with the whole notion that the recession was caused by the credit crisis. He claims that the recession must have started before the credit crisis or there would be no credit crisis.
When asked then why did the recession start, he again pleads ignorance.
This interview is embarrassing and shows how far the Chicago school has fallen.
The Efficient Market Hypothesis states:
"Current prices fully reflect all information. So, buying and selling securities in an attempt to outperform the market will effectively be a game of chance rather than skill."
The assumption is perfect information. However, the market reflects average information, which is why some outperform and some underperform the market consistently or most of the time.
Perfect Trader catches one piece of the hypothesis, the second that humans make perfectly rational decisions at all times. Chuck Prince (Citibank) in one of his interviews said he knew that the bubble was going to end badly but could not get out until the music stopped because there was to much money to be made in the interim. That is not a perfectly rational person IMHO. Combine imperfect information, with manias and panics as human emotion comes into play and you have what we experienced.
I think Mr. Farma got it right with this quote:
"Well, I think the big sobering thing is that maybe economists, like the population as a whole, got lulled into thinking that events this large couldn’t happen any more—that a recession this big couldn’t happen any more."
I take issue that this was not a bubble because it was the amalgam of markets into financial weapons of mass destruction, as Warren Buffett has alluded to.
Machiavelli999 said...
Fama first blames everything on Fannie/Freddie. Then when forced to confront the fact that a lot of these subprime loans were written by companies other than Fannie/Freddie, he pleads ignorance and says no one can really understand why this happened.
Fannie and Freddie don't make loans directly. What the article says is they were buyiing 20% to 30% of the subprrime loans. By any measure having 1/5 to 1/3 of that market is huge. And it was their reducing of standards that was the issue.
How much of the Treasury market does the Fed buy? Has to be minuscule and yet they're able to influence rates for the entire market.
And his response isn't that no one knows, it's that declining prices were the issue. Which was clearly the issue. If home prices had kept going up, the lenders would still be out there lending to this day.
Eugene Farma comes off very poorly here. Essentially he says we don't understand anything and nothing works but the market. Seriously?
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