John Cassidy's Interview With Eugene Fama

David L. Prychitko

Read it here.  There is simply too much for me to comment on.

Comments

[Charles K. Rowley]

In this interview, Fama clearly shows how far Chicago economics has declined since Milton Friedman retired. They do not seem to have a good monetarist on campus (and that includes Bob Lucas). They were always weak on banking. And Fama demonstrates almost a contempt for serious rethinking of his own work, is even sloppy in describing the efficient capital market hypothesis. Well, there is a silver lining in every storm. GMU economics looks better and better and better as mainstream economists flounder in the wake of a mid-level economic recession not dissimilar in magnitude to that inherited by Ronald Reagan when he assumed the presidency.

[Matt Stiles]

Reading that is like Chinese water torture.

[anon]

What? There was a sudden recession that made people unable to pay their mortgages -- it had nothing to do with over-extending credit in the first place? Or interest rates? The evidence is that lots of other countries with policies the fueled housing bubbles also had a crash? This guy is just weird.

[Jake McCloskey]

Are you guys even aware of alternate theories of downturns? By recession he just means a severe nominal shock. The housing crash, credit crunch and everything else are perfectly consistent with a monetarist view of nominal shocks. I didn't see anything strange about what he said.

[Bob]

I agree that interest rates and easy money were largely responsible for the current recession, but Eugene Fama's contribution to the average investor by advocating index investing is immense. I wish he would acknowledge that Mises predicted what would happen when interest rates were kept artificially below market. He sure has called Krugman out as the skunk.

[Niko]

"Are you guys even aware of alternate theories of downturns?"

Yes, they just don't make sense.

"Eugene Fama's contribution to the average investor by advocating index investing is immense"

How much they've lost so far?

This was a painful read.

[Pietro M.]

I must admit that Fama recovers some appearance of mental sanity as the interview goes on.

He says that the panic would have lasted two weeks under laissez faire: without a theory of STRUCTURAL unsustainability, there is no scope for recessions, no structural adjustment, and only price variations to take care of a change in data. The absurdity of this idea is the proof that Austrian economics is on the right track and the rest of the world is not.

He says that bubble don't exist because they are not predictable or recognizable. This is childish operationalism: bad epistemology in its purest form. What is not known is not... unknown, it is nonexistent. That's utterly ridiculous.

He may have said lots of rubbish. But his idea that "government involvement in economic activity is especially pernicious because the government can’t fail" it's insightful, horribly true, and deep. Even at Chicago, when you step off market efficiency, ricardian equivalence and monetary neutrality, something meaningful can be said. :-)

And what about "Insurance is not the solution: it’s the problem. Making the problem more widespread is not going to solve it."? I'll print it on my t-shirt.

When he says that econometrics is unable to check for the existence of inefficiencies and bubbles he is making a very Austrian claim. When he seems to believe that this proves that markets are efficient and bubbles don't exist, he is indulging in faith-based economic theorizing.

As usual, Chicago Boys are ideologically and politically close in spirit with Vienna Boys, but are intellectually lacking in the tools necessary to understand reality.

Free markets, as long as they are defended by these free-marketers, will be in intellectual troubles.

[Bob]

Did you forget about the bond part of the portfolio or the international exposure. That's part of the diversified approach. Investing is a long haul endeavor. Taking a picture at any given time and passing judgement is a fools game. The passive diversified approach over time beats active management by a 2/3 margin especially for the average investor.

[Barkley Rosser]

I will only note that while one cannot ever know 100% for sure that one is in a bubble or not, one can get a pretty good idea that one might be. For many assets there are indicators of fundamentals tied to some sort of income flow arising from the asset. So, stocks generate earnings, and housing generates rents. When one sees price/earnings ratios for stocks or price/rent ratios for housing rising far above historical averages, which happened to both the stock market in the 1990s and the housing markets after 2000, one should begin to suspect that one might be in a bubble.

Now, there is this argument pushed by people like Peter Garber that says there is a "misspecified fundamental" problem. Basically, one cannot disprove that rational agents are rationally expecting that there is a serious probability that the underlying income streams will be rising in the future, which does not turn out to happen after the fact. It is impossible to separate out econometrically the test of this from a test for a bubble, so one cannot prove econometrically that there is or is not a bubble.

Now there do happen to be some assets where one can do this separation with some degree of certainty, if not absolutely. The assets are closed-end funds, which are funds trading based on a set of underlying assets. As long as one can buy and sell those assets (which is not always the case), then the net asset value of the fund (the value of the underlying assets) represents a clear fundamental, after one accounts for some management fees and tax effects, the latter leading most closed-end funds to trade at single digit discounts most of the time. So, if one sees a premium appearing on a closed end fund that then rises sharply, one can be about as certain as one can be in economics of anything (again, assuming the underlying assets can be easily bought and sold) that one is observing a bubble.

Another participant here who has already been excessively tainted by association with me once upon a time published a paper with me and two other folks in a journal that I now have a strong relationship with that looked at the behavior of such premia on closed-end country funds around 1989-90 and found that they looked like bubbles, with such premia rising to as high as 100% on the Germany fund and the Spain fund and some others, before crashing hard in Feb. 1990. Bubbles, baby, bubbles, although you will not hear any of this from the ridiculous Eugene Fama.

Oh, in the 1989-90 episode there was a "Big Player," although it was not the usual bugaboo of a central bank or some other government agency. It was probably Nomura, buying up the closed-end funds in the fall of 1989 to sell off to sucker Japanese investors fleeing the collapse of the Japanese stock market bubble that peaked in December, 1989, and proceeded to tank thereafter, never to get back even remotely close to the level it was at back then. It was their fleeing from the closed-end country funds in Feb. 1990 that tanked that bubble.

[Bob]

Well, there is a silver lining in every storm. GMU economics looks better and better and better as mainstream economists...

What are you smoking? In what universe is the mainstream economics floundering while GMU economics is looking better? The universe at Fairfax?

[amv]

Since no one weighs in for of Fama, I do: http://coffeehouse-economics.blogspot.com/2010/01/great-recession-and-efficient-market.html

[Bill Stepp]

amv,
I don't know if the idea that higher long term returns come with additional risk is the core of EMT; somehow I doubt it, as that idea predates EMT by at least a generation, probably more.

Barkley,

I agree with your earlier characterization of EF; why the heck is he supposedly on the short list of Nobel (or whatever the correct term is) candidates?
Why the heck is

[amv]

bill, the 'core prediction' not the core , which is informational efficiency. it's a no-free-lunch-postulate.

[GRant]

Well, there is a silver lining in every storm. GMU economics looks better and better and better as mainstream economists... http://www.hotfilemediafire.com