Long tipped for a Nobel, Fama won it this year for his work on "efficient market theory," even as that theory has become somewhat politically incorrect in the wake of the bubbles, hysteria and "irrational exuberance" that many people blame for the housing boom and bust and the ensuing financial crisis.
But the prize honored Fama for pioneering analysis on the pricing and mispricing of assets. Co-winners Lars Peter Hansen and Robert Shiller have looked at the other variables in pricing – from risk adversity to unrealistic expectations.
"Understanding how mispricing of assets emerges," the prize committee concluded, "and when and why financial markets do not efficiently reflect available information, is one of the most important tasks for future research."
It was Fama's theory of efficient markets that led some to conclude that money managers can never beat the market and the resulting popularity of index funds.
In a 2010 interview with The New Yorker, Fama, who teaches at the University of Chicago, stuck to his guns in the wake of the financial crisis and maintained we have no way of knowing whether the market price for an asset is right or wrong, overvalued or undervalued, because it's the only price we've got. Any other judgment is made with the benefit of hindsight.
Simple as that. And he had some pretty simple ideas about regulating banks, too, because he didn't think it was a good idea for the government to step in and bail out banks.
"The simple solution is to make sure these firms have a lot more equity capital," he told The New Yorker's John Cassidy, "not a little more, but a lot more, so they are not playing with other people's money."
It is a refrain heard more recently from economists of all ideological stripes, even as regulators work on new rules to increase capital requirements for banks.
In hi! s 2010 interview, Fama felt more regulations were inevitable, because despite all the protestations to the contrary, the government would intervene to rescue banks deemed too big to fail and would want to monitor them closely.
"But I don't think it will work," the future Nobel laureate said then. "Private companies are very good at inventing ways around the regulations. They will find ways to do things that are in the letter of the regulations but not in the spirit. You are not going to be able to attract the best people to be regulators."
USA TODAY Money columnist Darrell Delamaide(Photo: H. Darr Beiser, USA TODAY)
Given that these institutions should have more equity to forestall failure, Fama also had a simple solution for what to do when they run into trouble.
"Let them all fail," he said, and the transcript notes that he laughs. "We let Lehman fail. We let Washington Mutual fail. These were big financial institutions. Some we didn't let fail. To me, it looks like there was not much rhyme or reason to it."
In his opinion, we would have figured things out in a week or two if the banks had been allowed to fail, as viable assets would go to other banks and bad assets would be, well, gone. The disruption might not have been any worse than it was with government intervention and all the uncertainty that entailed.
Because government officials were too risk-averse to allow that to happen, we'll never know how bad it would have been.
Fama did not win his Nobel for his views on bank regulation. His views on efficient market theory remain controversial. He and his colleagues in the "Chicago School" (the "freshwater" economists) are engaged in endless academic sniping with Nobel-winning Keynesians such a! s Princet! on University's Paul Krugman and Columbia University's Joseph Stiglitz ("saltwater" economists).
In fact, Fama said in this interview that Krugman, a columnist and blogger for The New York Times, "wants to be czar of the world." Questioned about Krugman's attacks on the Chicago School, he responded, "If you are getting attacked by Krugman, you must be doing something right."
Be that as it may, it is interesting that perhaps the one thing these economists agree on is that banks should have more capital (although of course there are other economists who defend the use of leverage at banks).
Maybe one of these years the Nobel for economics will specifically honor work on bank regulation.
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