I have to report the sad passing of the efficient market hypothesis. The theory was officially declared dead yesterday at the World Economic Forum in Davos. There were no mourners.
The announcement was made at a brainstorming session that involved many of the world’s top economists, politicians and business leaders … together with a few bankers wearing dark glasses and false beards.
Asked which policy assumption had most contributed to the global financial crisis, the most popular answer by far was the belief that markets are self-correcting. (Nassim Nicholas Taleb, author of The Black Swan, said it was that markets “robustify” themselves, which amounts to the same thing … I think.)
In recent years, the belief in efficient markets has dominated economic policy and financial regulation in the Anglo-Saxon world and increasingly across the globe. Its death, if confirmed, is a momentous event. At the very least, it will cause anguish among countless MBA graduates who have paid good money, worked long hours and consumed large quantities of cold pizza to learn about something nobody now believes in.
The efficient market theory (or more precisely, the closely related efficient banks theory) has already been given a bit of a kicking by one of its greatest supporters, Alan Greenspan. The former Federal Reserve chairman has said that the big mistake he made was assuming that banks’ self-interest would prevent them doing anything that would threaten their own survival.
It was a good thing Mr Greenspan wasn’t at Davos yesterday. He would have been set upon. When it comes to the sins of bankers and regulators, the mood among Davos types is just as ugly as it is among the general population.
John Neill, chief executive of Unipart, was given one of the day’s biggest rounds of applause when he declared that bankers who were involved in developing toxic products that caused massive damage to the global economy should be punished. If you knowingly make other kinds of toxic products, you go to jail. Why should bankers be different, he asked.
Regulators also came in for a battering. But the Davos consensus on what needs to be done was concerning. Asked what the top priority should be in terms of financial regulation for the forthcoming G20 meeting, half the delegates at the session said it was addressing the lack of an international regulatory framework.
This echoes the oft-repeated call by politicians, including Gordon Brown, for better international regulatory co-ordination.
Yet, as Lord Turner, chairman of the Financial Services Authority, told me yesterday, international standards and better co-ordination would have made little difference to the course of the credit crisis. It would not have improved the Federal Reserve’s regulation of Citigroup or the FSA’s regulation of Northern Rock.
Moreover, coming up with an international regulatory framework will be extremely difficult. Unlike in trade, for example, there is no treaty-based international organisation in which such a framework can be hammered out.
It will take a very long time. So long, in fact, that it is unlikely to be finished before the efficient market hypothesis rises again from the dead. As it surely will.
David Wighton: Business Editor’s Davos commentary.
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