Fama on Fannie, Freddie and the efficient market hypothesis.

Interview with Eugene Fama, who is credited with being father of the Efficient Market Hypothesis by John Cassidy, who writes Rational Irrationality

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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.

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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.

But Fannie and Freddie’s purchases of subprime mortgages were pretty small compared to the market as a whole, perhaps twenty or thirty per cent.

(Laughs) Well, what does it take?

Wasn’t the subprime mortgage bond business overwhelmingly a private sector phenomenon involving Wall Street firms, other U.S. financial firms, and European banks?

Well, (it’s easy) to say after the fact that things were wrong...

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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.)

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I spoke to Richard Posner, whose view is diametrically opposed to yours. He says the financial crisis and recession presents a serious challenge to Chicago economics.
 
Er, he’s not an economist. (Laughs) He’s an expert on law and economics. We are talking macroeconomics and finance. That is not his area.

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So what is your explanation of what happened?
 
What happened is we went through a big recession, people couldn’t make their mortgage payments, and, of course, the ones with the riskiest mortgages were the most likely not to be able to do it. As a consequence, we had a so-called credit crisis. It wasn’t really a credit crisis. It was an economic crisis.

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So you still think that the market is highly efficient at the overall level too?

Yes. And if it isn’t, it’s going to be impossible to tell.
 
For the layman, people who don’t know much about economic theory, is that the fundamental insight of the efficient market hypothesis—that you can’t beat the market?

Right—that’s the practical insight. No matter what research gets done, that one always looks good.

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