Scholar goes online to differ with the Obama Government
Economists do not come much more distinguished than Eugene Fama, who is known as the father of the efficient-market hypothesis and the author of many classic books and papers. Yet this courteous scholar from the University of Chicago Booth School of Business has been at the centre of a blogosphere firestorm, trading harsh words about US fiscal policy with other leading economists.
“Some of the comments were vitriolic,” Professor Fama, 70, says. “And some of the people say things online they'd never get away with in a serious journal. It showed the real downside to the internet.”
At issue is the effect of the bond-financed fiscal stimulus on the economy. Professor Fama is a critic of the Obama Administration's large-scale attempt to stimulate growth by deficit spending. “Stimulus plans can only work if the Government's uses of the resources are more productive than the private sector's,” he says. “Nobody for the past 35 years has believed stimulus plans would work.”
He argues that the newly issued government bonds are absorbing savings that otherwise would be used for private investment. However, the dispute demonstrates that there is no firm evidence about the extent to which bond-financed government deficits crowd out private investment.
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The spat also illuminates the extent to which opinion in the United States has polarised. As one commentator put it: “What's wrong with America? The outright partisan divide has been extended into all aspects of society. Does anyone doubt that Fama is an apologist for the ideology of the Right?” Professor Fama believes that the evidence strongly supports the efficiency of the stock market. “Prices are good estimates of the underlying value of the asset,” he says. “There are real risks of volatility in stocks and this current episode is a good example.
“This is not a financial recession. The financial problems are an offshoot. But nobody wants to believe that markets are efficient — especially not investment managers, who proclaim that they know better.”
Professor Fama is in London as the first recipient of the $250,000 Onassis Prize in Finance, awarded by the Cass Business School. In an address, he reported on how well fund managers perform, a subject of great practical interest to investors. He cited research looking in detail at the returns earned by more than 3,000 active investment managers at mutual funds in the US. There is no evidence from their returns that active investors do any better than you would expect on the basis of chance alone. Taking into account their costs, they underperform the market. Professor Fama says: “Active investment managers don't have enough skill to cover their costs.” Those who look as if they have done better for a period have just got lucky.
Nor will he accept even Warren Buffett as a counter-example: “He doesn't pick stocks,” he says. “He buys companies and runs them. Of course good management can add value.”
And, refreshingly for an academic, he turns the findings into investment advice. If you invest in shares, choose passive funds with low fees. “I don't know why investors buy active funds,” he says. Make sure, too, that you have an appetite for risk. He points out that for certain long periods in the past, the total return on Treasury bills exceeded that of the market.
Differing views account for the chasm between popular opinion about the non-efficiency of financial markets and the status of the theory among financial economists. There is no conclusive evidence that asset prices reflect true underlying reality. However, there is strong evidence that investors cannot consistently beat the market.
Professor Fama concedes that recent stock market history activity has been uncharacteristic. Although he believes that the recession in the non-financial economy is less severe than that of the 1980s, not since the 1930s has the volatility of share prices been so great for so long. He asserts that the US Government is making matters worse. He is scathing about the size of the Government's budget deficit and its bailout of the banks — not that he has any sympathy for the banks. “Bankers are in denial on so many levels,” he says.
The bailout, he says, mistakes rescuing individual banks for putting the financial sector on a sound footing. “They've nationalised some banks without admitting it, and it's been kind of random,” he says, clearly believing that others should have been allowed to join Wachovia and Washington Mutual in failing.
He disputes the conventional wisdom that some banks are too big to fail, believing that the bailouts have increased substantially bankers' incentives to take too many risks in future. We are stuck with a heavy burden of regulation, Professor Fama accepts, but he describes the bailout plan as “awful”.
He is no fan of the Obama Administration, which doubtless he will continue to demonstrate in fierce online debates.
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