November 30, 2010

The regulators never believed in the Efficient Financial Markets Hypothesis.

Sir, John Quiggin writes: “Claims of a Great Moderation were bolstered by the Efficient Financial Markets Hypothesis, which stated that the prices generated by financial markets represented the best possible estimate of the value of any asset, given the available information. It follows that market bubbles are impossible and that the deregulation of financial markets should help to stabilise the real economy.” “Why austerity and ‘zombie’ ideas are bound to fail” November 30.

That is obviously false because anyone truly believing in the “Efficient Financial Markets Hypothesis” would never have come up with such a screwed up idea of having bank regulators arbitrarily intervene in the markets by setting different capital requirements for banks depending on the perceived risk of default, when that risk was already being cleared for in the markets by their risk-premiums.

The regulators thinking that, with a little help from their friends the credit rating agencies, they had everything under control, allowed the banks to finance triple-A rated securities collateralized with badly awarded subprime mortgages, Greek public debt, or Irish banks with a leverage of 62.5 to 1. An efficient Financial Market, on its own would never have done such a stupid thing. For instance the unregulated hedge funds almost never exceed a 12 to 1 leverage.