Some thoughts on free markets

I'm certainly not a pro economist - but who would want to have been these days? But at least thinking about economics is kind of a hobby of mine. Since way before the crisis, but of course the last couple years have provided a lot to think about.

I was contemplating this article in the New Yorker interviewing Eugene Fama from the "Chicago School" of economics, in which he's mostly on the defensive.

At base is whether the "efficient market hypothesis" is in tatters after the financial crisis (most recently, but also dating back to 1987).

As the article summarizes the theory: "[it] says prices of financial assets accurately reflect all of the available information about economic fundamentals."

I think there's some things to be said in defense of that. I think the point that can be forgotten is the role of the Government and its presence in the market and what that means.

I've read the point, and am sympathetic to it, that the government bailout of the S&L banks in the late 1980's is what emboldened them more recently leading up to our recent financial crisis. This caused them to under-price risk and to take risks they shouldn't have. In other words, the presence of the Government as a "bailout" agent made it an actor in the market and was part of the "information available about economic fundamentals". Arguments about whether the *recent* bailouts are a slippery slope should remember we were *already* on that slippery slope.

In addition, the presence of Fannie and Freddie in the housing market and the loosening of restrictions on getting loans also made it a factor in the market, one which strongly boosted the demand side of the equation.

Then there's the role of the Government in controlling the cost of credit, another distortion, obviously stimulative during the housing boom.

In fact, as I remember it, and haven't heard much about it until recently, it was the repricing of ARM loans, sub-prime or otherwise, when rates began to get raised that precipitated the financial crisis of the last couple years.

For me this all makes it hard to judge free markets as having been at the root of the financial crisis, the markets not having been free and all.

That isn't to say that Government doesn't have a role, like with regulations such as Glass-Steagal - and it seems like some of that will be coming back. Hopefully we will judge regulation not by "how much" but by "how good".