Fama and Shiller Nobel Prize – One More Comment

It was announced today that Eugene Fama, Robert Shiller and Lars Hansen would share the Nobel Prize for economics. I don’t think you can appreciate Fama’s receipt of this prize unless you understand his career history going back to the 1960s.

Krugman doesn’t get it

Paul Krugman, who is astute in his particular branch of macroeconomics, is a little deficient when it comes to the finer details of investments and investment history. He has pointed blame at the efficient market hypothesis and Eugene Fama for much of what happened in 2008. What Krugman is missing are the subtle details – that Fama was not an advocate of the financial engineering that led to 2008. He thought the markets were too unpredictable. It was another group of efficient market guys – those who believed they could more perfectly quantify risk – who sowed the seeds for 2008. It is a subtle difference, one that most outside of the financial industry won’t understand and won’t care about, but it makes all the difference in the world.

I’ll try to break it down in as simple a way as possible.

Fama – Markets are efficient, so use low cost index funds

These other efficient market guys – Markets are efficient, so let’s try risk arbitrage hedge funds and deregulate the banks

Maybe it is based on the same theory, but the ultimate recommendation is totally different.

Shiller and Fama opposites?

In a post today, Krugman first says Fama and Shiller are opposites, then says Fama deserves the prize, and finally gives a compliment to the Nobel committee designed to insult Fama.

Unfortunately most people (especially the media) don’t understand Fama. He has got to be one of the most misquoted people I have ever known.

So without going into agonizing, technical detail about Fama’s history and why he deserves this prize more than almost anyone, I’ll give a quick anecdote that may also show that Shiller and Fama are not that different (and further illustrate Krugman’s misunderstanding of what Fama stands for).

In Peter Bernstein’s book Capital Ideas Evolving, he has a chapter on Robert Shiller. One of Shiller’s most interesting quotes is:

“They write Efficient Markets Hypothesis finance, but in their spare time they are trying to beat the market.  They don’t integrate the two activities. Over beer, they are transformed into entirely different people from who they are in the classroom.”

Shiller is referring to hypocritical professors who tell people they should buy index funds and not try to beat the market, but then go off on their own trying to beat the market. Shiller is right. There are a lot of professors who do this – some of which try to strike it rich by running a hedge fund.

….But Fama was never one of these guys, and that is a critically important fact. Through all the decades in his career, despite all the temptation to make money doing something else, Fama stuck to his theories and advice about what is practical and how families should invest. He also spent his time teaching in the classroom rather than rushing around promoting books and getting TV appearances.

Even more than his empirical work, Fama deserves the prize for his relentless honesty and incorruptible nature that has never faded. His long term position as the stalwart leader of the “good side” of the efficient market camp has had a huge (although indirect) impact on investors and on society as a whole.