The myth of the efficient market

One of the most noxious dogmas of the past financial era, one that was held as a near-religious ideal, is the efficient market hypothesis which held that markets are totally rational and everything is always priced correctly because all information is available to everyone. Right. That must be why Google stock was 711 in Nov. 2007 and 257 in Nov. 2008 when the underlying company hadn’t changed much. All totally rational. Uh, huh. Enron stock of course became worthless after the frauds were discovered. Some insiders knew,and were dumping stock. But that knowledge certainly wasn’t priced into the stock, now was it?

The religious fervor with which the efficient market hypothesis was believed led to all sorts of self-serving mischief, like government regulators being asleep at the wheel because we can’t let them interfere with the “magic of the marketplace.” That worked well, didn’t it?

These days, you would be hard-pressed to find anybody, even on the University of Chicago campus, who would claim that the market is perfectly efficient. Yet Mr. Grantham, who was a critic of the efficient market hypothesis long before such criticism was in vogue, has hardly been mollified by its decline. In his view, it did a lot of damage in its heyday — damage that we’re still dealing with. How much damage? In Mr. Grantham’s view, the efficient market hypothesis is more or less directly responsible for the financial crisis.

How such an extraordinary delusion became accepted will now be a subject for historians, up there with tulip mania, but happily, the efficient market hypothesis is now dead and buried.