What Is Not Seen

In a recent WSJ interview, Alan Greenspan goes on the defence once again, by refusing to take the blame for the present housing mess. Alan Greenspan the former FED chairman, has time and time again pointed out the impossibility of spotting stock market bubbles. According to him “bubbles are an avoidable feature of a dynamic economy” and that “[n]o sensible policy could have prevented the housing bubble.” Greenspan’s lack of understanding, or willingness to acknowledge, the cause of stock market bubbles, brings to mind a recent interview with Fama (from Paul Kedrosky). Eugene Fama is the creator of the efficient market theory, who recently spoke about stock market bubbles.

Region: Some economists—you know them well—say that the stock market crash of 1929 and the more recent climb and decline of the market in the early 2000s suggest that “irrational exuberance” affects the stock market. How do you reconcile this alleged evidence of herding behavior and animal spirits with the notion of market efficiency?

Fama: Well, economists are arrogant people. And because they can’t explain something, it becomes irrational. The way I look at it, there were two crashes in the last century. One turned out to be too small. The ’29 crash was too small; the market went down subsequently. The ’87 crash turned out to be too big; the market went up afterwards. So you have two cases: One was an underreaction; the other was an overreaction. That’s exactly what you’d expect if the market’s efficient[...]

If Greenspan is a believer in Fama’s market efficiency, or if Fama is a believer of Greenspan’s interventionist policy, I do not know, but clearly they have somethings in common. When it comes to the workings of stock market bubbles they both seem to have, no clue.