Efficient Market Theory and the Crisis
Our crisis wasn’t due to blind faith in the Efficient Market Hypothesis. The fact that risk premiums were low does not mean they were nonexistent and that market prices were right. Despite the recent recession, the Great Moderation is real and our economy is inherently more stable.
But this does not mean that risks have disappeared. To use an analogy, the fact that automobiles today are safer than they were years ago does not mean that you can drive at 120 mph. A small bump on the road, perhaps insignificant at lower speeds, will easily flip the best-engineered car. Our financial firms drove too fast, our central bank failed to stop them, and the housing deflation crashed the banks and the economy
This is by far the most unbiased and equal look at the cause of the financial crisis. The Efficient Market Hypothesis is the basis of all modern financial theory that is taught in school, and I think can often times make financial firms lazy - just because the market price takes into account all information does not mean that prices are correct.
