Christopher C. Faille, intrepid reporter for AllAboutAlpha.com has just published his book-length analysis of the crisis of 2007-08, in a book titled, Gambling with Borrowed Chips.
Faille takes issue with what he calls the “common misdiagnosis” of that crisis, the idea that it was all the consequence of rampant speculation and leverage. There is, he says, nothing wrong with speculation (“gambling”). Nor is there anything wrong with borrowing chips to engage in it. Both speculation and leverage serve a variety of valuable functions.
Faille discusses briefly the medieval hostility to the whole idea of borrowing money at interest, and expresses his relief that both the Renaissance and the Reformation played their respective parts in helping us, the western world, get over that superstition. Thomas Aquinas himself, in the act of codifying this prohibition, illustrated its implausibility. Aquinas said that one may borrow money without sin on two conditions: first, that one borrows from someone already in the business of lending money (i.e. one does not tempt an innocent into usury); second, that one has “a good end in view, such as the relief of [the borrower’s own] or another’s need.” Suppose, then, Faille asks, that I borrow money from a bank to go to a casino and gamble. Have I sinned? It may be on Thomistic premises that I have not, since the bank is in that business anyway. As to the relief of need, Faille asks, “How sympathetic a story would one have to tell about the life of the croupier whom [our gambler] keeps gainfully employed in this way, in order to satisfy the second condition?” He asks the question in order to make the whole idea of such prohibitions seem silly which, he plainly believes, it is.
But if we are to exculpate lending, borrowing, and speculating, what (or whom) do we blame for the recent crisis or crises? Faille’s view is that a profligate monetary policy necessarily produces bubbles. Whether the asset that inflates exuberantly is the Dutch tulip, an internet stock with “dotcom” in the name, or a derivative based on the repayment of McMansion mortgages, the dynamic is the same. The price of those Dutch tulips, for example, increased with notorious speed not long after the Spanish Empire discovered extraordinary reserves of silver in Peru. “In 1628,” Faille tells us, “Admiral Piet Heyn captured a Spanish treasure fleet on the high seas and Holland received the booty – roughly 89 tons of silver.” In more modern times, a money supply can expand without the discovery of new continents and the exploitation of their minerals. Money supplies expand because we have fiat money now and central bankers say the word. In the U.S., Alan Greenspan reacted to the relatively mild recession of 2000-2002 by putting his foot on the credit accelerator. A wise society will require that both leverage and speculation “work themselves out in a stable monetary and credit environment. In such an environment, bubbles prick themselves before they can do a lot of harm,” Faille writes. In our society, on the other hand, the lending encouraged by the monetary policies of a Greenspan or a Bernanke “was bound to put money into the hands of people who didn’t know what to do with it,” with the consequences we have witnessed. These bubbles eventually burst, simply because that is what bubbles do. It is better than to stop blowing them than to look about for a needle to blame for the prick.
Efficient Capital Markets
Faille includes a detailed discussion of the efficient capital markets hypothesis, which he defines as the view that “given minimally liquid and transparent markets, publicly listed securities will trade at prices that fully reflect all available information.” He compares this hypothesis to the view that there will never be any fresh meat in the Amazon River, precisely because there are so many hungry piranhas looking for fresh meat there. The analogy is between fresh meat on the one hand and inefficiencies/opportunities for alpha, on the other. Faille sees a paradox here: how do the piranha stay alive? If there really is no alpha, the piranha will give up or die off, and they’ll no longer be around to perform their policing function, keeping the river clean. Are the piranha stupid? That doesn’t work. Stupid piranha do not underwrite the theory, for the plausibility of ECMH depends upon the presence of sophisticated seekers and consumers of raw meat. Faille concludes from this paradox and related considerations that “the reality is sloppier than the theory, and it is the slipperiness at the edges that makes the theory (for the most part) a valuable one.”