20/20 Vision is Accurate

The other really noteworthy thing in the Eugene Fama interview is his weird ideas about bubbles:

I guess most people would define a bubble as an extended period during which asset prices depart quite significantly from economic fundamentals.

That’s what I would think it is, but that means that somebody must have made a lot of money betting on that, if you could identify it. It’s easy to say prices went down, it must have been a bubble, after the fact. I think most bubbles are twenty-twenty hindsight. Now after the fact you always find people who said before the fact that prices are too high. People are always saying that prices are too high. When they turn out to be right, we anoint them. When they turn out to be wrong, we ignore them. They are typically right and wrong about half the time.

Are you saying that bubbles can’t exist?They have to be predictable phenomena. I don’t think any of this was particularly predictable.

But of course some people did make money off the crash. Malcolm Gladwell writes at some length about John Paulson, one of those who did, in the print New Yorker. But it’s hard to make money off this kind of thing because, as Fama says, when the crash comes is impossible to predict.


The really strange thing, though, is the metaphysical claim that something can’t be real unless it’s predictable. Fama says that most bubbles are 20/20 hindsight. But 20/20 vision is good vision. The point about 20/20 hindsight is that you can see things clearly, once they’ve already happened. But those things really did happen. Whether or not you believe there was a methodologically reliable way to tell that there was a real estate bubble in 2006, there’s clearly such a way to tell today — it’s called hindsight, wild fluctuations in the price of the underlying asset that reveal swings driven by speculation rather than supply and demand for housing.

Consider earthquakes. We can’t predict when earthquakes are coming. But earthquakes are still very real — they topple buildings and kill people. And even though nobody can predict earthquakes, we can still say things of some predictive value about earthquakes. We have information about the causes of earthquakes, and some knowledge about where earthquakes are likely. We also know a bit about the relative frequency of different kinds of earthquakes, and we know about the sort of damage that earthquakes cause. This allows us to take prudential action regarding building codes, emergency procedures, evacuation plans, public education, etc. designed to mitigate the destructiveness of earthquakes.

If you had a guy standing around saying “there’s no such thing as earthquakes” when what he actually meant was “earthquakes are unpredictable,” then you’d wind up with very bad public policy. People would say that all these quakeproof buildings were needlessly expensive and stifling innovation. People would say that having police departments study earthquake response measures was antiquated, and that nobody had worried about that stuff since the seventies. Fiasco.