What They Tell You

Financial markets are efficient. Prices reflect all available information. Professional investors can’t consistently beat the market because prices are always right. Asset bubbles are rare or impossible—if prices seem too high, smart money will sell and correct them. Deregulation allows markets to work better. Financial innovation improves efficiency.

What They Don’t Tell You

Financial markets are highly inefficient and prone to bubbles and crashes. Prices regularly deviate wildly from fundamental values. Investors are driven by psychology, herding, and short-term incentives. The 2008 financial crisis wasn’t an aberration but a feature of how financial markets work. Financial innovation often creates risk rather than managing it. And finance has grown far beyond its useful function.

The Efficient Markets Hypothesis

The EMH, developed by Eugene Fama, argues:

  • All available information is immediately incorporated into prices

  • No one can consistently beat the market

  • Prices reflect true fundamental values

  • Bubbles are impossible because arbitrageurs would sell overpriced assets

This theory justified financial deregulation and the idea that markets should be left alone.

The Evidence Against It

Bubbles happen constantly: Tulip mania, the South Sea Bubble, the 1929 crash, the dot-com bubble, the housing bubble—prices repeatedly deviate wildly from fundamentals.

Volatility is too high: Stock prices are far more volatile than the underlying fundamentals (dividends, earnings) that should determine them.

Anomalies persist: Small-cap stocks, value stocks, and momentum strategies have beaten the market consistently—which shouldn’t happen if markets are efficient.

Insider knowledge matters: Those with better information do profit consistently, showing markets don’t immediately incorporate all information.

The Psychology of Markets

Behavioral finance has documented how psychology drives markets:

Herding: Investors follow each other. If everyone is buying, you buy too—not because of fundamentals but because prices are rising.

Overconfidence: Traders overestimate their ability to predict the market, leading to excessive trading.

Anchoring: Investors anchor on irrelevant reference points, affecting their valuations.

Loss aversion: The pain of losses leads to holding losers too long and selling winners too soon.

Short-term focus: Professional investors are judged quarterly, making them focus on short-term price movements rather than long-term value.

The 2008 Financial Crisis

The crisis wasn’t bad luck or unforeseeable. It was the predictable result of:

Deregulation: Glass-Steagall repeal, light-touch regulation, and regulatory capture

Perverse incentives: Bankers profited from risk-taking; losses were socialized

Financial innovation: Derivatives and securitization created opacity and systemic risk

Ratings fraud: Agencies paid by issuers rated toxic assets as safe

Ideology: Faith that markets were efficient and self-correcting

The “once-in-a-century” crisis was caused by policies based on efficient markets theory.

Finance and the Real Economy

Finance is supposed to serve the real economy by:

  • Channeling savings to productive investment

  • Helping manage risk

  • Providing payment systems

But modern finance has grown far beyond this:

Size: Financial sector profits have grown from about 10% of corporate profits in the 1950s to nearly 30% today.

Trading: Most financial activity is trading with other financial players, not funding productive investment.

Complexity: Financial products have grown vastly more complex, often in ways that benefit financial firms at clients’ expense.

Extraction: Much of finance’s profit comes from extracting rents from the real economy, not from adding value.

High-Frequency Trading

Modern markets are dominated by algorithms trading in microseconds. This:

  • Doesn’t provide capital for productive investment

  • Extracts tiny profits from slower traders

  • Creates flash crashes and instability

  • Requires massive investments in speed that produce no social value

Is this what efficient markets look like?

What Efficient Finance Would Look Like

A truly efficient financial sector would be:

  • Smaller: Serving the real economy, not itself

  • Simpler: Products understandable to users

  • Stable: Not prone to crises requiring public bailouts

  • Equitable: Not extracting massive rents through complexity and information advantages

The Lesson of History

Every generation forgets the last financial crisis. Regulation follows crashes but is eroded during good times. The myth of efficient markets serves those who profit from deregulation.

The efficient markets hypothesis isn’t just wrong—it’s dangerous. Believing it led to deregulation, which led to crisis, which led to bailouts, which led to… belief that next time will be different. It won’t be.