The Tufts Daily (TD): What were some memorable classes or professors you had at Tufts?
Eugene Fama (EF): I started out as a Romance languages major and then took an economics course, and I loved it, and ended up with a dual major. I fell in love with economics and I’ve been with it ever since. Harry Ernst was a very important professor, though he’s probably dead at this point. Lewis Manly was another one who was very good. I’m sure he’s dead at this point.
TD: What personally motivated your path from studying Romance languages at Tufts to loving economics so much that it brought you to where you are today?
EF: Well, I was getting bored with Romance languages, and I found economics exciting. When I went to interview for a job, it looked like a degree in economics would be much more profitable. But in any case, I wasn’t ready for a job, so I wanted to go to graduate school, and my professors at that time, Harry Ernst and Lewis Manly, [told] me to go to the University of Chicago, because they thought that was the business school that was more oriented towards academic work than the other schools I had been accepted to.
TD: What research are you currently working on?
EF: I’ve worked on lots of things since [receiving the Nobel Prize], and I’m currently working on how to measure risk and what the relationship is between expected return and risk. [That’s] the most simple way to put it; getting into any more detail than that would be probably not be appropriate for your audience.
TD: What do you believe is the most misunderstood facet of your work?EF: Whether you’re talking about academics or practitioners. Academics understand it perfectly well, I think. Whether they agree with it or not, that’s a different story, but they understand it. Practitioners, well, they all have their own quirks, so I can’t really comment on that. It took a long time for these ideas to percolate through the business community. It basically took 50 years for the efficient markets hypothesis to permeate in any real way, but the risk and return stuff that I’ve been doing forever — that permeated pretty quickly.
TD: Is there any reason you think practitioners misunderstood?
EF: [Practitioners didn’t misunderstand], they just didn’t accept it because it hits them in the pocketbook. Basically it said that all of the active investing techniques did not work. You’re crazy to pay high fees for them when in fact you weren’t getting what you were paying for. So they didn’t like that message.
TD: What would you most like to understand or explain about financial markets that you feel has not yet been understood?
EF: Almost everything. The appropriate way to measure risk. I mean, I’ve been looking at this risk-return problem for 50 years, and I still don’t think I have it nailed. I doubt it’s possible to nail it, so that’s kind of ongoing research, and it’s likely to be ongoing long after I’m done with it.
TD: In light of the 2008 global financial crisis, do you tend to believe that regulation improved the financial sector or that it went too far?
EF: No, I don’t think it went too far. I would say that in some respects it went too far, but in some respects it didn’t go far enough. I think it’s still dangerous in terms of the amount of leverage that’s in our financial sector. If there were another crisis, [financial institutions] would get bailed out again, and that’s something that they like, so there have been some of us that have said all along that basically the ones that are too big to fail should hold enough equity so that they can’t fail. But we’re nowhere near that. We’re still in a fairly dangerous position if we run into another episode like they did in 2008 and 2009.
TD: So you believe there could be room for further regulation?
EF: Well, they looked at the wrong stuff. They’re looking at detailed regulation when the basic regulation is [that] you have to have enough equity in there so that the debt doesn’t bring you down. I don’t think they really faced that, because they get lulled by the interest into thinking that somehow more leverage will hamstring the banks in what they do in terms of lending, [but] there’s an old Modigliani-Miller theorem that says that’s garbage. Basically, it could be all equity, and it wouldn’t change the amount of lending they would do. That’s going to be an ongoing fight, and hopefully not [one] to be tested with another crisis.
TD: Critics of passive investing have raised concerns about a concentration of voting rights. In your view, should passive shareholders be allowed to vote and why?
EF: Of course they should be. They’re shareholders after all. So I’m involved with an investment company, and we have 15 people who do nothing but look at these governance issues. So the bigger the fraction you own of a company, the more incentive you have to make sure that what they’re doing is something you agree with in terms of making sure the shareholders are better off. So I don’t see a problem there at all. It’s the opposite of a problem. The problem you have is the free-rider problem, where everybody owns such a small fraction and nobody has any incentive to be looking into what’s going on. So I think all of the passive managers that I know of are deep into corporate governance; I mean, they’re really concerned about how a company is operating. You get complaints from people who want us to go back to active management, so they can get back their high fees. [Passive managers] are the same as active guys. The incentive is not different. You don’t want these [active] guys stealing from you; that’s what it comes down to.
TD: Do you believe that at the limit there will always be room for active investors as necessary price-setters for the market?
EF: There’s definitely a need for them, but the problem is that all the bad active managers have to be offset by good active managers. So if the bad ones dropped out, there’d be fewer good ones to offset them and keep the market efficient. So I don’t think we are anywhere near the point where this is at all an issue. There are active managers who do it anyway, but it could be just informed individual investors that keep the market efficient.
TF: What is one piece of advice you would give to young people seeking to enter the finance industry, especially in investment roles?
EF: Well, my general advice that I always give to young people is: Find something that you really like to do, because you’re going to spend a large fraction of your life doing it. And if you don’t like it, basically, it’s a third of your life; you’re going to be very unhappy. So I’ve been really blessed in the sense that I really love my work, so it’s not painful to sit down at my desk and work. It’s really a joy. That’s the general advice I give, and it would apply to people going into finance as well. If you’re going to go into finance, basically you need a good background in economics and some background in statistics. Those are the two things you’re going to be faced with throughout your career. I try to prepare my students in those terms for stuff that they’re likely to see in the future that we don’t even know about now. So, if they’re going to be prepared to deal with it, they are going to need a background in economics and statistics to do that.
TD: What advice would you give to students graduating today in light of today’s economic environment and the growing challenges to traditional views of capitalism, markets and globalization?
EF: It’s really baffling that somehow evidence doesn’t seem to change people’s opinions. What is the government really good at? I mean, why are you asking for more government? Does more government ever work? Or does it always work in unintended ways? I tend to lean to the latter myself, but I’m a libertarian, so I don’t trust [government]. But basically, the evidence is clear-cut. Capitalism makes people better off. There’s no way around it. There’s a lot of envy going around, because the rich are doing very well. The poor are doing well, it’s just that they are not doing as well as the rich. I don’t know what the optimal amount of inequality is in order to make everybody better off. And that’s not a question that can be answered by the political process very well, either. But it really worries me that people don’t seem to learn from experience that socialism and more government basically were a complete disaster. There is no case of a socialist government that has ever worked in the long-term. So I don’t know what people are looking at. Socialism depends on people. Eventually you’re gonna get people in there who are going to steal everything. You see that in Venezuela currently; you saw that in the Soviet Union … So we’ll see how that turns out.
