You and two other economists will collect the Nobel on December 10 in Stockholm. Where were you when you found out?
I was preparing for my class, actually, at home [in Hyde Park]. It was six o’clock in the morning. They called from Sweden. I was surprised and thrilled.
The Nobel committee cited the influence of your efficient market hypothesis, which says that asset prices perfectly reflect all relevant information. That leads to the idea that trying to beat the market is an exercise in futility, right?
Almost surely. There’s quite a bit of evidence that even professionals don’t show any ability to pick stocks or to predict market rollbacks. Most of the people we identify as skilled based on returns have probably just been lucky.
Even someone like Warren Buffett?
He’s not a money manager. What he does is run companies. That’s a different activity entirely. Nobody would contend that improving the performance of companies can’t add value.
When you’re choosing among various mutual funds for your retirement account, say, why is a passively managed one [such as an index fund] so much better than an actively managed one?
It’s simple arithmetic. When an active manager buys lots of a stock, somebody else has to be on the other side of [the trade]. So active investment is a zero-sum game. Passive managers don’t play the game. They buy something resembling the market as a whole, or some segment of the market, and they don’t respond to the actions of active managers.
How do you feel about buying Illinois bonds?
Well, in the short term, they’re OK. In the long term, I wouldn’t touch them. The [state’s] pension liability is much worse than [the reported $100 billion that] people think.
States discount their liabilities—I think Illinois uses a discount of 7.5 percent [it’s between 7 and 8]—arguing that’s the expected [annual] return on their portfolio. But the expected return on a portfolio is totally irrelevant. What counts is, How risky are the claims that you have to meet? You’ve made a promise to your employees that you’ll pay them a certain fraction of their income that is usually indexed. Which means it’s a risk-free real outcome. What’s the risk-free real rate? Is it anywhere near 7.5 percent? It isn’t. Historically, it’s like 2 percent. A 2 percent discount rate would approximately triple Illinois’s pension liabilities.
Your theory of efficient markets has been used by conservatives as justification for dismantling many financial regulations, such as the Glass-Steagall Act—
It’s not true. Glass-Steagall [which separated investment banks and commercial banks] was dismantled because [the government] gave up trying to enforce it. The financial institutions were just too good at getting around it.
Janet Yellen, nominated to lead the Federal Reserve System, has said that the Fed needs to reconsider its traditional view that bubbles cannot be spotted and should not be popped. What do you think?
[Laughs.] It’s a joke. I think bubbles are things people see with 20/20 hindsight. If you look at any particular period where prices go up and then they go down, you will always find people who predicted that they would go down. Those are the people you pay attention to. The ones who are right get anointed.
Like your Nobel co-winner Robert Shiller, the Yale economist who argued that the bubble preceding the 2008 financial crisis was caused by “irrational exuberance”?
He got one right. But he’d been saying that for a long time. [Since] 1996, I think.
You got your MBA and PhD at the University of Chicago, and you’ve spent virtually your entire career there. Why?
The school fits my personality. I can be pretty sarcastic and forceful, and I’m not too tactful at commenting on people’s work. That’s a characteristic of everybody here. People are ruthless with one another. But it’s not personal.
You and your wife of 55 years have four children and 10 grandchildren. Who’s going to Stockholm with you?
There’s an excess demand for [Nobel] tickets in my house. Everyone wants to go. They’re going to have to face up to the fact that the boys have to wear white tails and the girls have to wear gowns. To say nothing of shoes. That’s already an issue.
In your 2011 paper “My Life in Finance,” you claim to be the inventor of the split-end position in football. For real?
Yeah! In high school, I was playing end. I was five feet seven and a half, maybe 160 pounds soaking wet, opposite these giant tackles that were like 250 pounds. So I just kept [chuckles] moving out.