Alan Greenspan recently asked the tantalizing question, "How did we go so wrong?" He answered by asserting that " [there is] little evidence of a learning curve. Asset price bubbles build and burst today as they have since the early 18th century, when modern competitive markets evolved." If anybody should be aware of the absent learning curve, Greenspan should. He has the distinction of having presided over two bubbles during his stint as the chairman of the Federal Reserve-high-tech and home prices-which also partially overlapped. Paul Volcker, Greenspan's predecessor as Fed chairman, made an interesting and related point at about the same time as Greenspan. He referred to "[t]he mutual trust among respected market participants upon which any strong and efficient financial system must rest." This feature of "strong and efficient" markets never occurred to me, and I do not recall ever seeing any comment of this nature in the literature on the Efficient Market Hypothesis that has come my way. Discussions of rationality, the quality of information, the dissemination of information, and the ability to analyze information are endless, but both adherents and opponents have failed to emphasize the importance of mutual trust in the functioning of efficient markets.
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