My column from Thursday’s Fin, with a not so subtle plug for my book.
Ideas are almost impossible to kill, especially when they serve powerful interests. There can be no better example than the efficient (financial) markets hypothesis, that is, the claim that the prices at which financial assets trade represent the best possible estimate of their value, taking account of all available information.
The efficient markets hypothesis ought to have been discredited once and for all by the absurdities of the dotcom boom a decade ago. But as soon as the immediate crisis had passed, with the help of the Greenspan Fed, financial market participants were singing the same old song. The one marginal piece of reform adopted in response to the dotcom disaster, the Sarbanes-Oxley bill was soon being derided as an overreaction.
If the dotcom boom was not enough, surely the near-collapse of the entire global financial system, brought to its knees by absurd speculation, ought to have killed the hypothesis. And indeed, some notable advocates such as Ian Harper in Australia and Richard Posner in the US, looked at the evidence and admitted it was decisive. But most supporters kept quiet when the crisis was at is worst. As soon as a partial recovery became evident they returned to preaching their gospel as if nothing had happened.
But even if no-one wants to admit it, the failure of the efficient markets hypothesis is making itself felt. an example of particular relevance to Australia is the collapse of the market for Public Private Partnerships. The case for PPPs rested directly on the belief, derived from the efficient markets hypothesis, that private financial markets would always outperform governments in assessing and managing risk. So, it was claimed, public infrastructure could be financed by transferring demand risk to private owners.
In the 1990s, governments were desperate to get debt off the books at any price, and signed deals that were massively profitable to the private ‘partners’ and even more costly to the public.
By the 2000s, governments had mostly wised up, and demanded that PPP projects should yield value for money when tested against a ‘public sector comparator’.
It was now the turn of the private sector to engage in over-optimistic dealmaking. With credit standards almost non-existent in the later years of the bubble economy, projects went ahead on the basis of absurd traffic projections, with disastrous results for investors.
In the wake of the financial crisis, illusions are less affordable. There is a big gap between the cost to governments of traditional bond financing for projects, and the return demanded by investors for taking on demand risk.
A traditional PPP deal makes sense only if the parties can find cost savings sufficient to offset the lower capital cost of government bond financing. For projects within the traditional scope of the public sector these conditions are rarely met – that’s why these activities were in the public sector in the first place.
Despite all this, everyone who matters is keen for PPPs to continue. The finance sector needs dealflow, and government bond financing does not yield the kind of fee income they need. Governments still want to get debt off the books, and remain absurdly terrified of the ratings agencies. And while the infrastructure industry is becoming disillusioned with the PPP model, it seems to be the only game in town for many projects.
The solution, for the moment, has been found in ‘availability payments’. The idea is that, instead of receiving a cash payment when the project is completed, the private partner gets a stream of payments, conditional on the project remaining operational. In economic terms, this is just the same as traditional public procurement with a bundled maintenance contract. Why then, go to the added expense and complexity of a PPP arrangement?
The answer may be found buried in a report on the website of Infrastructure Payments Australia which indicates that availability payments ‘may not be viewed as debt owed by the public entity’. That is, although it looks like a debt, and quacks like a debt, governments can pretend that the obligation to make availability payments is not really a debt. It remains to be seen whether Auditors-General will fall for this piece of creative accounting.
As the PPP example shows, the efficient markets hypothesis is a zombie idea. It is not so much dead as undead, buried by a mountain of contrary evidence, but still capable of emerging from the grave and doing immense damage.
John Quiggin is an ARC Federation Fellow in Economics and Political Science at the University of Queensland. His book, Zombie Economics will be published by Princeton University Press later this year.