There is a lot of wisdom in Stephen Brown’s argument that it wasn’t excessive belief in efficient markets that caused the financial crisis – it was the failure to understand the efficient market hypothesis.
Here’s the abstract for his The Efficient Markets Hypothesis: The Demise of the Demon of Chance?
Many commentators have suggested that economists in general and financial economists in particular have some responsibility for the recent global financial crisis. They were blinded by an irrational faith in a discredited Efficient Markets Hypothesis and failed to see the bubble in asset prices and to give due warning of its collapse. There is considerable confusion as to what this hypothesis is and what it says. The irony is that the strong implication of this hypothesis is that nobody, no practitioner, no academic and no regulator had the ability to foresee the collapse of this most recent bubble. While few economists believe it is literally true, this hypothesis is considered a useful benchmark with some important practical implications. Indeed, a case canbe made that it was the failure to believe in the essential truth of this idea which was a leading factor responsible for the global financial crisis
From the conclusion:
Few people today believe in the literal truth of the EMH. Over the past 40 years there have been many studies which have challenged its empirical validity, many of which are catalogued in Fama (1991). Much of this evidence has stemmed from a confusion between the EMH and the closely related Random Walk hypothesis. The experimental design in many of these studies does not exclude the possibility that they are infected with a variety of ex post conditioning biases. However, the issue does not hang on whether the hypothesis is true or false, but whether it is sufficiently true to serve as a practical benchmark for money manager performance, to use for the purpose of ascertaining whether particular kinds of announcements convey material information to investors, and to estimate measures of equity risk. While sophisticated investors can always make money by exploiting the small and transient ways in which the markets deviate from the EMH, small and otherwise uninformed investors may as well assume that the hypothesis is literally true.
In the period leading up to the current financial crisis few practitioners believed that the EMH had any practical implications. It was believed to be rather easy to make money investing in short term trends. Hedge funds and other investors borrowed heavily to invest in the markets. Banks invested in beta thinking it was alpha. The resulting increase in the leverage and resulting heavy debt burden taken on by financial institutions was a leading factor in the recent global financial crisis (Acharya and Richardson (2009)). One might take the view that it was the failure to believe the EMH that was in fact responsible for the crisis!