The work that won
A distinguished panel discusses why Eugene Fama, MBA’63, PhD’64, and Lars Peter Hansen won the Nobel Prize.
At 3 p.m., half an hour before the program “The Work Behind the Prize” is scheduled to begin in the Logan Center performance hall, about 100 people are queued up; the line stretches from the Gidwitz Lobby to the security desk on the north end of the building. Last month Eugene Fama, MBA’63, PhD’64, and Lars Peter Hansen won the Nobel Prize in economics: that we all know. What we don’t really understand is why.
I don’t need to be in this line, I realize once I’ve stood in it for 20 minutes; I’ve managed to wrangle a seat in the reserved section, along with University trustees and members of various Nobel-winning families.
“Remind me of your last name?” the usher asks a petite, dark-haired woman as they walk toward the front of the auditorium.
“Becker,” she says, as in Gary Becker, AM’53, PhD’55, the 1992 winner and the moderator of today’s panel. She’s directed to a seat in the front row.
The stage is set with leather armchairs and an Oriental rug. In a quick opening speech, Mario Small, dean of the Social Sciences Division, notes that this is the first time, since the economics prize was inaugurated in 1969, that two current UChicago faculty members have won it the same year.
In an equally quick speech, President Robert J. Zimmer points out that we are celebrating the winners in typical University of Chicago fashion, “by examining the ideas these prizes represent. Perhaps even by debating them.”
Then Becker takes the podium, explaining that each of the four economics professors on the panel—James Heckman; John Heaton, PhD’89; John Cochrane, and Tobias Moskowitz—is limited to ten minutes. “I’m going to try to moderate this distinguished panel,” he says. “I say ‘try’ because if you’ve ever dealt with these people—” The rest of his comment is lost in audience laughter.
In the media coverage of the Nobel Prize, journalists found it fairly easy to explain the significance of Fama’s work. As the New York Times put it, “Mr. Fama’s seminal theory of rational, efficient markets inspired the rise of index funds and contributed to the decline of financial regulation.”
Hansen’s was not so easy. Chicago magazine writer Whet Moser, AB’04, tried in vain to find an economist who could explain Hansen’s “award for scary math.” One economist (who had won a Nobel himself) said, “His work involves econometric methods on which I have no expertise at all, but I’ll trust the experts who consider it great work.” Another told John Cassidy in the New Yorker, “Hansen’s mathematical contributions are above my pay grade.”
Heckman, who won the Nobel in 2000, tries admirably to make Hansen’s scary math understandable, beginning by quoting Herodotus: “All is flux. You cannot step twice in the same stream.” He’s a charismatic, passionate speaker, like your favorite high school math teacher, and I kept thinking, if he would just slow down and walk the class through it two or three times—or maybe if I went to the extra help session—I would get it.
But there’s no time for that. He flashes Einstein’s elegantly simple equation E = mc2 on the screen, then shows Hansen’s Euler equation, which is nearly as simple: 1 = Et [Mt+1 Rt+1]. “This is Hansen’s E = mc2,” he says. I’m wondering why it’s called “Euler” and trying to figure out what the variables stand for when Heckman says, “Let me just conclude—”
“Conclude, now,” Becker interjects from across the stage.
“There are lots of practical applications,” Heckman says.
Then Heaton, one of Hansen’s students and collaborators, is up. His summary of Hansen’s work: “You can do something without having to do everything,” he says. “I’m not going to write down a bunch of equations,” directing an aside to Hansen, sitting with Fama in the front row, “Lars, I do know those equations.”
Whereas the Federal Reserve tries to model the entire economy, Heaton says, Hansen says you can learn from just two variables—consumption and the stock market, for example. Again, he summarizes Hansen’s approach: “What can I learn without having to know everything?”
“In conclusion,” Becker prompts.
Understanding the economy “can be difficult,” says Heaton, reading off his slide, which includes excited punctuation: “For individuals, and for economists too!” The implication for policy makers, he says: “Simple rules and regulations may be the best way to go.”
Next up is Cochrane to talk about Eugene Fama, who happens to be his father-in-law, though Cochrane doesn’t mention it. (Cochrane’s wife, the writer Elizabeth Fama, AB’85, MBA’91, PhD’96, is sitting with her mother in the second row. On the day her father won the Nobel, Elizabeth noted on her blog, “My mom, Sally, deserves this prize as much as he does. No researcher was ever better nourished to do his work, emotionally, spiritually, gastronomically.”)
Fama’s theory of efficient markets, Cochrane says, “is not a complex theory. Think Darwin, not Einstein.” But four decades after Fama’s publication of his groundbreaking paper on efficient markets, it’s still controversial, he says. Investors just don’t want to believe that active management produces lesser returns than investing in index funds. People still want to know why some investors seem to beat the market: “‘But what about Warren Buffet? What about my buddy Joe?’”
“Data is not the plural of anecdote,” Cochrane says, as the audience laughs; such stories have as much value to economics as “‘Grandpa got to be so old even though he smokes’ has to medicine.”
The final panelist, Moskowitz, says the Fama-French model (developed with Kenneth French, formerly of UChicago and now at Dartmouth College) “takes a very chaotic world and makes it a very simple world. That’s the general theorem you’ve heard today. They’ve managed to break it down into digestible pieces.”
At 4:38 p.m., seven minutes before the program is scheduled to end, Fama and Hansen are finally invited up onstage. Fama, Becker says, is “one of the few people who’ve been at the University of Chicago longer than I have.” Introducing Hansen, Becker notes how modest he is: “It’s hard for Lars to say anything positive about himself,” he says, “or anyone else, for that matter.” The audience laughs again.
Fama and Hansen have just a few minutes to weigh in on the financial crisis and it’s all over. Since there wasn’t time for audience questions, says Sunil Kumar, dean of the University of Chicago Booth School of Business, we should take advantage of the reception in the Gidwitz Lobby: “Please stay and grill the panelists and the prizewinners,” he says. “Get your money’s worth.”
My head is spinning with undigested equations. Today’s discussion was considerably more advanced than what I learned in Econ 198, Intro to Microeconomics, more than a decade ago; Econ 199, the macro course, would have helped, but I hadn’t taken it. I ask one of the event organizers how much of the content she thinks the audience understood.
“Twenty percent?” she estimates.
“You mean, 20 percent of the audience understood 20 percent of the content?” I say. I’m just trying to make myself feel better.
Fama and Hansen circulate, but no one seems to be taking Kumar up on his suggestion to grill them about economics. Instead, fan after fan approaches the prizewinners, asking to have their photos taken with them. Fama and Hansen cheerfully oblige.