RIP EMH?

The title link is to a Times article that almost makes a good point. The Efficient Markets Hypothesis (EMH) says that securities are priced taking into account all publicly available information. It doesn't say the price of a security is an objective assessment of value. A consequence is that one shouldn't be able to beat the market by using public information.

However it seems to me that the EMH has been asked to bear too much weight for regulatory purposes. In particular EMH seems to justify using current market prices in mark to market accounting, but prices are not values and reporting prices only reflects back at the market what it already knows.

Economist admits error shock horror

In an unusually frank article (see title link) Anatole Kaletsky reviews his predictions for last year and why he got them so wrong. He gives three reasons for the September 2008 meltdown in markets:

1) The surge in oil and commodity prices driven by speculation
2) Regulatory blunders culminating in the decision to let Lehman fail but sparked by 'mark to market accounting'
3) Ideological adherence to a belief that the 'markets are always right'.

Predictably, Ian Powell, chair of PWC the largest UK accounting firm, jumped into the debate to defend fair value, using the hackneyed mantra that fair value reflects 'reality'. Accountants in official positions spout this cliche over and over again. There are two things wrong with the view:

1) No one is arguing that fair values should not be reported as footnotes, only that they should not be used for measuring profit, hence there would be no loss of transparency if the role of fair values was reduced in profit-measurement.

2) Fair value is not 'telling it like it is', it is reflecting an error prone market value back at the market. As defined by SFAS 157, fair value is effectively an estimate of the price of an asset that isn't going sold, as agreed between two hypothetical participants in a market that doesn't exist. This is certainly not 'reality'.

To his immense credit Powell says quite explicitly:

However, fair value accounting is pro-cyclical and on its own this does carry risks for the banking sector.

If everyone could be persuaded to agree to that proposition and that financial reporting has a role in maintaining market stability, then it is possible some progress could be made in improving financial reporting.