Markets are Efficient if and Only if P = NP

The fall of 2008 wasn't a free market. In particular, the government was forcing lenders to accept more risk (viz sub-prime borrowers) than they would otherwise have done. Also, the lenders themselves incorrectly modeled their risk exposures.

None of your objections:

what about information asymmetry? What about borked incentives? What about just plain stupid? "I played golf with the guy so I'll buy it"? "I know these instruments are crap but I'll sell them to my clients to get them off my balance sheet"?

hold any water:

Information asymmetry (also, incorrect information as with lenders in '08): This has nothing to do with the efficiency of markets. The efficient market hypothesis depends on actors behaving rationally to achieve their goals. That does not mean that those actors will always be correct. For example, in The Myth of the Rational Voter[1], Caplan describes how it's actually rational behavior for voters to vote irrationally: the benefit of the degree they can sway the election is far smaller than the cost of acquiring sufficient knowledge to determine what candidate would most benefit them.

Bad incentives: it's the incentives (see "Invisible Hand") that make things work properly! To the extent that the incentives are wrong, these are the regulations, the aberrations that make things deviate from the free market. In your '08 complaint, that was the Congress forcing lenders to take on borrowers that would not normally have qualified. It also comes from externalities, places where our laws prevent the free market from completely accounting for the costs of an action. For example, because air and waterways are held in common by the government, without a real owner, there is nothing capturing the cost of pollution. Thus, incomplete property rights leads to market failures. If the government got out of the way, the market could resolve it (see "Coase Theorem")

Stupidity: as separate from your other points, well, there's no such thing -- at least not that we can perceive. Mises shows that (a) each person acts to maximize his own utility, and (b) it's impossible for outside observers (and frequently even the individual himself) to know what ends he is attempting to achieve. Thus, if your hypothetical golfer places some personal value on the relationship with his golf buddy, it may be perfectly rational for him to spend extra few bucks buying from the guy. And you and I certainly aren't privy to enough information to decide that it's not so.

Fraud: your Yankees example seems to be an example of fraud, and thus can't be considered a free market transaction. Fooling someone into a transaction is no different from forcing them into a transaction.

That said, research in psychology and econometrics has shown that people do systematically misconstrue very large or very small values, leading us to sometimes choose differently from what we really intend. The only solution to this, of course, is to formally model the problem to enable us to act rationally. In this day and age, such models are de rigeur, but -- as I note above -- the investment in the models itself has some risk: we're balancing correctness against cost to develop and feed the model. As with the rational voter, this can lead us to "rationally irrational" behavior, but this is just a meta-behavior of the free market, not an indictment of it.

Moreover, there is no way around any of the issues that you cite. All of these things can be applied equally -- if not more -- to government regulators (see "public choice economics", "regulatory capture", etc.). Why would you want to give power to entities who won't be able to use it any more wisely than the people themselves?

[1] http://en.wikipedia.org/wiki/The_Myth_of_the_Rational_Voter

[2] http://en.wikipedia.org/wiki/Human_Action

To the extent that government regulations are less strong than physical laws, isn't the market still free? For instance, methamphetamines are illegal, but they're still produced, distributed, and retailed; just with a higher cost for all involved than if they didn't have to take precautions against, and accept the probability of, detection and punishment. Given the incentives in place, the supply and demand curves for methamphetamines still meet, and the market clears.

I've always found the belief that markets can withstand any form of interference except government regulation fairly bemusing.

One side-effect that falls out of this more cosmopolitan view of free markets is that the fall of 2008 was the efficient outcome. If market participants had information about what would happen strong enough that they were willing to bet on it in 2005-2007, the catastrophic drop in 2008 would not have happened as it did.

Home prices crashed and then more or less stabilized. So yeah, I'd say the crash was close to an optimal price correction.

http://research.stlouisfed.org/fred2/series/SPCS20RSA?rid=19...

I'm a little confused how why you would believe people who follow Hayek are unfamiliar with questions of information asymmetry and borked incentives. After all, don't they form the basis of "The Road to Serfdom"?