Markets are Efficient if and Only if P = NP

My amateur understanding is that most academics get that it's a simplifying assumption, but that a lot of other people treat it as a guarantee. It's sort of like people who learn a little about evolution and then conclude that a) we are the most highly evolved organism on the planet, and b) we are therefore perfect.

It's fairly common for traders managing (or depending how you look at it, gambling) other people's money to be paid a percentage of the total money under management (for the sake of argument, let's say 0.5%) plus a much larger percentage (10%) of the upside.

That this leads to perverse incentives is, I hope, obvious to everyone here - I've literally sat down with traders and run best guess numbers incorporating the risk of getting fired (or losing investors, shutting down the fund, etc.), difficulty finding another gig doing the same thing vs. the potential gains, and the mathematical conclusion is almost always the same: go all-in, take on as much risk as you can possibly manage, and you'll do better personally than if you invested safely. The only real question is a moral one, i.e. do you care enough about doing what's right to actually try to preserve your client's money rather than gamble it away for a shot at a bigger prize? [Interestingly enough, I've found that most do, the problem is that there's a small subset that don't give a shit, and their abuses taint the entire field]

This type of risk-seeking unquestionably played a role in the recent collapse, I don't really see how that can be denied - sure, government incentives triggered the initial housing market buildup and drop, but IIRC that was initially only a 4% correction, it was only because of how massively leveraged the financial sector had become w.r.t. credit that such a drop had any impact on anything at all.

Do you really think the payment incentives in the financial sector are helping the market work properly? Or do you think that those payment schemes (a nibble of the principal and a chomp of the upside) are somehow caused by government meddling?

IMO, the problem is that it's a mistake to assume that the negative effects of "government meddling" end with official government. Any time you put a group of people together and have them agree on rules and regulations, especially ones about how to distribute money amongst themselves, you run the risk of creating incentives where individually self-interested actions actually work against the group. This applies to corporations, clubs, families, teams, etc., just as much as it does to governments.

The crash of 2008 was preceded by 20 years of deregulation. And the explanation? Too much regulation! A billion dollars in loans to minorities must explain the 2 trillion dollar problem!

There's nothing wrong with thinking a free market's the way to go for a given problem, provided you got there by engaging your brain rather than taking it on faith. Once you do that, you might find yourself thinking things like "Hm, maybe capital gains should be taxed as ordinary income", or "Hey, turns out it's mathematically impossible to balance the budget by cutting domestic discretionary spending".

The free market is more force of nature than construct of man, like gravity or a huge river. It can be harnessed, but it will efficiently crush you if you get in its way. It is also like the forces of nature in that it is extremely difficult to successfully harness it when one willfully chooses to not understand it because one does not "like" it, which is why the track record of social systems that start out with "Let's pretend the market isn't a force of nature but that we can will it into compliance with our ideology" tend to fare so poorly in practice; it's hardly any different than assuming gravity won't actually hurt you if you just love hard enough, then trying to get into rocket design. (The problem isn't that you won't get a rocket off the ground with such a plan, the problem is that you will....)