Financial Crisis and Economic Depression: 'Post Hoc Ego Propter Hoc'? Implications for Financial Asset Valuation and Financial Regulation

It was more than four decades ago when James Tobin stressed the fallacy underlying the Latin motto "Post Hoc ergo Propter Hoc". His point was that a causal relation, back then between money and income, must rely on something more than time precedence. However, this fact has not received proper attention, contemporary literature explains the current depression from the financial crisis which preceded it and its' resolution depends on proper rules of financial regulation. This paper argues different, the current depression resulted from weak growth reflecting weak profitability. We show that under this reasoning financial crisis episodes are highly probable, serving as the trigger of depressions. The latter implies that financial assets valuation depends on a highly variable required rate of return, contrary to the postulations of modern investment theory. Highly volatile asset returns places financial markets in a world of true uncertainty as opposed to calculable risk. This shred of realism gives different meaning and limitations to financial regulation. Any regulatory policy monitoring liquidity or solvency ratios can prove insufficient as zero or weak growth turns unstable, an event usually preceded by increased amounts of speculative investments. Therefore, financial regulation should focus on what kind of assets financial intermediaries can sell and what kind of assets banks, pension funds, corporations and the broad public can hold to protect taxpayers from future bailout costs at least in part.