I flagged this Matt Yglesias post about post-mortem examinations of the financial crisis as something to respond to. Matt writes:
I was at an interesting discussion with an ideologically diverse group of people last night of the future of financial regulations. One thing that there was broad agreement on that hadn’t really snapped into focus for me previously is the idea that doing rigorously precise forensic work on how to understand “what went wrong” and then design the rule that would have prevented this is neither necessary nor sufficient to improving things going further.
The basic reason is that we can be pretty sure that no matter what we do, we don’t need to worry about this exact thing happening all over again. Investors will be extremely reluctant to get involved in the exact kinds of products that recently crashed, everyone will worry that the first sign of housing price increases is a bubble, and regulators will be keenly aware of everyone’s pet theory of what went wrong.
I then spent most of the day wrestling with Chapter 8, and by the time I got home, I saw that Kevin Drum had responded with important data:
I think Ezra is properly skeptical of this advice, since bankers will in fact make the exact same mistakes they made this time around if we allow them to. It’ll take 20 years, but they’ll do it. Here in Southern California, just to provide an example close to home, the fact that we had a disastrous housing bubble in the late 80s didn’t put any brakes on the housing bubble in the early 2000s. In fact, the housing bubble was worse here than just about any other place in the country. It took us a grand total of 15 years to go from the peak of one housing bubble to the next.
(Ezra is, of course, Ezra Klein.)
I think Kevin’s exactly right. This plays into a minor rant I’ve been holding back for a while, which is that I’m sick to death of hearing people refer to the current financial disaster as if it were some one-in-a-million “black swan” event. On the contrary, the only thing about this that wasn’t entirely predictable was the degree of the damage.
Fundamentally, the root cause of this is that a bunch of financial wizards managed to convince themselves that real estate prices would always and only increase. That’s the only way the idiotic practices they engaged in make any sense at all– you can get away with making incredibly stupid loans to people who can’t possibly pay them back as long as they’re going to buy houses whose value will never go down, or even remain flat.
This is, at bottom, the same rock stupid decision that has led to every financial collapse ever. I’ve got a copy of Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds here, which was published in 1841, and he would recognize the current crisis as essentially the same as the other financial disasters he chronicles in his book. The only difference between this mess and the Dutch tulip mania of the 1630′s is that the people convincing themselves that prices could only increase know calculus.
The real lesson of this crisis is that the only infinite resource in the economy is financiers’ capacity for self delusion.
So, lay off the black swans. It’s not their fault. Responsibility for this crisis begins and ends with gullible bankers. And this is why we need broader regulation of the financial system: because at the end of the day, bankers (like all other humans) are greedy and gullible idiots.