Simple

by Russ Roberts on April 28, 2010

in Gambling with Other's $

Bryan Caplan weighs in on the cause of the crisis:

Arnold ably identifies two main narratives about the 2008 financial crisis.  But he neglects the simplest narrative of all: Once in a century, a once-in-a-century mistake happens. The end.

Bryan’s half right. It is the simplest narrative. But I’m not sure what he means by “once in a century.” We’ve had a whole bunch of financial crises around the world in the last 30 years. So his simple explanation has to be altered to:

“Once in a while, and lately with increasing frequency, mistakes happen.”

I know the simplest narrative is unsatisfying.

Yes it is. It’s a form of giving up on understanding. Some things may surpass understanding. But that sure is unsatisfying.

Nevertheless, it’s less unsatisfying than any other narrative I’ve heard. No matter how much detail the other narratives provide, they can’t explain the crash of 2008 without tacking on the assumption that, “Hardly anyone figured this out until disaster struck.”

That first sentence is subjective. Could be. The last sentence isn’t much of a reason to reject more complicated narratives. You’d want to look at the evidence and the detail. As it is, people have been warning about moral hazard and too-bg-to-fail for a long time, Gary Stern for example. So I would withhold judgment till I read what Stern wrote in 2004 for example in his book, Too Big to Fail. People have been warning about Fannie and Freddie for a long time.

I don’t doubt that lots of people in finance and government had perverse incentives and acted on them.  But without a once-in-a-century mistake, this perversity would have been gradually built into asset prices as it developed, not ignored, then suddenly noticed over the span of a few days in 2008.

Not sure which once-in-a-century mistake he is referring to here. My guess is that he means something about betting for too long on the price of housing continuing to rise. But it’s the role of leverage that was so destructive, not the misplaced bets.

Until someone comes up with something better, then, I’m sticking with the simplest narrative.  Despite its defects, it still beats the competition hands down.

Sure would like to know how he’s keeping score.

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