“A cascade of mistakes and missed opportunities” over decades led to the present problems, the president said. “It was easy money, while it lasted.” But, he added, “These schemes were built on a pile of sand.”But who knew it was a "pile of sand"? Surely, there were those who thought it was too good to be true, that the gravy train would end at some point. But who was going to tell willing lenders and willing borrowers not to transact, not to keep driving the economy up, not to increase homeownership, based on some wonk's grumpy prognostications? Certainly not politicians. Indeed, lenders would have been called worse names were they to have imposed some arbitrary normative notions about risk to justify turning down loans. The math, best as anyone could tell, was solid enough. The market, according to our then-best understanding of how it worked, determined what happened. We now understand that the market doesn't hold up under the fancy math that seemed to work so well. But we didn't know that then. We kept playing what our best understanding indicated was the smart bet. We doubled down on eleven and split aces and happily collected our winnings. Now that it's turned out there were jokers in the deck, we'll have to rethink our strategy. That will happen the same way every other wealth-generating idea has occurred: through the market. The market ferrets out cracks in economic systems and recalibrates itself towards efficiency. We don't need government to find holes in economic theories any more than rain needs it to find holes in a leaky roof.
[Clarification: A reader pointed out that my post might be misunderstood to mean that little or no fault belongs to the crooked mortgage brokers and other unscrupulous practices within the financial industry. Perhaps I should be more careful: I do not mean to ignore such sordid practices, or suggest that they are an acceptable brand of "self-interest" that fuels market activity. On the other hand, that was not what Obama was referring to. He was talking about systemic flaws in the finance industry that created what seemed to be “easy money.” I took that to mean, for example, that someone should have intuitively known that the Gaussian copula function that led to the mortgage-backed-securities debacle was implicitly flawed, and done something about it. (A great article on that here.) That formula, and the basic urge to capitalize on it, were not borne of some excessive greed. By all indications, it allowed us to tap into a great amount of seemingly reliable wealth. Who would have listened to admonitions against such manifest destiny?]
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