Incentives Align To Create Bubbles

from the blame-game-not-necessary dept

In the latest financial crisis, we've seen even more focus on casting blame than following most financial crises. It may be because of the sheer size of the mess this time, and it may be because the events that led up to this mess are a lot more difficult to understand than in the past -- and may even feel more nefarious. However, the deeper you look into the crisis, the harder it is to directly assign blame for the majority of the mess. Yes, there were scammers and fraud on the margins, but for the most part, everyone was doing things in a way that makes sense. This, among other things, is a key point brought out by Henry Blodget's article in The Atlantic about why these types of collapses happen so often. Basically, there is some amount of irrationality in the system, but over time, as more and more people seem to be making money against the irrationality, more and more explanations are made for why that irrationality is actually rational. And since the irrational activity goes on for so long, it becomes nearly impossible for most people to really believe that things are so irrational. So, it's not that there's anyone who did anything wrong that needs to be blamed, so much as we need to blame ourselves, for not taking enough time to recognize that what seems irrational in the beginning actually is irrational.

Of course, along those lines, it's important to realize that, as painful as market corrections like this are going to be, the end result is often beneficial. During the bubble period, lots of money gets thrown at certain things (infrastructure or products) that post-bubble are available for quite a discount. Bubbles help build up new institutions, and even if the original investments get washed away, something good often comes out of them in the end. It may not be clear yet how this financial crisis will eventually work out, but now is a decent time to be looking for opportunity in the carnage rather than worrying about who to blame.
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Filed Under: blame, bubbles, incentives


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  1. identicon
    Anonymous Coward, 26 Dec 2008 @ 12:44pm

    Re: Re: Its the exposition of core problems

    "Some would go so far as to claim that regulation is responsible for introducing moral hazards into the system."

    Yeah we will continue these cycles primarily because many people will always cling much stronger to thier beliefs (greed is good), when the ugly lessons of reality begin slapping them in the face (greed stimulates short term excess and creates the illusion of mitigating risk). Its far easier for most to rationalize away what doestn agree with thier personal philosophy of the universe (an unregulated market is a detriment to society and the creation of real wealth). However the point remains that many who have spent thier lives in economics have been rocked to the core by the realization that institutional self-interest doesnt work as it has been thought too for the last hundred years. These ripples may have not yet worked thier way out of the academic, "think-tank" economics world, but they will.

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