By Arnold Kling
Tyler Cowen invokes Fischer Black.
in his 1991 book, “Business Cycles and Equilibrium,” and his 1995 work, “Exploring General Equilibrium,” he argued that major business downturns could be caused by a combination of excess risk-taking and simple bad luck.
If this view is correct, then the fact this occurred in mortgage securities is pretty much an accident of history. Wealthy people wanted to take some risk, and if they hadn’t done it in mortgage lending they would have done it in something else.
It’s true that all sorts of risk premiums were artificially low in recent years, not just the risk premium on mortgage lending in the United States. And perhaps a general risk premium crash was going to happen no matter what. Still, I think that there is something even more fundamentally wrong: the discrepancy between dispersed knowledge and concentrated power. The concentrated power in the mortgage industry, with its Wall Street-Washington axis, produced particularly bad distortions.
In the absence of government distortions, speculators might have channeled more funds into investments other than inflating a housing bubble. Some of the other investments might have also been unsound, but they would have been more diverse and perhaps more socially beneficial.
What we are seeing now is the Freddie/Fannie model applied to the entire financial sector. You need a government guarantee in order to be a player. Once government-guaranteed firms are on a firm footing, the equivalent of “affordable housing goals” is sure to follow. That is, government will be bossing capital around to an even larger extent than before.
The claim that this crisis was caused by “deregulation” is a claim that government needs to exercise more power. Right now, that is the conventional wisdom of the establishment. There is no mainstream newspaper or politician raising any doubts about the wisdom of increasing government power. The free market is now a fringe phenomenon, and those of us who support it are irrelevant.