Myths about the Crisis

by the spring of 2008, a three-part conventional wisdom about the crisis had taken hold that still governs mainstream thinking about what happened

Jeff Friedman has written a blog post that expands on some of the arguments from the article that i've previously mentioned. He challenges three "myths", which I quote extensively:

1. Bubble talk naturally leads to visions of “irrational exuberance,”... [but] very sober housing experts and economists (including Ben Bernanke) agreed that there was no bubble, and there was nothing “irrational” about this consensus

2. This “executive compensation” theory of the crisis is now the keystone of the conventional wisdom, having been embraced by President Obama, the leaders of France and Germany, and virtually the entire financial press. But if anyone has evidence for the executive-compensation thesis, they have yet to produce it. It’s a great theory. It “makes sense”—we all know how greedy bankers are! But is it true?

   The evidence that has been produced suggests that it is false... For one thing, bankers were often compensated in stock as well as with bonuses, and the value of this stock was wiped out because of the investments in question. Richard Fuld of Lehman Brothers lost $1 billion this way; Sanford Weill of Citigroup lost half that amount. A study by Rüdiger Fahlenbrach and René Stulz [3] showed that banks with CEOs who held a lot of stock in the bank did worse than banks with CEOs who held less stock, suggesting that the bankers were simply ignorant of the risks their institutions were taking.

3. Had bankers been looking for the safety connoted by triple-A ratings, they could have bought Treasurys, which were even safer. If they were looking for yield, they could have bought double-A or lower-rated bonds. And why mortgage-backed bonds? The answer seems to be an obscure rule enacted by the Fed, the FDIC, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision in 2001: the Recourse Rule, an amendment to the Basel I accord that governed banks' capital minima.

This wasn't a crisis of "irrational exuberance", "bankers bonuses" or "speculation" - it was a crisis caused by ignorance. And since ignorance is pervasive, it challenges the roots of any regulatory regime.