Friday, July 3, 2009

Did Cognitive Errors Cause The Financial Crisis?

Are loose regulations better than strict regulations?

Critical Review is publishing a special issue on the financial crisis. (HT Arnold Kling)

Jeffrey Friedman writes:
If we take seriously the possibility that market participants are making cognitive rather than incentives-based errors, the case for regulation loses considerable force....

...Indeed, what may have saved the world from complete economic chaos in 2008 was the fact that the regulations were loose enough that many investors and many bankers had resisted buying the "safe" securities that most banks seem to have bought. Heterogeneous behavior like that, however, is allowed for, encouraged, and rewarded by capitalism; and is either discouraged or prohibited by regulation, depending on how tight the regulations are.
Arnold Kling has a link to Friedman's introduction on his Econolog Blog.

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