Because I'm a very interesting person, I spent last night watching a panel on the collapse of the financial sector. One thing you heard a lot -- from some folks on the left as well as some folks on the right -- is that we shouldn't overlearn the lessons of this crisis. It almost certainly won't happen again. Regulations meant to protect against its recurrence would be like putting a lock on the barn doors after the horses have escaped. And, in any case, the markets will self-correct for these particular failures. Mortgage-backed securities won't be a profitable product ever again. There's a surface logic to all of that. But it forgets that human being are very stupid, and very forgetful. Forty years ago, for instance, we got involved in an invasion of a small country whose government we didn't like and whose people did not desire our presence. Big mistake, we all agreed. Let's not do that again. A few decades later, the Soviet Union did the same thing. Big mistake, we laughed. Good thing we'll never do that again. And now here we are. That said, it's probably true that this exact crisis won't happen again. It won't be a subprime crisis, for instance, And mortgage-backed securities won't be at fault. Subtle regulations meant to prevent a precise recurrence are a very stupid idea. But there are bigger, more basic errors that sit beneath the specific financial instruments. Namely, long periods of expansion mixed with the natural incentives of the financial sector erode risk aversion. But however much risk the bankers felt they could assume, they were only able to actually assume that risk because of a regulatory regime that allowed absurd levels of leverage. Conversely, the commercial banks, who had saner capital requirements, not only survived, but enjoyed a windfall, as they purchased a slew of insolvent investment banks at firesale prices. So though this might not be a moment for subtle, clever regulations, it may well be a time for bigger, dumber regulations. If folks are indeed correct that the market would never again permit such absurd levels of risk, then why worry about such laws? Banks will never bump against their constraints anyway. But the thing about adding a lock to the barn door after the horses have left is that eventually the horses will be caught and returned to the barn. And eventually, the farmhand will forget to fear their escape. If the door now has an automatic lock, they won't escape. But if you're just trusting the farmhand's memory, you're in rather more trouble. That's not to say there aren't problems with various regulatory schemes or that large changes don't require serious consideration. But as Brad DeLong likes to say, there's government failure and there's market failure, and in any given case, you have to decide which is worse. Right now, we're watching market failure. And it's pretty goddamn bad.
