Behind the market meltdown

Why are these things happening on Wall Street, and what can we learn from them?

Legal and economic scholarship concerning markets and regulation are actually in the ballpark of understanding this, if not of developing bulletproof answers. During my early years in the legal academy (which I entered in 1987), market-based, anti-regulatory law and economics was sweeping all before it - on merit, based on the insights it was advancing and the defects in prior ways of thinking about the issues.

But the pendulum has decisively turned with the rise of behavioral law and economics plus a greater understanding of the range and importance of agency costs and asymmetric information problems. (An example, in his recent writing about the subprime market, is my NYU colleague Oren Bar-Gill.)

Unfortunately, the devastating law & economics critique of politics and government solutions proved to be wrong in only one sense - it was too optimistic (!). So what will come of all this is unclear, although one certainly could imagine regulatory responses (to help in the future, not with what we face at the moment) addressing the blizzard of bad subprime loans to people who didn't understand what they were doing, the unwitting use of securitization to magnify agency problems and misaligned incentives, etc.

Unfortunately, I anticipate government remaining indefinitely in the hands of people who rely on an outmoded version of free market ideology (outmoded in their invocation of it even though in fact it retains enormous force rightly applied) as a thin veneer over a conscious actual policy of organized piracy on behalf of friends and campaign contributors.