Monday, February 23, 2009

microeconomic crisis

There seem to be a lot of interesting microeconomics issues in the current economic crisis. But there is little discussion of the micro issues, in comparison with the macro ones. For example:

- Why did the financial industry screw up so badly? This can be subdivided into product design, compensation design, financial modeling, risk management, regulation, etc., which all failed. A whole set of long-standing institutions all evolved in bad directions within a few years. The macro cause seems to be a big savings glut from Asia and oil exporters. But why weren't our institutions more resilient on a micro level? Is there any way to improve them to be more resilient in the future?

- During the boom, investors trusted the financial industry a lot more than they should have, at least in hindsight. Why? Why weren't all those flaws visible?

- It seems that some people did notice the flaws, and tried to short the market, but there is so much "dumb money" out there which can easily overwhelm "smart money" on a timescale of years. Is this a problem for decision markets? Why or why not?

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