A lot of our work here focuses on the connections between expertise and decision making. Richard Posner of the University of Chicago suggests that the experts are at fault, by creating products and processes that decision makers failed to use correctly:

I do not think that the government does bear much responsibility for the crisis. I fear that the responsibility falls almost entirely on the private sector. The people running financial institutions, along with financial analysts, academics, and other knowledgeable insiders, believed incorrectly (or accepted the beliefs of others) that by means of highly complex financial instruments they could greatly reduce the risk of borrowing and by doing so increase leverage (the ratio of debt to equity). Leverage enables greatly increased profits in a rising market, especially when interest rates are low, as they were in the early 2000s as a result of a global surplus of capital. The mistake was to think that if the market for housing and other assets weakened (not that that was expected to happen), the lenders would be adequately protected against the downside of the risk that their heavy borrowing had created. The crisis erupted when, because of the complexity of the financial instruments that were supposed to limit risk, the financial industry could not determine how much risk it was facing and creditors panicked.

I disagree with Posner’s assertion that the government bears little responsibility. Accurate assessments of risk are central to the functioning of the financial system, and if expertise gets out ahead of ability to effectively use that expertise, then we can find our selves in a situation where risk turns into ignorance. This was the lesson of Long-Term Capital Management and appears to be the lesson in the current crisis. When all is said and done, I would expect that a hard look will need to be taken at the ratings agencies and their role in providing judgments of investment risk. It is governments job to ensure that these agencies are doing their job. Such regulatory oversight appears to have been lacking.