According to PhD Economists at the University of Chicago Booth School of Business,

The storm that rocked the world economy in 2008 involved many forces, hitting financial, housing and broader sectors of the economy all at once. As the world continues to reform and reflect on the lessons of that crisis, we note the broad consensus that has emerged among economists about what happened. In a recent survey we conducted, European and US economists alike emphasized the crucial role of flawed and fragile financial infrastructure in bringing the world economy to the brink. [emphasis added]

The survey was conducted by the Initiative on Global Markets Forum.

We asked the panel (along with the IGM’s US-based panel) to rate the importance of 12 potential factors, on a scale from 0 to 5, “in contributing to the 2008 global financial crisis”.

The 12 potential factors were:

1. Inadequate or flawed regulation, supervision, or both with respect to the financial sector (which includes financial infrastructure, banks, shadow banks, and interconnections in the system)

2. Underestimation of the riskiness of securities created with financial engineering

3. Bad incentives, fraud, or both in mortgage issuance and securitization

4. Funding runs involving short-term liabilities financing long-term assets

5. Failures by rating agencies

6. Inflated beliefs about housing prices

7. Elevated levels of US household debt as of 2007

8. A belief by bankers that their institutions were Too Big to Fail

9. Government involvement in subsidizing mortgages, homeownership, or both

10. Imbalances between global savings and well-functioning channels for investing those savings

11. Loose monetary policy by the Fed, by central banks around the world, or both

12. Fair value or mark-to-market accounting for financial assets held by banks

So which of these factors did the PhD Economists think played the most prominent role in the crisis?

The factors receiving the most weight were those related specifically to the infrastructure and plumbing of the financial sector: in particular, those involving its safeguards against mismanaged risks. At the top of the list was “inadequate or flawed regulation, supervision, or both with respect to the financial sector”. Underestimated risk associated with financial engineering was next, and the role of funding runs involving short-term liabilities was also rated highly as a contributing factor….Of course, many of the forces at work in the crisis were interconnected. And future economic shocks may differ from past ones….. Yet if policymakers want to know what economists believe were the biggest sources of trouble a decade ago – and arguably, therefore, the most in need of reform and repair – financial sector plumbing is the place to focus. [emphasis added]

The first thing regular readers will notice is how close to, but yet so far from, a coherent explanation of the drivers of the 2008 financial crisis the PhD Economists are.  Based on their rankings, the PhD Economists understood regulators failed and investors underestimated risk.

So what do the PhD Economists suggest should be done?

Place our trust in the same regulators who showed they were not up to the task of preventing a financial crisis.  Apparently engaging in the equivalent of rearranging the old and adding new deck chairs on the Titanic will make the regulators fit for this purpose going forward.

What the PhD Economists miss is how these symptoms of the crisis are interconnected and reflect the true cause of the financial crisis.

Regular readers know financial crises originate in and emerge from the Blind Betting quadrant of the Information Matrix.

Information Matrix

	Does Seller Know What They Are Selling?
Does Buyer Know What They are Buying?		Yes	No
	Yes	Perfect Information	Antique Dealer Problem
	No	Lemon Problem	Blind Betting

It is in this quadrant the value of securities is based on a story told by Wall Street.  Investors can Trust this story, but because of the lack of disclosure they cannot Verify the story.  As a result, when the story is called into doubt, there is no logical stopping place in the downward valuation of these securities other than zero.  Investors know this.  They respond by engaging in “bank runs” to try to get their money out when the story is called into doubt.  It is these “bank runs” PhD Economists see as a financial crisis.

With the Information Matrix, it is clear precisely how the regulators failed.  They failed to ensure all investments were in the Perfect Information quadrant and those that fell in the Blind Betting quadrant were identified as such.  This regulatory failure was shown by investors underestimating the risks hidden in the opaque securities sold in the Blind Betting quadrant.

With the Information Matrix, it is clear how to fix the financial system and prevent future financial crises.  The Transparency Label Initiative is the solution.

Without the Information Matrix, like the PhD Economists, you can spend a lot of time reforming and repairing the financial plumbing, but with little prospect of actually being successful.