How We Got Into This Mess

Megan McArdle does a great job of explaining it. Must read.

Money quote:

What we need, fundamentally, is not simply stricter regulation or less greedy bankers. What we need is better economic theory of how these things play out, so that the regulators have better tools to assess and prevent systemic risk. But that's not how we're thinking right now. What we're looking for is not better tools, but someone to blame.

If Obama came right out tonight and admitted that the Democrats in Congress coddled Fannie and Freddie to avoid over-regulating them, and agreed with McCan't that Wall Street greed was exacerbated by the lax regulatory environment enabled by the Republicans early in Bush's first term, he could introduce this concept of looking for a new way to understand how the markets work. Clearly no one, from the most learned economists of the Greenspan/Bernanke stripe, to the most ignorant consumers, had any idea how their behavior was affecting the markets.

I ran two quick and rough models to see where a $100,000 investment would wind up in 10 years. In the first model, I assumed that the investor got in when the returns were already high and increasing rapidly, then crashed after about five years and lost about 40% of their value in three years before regaining some momentum for the final two years. Not a perfect scenario, but plausible. In the next model, I used a steady 5% return per year, assuming wise investments, a conservative and diversified approach with no concern given to having to have the highest return. In the end, the second model performed as well or better than in most of the variations I played with on the first model. Some slight adjustments in the second model could pretty much offset losses, and eventually keep up with gains, from the first model.

Slow and steady wins the race. Sound familiar?