_____Before we talk about all that, what are the most surprising developments since you won your Nobel Prize?Surprising to whom? The bubble episode surprised so much of the world—Greenspan and Bernanke believed that markets knew how to handle risk, self-regulation was adequate and the banks had incentives to manage risk and so forth and so on. We saw that it isn't true—in a very dramatic way. That wasn't surprising to me because my Nobel Prize was about the economics of information and this notion of agency theory, that the people who are making decisions do not necessarily reflect the interests of those who they are supposed to be serving.The kind of incentive schemes that were being employed by firms, banks and financial institutions weren't consistent with any model of rational behavior other than exploitation. If you believe incentives matter, something untoward was going to happen. At the level of markets, securitization had some fundamental flaws, because you didn't have the incentives to monitor or manage them and created a moral hazard. To our leaders and erstwhile gurus, it came as a very big surprise. You have a market economy where incentives do matter, but in which they aren't always aligned.
The Special Note summarizes my overall thoughts on our economic situation
SPX at 1273.72 as this post is written
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