The credit crisis has destroyed the idea that unregulated financial markets always efficiently channel savings to the most promising investment projects. Millions of US citizens took on unsustainable debts... When the bust came, a large number of Americans who had been promised a new life in their beautiful homes were told to move out. This boom and bust cycle cannot have been an example of efficient channelling of savings into the most promising investment projects.

The fact that unregulated financial markets fail to deliver the wonders of efficiency does not mean that governments should take over. That would be worse. What it does mean is that a new equilibrium must be found in which tighter regulation is reintroduced, aimed at reducing the propensities of too many in the markets to take on excessive risks.

There is a second idea that is likely to become the victim of the financial crisis. This is the idea found in macro economic models, that individuals are supremely well-informed creatures...  If we have learnt one thing from the credit crisis it is that individuals did not understand the “truth” and, it must be admitted, neither did economists. Individuals who sold the new financial instruments did not understand the risk embedded in these instruments, nor did the buyers.  When the bubble started many interpreted the happy turn of affairs as permanent and took on massive levels of debt that turned out to be unsustainable. When the bubble burst, they did not understand what had happened and nor did most experts. Our world is one of a fundamental lack of understanding of the “truth”.

In the world of these macroeconomic models financial crises should not occur. And if they do, it cannot be because of malfunctioning markets. Governments that impose silly constraints on rational individuals are messing things up, and central banks that do not keep their promises to maintain price stability are the source of macroeconomic instability.

Lessons are only good for those willing to learn.