• People, like me, invest in some fund that does not provide easy transparency into their fundamental assets.
• People watch to see which funds grow over intervals from months to decades.
• People move to funds that grow faster.
• Economic events include large infrequent downward spikes—less frequent than the evaluation intervals.
• These spikes move into the non-linear region of the economy (viewed as dynamic system) and trigger bailouts. (Heads: investor wins—Tails: tax-payers loose.)
• The incentive to do-the-right-thing (plan for down spikes) is destroyed.

Some funds will be rescued (AIG)—some will be left to fail (Lehman Bros).

Stochastic Sampling is the only and very unripe idea that I have for a better system.

Mandelbrot argues for using non normal distributions and provides ample evidence that market moves do not conform to the normal distribution. I agree but I think that that misses a point. Mandelbrot is among those who claim that the market fundamentals are too complex and that we can only statistically model the market. I think it is important to view the market as a game in the sense of game theory. It makes no sense to play chess using statistical models of what your opponent has done in the past. We too we must drastically simplify, but in a different manner than does Mandelbrot. Game theory includes the concept of coalitions of players to make n person games into m person games where m<n. It considers stability of coalitions which I ignore for now.

The two coalitions I wish to consider are tax payers and Wall Street. I argue that computing the probability as of 2006, of the 2008 events is no more meaningful than trying to foresee your opponent’s next move by statistics. The very perception that the decline of housing prices was unlikely, made it likely because it allowed Wall Street to put the downside on tax payers. They took all the upside, which largely did not materialize, and we took the downside, which did.

The causal chain

• The moral hazard described above causes bad mortgages to be written because those that write them can sell them due their temporary superior rate of return. There were also political pressure and laws to write bad mortgages.
• The demand for houses rises and thus the rate of building them increases.
• The time comes when the infeasible mortgage terms become apparent as borrowers cannot repay.
• Foreclosures create houses that cannot be sold for that would require mortgage holder to book a loss. They cannot be rented for a variety of reasons. (I think banks cannot be in the rental business.) The market for houses becomes illiquid.