"It’s almost worth the Great Depression to learn how little our big men know"
Josef -- I'd say you're probably missing quite a lot, as you're no doubt aware.
The short answer is, I think you're giving the masters of the universe too much credit. "Looting" implies a degree of control and intent not present, IMO. To take the obvious example, had they (the masters of the universe) known the true nature of the game, they never would have held onto the toxic junk (super-senior CDO tranches, e.g.) that has done so much damage. Furthermore, "looting" implies a simple transfer of ownership: you had a load of stuff, then I stole most of it. In fact, wealth has been destroyed, and the $80tn in global financial assets of mid-2007 is now worth more like $60tn. As for the regulators, they have, in a sense, encouraged the recklessness through the implicit "too big to fail" guarantee. Institutions felt that they could take risks, because they would be shielded from the consequences. This misalignment of organisational incentives mirrors the misalignment of incentives on the individual level: just as financial intermediaries were exposed to the upside, but protected from the downside, so individuals made bonuses on the way up, but didn't directly and personally lose money on the way down. If you have a choice between making a risky investment for a fifty-fifty chance at making your salary and a bonus or just your salary, or making a risk-free investment and definitely making your salary... well, the expected value (to you, not to your firm or the firm's investors) of the former is obviously higher.
So it may be fairer to say some thing like this: a bunch of idiots broke the financial system, because on the individual level taking risks pays, and on the organisational level because they thought that if they ever got into too much trouble, the government would bail them out. As indeed it is trying to do, presently, to the best of its ability.
But these things, of themselves, were hardly sufficient. Necessary, perhaps, but hardly sufficient. The long answer is, I think, much more interesting, though I've not really got time to go into much of it right now. Have you ever heard of the "great moderation"? This is the phrase Ben Bernanke (I think) used to describe the reduction in aggregate economic volatility over the last twenty years. And if you take the data points for your risks models from this period, rather than from, say, the last one hundred years, you get very different output from the models. The stuff the banks use -- stress testing, value at risk, conditional value at risk -- told them everything would be fine, because it had always been fine, for as long as they could remember, which also happened to be a period of historically low aggregate volatility. There are some really interesting charts at the end of
this paper by a BoE researcher, comparing the two time periods across a variety of different measures, so you can see just how atypical the last twenty years were in relation to the long-run trend.
