Complexity of the financial system far exceeds the capacity of the market participants

Ezra Klein observed in his Washington Post blog on "What 'Inside Job' got wrong" and Brad DeLong seconded on his blog  in "what lessons from the little depression" the notion that

The complexity of the [financial] system far exceeded the capacity of the participants, experts and watchdogs. Even after the crisis happened, it was devilishly hard to understand what was going on. Some people managed to connect the right dots, in the right ways and at the right times, but not so many, and not through such reproducible methods, that it’s clear how we can make their success the norm. But it is clear that our key systems are going to continue growing more complex, and we’re not getting any smarter, or any less able to ignore risks that we know we should be preparing for.

Yves Smith responded in a post on NakedCapitalism,

To the extent it has been hard to figure out what happened (and I submit that the mechanisms that turned what would otherwise have been a contained subprime meltdown into a global financial crisis actually are not that hard to understand), it is because the perps and the regulators have made sure some of the key drivers have not been investigated and continue to be opaque and complex, which allows the financial services industry to continue looting. 

For instance, it is simply inexcusable that after the collapse of Bear Stearns that there was not a full bore coordinated effort among international regulators to get to the bottom of credit default swaps exposures (CDS were the reason Bear, a firm that most would have judged to be non-systemically important, was rescued). 

But who is doing what to whom in the CDS market still continues to be a mystery, even though the AIG bailout made it clear that it would be government backstopped and hence is a matter of public interest. 

Indeed, one of the reasons presented by Angela Merkel, among others, for why Greek debt can’t be restructured is the bugaboo of the CDS exposures. They’ve now become a preferred vehicle for holding governments hostage, which serves the big end of the banking industry just fine. 

In general, the failure to have regulators to demand data from the major banks and do decent post mortems is a mind-boggling dereliction of duty. 

I agree with Yves that the complexity of the market does not exceed the capacity of the market participants to understand.  Rather, what blocked understanding of what was going on was opacity.  It is exceedingly difficult to analyse anything without information.

Both Ezra and Brad focus on the idea that few people were able to connect the dots in the right way and that how they did so is not susceptible to being reproduced and becoming the norm.

Regular readers of this blog know that your humble blogger is the exception to this idea.  I have a public track record that shows I was able to connect the dots.  Not only in seeing the crisis coming but also in predicting which regulatory responses were going to be successful and which were not going to be successful (see for example the posts on Ireland and Spain).

More importantly, as illustrated by the FDR Framework, the methods I used are reproducible and can be adopted as the norm.

If they have the time, I would be willing to explain the FDR Framework to Ezra and Brad.