If you don't have an accurate theory of how the financial system works, then you won't ...

In an interview with Pieria, economics Professor Steven Keen succinctly summarizes why the economics profession failed and is still failing when it comes to our current financial crisis:

if you don’t have an accurate theory of how the system works then a) you’re not going to see a crisis coming and b) you’re not going to know what to do about it.

Please re-read Professor Keen's comment.

Regular readers know that our financial system is based on the FDR Framework.  The FDR Framework combines the philosophy of disclosure with the principle of caveat emptor ("buyer beware").

Under the FDR Framework, governments are responsible for ensuring that market participants have access to all the useful, relevant information in an appropriate, timely manner so they can assess this information and make a fully informed decision.

Under the FDR Framework, market participants are responsible under the principle of caveat emptor for all losses on their exposures.  It is this responsibility for loss that gives market participants an incentive to use the disclose information to assess the risk of any investment and to limit the size of any investment to what the market participant can afford to lose.

With the FDR Framework, it is easy to see a crisis coming.  I know as your humble blogger predicted the crisis.

All one has to look for is opacity creeping across wide swathes of the financial system.  Opacity changes the financial system from being anti-fragile to being prone to crashes.

By definition, where there is opacity, market participants cannot assess the risk of their exposures.  If market participants cannot assess the risk of their exposure, they cannot properly limit their exposure to what they can afford to lose.

Hence, rapid growth of opacity in the financial system is likely to be associated with crashes when the true risk of the investments is exposed.