A short article from the Economist serves as an introduction to two other articles.  The intro has a long comment section.  It’s definitely worth a look.  A sample:

The charge that most economists failed to see the crisis coming also has merit. To be sure, some warned of trouble. The likes of Robert Shiller of Yale, Nouriel Roubini of New York University and the team at the Bank for International Settlements are now famous for their prescience. But most were blindsided. And even worrywarts who felt something was amiss had no idea of how bad the consequences would be.

That was partly to do with professional silos, which limited both the tools available and the imaginations of the practitioners. Few financial economists thought much about illiquidity or counterparty risk, for instance, because their standard models ignore it; and few worried about the effect on the overall economy of the markets for all asset classes seizing up simultaneously, since few believed that was possible.

Economists need to reach out from their specialised silos: macroeconomists must understand finance, and finance professors need to think harder about the context within which markets work. And everybody needs to work harder on understanding asset bubbles and what happens when they burst. For in the end economists are social scientists, trying to understand the real world. And the financial crisis has changed that world.

The second article is about market (in)efficiency.  A sample:

In 1980 Sanford Grossman and Joseph Stiglitz, another subsequent winner of a Nobel prize, pointed out a paradox. If prices reflect all information, then there is no gain from going to the trouble of gathering it, so no one will. A little inefficiency is necessary to give informed investors an incentive to drive prices towards efficiency. For Mr Scholes, it is the belief that markets tend to return prices to their efficient equilibrium when they move away from it that gives the EMH its continuing relevance.

Economists also began to study “institutional frictions” in markets. For instance, the EMH’s devotees had assumed that smart investors would be able to trade against less well-informed “noise traders” and overwhelm them by driving prices to reflect true value. But it became clear that there were limits to their ability to arbitrage folly away. Andrei Shleifer, a Harvard economist, among others, pointed out that it could be too costly for informed investors to borrow enough to bet against the noise traders. Once it is admitted that prices can move away from fundamentals for a long time, informed investors may do best by riding the trend rather than fighting it. The trick then is to get out just before momentum shifts the other way. But in this world, rational investors may contribute to bubbles rather than preventing them.

In the early years of the EMH, researchers spent little time worrying about the workings of financial institutions—a weakness of macroeconomics too. In 2000, in his presidential address to the American Finance Association, Franklin Allen, of the University of Pennsylvania’s Wharton School, asked: “Do financial institutions matter?” Lay people, he said, “might be surprised to learn that institutions play little role in financial theory.” Indeed they might. Mr Allen’s explanation was partly that the dominant theories had been shaped at a time when America, especially, was spared financial crises.

What I find unusual is that after talking about the lack of theory about institutions–which would seem to suggest that academics should be taking a closer look at field studies (as I discussed in this post), they go on to sing the praises of behavioral economics, which I don’t see as being much more institution-driven. (Tip:  click on the Meta-Research category on the left of the website to see all of the posts that talk about research at this level.)

I also wonder whether accountants are less susceptible to the ‘didn’t see it coming’ accusation.  After all, accounting academics have long raised concerns about off-balance sheet financing and delayed recognition of impairments, two key contributing factors.  So maybe we can’t say we knew exactly what would happen, but many accountants saw trouble in the making.