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From Cato Unbound, Professor DeLong jumps to the heart of the matter.

Things are even worse as far as the risk discount is concerned. Our models predict that in normal times, with the ability to diversify portfolios that exists today, the risk discount on assets like corporate equities should be around 1% per year. It is more like 5% per year in normal times — and more like 10% per year today. And our models for why the risk discount has taken such a huge upward leap in the past year and a half are little better than simple handwaving and just-so stories. Our current financial crisis remains largely a mystery: a $2 trillion impulse in lost value of securitized mortgages has set in motion a financial accelerator that we do not understand at any deep level but that has led to ten times the total losses in financial wealth of the impulse.

There's not much else to say. With this crisis, some ideological humility is needed. Someday, a bright economist will develop a theory for what's going on today. But for right now, much of it is a mystery.

(H/T: Arnold Kling)

Posted by edelfenbein at December 8, 2008 8:36 PM