Wall Street and calculating utility

Great article here by Michael Lewis (of Moneyball fame, as previously referenced on this blog) about the financial collapse.

The thing I find most interesting about it is how the heart of the matter is that assets were overvalued, and what that says about a market. Wall Street firms were selling assets that were ridiculously overvalued, and acting as though they had value. It is easy to try to blame the firms for inflating the value of their assets, except people were willing to buy these assets. It takes both a buyer and a seller to set a price, and buyers were just as irrationally overvaluing assets.

This is, in a sense, almost frightening, because it suggests a way in which the market system is flawed. It is essential to a properly functioning market that buyers and sellers understand the utility of what they're selling or purchasing; indeed, that's how the price is set. Buyers only pay a price that's equal to or lower than what the good (or asset) is worth to them, and sellers only take a price equal to or higher what it's worth to them, and an equilibrium is found.

However, what if buyers and sellers aren't able to know what a good is worth to them? It's not implausible. When we discuss the myriad calculations that must be done to determine a good's value, it is unreasonable to think that everyone performs those calculations; surely people value and undervalue goods.

That, however, is the key: error in valuing goods should be random. What happened in the run-up to the Wall Street crash is that error in valuing goods was systematic, and all in the overvaluing direction. This sort of systematic error subverts the market.

Hopefully I'll be able to clean up this post and expand upon it, but these are my thoughts for now.