Information and the Crisis

This is a classless cross-post from Marginal Revolution, which linked to the original article. This is something I've been suspicious about for a long time. Various culprit have been taken to task for the crisis... the instruments (securitized mortgages, credit default swaps, etc.), the players (non-creditworthy borrowers, greedy mortgage brokers, greedy insurance salespeople), and the market system itself. But in theory, this all should have worked out. In fact, buying insurance on mortgage bundles should have been almost unnecessary, as theoretically securitization diversifies a mortgage portfolio thereby reducing risk of catastrophic loss.

Theory though, it seems, always assumes high-quality, timely, and understandable information. This is not what we had, and there was no incentive to make it thus. Certainly there were incentive problems (as well as vetting problems, as many of the less ethical mortgage brokers turned out to have had criminal records) along the way. But shouldn't this have come out in the perfect-information wash along with everything else, and factored into the market price of said securities?

Hopefully there's a silver lining in this: some way that the quality, complexity, and timeliness of information can be taken into account in pricing various derivative securities (or any securities). Certainly we shouldn't do away with the instruments (many of them, anyway). There has to be some way, however crude, to derive a crude factor based upon information quality, and use it to normalize the value of a security relative to alternatives.