New Economic Perspectives has the William Black piece Larry Summers’ Take on Efficient Markets and Regulators: Brilliance v. Idiots. Here is perhaps the key insight.
It would be good if economists read the criminology literature on control fraud. It would be good if economists read the regulatory literature on control fraud. It should be unacceptable that economists fail to read the economics literature about control fraud by a Nobel Laureate (Akerlof, 2001). Summers missed the most fundamental point about accounting control fraud. Here’s the key passage again: “the parties to these kinds of contract are largely sophisticated financial institutions that would appear to be eminently capable of protecting themselves.” “Institutions” are not the issue – the controlling officers are the issue. In accounting control frauds the controlling officers loot “their” “institutions.” “Institutions” are “[in]capable of protecting themselves” from their controlling officers.
I have heard it said that magicians love to perform in front of an audience of engineers. The engineers keep looking for logical explanations of how the tricks could be performed without realizing it isn’t logic, but deception that is behind the trick.
Applying this to economists, they develop all sorts of theories on how the rational person will behave in an economic situation. What they don’t always take into account is how people might make money the easy way by deception.