You might check out the work on Common Knowledge vs Mutual Knowledge as it helps explain these sorts of complex regimes.

Also “implicit collusion” in poker tournaments.

You’re right. I thought of mentioning Ramachandran’s critique of Trivers but decided against it because I wasn’t leaning on a strict interpretation of Trivers’ conclusion. As Ramachandran mentions, self-deception has maladaptive consequences. But its not clear to me that the true believer banker is engaging in true self-deception given that he benefits in the short run. As I see it, the conclusion is more relevant for the knowing deceiver who has an uphill task competing with a true believer.

But yes – I think Ramachandran’s paper especially is fascinating reading and very well-written and accessible.

On Kuhn again you’re right. My point was only that Ramachandran gives us a neurological basis for the inflexibility of the old guard even if they are being entirely sincere.

And I’m glad you agree with the central point!

If people have any systematic deviations from rationality, the economic system will evolve to exploit those deficits until stopped by breakdown or regulation.

So for example credit card and rental car insurance exploit risk aversion, pay day loans exploit hyperbolic discounting, etc.

Markets adapt to amplify irrationality.

However, in quoting Trivers via Ramachandran you really might mention that Ramachandran thinks Trivers is, if not wrong, not entirely right, either.

Moreover, claiming Ramachandran provides a neurological explanation for Kuhnian paradigm shifts is over the edge. In the first place, I spent about three years of my life studying those issues, coming to the conclusion that, on the whole, the less said about Kuhnian paradigm shifts the better. More directly, Ramachandran’s work would lead one to believe that after a certain point scientists should shift paradigms. In fact, as Kuhn documents, what happens is that the new paradigm wins when believers in the old one die off. It’s the young, who have less invested in the old way, who make the shift. See “Night Thoughts of a Classical Physicist.”

I should add that I agree with your main point; several lines of argument show that the assumption of deliberate exploitation of the value of the implicit government guarantee is not necessary to explain that guarantee’s role in the mess.

(Adds Jeffrey Friedman to list of people who should never be allowed to write about finance again, except with the small Crayola box.)