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In the years before the global financial crisis of 2008, I served as a staffer at the Federal Reserve Board. I recall writing a stream of memos extolling the virtues of the U.S. financial system. Echoing the received wisdom of the day, I asserted that our financial system was efficiently moving risk to those entities that were best positioned to bear it. The results were stronger economic growth and a more resilient economy.

Moreover, I speculated, perceived market excesses were unlikely to create first-order disruptions. The millions of investors who were putting their money at risk had incentives to ensure that pricing remained reasonably aligned with fundamentals. Broadly speaking, the financial system was optimized and a source of strength.

Then the U.S. financial system melted down. Suddenly, we faced an uncontemplated—indeed, a previously unthinkable—set of challenges. The collapse of the intellectual framework that we had previously accepted as fact meant that the response to the crisis was constrained by a lack of understanding: We were on unfamiliar terrain.

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