Most of economics can be summarized in four words. ‘People respond to incentives.’ The rest is commentary,” claimed economist Steven E. Landsburg in his best-selling book The Armchair Economist: Economics and Everyday Life. The problem in real life arises when incentives are not properly structured.
The 2008 financial crisis was in a sense a consequence of misaligned incentives. Individuals in the US were borrowing because housing prices were rising; lenders were lending without much due diligence, partly because they had the option of selling those loans to some other agency which would convert them into mortgage-backed securities and pass them on to investors looking for higher returns. Everything was going according to script, and everyone in the system had the incentive to do what they were doing, until it all came crashing down in 2008.
