A few points that I failed to make previously.
If nothing else, this work really is about the idea that ignorance can be an explanation for bad choices. The authors seek to stress that it does not always have to be the result of omniscient actors making a particular choice with the potential consequences fully in mind.
Also, the book identifies that the problem was probably too many regulations. The Federal Register is simply voluminous and it is probably a safe bet that as new ideas are turned into law, they are not necessarily done so with a full grasp of what else is already in place. In that way, it becomes like a chemistry experiment where you're not sure what the reaction between different moving parts will be.
In this case, we have a 1936 rule that limits institutional investments to minimum ratings. Then in 1975 we have rule changes that grant an oligopoly to the three biggest rating agencies. Then you have the more recent Basel framework and Recourse Rule that made mortgages and MBS more favorable from a risk perspective to institutional players, followed up by government policies that made housing more accessible to all. The result: fireworks.
Finally, a passage from the book that resonated with me:
"The systemic advantage of capitalism is that it allows heterogeneous interpretations of what is going on to be "enacted" simultaneously by competing businesses. The disadvantage of modern democracy is that in attempting to solve social and economic problems, either the people or their agents -- legislators and regulators -- must adopt a single interpretation that, in legal form, homogenizes behavior throughout the entire system. If this single interpretation is erroneous, the entire system may be jeopardized."
