When house prices are going to rise, or people expect them to rise, by 10 or 12 per cent a year, an additional 1 per cent on the interest rate is not going to stop people from buying houses. Of course, we could have said that to buy a house, no one may borrow more than three times their income and that everybody has to have a down-payment of at least 50 per cent of the property price. But I suspect that any government that tried to introduce regulations like that, or comparable regulations to stop bankers from doing deals, would have been swept from power.
UPDATE: see the first commenter below, who points to Wolf's remarks that the efficient markets hypothesis has taken a beating.
Fischer Black, a major figure in the efficient markets school, once shocked people by saying that he felt that prices were correct within a factor of 2. That seemed like an awfully wide range for someone who believes in efficient markets. But it seems fine to me. Maybe the range is even wider for something like oil, where there are so many unknowns.
I think it is possible to believe that financial markets can be subject to wild swings of sentiment and still believe that they should be left alone. If government had been given free rein in 2005 and 2006, who is to say that the political focus would not have been on making housing more "affordable" and throwing more gasoline on the fire, so to speak? In fact, that is more or less what Congress and regulators did.
There is a vast difference between saying that "In hindsight, government could have stopped bubble X," and saying "government officials can be counted on to distinguish better than speculators the difference between permanent trends and transitory shocks; moreover, government officials face few political constraints against acting on their superior information."