Guest Post: Was it “Nobody Saw It Coming” or “Everybody Who Saw It Coming Was a Nobody”?

By Richard Alford, a former economist at the New York Fed. Since them, he has worked in the financial industry as a trading floor economist and strategist on both the sell side and the buy side.

A number of economists, economic policymakers, regulators, and central bankers have attempted to explain away their failure to both foresee and mitigate the current financial crisis by asserting that no one saw it coming. The inference is that they cannot be held accountable for something so unusual, so extraordinary, and so unforecastable that that no one saw it coming. Robert Shiller, in a November 1, 2008 NYT OP-ED, noted the following example:

Alan Greenspan, the former Federal Reserve chairman, acknowledged in a Congressional hearing last month that he had made an “error” in assuming that the markets would properly regulate themselves, and added that he had no idea a financial disaster was in the making. What’s more, he said the Fed’s own computer models and economic experts simply “did not forecast” the current financial crisis.

However, the Fed and other policymaking agencies cannot honestly claim that no one saw it coming. There is ample evidence that:

• Economist and commentators “saw it coming”; and

• Economists and others repeatedly brought their observations to the attention of the authorities including the Fed, but were ignored.

In fact, the Fed increasingly exhibited a willingness ignoring critics and criticism. The existence of this pattern at the Fed can be illustrated by looking at two presentations by Kohn. The first is from 2003 and the second is from 2005. But first, a return to Shiller’s OP-ED piece:

Mr. Greenspan’s comments may have left the impression that no one in the world could have predicted the crisis. Yet it is clear that well before home prices started falling in 2006, lots of people were worried about the housing boom and its potential for creating economic disaster. It’s just that the Fed did not take them very seriously.

Schiller blamed self-censorship and group think. Shiller reports that while he was a member of the economic advisory panel of FRBNY, he felt the need to use self-restraint and stated that he only gently warned about bubbles in the housing markets.

It is one thing for someone to practice self-censorship. It is another thing all together for an institution charged with a public responsibility to allow and foster an atmosphere in which someone well respected enough to be asked to sit on an advisory board feels as though he or she must temper their statements or pull punches. What was the role of the advisory board, if the members did not feel free to raise and discuss competing views or alternative policy paths? In the context of the dynamics of globalization and financial innovation, why was conformity to a static consensus tolerated and even encouraged?

Furthermore, while the Fed had a responsibility to promote economic and financial stability, Shiller did not. Once well respected economists and analysts highlighted the possible risks the Fed had an obligation to assess those risks. Shiller also reported that the group-think that ignored signs of the impending financial crisis extended well beyond the halls of the Fed:

I gave talks in 2005 at both the Office the Comptroller of the Currency and at the Federal Deposit Insurance Corporation. I argued that we were in the middle of a dangerous housing bubble. I urged these mortgage regulators to impose suitability requirements on mortgage lenders, to assure that the loans were appropriate for the people taking them.

The reaction to this suggestion was roughly this: yes, some staff members had expressed such concerns, and yes, officials knew about the possibility that there was a bubble, but they weren’t taking any of us seriously.

Returning to the Fed, a speech by Kohn in February 2003 indicates that while Shiller was self-censoring, other commentators had been pointed enough in expressing their concerns to merit a response:

In particular, a number of commentators have raised the specter that imbalances are being created in the markets for consumer durable goods and houses–unsustainably high prices or activity–that will produce macroeconomic strains when, inevitably, they correct. These concerns obviously echo those expressed by some observers that monetary policy allowed run-ups in equity prices and capital spending in the 1990s that ultimately proved to be destabilizing.

In a footnote, Kohn went on to say:

Another possibility is that the buildup of debt associated with the strength in household investment will feedback adversely on financial conditions, especially as the boom unwinds. Such consequences could occur even in the absence of a “bubble” in housing prices if households were overextended and lenders had not taken adequate precautions against even a measured drop in collateral values… Moreover, loan-to-value ratios on mortgages have been about flat, leaving ample cushion for moderate housing price declines, should they occur. These observations suggest that widespread credit difficulties with important macroeconomic effects are unlikely when interest rates rise.

Kohn not only acknowledged the existence of the commentators and their concerns and took them seriously enough to present evidence that he thought should lay to rest those concerns to rest. He also suggests that the likely short-lived nature of the interest rate -driven increases in housing prices and real estate investment implied that any resulting macroeconomic or financial problem would be of a manageable scale:

Judging from this analysis, and bearing in mind its inherently tentative–if not speculative–character, it seems likely that as the economy strengthens and interest rates rise in response, household investment and prices are likely to soften some relative to recent trends, but not to break precipitously. Houses and cars would not be providing the impetus to economic activity they often have in past recoveries…

At the Jackson Hole Conference of 2005, a speech by Rajan, the then Chief Economist at the International Monetary Fund, “Has Financial Development Made the World Riskier?” and a response by Kohn allows us to get a read on Fed policymakers reactions to warnings about possible economic or financial dislocations two years later. In the opening paragraphs, Rajan argued that the transformation of the financial sector had made it more efficient, but at the expense of increased risk:

The expansion in a variety of intermediates and financial transactions has major benefits,…However, it has potential downsides, which I will explore ..

… the incentive structures of investment mangers today differs from the incentive structures of bank managers in the past in two important ways. First,… managers have a greater incentive to take risk. Second, their performance relative to other managers matters.

The knowledge that managers are being evaluated against other managers can induce superior performance, but also perverse behavior.

One is the incentive to take risk that is concealed from investors—since risk and return are related , the manger then looks as if he outperforms peers,,, typically the kind risks that can be concealed most easily… are known as tail risks.

Both behaviors can reinforce each other during an asset price boom…An environment of low interest rates flowing a period of high rates is particularly problematic, for not only does the incentive of some participants to “search for yield” go up, but asst prices are given the initial impetus which can lead to an upward spiral, creating conditions for a sharp messy realignment…..

…the most important concern is whether banks will be able to provide liquidity to financial markets so that if tail risk does materialize, financial positions can be unwound and….the real consequences to the real economy minimized.”

The balance of the Rajan paper was a development of these ideas along with the presentation of considerable amount of supporting evidence. He referenced over 50 plus scholarly papers. Rajan never forecasted or predicted the crises which were to follow relatively quickly. However, he concluded:

a risk management approach to financial regulation will be important to attempt to stave off such states through the judicious operation of monetary policy and through macro-prudential measures. I argue some thought also should be given to attempting to influence incentives of financial institutions mangers lightly, but directly.

Kohn was a Discussant, but his response was not so much a discussion or rebuttal of the Rajan theses as it was simply a restatement of his and presumably the Fed’s belief that the greater dispersion of financial risk away from banks necessarily implied lower levels of systemic risk. There was no discussion of the implication of the changes in incentive structures or herding behavior. Kohn dismissed concerns about tail risk citing reduced volatility of output and inflation over the previous twenty years. However, who believes that tail risk has to either manifest itself in a twenty year period, or be non-existent. Furthermore, the factors cited by Rajan had come to dominate the financial sector only during the prior ten years.

No mention was made of LTCM or the Tech bubble. Concerns that low interest rates may contribute to increased risk in the financial system were dismissed on the grounds that those policies contributed to greater stability in output and inflation. Kohn never addressed the point that the shift away from bank-center finance might leave the system short of liquidity should risks materialize.

In short, Kohn’s response to Rajan’s theses was nothing more than a curt dismissal when compared to his detailed response to the specter of imbalanced -induced concerns voiced by the unnamed commentators in 2003. It appears that the perceived need to respond, even if only in words, to well researched warnings by prominent economists had disappeared.

Furthermore, Kohn on this occasion and presumably others, never publicly revisited (to my knowledge) the contingencies which were in part the basis of his rejection of the warnings in 2003. Interest rates had risen very slowly amidst a jobless recovery and a failure of investment spending to propel the economy. Ten year Treasury yields were only about 25 bps higher and monetary policy remained accommodative. Loan to value ratios had started to erode as had lending standards. If Kohn had re-checked the reasons he cited in his in 2003 rejection of warnings he would have found that the conditions he had cited for being sanguine no longer obtained.

In summary, numerous people, including well respected economists and officials saw the grounds for economic and financial crises being laid. Furthermore, these warnings were brought to the attention of US policymakers. Assuming the two presentations cites above are representative, the warnings were at first treated as worthy of a serious response. However, even as evidence of serious imbalances and bubbles grew, the responses to warnings became perfunctory and devoid of serious analysis.

Houston, we have a problem.

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30 comments

  1. NS

    In the ’91 recession, it became clear the economic paradigm was totally wrong. The introduction of 401Ks to replace pension programs, HMOs to replace real benefits in health care and fear of job loss in the hearts of workers from ‘efficiencies’ and then massive outsourcing was the “Contract with America”. It was at this time, some of us whose profession require deductive reasoning skills, understood what was coming. Economists and leaders who came from ivory towers of academia or from the cut throat world of Wall Street believed their own bull of how they couldn’t possibly be wrong. Arrogance produced from narcissism ruled for 25 years. The results were easy to figure out. The nations government was hijacked with endless streams of dollars from lobbyists who rule the nation instead.

    Even some of the great unwashed got it while those who eat gilded foods enjoyed their version of opium. The gig is up. There will be no pretty end to this. I and others can only hope that the disconnected will get connected at the end of a pitchfork.

  2. fresno dan

    In my view, asking the Federal Bubble Blower (i.e., the Fed) to recognize bubbles, is like asking the owners of “Ben and Jerry’s” to recognize the dangers of obesity.

    The Fed, after the stock market bubble, 9/11 and recession of 2001, wanted the economy to get going. If you only have a hammer, everything is a nail school of management, let’s keep interest rates low…for a long time. HooRay – new housing bubble. Some people saw the housing boom as a bug – the Fed saw it as a FEATURE. The FED wanted another bubble.

    The truth is, no one in modern government has the gumption to impose even the most minimal austerity. It will come however…

  3. carol

    Richard, I would like your title even better if you had written: “Was it “Nobody Saw It Coming” or “Everybody Who Saw It Coming Was Treated as a Nobody”?

    It weren’t just some bloggers, unknown pre-crisis (now known, read and invited to the Treasury ;-) ), but also people of their own. They were mistreated (Rajan received a cold, stony face from the ‘maestro’ himself, and a BIS chief-researcher recently revealed how his alarm study was plainly neglected as the BIS bankers were up in arms because a promised, rare Mouton-Rotschild wine was after all not the served at dinner!!).

    You do not mention Bernanke. I spent an hour of my life watching him on 60 minutes earlier this year. He came across as a friendly man, nice to have as a neighbor. However, he didn’t strike me as an intellectual high-flyer.
    I’ve read some of his speeches, and really, they show basic limitations in his intellectual abilities. E.g. a speech in which in recognized some people worrying about housing bubbles, and then saying, oh those worriers are wrong, as yes households take on high debts, but they also have high prices assets. Bernanke only considered the household balance sheet, and completely neglected cash flow issues, i.e debt servicing out of income. See also e.g. Steve Keen, http://www.debtdeflation.com/blogs/2009/01/11/bernanke-an-expert-on-the-great-depression/

      1. carol

        It’s already bad enough to not read nobody-bloggers (just because they were nobodies at that time, even though they could have opened your eyes), it’s even worse to not read and listen to ‘your own kind’ when they say things you don’t want to hear.

    1. surferdude

      carol it was even worse than “Everybody Who Saw It Coming Was Treated as a Nobody”? i worked at bank regulatory agency and was essnetially the chief risk officer in the southeast. we started issuing warnings in 2003 to supervisors and bankers about the excessive concentrations in cre/c&d lending and the non-existent underwriting standards in residnetial re lending and the potential adverse outcome. this message was not well received and in fact led to my removal from that position and a prohibition from speaking or publishing. i was not alone as there were a handful of others in my agency that were also removed from thier positions for expressing similar concerns. unfortunately, no one is calling the bank regualtory agencies on the carpet for their malfeasance and the very executives that ignored these warnings are still in place.

      quotes in the shiller article strike home. in particular, the anecdotal comments about the condo bubble in miami. we actually wrote a comprehensive analysis on that market in 2005 pointing to the looming problems. i drove that market several times, taking many photos, and could not even keep up with the crane count. this information was conveyed to senior agency officials several times. as shiller said, no one was taken seriously.

      1. Doc Merlin

        Sigh, yah, “a prophet is not without honor save in his own country.”

        When you tell people about a bubble they get very upset, I remember the similar reactions I had when I was trying to tell people that 140 dollar a barrel oil was absurd.

  4. Richard Kline

    “Kohn was a Discussant, but his response was not so much a discussion or rebuttal of the Rajan theses as it was simply a restatement of his and presumably the Fed’s belief that the greater dispersion of financial risk away from banks necessarily implied lower levels of systemic risk.” This point is stated here succinctly, Richard, and will I suspect be very important in understanding how policy responses failed during the bubble beyond the more obvious drivers of selfish ideology and crony capitalism.

    Policy makers were sold on the idea that risk was _dispersed_ by securitization and derivatives. That is in fact how the insurance industry works, that many lose a little in the instance of ‘an event,’ but that none are wiped out and that ongoing profits keep them hale. But to follow the analogy is simply to see where and why it fails. If insurers stack risk upon risk on the understanding that any one part of it is dispersed, that does not imply that the volume or risk in aggregate is survivable. If high-risk behavior is endemic, it endangers _the asset class_; for example, one house on the hurricane coast is no loss to an insurer, but a million insured condos will all lose value when a storm shows the real exposure. Furthermore, spreading risk around doesn’t make it disappear. Asserting that stability is enhanced by diffusing risk is vacuous without knowing who is holding that exposure, a question few seemed to concern themselves with until the markets asked it for them.

    Policy makers—legislators, regulators, agents of the executive—were sold a false analogy about dispersion of risk. . . . But it wasn’t an _entirely_ false analogy: For the underwriters who moved risk off of THEIR books, dispersions _was_ a mechanism of stability. _FOR THEM_. And this is where the metaphor likely came from. Dispersion allowed underwriters to literally turn risk into gold by getting fools to take pennies on dollar to hold the bag or even better to buy that risk from the underwriters for a premimum as a ‘security.’ Dispersion had nothing to do with systemic stability; everything to do with corporate profitability. The intellectual failure of some to many to think this through says straight away that the risk valuations and instruments of dispersion are too dangerous for human societies to tolerate because they are not comprehensible to reasonably informed adults, as we see here, and thus ideal vehicles for exploitation in consequence of asymmetric understanding.

    —But that said, anyone asserting that “No one say this coming” by that very statement announces their intellectual vapidity, and thus does the public service by branding their own opinion on anything regarding economics of finance of negative value.

    1. john c. halasz

      Your point can be made simpler. The idea of insuring financial assets doesn’t make basic logical/economic sense, because it’s circular: financial assets are used to insure financial assets, which only results in amplifying the downward spiral, when such “insurance” is called on en masse in a crisis. (The million house hurricane isn’t an exact analogy, since, while it might bankrupt the insurers, it is a remote, but approximately calculable probability, would be partly addressed through re-insurance, doesn’t worsen the hurricane that has already occurred, and will result in some partial pay-outs). Further, there is no way to generate a market price for such financial “insurance”. The only plausible provider of such “insurance” is Uncle, not because he can price it in real time, but because of his money-creating, debt-bearing, and taxing fiscal powers, but even those are not infinite and imply cyclical claw-backs from the system and enhanced regulatory powers against “moral” hazard.

  5. But What do I Know?

    “A man hears what he wants to hear and disregards the rest.”

    When Greenspan and his toadies pathetically claim that “no one could have seen it coming,” they sounds eerily like the bad guys in Atlas Shrugged (I wonder if Sir Alan ever goes back and reads through the book. Maybe he thinks he is Francisco D’Anconia, destroying the system from the inside.) I know Ayn Rand was psychotic and her version of Utopia is kooky, but she sure got the villians’ speeches and methods down right (much like Marx in that way–he was pretty good in talking about the bourgeoisie and their virtues and vices–not so good in envisioning an alternative future.) I guess it’s much easier to see the symptoms than the cure, if there is a cure.

  6. joebek

    The curiosity is that nobody sees it happening again, right now. How many are lambasting the FED, the ECB, the BOE and the BOJ for resisting the deflation, the Nietzchean revaluation of all values? So what we have is the general crisis of the democratic intelligentsia. The question of the hour is whether Plato was right. Is democracy intrinsically flawed? Is the whole focus of so much of the blogging community on the question of regulation really just an evasion? It could have been prevented, yes siree! No doubt about it. Next time we will stop it. Freson Dan @ 7:31 is closer to the truth.

  7. killben

    “In summary, numerous people, including well respected economists and officials saw the grounds for economic and financial crises being laid. Furthermore, these warnings were brought to the attention of US policymakers. Assuming the two presentations cites above are representative, the warnings were at first treated as worthy of a serious response. However, even as evidence of serious imbalances and bubbles grew, the responses to warnings became perfunctory and devoid of serious analysis.”

    See any difference to WHAT IS HAPPENING TODAY .. SO WHEN DO YOU THINK THESE WORMS, VERMINS AND LIMPETS ACT .. AFTER THE HOUSE HAS BURNT DOWN NEARLY FULLY .. AND THEN TRYING TO TAKE CREDIT FOR HAVING ENSURED IT HAS NOT BURNT DOWN FULLY

    HOW DO YOU THINK YOU SHOULD TREAT THESE GUYS WHEN YOU SEE THEM ON THE ROAD …. STONE THEM

  8. jake chase

    The interesting question is whether what they are now doing will work. The Fed has committed itself to a zero interest rate until employment turns up. This suggests one way speculation in stocks, currencies, commodities, except for the fact that every trade needs two sides and the bank traders looking for derivatives profits must be satisfied with imperfect hedges. All the financial statements of all the players are phony, and nobody knows anyone elses true exposure. Give the whole thing another six months and then some unexpected blip in the weather will bring down the whole house of cards. I wouldn’t bet against deflation quite yet.

  9. yoganmahew

    Not only did “nobody see it coming”, but “everyone knew it was too good to last”… at least that’s the twin messages the Irish government is peddling to its citizens…

  10. Sasher

    Hey all: who among the Fed is going to listen to a guy named Raghuram Rajan (who was a well respected economist in IMF)? He is not part of the “in-crowd” at the Fed. There is very little diversity within the Fed. Who is going to listen to Asians who are just as smart since they don’t belong…
    I think most Americans are being ill served by the clique-ish nature of the Fed Reserve Board and Presidents. I think nothing short of total discrediting of this Fed will result in wholsale change were a diverse set of opinions both in color and content is allowed to be let in.

    1. Francois T

      Not only is the Fed an “in-crowd” but they’re breeding future generations of dopes. I read somewhere (wish I could recall where) that the Fed directly or indirectly provides advanced economic studies grants for more than 50%+ of ALL US economists.

      Now, tell me who will be the foolish soul to contradict the official talking points memos of their benefactors?

  11. Doc Merlin

    FINALLY! Thank you!
    I was getting sick of the “no one saw it coming” when lots of people did. Peter Schiff saw it, heck Cramer did a whole show on it in iirc early 2007, Raghuram Rajan saw it. Tylor Cowen’s Austrian alternate self saw it.

    This problem in inherent in any risk regulator or centralized banking system small groupthink problems in important people become national bubbles, and outside voices will be ignored.

  12. winterwarlock

    A little History might be helpful:

    We are now on version 16.6.8.2.5……etc

    We jump ahead to the early 80s, but keep in mind that navies have been installing economies for centuries.

    The prototype for this latest version, replacing the manufacturing economy with the information economy, came out of San Diego, and was funded with Star Wars money.

    The original idea was to create a quantum improvement in education / price disclosure / democracy, and roll it out with the ongoing Internet development, so individuals could expand the economy outward from the edge.

    Naturally, once leadership could see the possibilities, they stepped in and warped the system. They cut up computer science, making each subject an entire degree, and rolled out watered down university expansion along with Microsoft, firing all the kernel programmers that dissented.

    It wasn’t long before they did the same thing with the all university subjects, and the information economy devolved into the service sector, university expansion, water-down-the-soup economy you see before you, which was replicated across the global economy with the financial leverage, the debt manufacturing machine of public utility holding companies, controlled by the nexus of agency and inside stockholders.

    Because everyone was so enthralled with the Internet, they simply financed it with the speculation machine, and the rest of History most of you know. It didn’t take long for the people with make-work jobs, who were paid significantly more than actual production jobs, to start behaving like the old families and treat production like a second-class citizen. The unions were corrupted with excessive pay at the top and a pension ponzi scheme that tipped the balance.

    Those original kernel programmers didn’t quit. They started building new economies on their own, and those economies have passed their tipping points, sucking resources right out of the old economy, leaving behind non-performing assets.

    The people who are bred to see the world as they are told to see the world, on the tv, in the financial reports, can’t see these new economies, but the good portion of the kids can, which is why they are more and more urgently trying to get kids right out of the womb for indoctrination, and employing the banking and credit family law information system to target anyone that doesn’t conform to conventional spending patterns.

  13. Kirk Powell

    “Nobody saw it coming.”

    A customer walked into my store and told me the peril of NOT bailing out Citigroup. What struck me was two things: 1) At what point did it become plausible to give free money to bankers? and 2) Why does a fear of tomorrow reign so deep in the conscious of Americans?

    The answer to the latter question establishes the primary. Several fundamental changes happened in America in the past generation: most notably we went from being sel-employed farmers in 1900 to dependent corporate drones in 2000. Jobs have replaced opportunity, how and why? The answer lies within the Federal Reserve.

    I own a small business. I don’t have access to free money (0% interest rates). When I experience a problem financially I am faced with bankruptcy court … and my assets are sold to the highest bidder. Those with access to free money through the Fed are giving a blanket protection against any competing interests.

    That “house of cards” finally met its end in September, 2008. And instead of society ripping back to normalcy … the Fed violated laws to give billions to “systemically important” institutions to keep the “system” alive.

    Fear. A fear of loosing ones job and a fear of loosing health insurance drive voters to re-inforce the notion that they need Corporate America when in reality the jobs market should be farthest from their minds … what about the economic viability of the free market economy? I have been free of the ‘job market’ most of my life because I never accepted the notion that I “needed” a job. I never accepted the notion that I “needed” more debt [Bernanke at the start of the recession commented that the principal problem was that consumers needed more debt].

    Where did the education of fear come from? The savvy self-sufficient have been replaced with socialized expectant drones under the guise that we can’t all be JP Morgan. But in fact, the very principle of the American free market economy is that ANYONE can achieve economic greatness through a diligent desire to be successful.

    End the Fed. End the trove of free money that has given Corporate America a strangelhold on Main Street … and ‘getting a good job at a corporation’ will no longer have the implicit benefits of the state backing their reckless and often illegal behaviors that have been used to eviscerate Main Street politically and economically.

    End Corporate Communism.

    1. Vinny G.

      Kirk Powell,

      You make many good points. I too have observed an irrational fear of the future in this country. At its deepest core, America is a society built on fear and intimidation. Make no mistake about that. Fear here pervades all societal and relational aspects.

      There is a huge difference in this regard between the US and other societies. In fact, I have felt it in my own life, when I immigrated here from Europe many years ago. I remember landing in NYC, seeing all the homeless, panhandlers, Harlem looked like Hiroshima at the end of WW2, and thought to myself: “If this is America, I want to go back.” But I didn’t go back. Yet, I realized early in my life here that I only have myself to depend on. I realized that if I fall, I fall all the way down. So I worked hard, I saved, I filled my walls with diplomas, I started businesses, and I did all I could trying to somehow regain some of the emotional safety I grew up with. I never achieved that. The only time I feel safe and secure is when I go back to the old country, which is more and more often now.

      I don’t want this for my children, I am sorry.

      Vinny

  14. MacroStrategy Edge

    Richard has reinforced an important point. To understand what Shiller was up against, take a look at the following NY Fed conclusions on the housing market, circa 2004.

    http://www.newyorkfed.org/research/epr/04v10n3/0412mcca.html

    I would suggest what happened over the prior two decades is that policy makers became (some consciously, others unwittingly) beholden to asset bubbles in order to achieve anything resembling prior trend real GDP growth rates.

    This issue is barely raised, and has yet to be addressed, because many layers of society (including prospective retiring boomers who had not saved enough out of pay checks along the way), not just Wall Street, became dependent upon serial asset bubbles, and also because their is a good deal of resistance to searching for other ways to generate sufficient growth.

    Placing the Fed in a key role as systemic risk regulator is very foolish if you listen to what Shiller reports on his own experience. Maybe Chairman Bernanke is chastened from a near depression experience, but as mentioned above, just look at the one way highly correlated run for equities, commodities, commodity currencies, and you have to recognize the old game is being played once again.

    Surferdude, I do admire your integrity. It was just as bad inside the investment management firms running pension fund money etc. I could not believe a generation of equity analysts and portfolio managers who saw the tech/telecom bubble blow could so willingly pursue a second asset bubble so soon after the late 2000-early 2003 equity bear market. I mistakenly assumed that experience would return investor professionals away from playing cynical momentum gains and get them back to doing serious fundamental and valuation analysis. Instead, the main lesson they took away from the dotcom bust was a strange belief that they could get off the bus before it went over the cliff again. And given their incentive structures – beat the S&P 500 index, and beat the other equity managers quarter after quarter in their particular investment style box – I suppose that belief was required if they were going to stay in the game and make big money.

    The oddest thing was, when the whole thing went pear shaped again last year, and they had already put me out to pasture as a consultant at the end of 2007 for being so foolish as to call it a bubble and to describe in advance what would happen when it popped, only one of my former colleagues had the guts to say I had it right all along.

    Truly a twisted world we live in.

  15. craazyman

    Thus sayeth the prophet Maximus, late of Rome and the baths and diallances along the walls of the circus, fear not children and do not let the sweat touch your brow and do not trouble your mind with complexities. Riches, yeah, they be abundant and he who lendeth the coin of the realm is blessed of the Lord, for as the credit increaseth so ye increaseth in your stature and ye call to each other in glad voices and raise drink in merriment and mirth. Mind ye not the prophets who rage and wail, truly they are an abomination, abhorred by the Lord of Hosts. Nay, they adorn themselves with contumnely and wail in lamentation and annoy the pleasure of the Lord with their vainglory. Bind ye together, children, and adorn ye selves in perfumes and annoint thyselves and walk as those who are blessed and be of good cheer, for the abundance hath no end, yeah, even unto the last days and the debtor shall make peace his debts and ye shall prosper, even unto the end of time.

    -Somnabulations, Book V, v ii-ix

  16. Hugh

    Many of us predicted what happened. We also know can see what is coming.

    Quite simply those who did not need to be out of a job and those who did see need to replace them. But this will not happen because these are elites and the first priority of an elite is its own, not the country’s, survival. This also explains how what is avoidable becomes inevitable. Our elites can’t fix this problem because to fix it they would have to do away with themselves.

  17. alex

    Anybody who didn’t see this coming was either an idiot or willfully self-deceptive (which is worse).

    I’m an electrical engineer, not an economist or someone in finance. I knew we were in a housing bubble because when I bought a house in 1999 I was quite conservative about how much I spent. Yet a few years later I wouldn’t have been able to afford my own house if I’d had to buy it then. If a person earning a good middle class income couldn’t afford to buy a modest house, then who could buy them at ever increasing prices? The only people I knew who tried it were stretched to the limit (and maybe beyond).

    The only thing I’ll say is that while I knew housing was going to come down, and there would be lots of foreclosures, I didn’t appreciate how bad the ripple effects on finance as a whole would be. However, I suspect that any half decent econ or finance type who was familiar with CDS, flimsy capital reserves, etc. would have been easily able to see it.

  18. Vinny G.

    This nobody saw it coming. To me, it was in the air, too obvious to miss. And I took steps to protect myself.

    But when I would tell my friends and relatives that their house prices aren’t going to keep rising, they’d laugh at me and say, “You know, Vinny, I’m redoing my driveway in Spanish brick. I’m paying for it with my Citi card because I have a 60k credit limit. And I’m getting a third new Lexus too to go with it.” And I would shake my head, and head back to my rented apartment in my Toyota.

    Now here I am, not having lost a penny in this crisis, looking at my friends having to decide between mailing the their house keys back to the bank or selling the Spanish bricks one at a time on eBay.

    And, by the way, some of my friends that acted the way I described in the second paragraph above are no longer returning my calls — I wonder if they are ashamed of their own stupidity. Heck, I’m not lending them money if it comes to that…LOL

    Vinny

  19. DJT

    This lowly engineer and observer of human nature did not see the fallout from the collapse of the housing bubble, lacking sufficient financial knowledge. But I knew there was a housing bubble. In fact, I was standing with a high level supervisor in a subdivision in Sacramento in the summer of 2006 and I turned to him and said “This is the peak of the market, right now.” I was within 2 or 3 weeks of being dead on I found in retrospect. I could hear the justifications for supporting prices and increasing prices but they explanations were getting thinner and more frantic.

    I did save a bundle by waiting to buy. But if I had known more about high finance I could have retired on investment earnings from the crash. One pal who agreed with my analysis made a lot of money shorting stocks.

  20. Marc Schlee

    In 2002 a friend of mine wanted to buy a house. I looked at the mainstream business publications and advised her against it, saying that from what I had read the real estate market was getting ready to crash.

    Does Alan Greenspan not read “Business Week” or “Economist”?

    FREE AMERICA

    REVOLUTIONARY (DIRECT) DEMOCRACY

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