Arnold Kling  

Why I Was Wrong

Becker Embraces Unhappiness Re... Should We Penalize Liquidity P...

Did I fail to foresee the financial crisis? Absolutely. Brad DeLong gives some reasons that also go for me.

I was "expecting," in the sense of anticipating that it was they were both likely enough and serious enough that public policymakers should be paying significant attention to guarding the risks that it would create:

(1) A collapse of the dollar produced by a panic flight by investors who recognized the long-term consequences of the U.S. trade deficit...

I was not expecting...

the fact that highly-leveraged banks working on the originate-and-distribute model of mortgage securitization had originated but had not distributed: that they had held on to much too much of the risks that they were supposed to find other people to handle...

the panic flight from all risky assets--not just mortgages--upon the discovery of the problems in the mortgage market...

the engagement in regulatory arbitrage which had left major banks even more highly leveraged than I had thought possible.

I will add that I was definitely not expecting Freddie Mac and Fannie Mae to have ventured so far away from the idea of investment-quality mortgages that they had enough exposure in subprime loans to wipe out their capital.

The original demand for a "Why I was wrong" post comes from Calculated Risk (I thought this was Tanta, no?), who chastises me for having gotten snarky in August of 2006 about Nouriel Roubini's claim that the odds of a recession by the end of the year were 50 to 70 percent.

Excuse me? Does the third quarter of 2008 count as "the end of the year" in 2006? I think that my old post that Tanta dredged up illustrates exactly why Roubini and Krugman were not taken more seriously. They made extravagant doomsday predictions in good times and bad. Krugman has been screaming "Depression! Liquidity Trap!" for seven years now. At this point, I would concede that the probability of those events has increased from one in a million to one in a thousand. That's not quite a license for him to say, "I told you so."

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COMMENTS (21 to date)
Boonton writes:

Fair enoough, but it does seem interesting that someone can call a 'one in a thousand' event year after year and in only 7 years it comes true.

Looking back I'm thinking that we saw an odd pattern of liquidity traps in other countries (wasn't Krugman originally talking about Japan)....panics where currencies dramatically changed values on what seemed to be a drop of a hat, various bubbles popping that caused an escalating amount of damage, and the collapse of LTCM where the Fed was praised for saving the world.......looking back I wonder now if at any given time there was 50, 80, 100 LTCM playing in the market if perhaps the 1 in a 1000 year event might have gotten transformed into a once a decade event?

Garrison writes:

It seems that you're conflating Tanta with Calculated Risk, who are two distinct people posting on a blog called Calculated Risk. It was CR who wrote that post, not Tanta.

When I first saw the CR post asking you to explain yourself, I thought it was uncharacteristically emotional and unintellectual for that blog. I hope you (plural) don't get stuck in this abyss.

Unit writes:

Also Krugman was predicting a run on the dollar due to the trade-deficit with China (I attended a lecture of his), not the sub-prime mess (maybe he did more recently, but not two years ago).

Niccolo writes:

Well, I don't know about boys crying wolf, but I do think that someone like Frank Shostak deserves some credit for following up on some of Greenspan's indications of housing troubles as early as 2004.

Now, I know, I know, the Mises Institute has been particularly bad about the wild and outlandish predictions, but I think for Shostak, at least, he's been relatively on target and pretty tame about things.

Gary Rogers writes:

I will continue to scream about unsustainable government spending. We are not done with this crisis yet.

Bill Stepp writes:

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Marcus writes:

What about the possibility the problem is bigger than just the housing market? I mean, can falling house prices in just four states really put this kind of damper on the entire world's economy?

How did rising oil prices play into it? Or the Fed raising rates? So on and so forth...

PrestoPundit writes:

Calculated Risk is on edge about all this because he was subject to unending criticism for sounding the alarm that was a serious bubble brewing in the housing market when he first began to blog (he says it was the housing bubble which inspired him to start his blog.)

When you wave the red flag, are attacked for this, and it turn out you were spot on, it truly grates that folks who should have know better but didn't are still in control of policy -- and are still in control of the terms of the debate within the economics profession.

But I do think Calculated Risk is turning his guns on the wrong target if he's going after Arnold on this.

And with Arnold I do think Paul "the broken watch" Krugman gets zero credit for understanding what is going on, beyond his (Keynes distorted) yammerings on the significance of the imbalances with China.

ionides writes:

Regarding this quote:

"I was "expecting," in the sense of anticipating that it was they were both likely enough and serious enough that public policymakers should be paying significant attention to guarding the risks that it would create:"

It really isn't coherent or grammatical, or something. Was a word left out? "anticipating that it was they were both likely" doesn't mean anything.

Pete writes:

If you start predicting a recovery now, then you can claim credit when things (inevitably) get better. Even if they get worse first.

Mike writes:

I don't know why DeLong insists on carrying water for Krugman, who has consistently been so wrong on the economy. Yes, we are likely in a recession now, years after he predicted, and he got all the details wrong, but beyond that, well....

I'd like to second what another poster said about Frank Shostak being probably among the most accurate of analysts/forecasters of this crisis.

The Austrians have generally done very well for themselves, which is ironic because if you ask them they'll say that they can't forecast detaiis, they cn only tell you that there are some serious problems building up that are going to break out in a big way some time in the future.

otey writes:

I get it. It's much worse to be wrong because you were too early than to be just wrong.

That Cato Institute is quite a place.

Mike writes:

In addition to Shostak, Peter Schiff was another person who seemed to get things pretty correct (more correct than Krugman, anyway):

Dan Weber writes:

It's best to predict the disaster early and often. Nassib Taleb is the best of the bunch, because when anything bad happens, he can point to his book and say "I told you so!"

There's a reason that economists have the saying about "predicting 13 of the past 5 recessions."

(As for Tanta, I wonder if I'm at fault for making a comment here that was in confusion about her gender here, which may have confused people into thinking they were the same person.)

James A. Donald writes:

I was aware in 2006 that Fannie, Freddie, and major banks were making money available to winos and wetbacks - I was aware that the great majority of loans being made were unlikely to be paid back if houses failed to rapidly appreciate. I was aware that the great majority of loans were being made to people that were so obviously irresponsible and insolvent that a normal person would treat a loan request from such people as a request for a handout.

I expected however that the crisis would be resolved by irresponsible lenders being stiffed, rather than bailed out by the US taxpayer, and was therefore expecting a crisis considerably less serious than the one that is happening.

Bo writes:

While I hear a lot of gloating and sober tsk-tsking from those who "predicted" the turmoil now, I'd be interested in hearing what their predictions are for economic recovery.

Can they foresee the reasons for an economic boom, or will they just skip ahead to what they think will cause the next economic recession?

And Otey, in retrospect, should I have prepared for a recession in 2005, and sacrificed the potential profits I could have made between 2005-07? This is why timing is important in predictions too.

Dan Weber writes:

Predicting the inevitable without a time frame is useless. Let me make a few:

  • The Republicans will take back the White House.
  • After that, the Democrats will get it back.
  • There will be an economic recovery. After that, there will be a recession.

Only a little bit less useless is to make an unfalsifiable prediction, like "the US will elect a woman to be President."

Bubbles are harder to deal with. What constitutes a bubble? It's very hard to stand in front of the oncoming train and say that it's will stop before it hits you, because of the nature of bubbles. And I'm still not sure if we had an oil bubble or not.

Still, I think Krugman deserves credit for calling the housing bubble, and his analysis seems to be correct when looking backwards. (If you don't like him you can point out all the other predictions he made that haven't come true.)

Greg writes:

I agree that timing is important with these predictions, but aren't we oversimplifying the issue a bit? Let's say someone predicts that the US economy will go into recession because of X, Y, and Z (say unsustainable housing prices, excessive leverage, etc.). Just because it doesn't happen immediately doesn't invalidate the analysis, and it likely means the actual crisis will be that much worse because adjustment has been delayed. If other economists, pundits, and public officials had listened to the doomsayers, we would likely be better off now.

Also, considering that the official recession is now pegged to December 2007 by the NBER, the 2006 predictions don't seem quite so bad.

I do think, however, that the pessimists should spend some time trying to forecast the recovery. Being the Cassandra all the time probably does limit one's intellectual flexibility, the same way some market cheerleaders over the last few years seem to have become incapable of fully acknowledging legitimate economic problems.

lxm writes:

The bottom line seems to be that nobody got it. No one saw the complete train wreck a coming down the tracks.

If that is the case, then the question becomes exactly how useful is economics as a discipline? Here we've got all these brilliant people and deep sources of information about financial transactions and markets and none of them knew what was about to happen.

I don't find it at all satisfactory that these brilliant thinkers (I mean that seriously, not ironically) will now go back to making the same ideologically driven economic arguments they made before this crisis as if nothing at all had happened. Give me one good reason why anyone should trust their policy prescriptions. Are they scientists or are they astrologers. And why aren't they the least bit embarrassed.

There is something very basic wrong here. Economics needs to rethink itself.

Barkley Rosserr writes:

I was loudly and publicly calling that we had a housing bubble from early 2005 on, once I saw the Shiller data on historical price to rent and price to income ratios. From Sept. 2006 I was calling that the derivatives market was overly fragile and entangled and would probably explode as housing prices declined and blew up mortgages and their related securities. I also said this would result in a recession, although I never said when or how deep it would go or how it would last, and I am still not willing to call any of those.

Where I was wrong was that I agreed with Arnold and Brad that the US current account deficit and massive foreign net indebtedness was a problem. I thought these crashes would lead to a massive collapse of the dollar. I was dead wrong on that one, with the old "dollar as safe haven" dominating instead, with it rising and now 90 day T-bills are yielding one basis point. Duh.

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