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March 18, 2009



It's always interesting to read predictions about the future from people who lived in the past. Usually they got it comically wrong, but sometimes they got it right and then they become gurus of the past like Toqueville. Anyway, the whole enterprise ought to make us humble.


Rahn's article irritates me.
"...the high-paid wizards at Goldman Sachs were projecting it to go over $200 per barrel..."

Which it would have, if securitization had truly conquered risk in real estate. But it didn't. Essentially everything hinged on one's appraisal of that, and most economists aren't experts in it. We can say that certain people who should have known better missed the boat, but everyone else whose work depended on them can only be at so much fault for mispredictions, given what was essentially bad inputs to their models.

I won't go over Iraq again, but I'm sure everyone can guess what I'd say about that.

"...the global warming theorists said..."

Which ones? Was this really a consensus? How confident were they of the "hockey stick" thesis? Straw man.

"...the planet has actually been getting cooler over the last decade..."

Says who? The hottest February on record was in '98, yes, but average global temps have still been climbing, if not as quickly. The skeptics may yet be right (I take Lomborg very seriously, for one) but that's highly questionable.

Nathan Smith

Oh, I don't know. I can sympathize with the public thinking that economists ought to have seen this coming. Something this big. And now there are so many things about the lead-up to the crisis that look obvious. Signal 1: House prices were out of line with incomes. Signal 2: Debt of all kinds, especially mortgage debt, was surging. Reminder: Mortgage debt is secured by the collateral of real estate. Implication: When house prices fall, those mortgage contracts cease to be incentive-compatible. Ergo, mortgage delinquency and default rates rise. Ergo, mortgage-backed securities will fall steeply in value. Ergo, banks will become insolvent. Ergo, given the way the financially system is woven together with itself and the economy, the Fed and the politicians have to try to save key institutions. Which alters incentives and creates new sources of long-run risk. Which makes investing dangerous and drops the stockmarket.

This story seems relatively straightforward in hindsight. Why was it so impossible to foresee?


It wasn't impossible to see so much as forecasters assumed that the people whose job it was to oversee matters at the beginning of Nathan's chain chain would have done their homework, because forecasters assumed was in those peoples' interest to do so. But it wasn't, which is really where it all broke down. Over time, the market creates ways of connecting performance with compensation, but only through experience with failure. Few understood the real significance of securitization, or rather, few understood that the complexity masked risk rather than resolved it. There's really very little that's obvious about the impact of CDOs.

On the other hand, I think most economists were aware of the rising counterparty risks and so on in late 2007 and correctly said that we were in a very, very dangerous time. It was the talking heads that dismissed those warnings and prevented them from entering the national conversation.

But, my memory may not be accurate and I'm not sure how to check it. Perhaps everyone was more surprised than I remember. What I am sure of is that economists have rarely if ever agreed on what (if anything) should be done in response to the risks, and that the specific trajectory of the economy will probably always surprise.

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