And those with status and power within the profession aren't smart enough as people. Yeah right.
Psychopaths.

I don't think it took an economist to see this coming--just common sense. I can remember arguing with someone about this at a party something like 4 or 5 years ago. I was just looking at our local housing situation and noting that I (50 something years old) personally could not recall any period where housing prices rocketed upward at 20% or more per year for years at a time. It was obviously a bubble, which would burst sooner or later. When something appears to be too good to be true, it usually is. I think everyone really knew this was irrational exuberance, but they all thought they were smart enough to sell at just the right time before everything went bust, which of course most people did not. Now those that did sell just in the nick of time are proclaiming themselves geniuses, when in reality they were just very lucky.

And, of course, Dean, you and Shiller saw it coming and wrote all about it in perfectly analytical ways.

Why aren't you both testifying to Congress and appearing on PBS? (I did see you a few days ago on PBS, but you didn't get to talk about the bubble.)

How Greenspan can get away with saying that no one could have forseen this bubble and its crash and consequences boggles the mind.

Dean, you summed up the problem perfectly with this sentence.

"Those whose views are taken seriously mimic the views of those with status and power within the profession, they do not think independently."

And of course, that is also the prime criteria now for those who run the Washington Post: to kowtow to and publish pablum that will win the favor of those with "status and power."

Selise, commenting on an Ian Walsh post at FDL, cited a GAO report, which predicted essentially everything that's happening now.

Sadly, we're not going to see accountability from anyone that Dean is talking about or anyone who had a hand in this disaster. What I'm worried about is how deep the groupthink he describes runs through Team Obama. And if it's entrenched, what can citizens do about it? I tend to be hopeful about citizen action but I don't see a way to fix this problem short of the sort of upheaval that characterized the years that produced FDR. I don't want that.

Dean,
I think the woman who won the $1000 from CEPR should give it back.

I can't find the letter, and can't recall which branch of govt. she worked for. Any sense of if she believed what she was writing?

Dean, just a note of appreciation for the work you're doing with this blog.

It must be so frustrating to keep your consistent attention on the consistent inattention bias of the media world we live in. Keep tearing away the veil -- you and I and all the other readers of this blog would prefer it if we lived in a world where you didn't have to keep on doing this, but until that time comes, just keep in mind how important your work is to us now -- and how important it will be to clear-sighted researchers in the future.

It must be really irritating to realize that these idiots crashed the world economy because they didn't pay attention to the housing bubble, and it is a kind of serious lapse (lots of people affected in very negative ways), but look at punditry in general--how often do they spout the ruling conventional wisdom and end up being wrong?

Amen.

Awesome article. I thought your comment about economists operating as a fraternity rather than "a real forum for debate and truth seeking" was insightful. We might as well add generals testifying before Congress about any war to this list of fraternalists rather than speakers of truth.

t must be really irritating to realize that these idiots crashed the world economy because they didn't pay attention to the housing bubble

But are they really that inept? They had to know this was coming. I only think it's half-crazy to think they planned it.

nah, Dean

you miss the point.

they knew it was a bubble. but the point of a bubble is you make money out of it until you think it's about to blow. then you get out.

calling it a bubble while it's still expanding would spoil the fun.

do they care about the "world economy"?

not that much. they have got theirs, and they will wait until time to start the next bubble to get some more.

It's not just he economists in a fraternity mode.

The major culprits from investment bankers and lenders made out with great profit. I am talking about the CEO and president types.

They used other peoplem money to play or leverage and made a killing.

And after their massive failure, we once again are giving them money to their former firms.

Coberly, I'm not sure these guys got out with "theirs" free and clear. There are a lot of guys from the investment banks without jobs right now. Nobody, not even those making money off the bubble, can predict the future and call the top or bottom.

eRobin--

I always reserve judgment on conspiracy theory. After all, how many people would have believed that the Reagan Administration would devise a plan to sell arms to Iran and use the profits to fund the Nicaraguan Contras? But, as we all know...

But it's just as likely that they believed their own ideology--that markets always work for the best (for them, anyway), that people would find some way to pay their mortgages because they wouldn't want to lose the house (that one was very popular in our local press), that these new credit instruments were like, really great, and couldn't crash any more than, oh, Windows Vista (oops, should have thought that one through a little more).

The bankers etc. who did this have so little knowledge of the economics of the poor 2/3rds of the population that they can actually believe that everyone has a plasma screen TV, a boat, a Suburban, and goes to Tahiti on vacation. The idea that an increase in a mortgage payment of $500 would drive someone off a cliff financially is beyond their ken.

You are wrong, Economists have known about this. Read Ron Paul. He has been warning about the failure of the Federal Reserve system for years. Look back to Milton Friedman and his criticism of the Feds actions that caused the great depression.

The fact is the Fed is unfair and inefficient, it causes problems by existing and causes a lot more problems by trying to fix anything.

This article is bang on. Take a look at Peter Schiff. He's been predicting this for years. I particularly like where he takes on an arrogant former Reagan economic adviser: http://www.youtube.com/watch?v=LfascZSTU4o

Peter understands basic economics better than any of these neocon Friedman Chicago boys. There is a fundamental difference between real wealth generated by productivity and paper wealth generated by speculation.

The need for properly regulating banking systems and capitalism in general should be easily understood though basic project management principles (reward systems), competition mathematics (game theory), a even evolution theory (natural selection).

It's this simple: that which is rewarded is eventually maximized. Laissez-faire capitalism rewards winning, not making a better mousetrap. That means lying, cheating, stealing, exploiting, buying politicians, monopolizing, and so on are things that naturally come out of it. Anything to make a quick buck.

Regulated capitalism punishes bad behaviour and so what gets rewarded is long-term stability, productivity improvements, and generally making a better mousetrap.

I sure would like to beat the press.

Jiff
www.online-privacy.cz.tc

GREED and STUPIDITY dance hand in hand in this world. When YOU get greedy YOU get stupid too.

Iceland - with a population of only 320,000, and a location that causes high import prices...what could go wrong? Anybody who banks with a country that small should expect high risks.

Have you anything to offer other than what amounts to an ad-hominem attack? I am by no means necessarily saying that you are wrong, but the reason that these economists are respected is not because they are prescient, but because they can develop their positions based on sound economic reasoning, and make the best use of the information available to them. Undoubtedly their reasoning in this case was based on assumptions that didn't hold, but this seems to have been a mistake made across the board; and so perhaps one that goes to a human failing of overconfidence rather than to incompetence or massive conspiracy on the part of the economic establishment. The response to the crisis, though, certainly has been nothing short of criminal, and in that respect your position has my full support.

Kabir wrote, I am by no means necessarily saying that you are wrong, but the reason that these economists are respected is not because they are prescient, but because they can develop their positions based on sound economic reasoning, and make the best use of the information available to them.

You miss a key point: the economists, as (correctly) portrayed by their own theories.

It's all the rage among economists to say "incentives matter." And I actually agree with them.

But what if this principle is applied to economists? Well, clearly, in a world dominated by the rich and powerful, they're going to do the bidding of the rich and powerful, because it pays a hell of a lot better than simply seeking the truth.

Whenever I read anything by Mishkin I always thought of munchkins. Don't know why...

Kabir,

what is the "ad-hominem attack" here?

The point is very simple. I and a few other economists were making very clear arguments based on sound economic reasoning, saying that things were going to fall apart.

The prominent economists in the profession, including Alan Greenspan and the others are the Fed opted to ignore these arguments. (They did not use evidence to show that there were wrong, they ignored them.)

Now, exactly what I predicted would happen has happened. Their response is that "no one could have known" and they expect the public to accept that. And none of the them get fired.

Agreed - there is no "ad hominem" about this, neither with respect to the economists nor the media (supposedly) covering and questioning them. Today I wrote a piece about Joe Nocera at the Times, who seems to think it's more important to strut his insider status than write clear opinion. It would be laughable if only the consequences weren't so dire.

CORRECTION RE: "The point is very simple. I and a few other economists were making very clear arguments based on sound economic reasoning, saying that things were going to fall apart."
Change "I and a few other economists ...." to "I and a VERY few other economists ...."

For me the wonderful thing about being able to read is, selection of reading material is MINE alone. And, the wonderful thing about the internet is it provides me with the ability to counter-balance the "nonsensical blather" our decision-makers throw at us daily to rationalize their shortsighted greed. Personally, I haven't watched or read AG's latest charades, and I ask - why would anyone?
I am grateful to you, Dean, for sharing your extremely tight arguments on critically relevent topics. You helped confirm our decisions that have made our meager retirement possible. Likewise, I'm equally grateful to the internet for making it SO easy to find you & your work!

Greenspan's comments are even stupider than you make them out to be. He wasn't irresponsible becaue he didn't predict the collapse. He was irresponsible because he didn't even recognize that it MIGHT collapse. My house probably won't burn down, but I should know it might and I should think through what to do if it catches on fire, just in case.

It is obvious that it was possible real estate prices MIGHT fall 20 percent or more nationally. Someone should have been asked to look at what would happen in that case. Would any financial institutions collapse? Would that endanger any markets? What should we do in that case?

That is why Greenspan's comments are so stupid.

. . . the bubble was easy to see and the damage that its collapse would cause was entirely predictable. Dean Baker

Calling the "bubble" -- even if two years too early -- was no great accomplishment.

Anticipating what damage the bubble's deflation would cause and how it would cause it was the important challenge.

Does anyone recall the name of anyone who described the effects -- the what and how -- of the bursting of the bubble?

The question is not whether or not Greenspan is an idiot. The question is whether or not there is anything within economic theory that would enable the FED to recognize definitely that there was a housing (or previously a stock) bubble that presented a systemic problem. There are all kinds of bubbles that can come and go without presenting a systemic problem. Consider the National Football League. The recession will likely result in a reduction of NFL teams by half and the reduction of the value of NFL franchises by half. So we can say that the NFL is a bubble. (Even worse in the college football bubble). But we can be pretty confident that the deflation of this bubble will not have systemic consequences. So what's the difference? Well for the most part the NFL bubble is not based on leverage. So the question is then what is the non-financial nature of leverage that enable one to recognize a bubble of systemic import. I am not sure this is known.

Rob

i probably travel in meaner circles than you do. as a child i got to watch scammers up close. i don't see anything in the high end financial operators that i don't recognize from my old days.

if some of those people got hurt... i suspect it was mostly the small time functionaries who may well have believed in what they were doing. it's not as if Greenspan mans the phones himself.

kabir

"sound economic reasoning" is actually quite easy to come by.

so are "assumptions that don't hold."

We may also note that neither the home price "bubble" nor its collapse is the problem we're suffering from, currently.

The problem is past lending which failed to meet historically reasonable standards. It was the lenders failure to assure themselves that the borrowers had the capacity to repay the loans and the collateral to secure the loan if the estimate of capacity turned out to be in error which caused the present "crisis."

N.B. The stock market bubble (1996-2000) caused no serious damage to the financial industry; ergo, "bubbles" don't necessarily cause crises and identifying them isn't enough to qualify for the laurels in economic prediction.

Ellen1910

on a thread below you endorsed the fallacy that America consists of only two people: one "the boomer" and two "the poor post boomer." i won't hijack this thread to try to explain the fallacy, but do think you ought to think about it.

meanwhile your parsing of identifying the bubble, describing the mechanism of harm, and "no serious damage to the financial industry" seems bizarre.

Indeed, those who spent their time in the past years sounding off about the housing price bubble to the exclusion of warning 1) about the financial institutions' failure to maintain traditional lending standards, 2) about those institutions' increasing leverage and 3) about the deteriorating quality of their balance sheets bear responsibility for the present "crisis" for having taken everyone's eye off the ball.

It's only appears "bizarre," coberly, to someone who doesn't understand the cause of the present financial crisis.

I gather that your among those who don't.

By the way, coberly, I asked a question, above. Allow me to repeat it (I'll put it in bold to grab your flagging attention):

Does anyone recall the name of anyone who described the effects -- the what and how -- of the bursting of the bubble?

Now, I realize that you didn't predict the crisis or describe how it would come about, but do you recall anyone else who did. Oh, and a link to that person's prediction would be ever so nice.

In which the chief commentator on economics at the FT spends a whole day insisting nothing was obvious:

I hope to be interesting and to help people understand some of the things that are going on. That’s all. I don’t take my job more seriously than that. Why should anybody else?

-- Martin Wolf

http://danielsimpson.wordpress.com/2008/10/23/never-cry-wolf/

Er, quite...

That the housing bubble could not be sustained was obvious. But the impact of its ending on the entire financial system has surprised me. Martin Wolf

Two separate issues.

You don't get kudos or the right to toot your horn unless you got both, right.

That's like saying that you don't get credit for predicting a gas explosion unless you can accurately estimate the amount of bricks that will remain standing afterwards.

The fact is that the bubble was fairly easy to predict by smart people who weren't ideologically myopic, being linear, direct and inevitable, but the subject was totally excluded from all non-academic discourse with a condescending smirk. The result of the bubble is impossible to predict because it is non-linear, involving the reactions to the bubble, and the reactions to the reactions to the reactions to the bubble ad infinitum. Asking the people who were right about one thing to be infallible oracles about everything that will happen in the future or else not deserve credit for being right about the thing that they were right about is to set up a rhetorically impossible standard in order to create an argument where none exists.

The result of the bubble popping is that we are losing 8 trillion in fictional wealth that we used to sustain our consumption. This was predicted by everyone who predicted the housing bubble. What else do you want? Should they have predicted exactly how low your own home value would go down on page 122,000,000 of a very large appendix?

Ellen

i suppose i asked for that. but it doesn't change my mind.

for what it's worth, my suggesting that you were buying a fallacy, and that your parsing seemed bizarre were invitations to explain your reasoning better. but i can see why you saw it as name-calling and responded in kind.

i don't think there is much danger of Greenspan's former acolytes seeking either of us out for future guidance and inspiration.

Sorry about that terrible sentence in the above comment. The reference to linearity, directness and inevitability was meant to refer to the bubble, not to the ideologically myopic :)

I read your column from time to time, and I agree with you on the housing bubble. I think one other point is that blogs were just beginning at that point. I used to be a big newspaper reader, and I must say, blogs have contributed much, much more to my understanding. Blogs have memory, detail, and debate (commenters can provide quality rebuttal). It is just a better medium for anyone who is serious in assessing a situation.

I'd thought this thread was pretty much exhausted, but Mr. Baker has "reopened" it with an apologia of his not having warned earlier (or at all) of the size, shape, or character of the crisis the financial system is experiencing or the likelihood of its occurring.

He argues that announcing the existence of a bubble implied that something bad would happen when the bubble burst.

I don't believe that defense can prevail. Why?

Firstly, because bubbles can burst without doing systemic damage (the dotcom and TMT bubbles are examples).

Secondly, the banks' business models insulated them from the financial effects of mortgage defaults (the model called for them to act as conduits, only). It was not until 2006 (and perhaps, late 2006) when customers for their securitization products stopped buying and the banks, in violation of their own business model, took these mortgages on to their balance sheets.

Thirdly, European banks proved to be purchasers of these toxic mortgage products and for that reason are in worse shape than U.S. banks (they are not under U.S. regulatory authority and can't be controlled which would be fine except)

Fourthly, in order to increase their leverage banks, here and abroad, removed risky assets from their balance sheets by way of SIVs and purportedly decreased the risk of other assets by purchasing credit default swaps, a relatively new type of derivative.

Note: When a bank decreases an asset's apparent risk, it can loan more money against that asset -- that is, take on more leverage and increase its profits.

The CDSs have had the effect of tying financial firms together in a web of strands which, if a certain number are broken (no one knows how many are the tipping point), can bring down the entire web.

The commercial and investment banks, insurers, monolines, rating agencies, and others all argued that their models distributed the risk away from the system toward the crazies like the hedge funds who, if they took a loss or went belly up, would not harm the financial system.

They were wrong.

But unless a person identified what the banks were doing and explained how the collapse of the house price bubble would destroy the value of the insurance (and the risk ratings) they'd bought via CDSs and the destruction of their balance sheets as the junky SIVs and junky mortgages and junky ABSs and bad CRE loans and foolish LBO lending came back on those sheets, then, all one has said is "There's a bubble."

But since it was the banks' business model and their failure to maintain discipline ("When the music plays, you have to get up and dance") that caused the crisis and not the bubble, calling a bubble doesn't amount to a warning let alone a prediction of systemic financial failure.

well, ellen

but you have shifted the point.

i believe Dean was complaining originally that the people who said there was no bubble are not the best people to ask for an analysis and prescriptions for a cure.

your response is apparently to say that identifying the bubble confers no credit unless at the same time the person so identifying also identifies the exact mechanism by which the bursting bubble will cause harm.

you also seem to think that if no harm is caused to the "financial sector" then no harm is caused.

i don't question that you know more about banking than i do. i do find your logic questionable. and while wandering from the point of the essay you are commenting on is time honored blogging tradition, insisting that the author defend a case he wasn't making is a little... bizarre.

The only thing that prevented a disaster after dot com was another place to put the massive amount of fictional wealth created during it - into the housing market. In order to avoid a catastrophe now, I would recommend that everybody pay off the debt in tulips(or maybe the future production of China).

Just because every bubble didn't cause an instant depression is not enough to sustain your premise that bubbles have nothing to do with financial crises. Bubbles create garbage debt that has to be paid back. If you pay it back in magic beans, and people accept those magic beans, unless we see fields of giant beanstalks leading to treasure troves in the clouds, you delay the effect, you don't eliminate it.

Ellen, What NONSENSE youe spew! 'Calling the "bubble" -- even if two years too early -- was no great accomplishment.'
Name an Economist who spoke & wrote against the Boskin Commission's dramatic downward adjustment to the CPI. Name an Economist who did that AND spoke and wrote against the total repeal of Glass-Steagall without putting in place new oversight of the deregulated sector (that went nuts leveraging house bets over the next 8 years). And then name an Economist who did both AND wrote extensively back in '02, '03 & even '04 on the POETENTIAL problem we faced IF corrective measures weren't taken to address the growing housing mess.
No, I thought not.

Allow me to remind you, bailey, that all liberal economists opposed GLB; they were proud to do so -- which is why liberals have to be suspicious of a fellow whose principal economic advisor is Robert Rubin, who didn't and worse, promoted it to his boss.

You may say that a certain "Economist" wrote about a "POTENTIAL" problem but that doesn't mean he actually did. After all, it is a commonplace that memories often become unreliable when subject to the stress of defending an indefensible position.

Better you should link to one of these purported writings --presumably, not a difficult task since they were -- as you allege -- extensive.

> I particularly like where he takes on an arrogant former Reagan economic adviser:

Wow. Just wow. Watch the video, everybody.

Ellen1910, you clearly couldn't be bothered. You wanted somebody who would lay it down? Here in 2006 was a guy who word-for-word predicted this: the foreclosures, the bank failures, the consumer spending pullback.

I mean everything, it is stunning.

And of all guys, the idiot Laffer is his (as we see now) foil. Idiotically spouting all the nonsense that everybody Schiff was talking about - the overstressed 2 worker households, the people who wonder why everything is "made in China" - were subjected to. Sadly many were fooled by it, and the suburbs stayed red until 2006.

It's all there - housing was "real wealth", Greenspan was a god, low interest rates were America's birthright and could continue forever.

I think Dean Baker is a good economist. I even kind of like his politics, although I suspect he would rather I didn't, as I have a poster of Che Guevara on the wall of my living room. But expecting him to have predicted the exact nature of the crisis is asking him to be a seer, not an economist. And he was more specific than I, who said to husband, "this will not end well."

Specifically, in his August 2002 paper, he wrote:

"The average ratio of homeowner’s equity to value, at 55.2 percent, is near its low for the post-war period. A sharp drop in home prices will send this ratio far below its previous low point. Since there are considerable differences in housing markets across the country, if housing
prices fall 10 percent nationally, then many regions will see price declines of 20-30 percent. This will create a situation in which millions of families have little or no equity in their homes. This is an especially serious issue with the large baby boom cohort nearing retirement. It will also lead to a surge in mortgage default rates, as many homeowners opt not to keep paying a mortgage that exceeds the value of their home. This could place serious stress on the financial system.
In the late eighties Japan experienced a simultaneous bubble in its stock market and its real estate market. The collapse of these bubbles has derailed its economy for more than a decade. A similar collapse in the United States, coupled with a poor policy response, could have similar consequences here."

Peon

thanks for doing our homework for us.

You're welcome, coberly. The chicks always do the reading.

Greenspan's testimony included the following:

1) the crisis is a once-in-a-century (random) occurrence, implying a deregulated market works 99% of the time

2) forecasting the effects of regulation (or anything else by Fed Res staff) is 60% right and 40% wrong

3) the housing bubble was recognized in early 2006 but considered self correctable without serious price declines

4) due to a data lag on sub-prime loans, a surge in these loans was not identified coincident with the bubble, implying that had the data been available, the bubble would have been taken more seriously, but no intended action was provided

5) market corrections have already eliminated the need for regulations going forward, other than requiring mortgage originators to keep some skin in the game

6) "private counter-party surveillance" would provide competitive discipline in the absence of transparency, where the latter was destroyed with complex, incomprehensible contracts coupled with deregulation supported by Greenspan

... therefore

forecasting the effect of regulation is useless since a deregulated market is right 99% of the time

the surge in sub-prime loans was posed as an exception to the 99% rule, as if something could have been done absent the data lag

the absence of transparency reduced the forecast outcome from 60/40 to a zero certainty, to guarantee that the effect of regulation could not be forecast at all

in typical, circular obscurity, Greenspan admitted to much less complicity than generally perceived, concealing that he systematically undermined the presumed holy grail of free market ideologues - transparency - by claiming that what could not be known could not be forecast, what could be forecast was a toss-up other than sub-prime loans - which wasn't known soon enough - all the while asserting that because everything that could be known was known, the crisis had a 1-in-a-100 random chance of occurence, implying that was the risk taken when transparency was removed from the shadow market

The major culprits from investment bankers and lenders made out with great profit. I am talking about the CEO and president types.