I Saw the Crisis Coming. Why Didn’t the Fed?
nytimes.com
nytimes.com
That is: One possible answer to the question in the title is: "Because actually the available information didn't make it clear what would happen and when; you thought it did, but actually you just got lucky."
Whether that's actually the case here is of course difficult to tell. On the one hand, hindsight bias (http://en.wikipedia.org/wiki/Hindsight_bias) makes it likely that it won't feel like it is, even if it is. On the other hand, uh, it does indeed feel like the crisis was pretty predictable. (But I bet that most people who are now saying "well, that was hardly surprising" failed, just as FWIW I failed, to short the market heavily or anything. Not-being-surprised is cheap.)
The rest of your comment is right on the mark.
If he was really so sure of his assessment back then then why didn't he short sell a bucket load of these mortgage backed securities?
This was really a great trade because his losses were capped at around 5% a year while his upside was huge, imagine a 6:1 payout.
"The market can stay irrational longer than you can stay solvent." is the traditional response.
The problem was "obvious" in 2001.
Even if the people that did predict it were the kind of people that always predict recessions, they still should have caused a little bit of head scratching in the Fed and in the top banks and the rating agencies. Somebody could have actually done some simple arithmetic to determine whether the average person can afford the average house. I mean this is not difficult stuff.
That is complete bullshit. Try telling that to Paulson, who made billions on the crash. I saw the signs myself, but did not understand them, not believing that people like Greenspan would allow something so stupid to take place. When studies show that Americans trust their government less than ever, mark me down as a statistic.
When a bank official told me that "jobless, bankrupt, illegal immigrant, it doesn't matter," they can get somone a home loan, I should have known what that meant, and so should the Fed.
Greenspan should just shut up and accept his legacy.
It was Burry that came up with the idea for using credit default swaps (CDSs) to short the subprime mortgage market.
That idea eventually found its way to Paulson, who was able to use it on a larger scale.
There's no excuse for "experts" like Greenspan to have missed it, when the everyday people running websites like seattlebubble.com saw it coming.
http://graphics8.nytimes.com/images/2005/06/15/business/arm3...
Note the date.
To me, spotting bubbles is not so difficult. There are a few great investors who have excellent track records when it comes to dodging bubbles/crises. They may not profit immensely, but their downside is usually protected and they are cash rich to pick up securities on the cheap.
The real difficulty comes from figuring out when a bubble will burst -- which is really anyone's guess. Burry himself ran into trouble on this end which created friction and eventually lawsuits with his investors.
Despite the attention I paid to it, I still failed to make a profit. When things finally started unravelling, I took several put option positions (assuming the price would decrease) in the obviously doomed companies, for really cheap prices. But my mistake was not goibg out further time wise. I was up substantially (500% was my best) in almost all my positions within a week or two, but when the fed and other players weighed in with changes to the rules of the stock market, and CEO's taking actions that are blatently fraudulent but not enforced by the SEC, things turned against me and I ended up selling for a 40% loss. Of course if I had simply taken a boring short position I could have made a guaranteed 40-60 percent, but how exciting is that?? :)
Making money in the market, even when you KNOW what is going to happen, is amazingly hard. Especially when the FED and SEC are literally changing the rules on a daily basis, as they were back then, and when CEO's can lie, cheat, and steal with impunity.
There were two public companies that had CDS portfolios where they stood to make a lot of money. A direct equity investment or LEAPS would have worked well there. I took this approach.
Alternatively, it seems like out the money puts on financial institutions would have done really well. Michael Lewis chronicles a few guys from Cornwall Capital that made something like 100:1 payouts on out the money puts for Bear Stearns. These guys crushed it when Bear went BK. This cheap insurance approach is used by a few really well known investors and it is the one I'm gravitating towards for the future.
Nor do they do so well when the SEC decides to suddenly ban short selling on a certain subset of stocks.
If you look at long term indicators of indebtedness it is utterly clear that the US (and some other countries) were at extreme levels in 2007. There was never a dispute about that and it's easy to check. The dispute was about the interpretation of these numbers.
Greenspan and many others argued that the more sophisticated financial system should be able to sustain these levels. He thought that the new securitisation market led to more flexibility and risk tolerance. He turned out to be wrong. This time was not different (see Rogoff on that one).
People who predicted that this time was not different and high levels of debt would lead to a crash were not predicting some freak event. They just followed the conservative assumption that history is going to repeat itself. And it has.
The point is that the reason isn't justified because the person correctly predicted an outcome. The reason is justified because the reason was based on true fact and is demonstrably capable of causing the effect.
Now if the Colts win the super bowl despite having worse talent because the opposing Saints team members all got drunk the night before and were playing with hangovers, then you would be justified in saying the predictor was lucky. It's not enough to say someone could have been lucky and then dismiss them. You should show they were lucky or accept they were correct in their reasoning.
It should be pointed out that with Aristotelian logic, that is false. "Previously I said X will happen because of Y, and X happened." is basically "Y implies X; X is true; therefore Y".
Nevertheless, it is true that if a person makes a claim that something will happen for a given reason, gives plausible logical reasons, that we have priors that also indicate the causative connection is sound, and the prediction ultimately comes true, we should not just ignore it. We may not be justified in using Aristotelian logic to conclude with 100% confidence the person's reasoning was correct, but we are justified in taking it into account and concluding that there is some reason to believe this person, who made a prediction contrary to many people's other beliefs, may in fact have something.
After all, if you're not going to listen to people who make accurate predictions with plausible reasons used for their predictions, you can just give up on science right now, because that's all it is.
And I think you're making a mistake to equate ball games with debt markets. The fortunes in ball games can quickly and unpredictably turn. Debt doesn't work that way. If many people on low income take out mortgages on a teaser rate that goes up two years later to levels they cannot afford unless house prices keep rising at historically exceptional rates so they can remortgage, you know you're going to be in trouble eventually.
As a nation, we cannot afford to live with Mr. Greenspan’s way of thinking. The truth is, he should have seen what was coming and offered a sober, apolitical warning. Everyone would have listened; when he talked about the economy, the world hung on every single word."
Instead of expecting Greenspan to see exactly what Burry saw, wouldn't it be better if we didn't have a single point of failure? In the absence of Wall Street's reliance on the Fed, Burry's insurance plays could have further pushed up prices and signaled to everyone else that something was wrong.
November 2005, Dean Baker and David Rosnick
http://www.cepr.net/index.php/publications/reports/will-a-bu...
(Baker has papers going back to Oct 2003 on it)
Can you explain this point further? How did Burry's investments not raise the prices of credit default swaps? What does Wall Street rely on the Fed for that led to that result?
This is what they mean when talking about transparency.
http://streetcapitalist.com/2010/03/24/learning-from-michael...
It is pretty amazing to see how far he has come since then, from a young doctor posting about investing on the internet to going head to head with Greenspan.
Multiple people in academia predicted the crash. Nouriel Roubini (spelling is wrong) Peter Schif, every economist that ever posted on Counterpunch, etc.
And also of course most ordinary people predicted it. If you look at the housing forums on the Internet from about 3 to 4 years ago you will see that most people were sure there would be a crash and only people that were already deeply invested in real estate were trying to think of ever more creative ways to deny it.
So Greenspan's statements speak more about him than the actual reality. He and the Bush government just surrounded themselves with economists from one very narrow school of thought and did not listen to anyone else. It is not that people did not predict the recession, it is that Greenspan would not listen to anyone who predicted it, therefore nobody that he bothered to listen to predicted it.
So they did the logical thing. They discontinued publishing the M3 statistic in 2006.
Yep, they decided we just need to bury our heads in the sand and the developing crisis would just go away.
But did it?
http://www.shadowstats.com/alternate_data/money-supply-chart...
The real challenge is to design a system with more stability.
My opinion is that while we have had many putative capitalists in charge of regulating markets, we have very little understanding of what it takes for markets to function well. One thing missing from the debate is an interest in reducing informational asymmetries. If I have two bags of apples one paper and one see-through plastic, you are going to buy the plastic bag (environmental issues aside).
Our financial markets don't work very well, because financial accounting is the opaque paper bag.
2) You know what they say about broken clocks and being right. Someone who is always predicting a collapse will successfully predict any collapse.
The guys always predicting collapses are crackpots. The normal people who called this bubble because they realized house prices had jumped without corresponding changes in income or demographics, but only changes in bank lending standards, were not crackpots.
That said, it is often worth paying attention to those who are a little bit outside the mainstream. That goes especially in economics, which is far from an exact science, and is full of political agendas.
Its a herd phenomena, with a real price rise enforcing the belief in the trajectory of those price increases.
But at some point, despite all efforts to recruit more people into the bubbly market, price increases slow then stall and beliefs change and the down trend inevitably begins.
The naysayers, the non-believers, those darn negative people who don't buy in and reinforce the bubble but actively try to save their friends, will always be swimming against the tide.
The difficult part is distinguishing between social proof and actual facts.
The fact is that most of us are followers and that will always be the case. That's how we're wired. If it weren't, societies wouldn't even be possible.
The best we can hope for is to keep the use of force out of the equation. We were all forced to take on the risks of all that lending, something we would not have done voluntarily.
Now we are on the hook for it and some day we will realize how truly costly it has been.
Til then, feel free to think of me as a crackpot.
Either that, or he will be me- a lucky satirist.
How far should this go? Anyone should be able to own and even construct derivatives. Such a market would bring along a host of educational material and means to understand the provenance of your derivatives and the counter-party risk. Obviously this accessibility and transparency would benefit professional derivative investors as the pool of clients, information, transparency, and alternative parties and views with which to trade expands.
But this is impossible as long as the notion of "qualified investor" exists. If Greenspan and traditional economics has any hope of being correct then what is needed is to enlarge the pool of "qualified investors" to simply everyone. We need not more regulation but less but for the requirement that the prospectus be accurate, intelligible, and anyone that sells "investments" must do business with anyone has the purchase price.
Taleb says market-based black swans are becoming more common. The question is: are they common enough to make a profitable business out of suppressing them?
I like to say that if Greenspan had replaced his famous "irrational exuberance" comment with one citing "incredible short selling opportunities for insightful investors" things would have turned out much better.
Notably he did speak up about Fannie and Freddie in the early 2000s but was silenced by the GOP's drive to make war -- nobody wanted the economy cooled at all when gas prices were already creeping up.
So what's the man to do now? He could admit all that about the war and cast serious doubt on the Fed's independence and the US financial system, or he could insist that the boom/bust was a complete and total mystery.
In his last book he goes to great pains to marvel at seemingly impossible "risk adjusted rates of return" throughout a variety of markets, but concludes that in the case of housing it's still "froth" and not a bubble. Since the bubble hadn't become obvious at the time of the book's publication, what else would he say?
But more practically, we should all realize that if housing prices had dipped about 1-2% less than they did, most of the damage would not have occurred. Our institutions (banks, etc.) were calibrated to handle some amount of systemic risk, but not as much as it turned out they should have.
Hindsight is 20/20 and Burry may have been extra prescient, but like any bettor he could have been wrong. Since he had no additional information than the rest of the market, we can conclude that the rest were all sheep (or idiots) or that there was actually some -- gasp -- chance going on.
The difference is that the majority of people, institutions, etc., misjudged just how much calamity would be caused by price deviations that they calculated to be highly improbable.
Wrong. Fannie and Freddie were protected by Dems, not Repubs. Mccain got his teeth kicked in over this one.
Interestingly enough, Fannie and Freddie execs during that time were largely Dems, most of whom who landed in the Obama administration. While at Fannie and Freddie, they took out millions.
Oh, and during this time, Fannie and Freddie were lying about the mortages in their portfolios, which threw off everyone's risk evaluation. (Their portfolios contained far more subprime than they admitted to.)
If Fannie and Freddie weren't politically connected GSEs, folks would be in jail.
He spent 99% of his political capital on war and at best 1% on everything else. He was far from powerless, having control of both houses of congress. The fact is he was perfectly fine with the GSEs being someone else's problem so nobody would get distracted away from the "war".
Incidentally the GSEs were taken off government books in order to make the budget look better so we could "afford" the Vietnam war.
In this matter, Bush's sins are sins of omission - as you point out, he didn't do anything. Dems did something, but what they did was wrong. For example, they actively protected Fannie and Freddie. Those are sins of comission.
Note that Bush didn't change the regulatory structure - he went with what Clinton left him. Again - omission vs comission.
It's the difference between manslaughter and murder.
And, that's ignoring ACORN's role. Among other things, they picketed banks that didn't make enough loans to folks who couldn't afford them. They tried to intervene with regulators. And so on.
Yes, Bush might have been able to keep this from happening, but he would have been fighting Dems the whole way.
He didn't fight. They pushed bad policies. There is a difference.
And, I note that Barney Frank is still in office and Gorelick, among others, are in the Obama administration.
Bush? Not in office.
And the revoking of Glass-Steagall under Clinton? That was introduced by Republicans in both the House and Senate, with the Senate vote being almost entirely on party lines. Yes, Clinton signed it, but it was a Republican bill.
If the recent crisis had been a bit smaller, existing reserve levels would have been fine.
If the crisis had been a bit bigger, then it's not certain whether even the previous reserve requirements would have been sufficient.
The only way you get 100% security is to have a 100% reserve requirement. Anything less is gambling.
So if you critique the lowering of reserve rates you are obligated to state what sort of odds you think are more reasonable.
Irrelevant because it didn't have any effect on the crisis.
In fact, it allowed some transactions that had some hope of slowing things down.
Note that the non-regulated institutions did better, as did the non-regulated arms of regulated institutions.
AIG was regulated up the wazoo.
Those "other lines of biz" provided some diversification that gave them some chance of survival. It also made it possible for banks to save some of the trading firms.
You clearly disagree, so let's have names.
That we were in a period of historically exceptional housing price growth was obvious to everyone at the time. I heard many people claiming to be the next Warren Buffet b/c their house had appreciated 20% in the past year.
The question we need to ask is, why were there initial calls to attend to the GSEs in 1999, 2000, 2001 but none after? I'd argue that it's because a) the extent of the problem was realized and those in power figured they'd let another president deal with it, b) those in power wanted to focus on their own agenda which didn't involve cleaning up the GSEs, or c) both.
Yet he did nothing, except that he did (see below), and what he did was counter to the above claim.
> The question we need to ask is, why were there initial calls to attend to the GSEs in 1999, 2000, 2001 but none after? I'd argue that it's because a) the extent of the problem was realized and those in power figured they'd let another president deal with it, b) those in power wanted to focus on their own agenda which didn't involve cleaning up the GSEs, or c) both.
You're forgetting Bush's bid in 2003 and McCain's bid in 2005. (The 2005 bill was actually considered in 2006.) So much for the "none after" theory. (Google "2005 mccain fannie freddie")
The evidence suggests that neither of the above theories was a major factor, that the driving factor was that every effort to deal with GSEs showed that it was an unwinnable fight. The populists wanted folks to get mortgages even if they couldn't afford them.
FWIW, during their brief tenure in the senate, Senators Obama and Clinton got more money from Fannie and Freddie than the chairmen of the relevant committees. In fact, their totals (over their entire tenure) were approaching the totals of those chairmen, even though the chairmen had been getting such donations for decades longer.
You can try to argue that Bush -- the guy who had control of both houses of congress and was able to sell an unpopular war -- was politically powerless do do anything, but that's just not persuasive. He decided not to make it a major issue... and he benefited tremendously from that decision... America felt rich while we waged a very expensive war and paid $5 per gallon for gas.
To use an analogy, maybe it was a Democrat who lit the cigarette and fell asleep, but it was Bush who saw the smoke, mentioned that a fire might start and then completely ignored it until it became a blazing inferno.
(I am not a member of either party so I am not intending to absolve Democrats of their share of the blame... but in this case I think most of it rests firmly on Bush's shoulders).
By the way, this was right before Mankiw got fired:
http://www.marketwatch.com/story/bush-adviser-warns-of-fanni...
Huh? 03 wasn't campaign season. And Mccain wasn't running for re-election every time he went after Fannie and Freddie.
I'm not claiming that Repubs, notably Bush and McCain, did a lot - I'm pointing out that they did do what you claimed that they didn't do. And, that they weren't pushing the other way, as Dems were.
As I've written before - manslaughter vs murder.
> You can try to argue that Bush -- the guy who had control of both houses of congress and was able to sell an unpopular war -- was politically powerless do do anything, but that's just not persuasive.
I'm not claiming that he was powerless. I'm claiming that he didn't care that much.
However, there's a huge difference between that and throwing gas on the fire.
> To use an analogy, maybe it was a Democrat who lit the cigarette and fell asleep
Except that that's not what happened. Dems insisted on pouring gas on the fire and fought anyone who tried to intervene.
Bush didn't fight back much. That's wrong, but it's not nearly as wrong as actively pushing bad policy.
> He decided not to make it a major issue
true
> and he benefited tremendously from that decision
false.
He didn't take a hit for trying to deal with it, but that's not the same as benefitting. And, Dems did benefit from it.
Lots of people benefited, but that doesn't make them as culpable as folks who pushed and defended the GSE's misconduct.
Plus, Bush did make some attempt to try to rein in the GSEs. Yes, he could have done more, but again, that distinguishes him from folks who opposed those efforts.
Surely you're not arguing that "Bush was a disaster on the war" implies "everything bad that happened is completely Bush's fault"?
Now, talk about "nobody could have predicted this" (c) Obama
If I could see it, anyone could have. I'm not particularly smart or well-connected.
[1] http://www3.sympatico.ca/taylormcgreal/thecomingcrash.html
The "good old boy" network was reluctant to admit that they all screwed up.
No matter how many people are yelling "soon, we're toast!", you won't hear it if you don't want to imagine such an outcome in the first place.
Boom.
The Fed engineers this stuff.
Whereas: Congress, the Federal Reserve, and the U.S. Treasury have put the American taxpayer on the hook for over $12 trillion in bailouts and loans; and
Whereas: Federal Reserve Chairman Ben Bernanke recently refused to tell Congress who has received trillions in these funds from the Federal Reserve; and
Whereas: Allowing the Fed to operate our nation's monetary system in almost complete secrecy leads to abuse, inflation, and a lower quality of life for every American
This is an obvious case of corruption of our government. No one was regulating because they didn't want to regulate it.
This is why there needs to be things like campaign finance reform and people should seriously go to jail without chance of being pardoned for these types of crimes.
Willful ignorance of this shit should have been considered aiding & abetting theft.
But no, no one will go to jail because the rich and powerful never go to jail. They didn't get rich and powerful by not being corrupt.
Greenspan was a goddamned Rayndian. Stephen Friedman had super strong ties to goldman sachs, In fact, almost everyone high up in the fed has ties to banking in one form or another. None of the people involved are even interested fair in regulation.
I don't understand why this is controversial. it is a fucking conspiracy and I'm calling it as it is.
Would my post have been better if I had suggested execution, or is the real reason it is downvoted because it is unpopular to call something a conspiracy?
we all tell ourselves these fairy tales about how the world is fair and there are no conspiracies and closed door deals between those in power, but it is all a lie.