Nobody Could Have Predicted
An interesting observation from John Quiggin:
One ‘black swan’ explanation of the mortgage crisis was that the mortgage derivatives created by Wall Street couldn’t fail except in the event of a simultaneous downturn in all major housing markets in the US, something that had never been observed, and therefore could not be included in the models. But of course the reason such a thing had never occurred was that local housing markets had been separate from each other, with their own sets of banks, S&Ls and other financial institutions. The very banks that were doing the modelling were creating the conditions under which a national bubble and bust could take place. This was both foreseeable and foreseen.
I would also say that if it’s really the case that financial risk models can’t account at all for the possibility that something that’s never happened before will happen, then these models seem really really worthless. It’s not like we have 100,000 years worth of data on what advanced economies look like. You have to expect the unexpected. I suspect that risk modelers understand that perfectly well, and this is just an exercise in post-hoc excuse-making. The fact of the matter looks to be something more like — a firm that followed a sounder risk-model would have gotten much lower short-run returns in a way that would have been bad for bonuses, bad for stock prices, and bad for attracting investors.
60 Responses to “Nobody Could Have Predicted”
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December 22nd, 2008 at 11:26 am
Were all the Jennifer-related posts deleted, or am I just the first?
Um, first?
December 22nd, 2008 at 11:26 am
Now we know Jennifer Palmieri’s views on home sales! Also Third Way’s official opinions.
I don’t know what Yglesias is doing but he isn’t writing on this blog. It’s been hijacked by Palmieri, CEO of Center for American Progress.
December 22nd, 2008 at 11:28 am
Matt Yglesias has partnered with the Finnish Ministry of Trade and Industry, the Train-lovers of Finland, the Finnish Professional Basketball Association and Se Kasvu-Tapa, a Helsinki think tank devoted to the promotion of Finnish incrementalism, to bring you this post.
December 22nd, 2008 at 11:28 am
Sorry Matt, but I just can’t read this shit anymore
December 22nd, 2008 at 11:29 am
Nothing damages a blogger’s credibility more than obviously ignoring a great big elephant in the room.
Just sayin’…
December 22nd, 2008 at 11:30 am
Matt, you are getting so small today I can barely see you.
December 22nd, 2008 at 11:32 am
Yeah, this is just getting weird.
December 22nd, 2008 at 11:32 am
Damn it matt! address the post made by Jennifer Palmieri!
did she threaten to fire you or something if you did address it?
December 22nd, 2008 at 11:34 am
A-W-K-W-A-R-D
Methinks MY is trying hard to bury the elephant in the room.
December 22nd, 2008 at 11:37 am
C’mon Matt… Cowboy up and just post a note to your readers.
December 22nd, 2008 at 11:37 am
This post has been read and approved by Jennifer Palmieri, CAP, the Obama transition team, the DLC, the DSCC, Goldman-Sachs, Blackwater and the AARP.
December 22nd, 2008 at 11:40 am
Seriously matt, you’ve been trowing up posts at a rapid pace and nobody will mind them until you address this, if you’re getting advice by Jennifer Palmieri to bury her post so it’ll go away, remember she caused this mess.
Until you’ve told us what the bleep was going around here, it’s not going to stop. You’re doing yourself harm here.
December 22nd, 2008 at 11:40 am
I forgot: most importantly, this post has been read and approved by Third Way, an excellent group working hard on work products for liberal ideals.
December 22nd, 2008 at 11:42 am
I’m sure Matt is waiting to be given permission to respond.
December 22nd, 2008 at 11:45 am
From the housing thread:
“I’ve been asked by CAPAF and CAP management not to discuss internal policies or mention Third Way any further, and I’ve agreed. I’m asking my commenters to respect that too.”
December 22nd, 2008 at 11:45 am
Ya but did anybody read any accounts of people buying houses worth 5 times their income on zero down, interest only, super double bonus option ARMS? The owners were maxed out with 2 incomes just paying the teaser rate, the teaser didn’t even cover the interest, and the remainder of the interest was negatively amortized back onto the principal.
In other words, not predictable my foot. Lenders deliberately wrote these loans with every intention of locking homeowners into a lifetime of interest payments and refinancing fees. Lenders fully intended to foreclose on the properties.
December 22nd, 2008 at 11:46 am
> Until you’ve told us what the bleep was going around
> here, it’s not going to stop. You’re doing yourself
> harm here.
Telling the people who sign your paycheck to their face that they are incompetent idiots is not a good idea in all but a very few organizations on Earth. Matt’s bosses have made fools of themselves and are probably now well aware of that. Plus the blot spotlight has now been turned, quite deservedly, on Third Way and its connections to the Obama Administration. There isn’t anything Matt can do that would help him in any way, so don’t hold your breath waiting for a post about the mess.
Cranky
December 22nd, 2008 at 11:48 am
The thing that’s infuriating about the goddamm ass-licking apologists for the Republicans and Wall Street is that their bullshit is an insult to our intelligence.
It’s the equivalent of saying “Hey, just because we drunk a fifth of Jack Daniels before climbing into our car is no reason for you to blame us for hitting that other car and killing that family.”
Weren’t these the same two-faced assholes who were declaiming about poor peoples’ lack of personal responsibility a few years ago?
December 22nd, 2008 at 11:48 am
Small fuckups happen. But when CATASTROPHIC FUCKUPS happen it’s because someone got bought off.
December 22nd, 2008 at 12:03 pm
The Talebian “Black Swan” strikes again!
December 22nd, 2008 at 12:07 pm
> I guess some people find it comforting to think that
> there is some intelligent design, even of an evil
> kind, behind all catastrophes. But the problem with
> this attitude is that it suggests these problems can
> be dealt with at the level of individual incentives
> and disincentives. However, in truth human beings
> are fallible even with the best of incentive structures.
Up until 2003 I used to post similar comments (from 1983 on in fact). Post-2003 the problem is that the Cheney Gang has shown that it is quite possible for a fairly large group of people with large amounts of power to act malevolently in secret, keep their actions secret, and not only hide their tracks but use the legal system to prosecute anyone who investigates much less opposes them. So it is quite a bit harder to argue that there are no such things as conspiracies any more.
Cranky
December 22nd, 2008 at 12:08 pm
It’s not even true that prices had never fallen across much of the country before. It’s sort of true, but only if you temper some line about the fall in home prices (e.g., in the Depression, in the late Reagan years) by saying that there were geographic movements of workers in some areas of the country that should also be noted.
But that aside, the argument for not imagining a widespread fall sounds simply illogically, since it requires not noticing a widespread rise. Logic aside, it also means dismissing those who did foresee a fall, who were not inaudible.
All one can claim is not having seen the shift in financial institutions that would change the effects of a crash, from simply hurting home prices, hurting people who depended on their home’s value, and auguring a recession by decreasing demand. This time, it’d also mean a crash in the financial industry. And in fact I didn’t foresee that myself. But the deregulators who permitted it might have.
December 22nd, 2008 at 12:11 pm
@ibc
But there’s no way of knowing if anyone posting comments as Yglesias or Matthew Yglesias is actually the owner of the blog. Plus, there’s a suspicious absence of spelling errors and typos.
December 22nd, 2008 at 12:12 pm
Well, he did put up something a few posts back:
And thus ends another interesting blog. It’s been a fun ride, Matt. Glad we could be of service (and I’m not being sarcastic) in helping you getting a step up to do the stuff you wanted.
December 22nd, 2008 at 12:16 pm
Were these scheduled posts?
Matt are you alive? Were you eaten by the gazzionaires who run Third Way? Does Jennifer have you locked in the basement?
Wassup?
December 22nd, 2008 at 12:18 pm
It becomes clearer if you look at it as a mortgage backed securities bubble rather than a housing bubble. The housing bubble was an effect, not a cause.
During a normal period of upswing in housing prices, these securities became a hot commodity. To make more of them, you need more mortgages. More mortgages means more house purchases. However, you can’t push sales by lowering prices of houses (it defeats the purpose), so instead you lower interest on mortgage loans. This boosts both sales and prices, in a nationwide manner.
Housing prices didn’t rise because of a desirability of location, like usual, instead they rose because borrowing money became cheap. Low interest rates went beyond national, to international effects.
December 22nd, 2008 at 12:18 pm
<i?The fact of the matter looks to be something more like — a firm that followed a sounder risk-model would have gotten much lower short-run returns in a way that would have been bad for bonuses, bad for stock prices, and bad for attracting investors.
This also illustrates why regulation is actually good for business, in the long run. Honest dealers are driven out by chiselers and fraud-peddlers. You need someone certifying weights and measures in a bazaar–otherwise the people selling short will put the ones who provide full measure out of business. You want someone enforcing safety at a meat packing plant, or the corner cutters will put the safety conscious out of business.
December 22nd, 2008 at 12:18 pm
Wow, Matt’s hit the front page at Josh’s. That’s Kos, Atrios, and now TPM, all of whom seem to value Matt’s independence more than he himself does.
December 22nd, 2008 at 12:20 pm
Oh, the point I was trying to make is that a commodities bubble is not a “black swan”. The fact that the securities were backed by mortgages should not have changed the swan black.
December 22nd, 2008 at 12:53 pm
Ironically, some people were calling this a housing bubble way back in 2004 and 2005. I believe the Economist was one such publication. There were a number of clues: the meteoric rise in prices vs inflation, the gap between cost to rent and cost to own, and the rise in non-owner occupied.
A lot of people had their “heads in the sand” on this issue, they chose to ignore the warning signs because “housing always goes up” and “housing is the safest investment”. Now they are burned. Some people put 10 or 20% down and the market crashed so hard that they are underwater. I feel bad for these people.
December 22nd, 2008 at 1:01 pm
DTM,
I was going to just slam you on that mean post to Matt, but then you wrote something intelligent in response to another commenter that I do not think is accurate.
It is not that difficult to write/create quantitative models that would account for things that have never happened before. You just have to have some imagination. Additionally, these were people working in finance, so they were being paid like 3x as much as other people with similar backgrounds. Additionally, a tried and true method of risk management called “scenario analysis” has been developed to address exactly this issue.
Also, anyone with any modeling experience knows how easy it is to plug in crazy-ass numbers into the model and see what you get. In fact, this is usually a big part of the testing phase.
December 22nd, 2008 at 1:30 pm
mickslam, in many cases people evaluate the financial modelers simply on whether or not they come up with the answers they want. The models are often a cover-your-ass rationalization. If you can “plausibly” tinker with the assumptions to make the salespeople happy, that’s what will happen.
December 22nd, 2008 at 1:58 pm
Economists (like myself) are well aware that integrating spatial markets can bring lots of economic benefits, but the very act of tying those markets together means that there’s going to be more integration between those markets. It’s unfathomable to watch a nationwide boom in housing prices and not include the possiblity of a nationwide bust. We’re actually hiring a financial economist this year, and I’d throw any bum out on the street who presented a model that didn’t allow for this simple fact. But perhaps that’s the difference between acacemia and industry.
The other thing that’s relevant here might be the Lucas Critique. These modelers had basically observed that teams usually punted on 4th down, and built their models assuming that teams usually punt on 4th down. Of course, the rules of the game had changed, and now teams got 5 downs, and they weren’t punting on 4th down anymore…
Two other points: Matt’s essentially describing a Prisoner’s Dilemma, which I think has some traction in thinking about this crisis. All firms would be better off playing safe, but there’s gains to be made by an individual firm playing for the big gains, and thus firms play it risky. And so the resulting equilibrium is crap for everyone. Not a perfect model (none are), but I don’t doubt there was some of that. You can imagine the guys earning a safe return getting hassled by their bosses for not pulling in 12% like the guys across the street.
December 22nd, 2008 at 2:08 pm
Re DTM’s comment “Dinosaur #1: Is that a giant asteroid about to hit the planet?
Dinosaur #2: Yep. I wonder who got bought off?”
——————-
False Analogy. The government does not govern the orbits of the asteroid belt.
The government does –or is supposed to –regulate Interstate Commerce.
Every day, millions of the most stupid fucking people on the planet get into their cars and drive millions of miles. 99.999999 percent of them make it to their destination.
A few car wrecks per day is understandable. Several million fucking cars running off the road at the same time is not.
There is simply NO explanation for a fuckup of this magnitude other than deep criminal corruption.
Past and present Republican Members of Congress will be fortunate if they don’t end up swinging from the fucking trees sometime over the next 3 years.
December 22nd, 2008 at 2:55 pm
Sorry but let’s assume that somebody put the total collapse of the entire housing market into the model. What’s the probability that would be assigned? 1% or something close is what would be my assumption. Then it wouldn’t really have effected the model much
Problem was that it just got to complicated for people to comphrehend. One guy said to me when I was working at a hedge fund – that a lot of these derivatives were dreamed up by people who were the only ones who could accurately (or sort of accurately) value them so they’d make money on the arbitrage. Close to the truth. By the by the guy who ran the hedge fund said that a lot of this was cruising for a fall and made money betting agains these guys
Great boss, great investor, far more right wing then me.
December 22nd, 2008 at 4:45 pm
I could tell it was going under when I saw the working poor in my neighborhood buying new houses, and I suspect that the models were made to bamboozle investors.
December 23rd, 2008 at 1:12 am
If it wasn’t predictable, how did some people get it right? If the models weren’t correct, that doesn’t mean there aren’t models that could be correct. It just means the models need to be improved to account for what people like Jim Rogers were saying all along. Bubbles burst.
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