The Trouble With Prescience
Via Paul Rosenberg, a very interesting pre-crash paper from Dean Baker called “The Run-Up in Home Prices: Is it Real or Is it Another Bubble?” His conclusion was bubble. He marshals a variety of evidence for this conclusion, but the key point is simply that the notional value of homes was increasing much more rapidly than the actually observed price of renting a place to live:
The only problem with the paper is that it was published way back in 2002. Baker not only makes the case for the existence of the bubble persuasively, but he highlights most of the various ways in which its collapse will create huge economic problems. But in 2003, the houses are more expensive than ever. And in 2004, things have gone up even more. Then they keep going up in 2005. And then for another year! And this is precisely what makes bubbles so problematic. Even when you’re pretty sure you’ve identified one, this gives you almost no insight into questions of timing. Consequently, it’s quite difficult to use your insight to go make tons of money. And that in turn makes the bubbles more severe, since the skeptics are basically out on the sidelines.
And in the reputational economy of analysts the consequences are even worse. If you go along with the herd and then predict a problem a month before it arises, then you strike everyone as prescient. But if you start warning about something and then it doesn’t happen, and then you keep nagging people, and then you keep complaining about how nobody’s listening to you, you start getting dismissed as a crank. And when you’re proven right, you’re still that crank nobody wants to listen to. You don’t get hailed as a hero. But Ben Bernanke who made very mainstream mistakes and then pivoted adroitly once the bill came due does.
31 Responses to “The Trouble With Prescience”
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August 30th, 2009 at 8:48 am
I guess the way to check the validity of your theory is to graph Dean Baker’s appearances as a pundit in mainstream media outlets. Did his star rise after his alert on the bubble? Same goes for Doug Henwood.
Whatever the outcome of the analysis, both these guys are my heroes because by 2004 I had heeded their warnings and moved my savings out of the stock market.
August 30th, 2009 at 8:52 am
This is a very good point. Just to draw out the argument a bit further-
What this post gets at is first not merely why bubbles do not simply disappear on their own with the working of The Market. The point is first this basic Keynesianism, and the related necessity for various forms of centralized regulation.
But more than that, the citation of Bernanke and the “cranks” gets at how economic ideology has propagated itself over the last several decades. The rightist ideologies of the rational market and attendant deregulation survive because they survive the short busts integral to late capitalist economies, even though empirically these busts disprove fundamental tenets of reigning economic ideology.
It’s going to take something significantly more severe or more protracted to do anything significant about the contemporary practice of economics. I tend to think it would be a better path, rather than attempting to reform economics, to push people to give less credence to economics in deference to other fields that also have a lot to say about our society, and aren’t as fundamentally broken.
August 30th, 2009 at 8:54 am
But there were limits to Baker’s prescience. Notice that on p. 16 he praises the Fed for its adoption of a low interest rate policy to counter the collapse of the stock market bubble. This could and did contribute to the continuation of the housing bubble, which he had already diagnosed. So even the man with the correct diagnosis recommended the wrong policy. He was a “premature anticrashist.”
August 30th, 2009 at 8:59 am
this is a good point.
those of us who have wanted to but have refused to buy housing for the duration of the bubble and have spent years renting have lost the utility of ownership for those years. that’s been an annoyance, for sure.
and as i’ve been prone to say on other boards, nobody made money shorting the housing market in 2004. in fact i am sure that a lot of people lost hugely.
August 30th, 2009 at 9:32 am
“Consequently, it’s quite difficult to use your insight to go make tons of money.”
But isn’t it also kind of hard to time it in such a way as to “lose” a ton of money? Sure, if you just graduated from college in late 2005 and took out a huge mortgage you couldn’t afford, the crash killed you. But let’s say you bought your first house in downtown Baltimore in 1996. You probably paid $80,000 for it. Prices started rising, so two years later you sold that house and made $50,000, and bought a $150,000 in a better neighborhood. This kept happening, and pretty soon you were in a $500,000 house in a really good neighborhood when the crash came. Suddenly, your house was worth $200,000. So did you lose $300,000? Not really. You never really “invested” $500,000 in the first place. You used wealth that really didn’t exist to purchase a ridiculously inflated house.
Again, there are obviously tons of people who got stung by the crash. But I actually lived in Baltimore starting in 1996. I knew lots of people who kept telling me, “You HAVE to get into this market.” I, of course, was the crank. Way back in 1998. So these friends of mine had an entire decade of high living while I kept renting pretty basic bachelor pads. They were the smart ones for that whole time. Now, not so much. Either way, I have a hard time seeing how they “lost” any money on the process. I think very few of the houses have fallen back to their 1996 levels. The ones who are really hurting are the ones who used their equity to buy $65,000 SUVs and $200,000 boats.
These people are my friends. But come on. I have a really hard time feeling bad for them. Obviously, writ large, this is bad for the economy. But on a personal, individual basis, I think you have to take “crash” stories on a case by case basis. Many of the people I know would be doing fine if they hadn’t added the boats and SUVs to the mix. Moreover, they lived really, really, ridiculously luxurious lives for an entire decade. That has to count for something.
August 30th, 2009 at 9:51 am
I don’t know what the practical money-making implications of MY’s point would be. But the implications for what he calls “reputational economy” are pretty devastating. To respond to DivGuy @2 — what makes you think that the “reputational economies” of other fields respond in any more far-sightedly than finance does?
My observation is that academia actually works in very much the same way. In the 1980s it was hip to be a poststructuralist. Now it’s not. So, you figure all those people who hopped on the poststructuralist bandwagon got burned and are now discredited? Hell no. They accumulated name recognition by hopping on that bandwagon, and name recognition doesn’t disappear just because everyone is now on a different bandwagon.
In short, as herd animals, human beings are pretty crappy at accountability. We don’t tend to blame people who made mistakes … if we also made the same mistake.
It’s profoundly depressing but true. We celebrate a few famous examples, but on the whole the benefits of being “ahead of your time” are pretty skimpy. It’s easier to accumulate a reputation for wisdom by making the same mistakes as everyone else.
August 30th, 2009 at 10:01 am
@5 – Your friends lost $300,000 because someone gave them $500,000 and now want your friends to give the whole amount back to them (regardless of what the asset they bought actually now costs). Yes the economy didn’t actually lose anything in aggragrate, but your friends definately did.
August 30th, 2009 at 10:04 am
Not to sound too cynical, but … this is actually one of the first things grad students have to learn. Because the mythology of academia is all about prescience and cutting-edgery, they come in thinking that they should choose a topic no one else has worked on, to maximize originality. And they’re terribly depressed if they discover that someone has worked on a related theme. But in reality, it’s very hard to get recognition if you’re working on something that’s genuinely “out there.” For a junior scholar, it tends to be prudent to work in an area where there’s an established conversation, so hiring committees will be capable of recognizing the significance of your work.
August 30th, 2009 at 10:11 am
Nationally home prices peaked in the second half of 05. I am uncertain if that is median or average but I’ve seen that date enough from multiple sources to consider it true.
Home prices stopped rising when mortgage credit peaked. The home price inflation was just the result of the mortgage mania. It was a credit phenomena. There is no chicken or egg question in this matter. Home prices could rise as long as mortgage credit continued to rise. Predicting the end of that was no easier than any other prediction however.
The thing about real estate however is that prices are always very slow to roll over at the top of a cycle. Sellers refuse to lower prices at first. So houses just go unsold and prices remain high for a long time. The scope of the looming disaster was ignored by everyone which had devastating consequenses. The majority of foreclosures and bad MBS’s date from after the price peak. Well they did but now we have moved on.
The so called sup prime problem was almost entirely a post 05 problem. Wall Street and the financial sphere were desperate for more mortgage paper so on down the line the mortgage industry did everything possible to fill the demand. Anyone breathing could get a mortgage. This was something Greenspan knew about and encouraged. The political sphere was ignorant of it. After all if all voters were going to get rich on their homes what’s not to like?
August 30th, 2009 at 10:12 am
jmaouro,
But the friend bought a house in 1996 that cost $80,000. A year later, that same place was worth $130,000 or $150,000. Same place. Nothing changed. So he traded that in and bought a $150,000 house in a different neighborhood. A few years later it was worth $300,000. He traded again, bought a $300,000 house that soon appreciated to $500,000.
It’s now worth $200,000. So did he lose $300,000? Well, no. He only paid $300,000 for it in the first place.
Did he lose $100,000? I don’t think so. He had $80,000 invested from the get go. He could keep trading down back to that original house, and the loss would be lees than that.
August 30th, 2009 at 10:15 am
Dean Baker sold his condo in 2004; a few months ago, he bought a house, using that $8,000 “new homeowner” tax credit. Mark Kleiman (Reality Based Community) has also written many times that he sold before the bubble burst. Something tells me neither one of them worried too much about being seen as a crank or a hero — all the way to the bank, as they say.
August 30th, 2009 at 10:22 am
I don’t think that is very true. Krugman, who predicted the bubble for a long time, is widely respected even by people who disagree with him. Cranks get dismissed as cranks…the fact that they might be occasionally right has nothing to do with it.
And quit with the Ben hating. He is considered somewhat of a hero for his unprecedented response to the greatest challenge our economy has faced since the great depression. The fact that he did so despite the opposition of the conservative leaning “market uber alles” economists (his ideological peers as some would say) is somewhat praiseworthy. No one is saying he was the most prescient guy out there. His true convictions and bonafides will be determined by his role (or not) in designing a new financial regulatory regime.
August 30th, 2009 at 10:30 am
Sam’s story is beautiful. Everyone who had that experience thought that they were smart and savvy, and profiting from their acumen. Thinking they deserved it. When in fact it was just inflation. Vast amounts of credit were extended for real estate which begat more demand and higher prices then more demand for credit, in a virtuous circle. A new age was declared, reliably. Prices will never fall many a tout declared, probably believing it.
Any market which is rising attracts money, liquidity. When most of that money is borrowed as it always is in real estate a particularly bad systematic condition arises. Local and regional RE bubbles have been common in US history. Their dynamics well understood, if your willing to look. Florida has had many of them. Always fueled by easy credit and the promise prices would never fall. Since perhaps only the 1840’s saw a national bubble a lynch pin of the mania was that there could not possibly be a national crash. This was the final lie which fueled the last desperate bubble expansion, after 05.
August 30th, 2009 at 10:33 am
You mean Rosenberg didn’t write 7,000 words and attempt to create some abstract historical model while name-dropping his grad school intellectual heroes? All the while making his cutesy, smug unfunny asides in the comment threads at *anyone* who may disagree with his brilliance? The guy is one of the biggest blowhards on the web.
August 30th, 2009 at 10:44 am
Regarding Bernanke, I’m surprised no one has noted that Matt is channeling Keynes….
Keynes once noted that ‘a sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way with his fellows, so that no-one can really blame him.’
Bernanke is respected because the first half of his first term he was a sound banker. The jury is still out on the remainder of his terms(s).
August 30th, 2009 at 10:46 am
You mean Rosenberg didn’t write 7,000 words and attempt to create some abstract historical model while name-dropping his grad school intellectual heroes?
Well, there was a vacancy for that position ever since Stirling Newberry stopped blogging, and Rosenberg was chosen among many qualified candidates to fill that role.
August 30th, 2009 at 10:49 am
But Ben Bernanke who made very mainstream mistakes and then pivoted adroitly once the bill came due does.
It’s sad that these stories become conventional wisdom. Ben Bernanke did make very stupid mistakes, along with the rest of the Fed board and most mainstream (read supported by wall street) economists.
Bernanke agreed with Greenspan that a bubble must run its course and then the mess can be cleaned up.
I think that, rather than “pivoting adroitly”, what Bernanke has done is to partially reinflate the bubble and merely postpone the day of reckoning. At great cost to the US economy.
Dean Baker and others are saying the same thing, but of course, Baker is a crank.
August 30th, 2009 at 10:51 am
There is another wave of foreclosures coming. In addition perhaps a million homes currently in default or foreclosed have not been put on the market.
There is no market for mortgage backed securities. Virtually all mortgages being made today are being purchased by the GSE’s and their old cousin now in the forefront, the Federal Home loan Bank. In other words there is no private money extending residential real estate credit. The market is limping along and taxpayers are now assuming all the risk of future losses. If the government was not ultimately supplying virtually all mortgage credit there would be no mortgages. No mortgage money and prices would fall precipitously again.
In some areas now homes are being bought, inevitably forclosures, for cash and rented. This is a very good thing. When that makes sense the market has found a rational price.
The worst hit areas are going to be the very far suburbs. Nobody want’s to live 50 miles from the job anymore. Many an ex urban development is going to end up bulldozed.
August 30th, 2009 at 10:59 am
Nobody want’s to live 50 miles from the job anymore. Many an ex urban development is going to end up bulldozed.
Nobody ever wanted to live 50 miles from their jobs. The housing bubble didn’t suddenly make people want to have 1.5 hour commute. What will collapse — slowly — the super-exurbs will be Peak Oil. If we don’t change zoning rules to allow lots denser housing we’re going to be screwed real soon.
August 30th, 2009 at 11:19 am
[...] Matt Yglesias explains why there is no professional benefit to being prescient in the economic world: [...]
August 30th, 2009 at 11:39 am
Dean Baker is a Keynesian who supports the insane policy of monetary dilution. In his instant paper, he wrote:
This year, in the pathetic book “Meltdown: How Greed and Corruption Shattered Our Financial System and How We Can Recover” edited by Katrina vanden Heuvel, he wrote the same nonsense on page 129:
This sound just like Friedrich Hayek explaining to Bill Buckley the essence of Keynesianism as explained to Hayek by Keynes: A ruse to lower wages without the victims knowing what hit them. And that low interest rate policy sure worked out great, didn’t it?
I would also note that having the Fed give “warnings” about bubbles is absurd. Why not just get it out of the business of creating them?
Fiat money creation is the intentional policy of the government central bank to dilute the money supply which results in the theft of purchasing power from those holding the old money to those receiving the new money first. It is “stimulating” only in the sense that a) people are tricked into receiving lower wages or prices without realizing it; and b) people getting the new money are, in effect, getting some “free” money. Let’s spend it — whoopie! The entire process is outrageous and immoral. There is no factual, logical or historical basis to suggest that anything good can come from it. As the Austrian Business Cycle Theory has demonstrated long ago, the process totally distorts the investment and capital structure leading to an inevitable boom following by an inevitable bust.
As Baker naively noted in his paper:
No sh*t, Sherlock.
All of these bubbles were the result of Federal Reserve monetary dilution. Even so, Baker then calls in 2009 for more Fed monetary dilution which will only further muck up the investment and capital structure of the economy preventing it from liquidating malinvestments and only prolonging the depression.
The Fed was created by the big bankers for the big bankers. The Fed is an artifice of theft, fraud and poverty creation, and Keynesianism is the web of deceit used to trick, fool and confuse the public. And you “progressives” are its biggest cheerleaders.
Pathetic.
August 30th, 2009 at 12:32 pm
Note well that Dean Baker used the causal analysis of Hayekian
macro here — artificially low interest rates led to malinvestment in housing capital and financial speculation in housing capital. Also straight out of Friedrich Hayek is the juking of conumption and the crash in savings — even as long term capital investment was spiking.
This is all straight out of Hayek — and several economists used Hayek to provide the same analysis as Baker.
Your hero here is a Hayekian macroeconomist. Live with it.
August 30th, 2009 at 12:55 pm
Re: But there were limits to Baker’s prescience. Notice that on p. 16 he praises the Fed for its adoption of a low interest rate policy to counter the collapse of the stock market bubble.
In early 2002 (or now, for that matter) there was good reason for a low interest rate policy: that is how the Fed fights recessions. But by 2003 those reasons had disappeared.
Re: Wall Street and the financial sphere were desperate for more mortgage paper
This is nonsense. Wall Street was certainly more than happy to securitize anything it could get, but that’s not where the speculative fever came from. It came first of all from a large number of ordinary people thinking they had found a get-rich-quick scheme in house flipping, or else tempted to take easy money from HELOCs and cash-out refis. Then you had the mortgage brokers and real estate industry in general eager for sales, sales, sales. And some extraordinarily reckless mortgage companies running what was basicaly a Ponzi scheme, and in which a lot of formally reputable banks yielded the temptation to join. Wall Street played a role, true, but it did create the bubble on its own. Morever by 2006 it began to dawn on Wall Street that too many of the new mortgages were going bad, contrary to what the models predicted. Analyses was done and the truth was discovered: too many mortgages were based on inflated appraisals and outright lies about borrowrs’ income and living intentions. This is when the breaks came on, when Wall Street began vetting mortgages much more closely before buying them for securitization, and the resulting increase in rejections is what started the dominoes falling.
Re: I think that, rather than “pivoting adroitly”, what Bernanke has done is to partially reinflate the bubble and merely postpone the day of reckoning.
Um, where has the bubble reinflated? There are a very few markets in which real estate has shown some modest gains– again, VERY FEW. In most markets real estate has fallen or at best remained flat. There’s no bubble out there, except the last remnants of a collapsing one.
Re: Nobody want’s to live 50 miles from the job anymore.
But in some of these areas people who don’t work (e.g., retirees) at all or who work locally will be happy living. It’s a mistake to think that everyone works downtown these days and if a suburb is 50 miles from downtown everyone living there must have a 100 mile round trip commute.
August 30th, 2009 at 1:23 pm
Keynes: It’s better for your reputation to fail conventionally than succeed unconventionally (quoted from memory, so that’s not exact).
August 30th, 2009 at 1:30 pm
“Nobody want’s to live 50 miles from the job anymore”
I think this is wrong. I know a ton of people who want to live 50 miles from their job. The thing is, they don’t want ANYONE ELSE to live anywhere near the road they use to get there. They want a gargantuan, eight-lane highway directly from their town to the office, and they want free parking when they get there.
This would give people a 50-minute commute and relatively low costs. It would also allow them to live in a quaint, uncrowded small town, with all of the benefits such as low cost of living, plus easy access to all the amenities that a city offers.
Sadly, it’s completely unreasonable to expect this to be a sustainable situation. As many people from Northern Virginia now know.
August 30th, 2009 at 1:48 pm
Um, where has the bubble reinflated
The price of oil has doubled since January despite a severe recession. The stock market is up considerably in spite of grim outlooks for most business. In my view those are bubbles caused by Fed policy.
August 30th, 2009 at 2:24 pm
The price of oil has doubled since January despite a severe recession.
Peke Oil.
http://www.princeton.edu/hubbert/images/chart-5-27-08-t.gif
The chart is pre-Burst Bubble, pre-Recession, but it’s an apt teaching tool.
August 30th, 2009 at 4:02 pm
Re: The price of oil has doubled since January despite a severe recession.
This is true, and I suspect that speculation is at the root of it. Note however that the price of oil has not continued to climb and is set to fall a bit in the autumn and winter. If this is a bubble it’s a very small one, and self-limiting.
Re: The stock market is up considerably in spite of grim outlooks for most business.
The stock market fell too far, IMO, prices driven down by panic and hysteria, and the rally we’ve seen has been a mild correction. We are certainly well off the highs of the past! Also, I disagree that the outlook for most businesses is “grim”. The recession is ending, albeit slowly, and the stock market is anticipating the recovery. No boom, no bubble, just a gradual, moderate recovery.
August 30th, 2009 at 7:33 pm
Is there an economist who includes the manic aspect of a bubble? There was a definite emotional aspect to the housing bubble. Saw the same thing happen with marriage in the nineties, and wonder what the divorce rate is for that batch.
I watched the whole housing bubble from the vantage of a person who had no intention of doing anything but renting, and it looked pretty crazy. The home make-over shows proliferated, and it seems like a lot of people were entranced. Suddenly, buying a house was the thing to do, and I couldn’t see any reason for that to be the thing to do. Houses were already ridiculously overpriced, and the middle class was more indebted than ever. I was completely floored by the whole idea of buying a house with no money down.
Now those home make-overs are for selling homes.
August 30th, 2009 at 8:55 pm
What did Roddis just say? Baker is a pathetic Austrian Keynesian ? That sounds awful, whatever it is.
The Austrians have been predicting disaster for 75 years or so, and sooner or letter they’ll be right.
August 31st, 2009 at 10:07 am
Savvy and entrepreneurial real estate investors have a saying — “you are only as successful as your last deal.” Because the habit in America is to keep leveraging up, you can and often do lose all accumulated equity as soon as you enter into your first unprofitable real estate venture.
Overlooked in the bubble, also, are people like a friend of mine who, in 2005, thought that prices had gotten out of hand but literally could not find any property that she could rent in order to keep her children in a particular school district. I guess they should have tried harder, because they are almost certainly upside down on their house, which they financed with the proceeds of their previous house. I don’t know if they have lost all the equity from that house, but they have certainly lost most of it.