Biden: "We Misread the Economy"

SergeantPsycho said:
So vice-president Biden made a satement yesterday that "We and everyone else misread the economy". I don't think I need to state my position, but I'd like to hear everyone else's.

HOW DID THIS HAPPEN?
Why the Economic Crisis Was Not Anticipated
By RICHARD A. POSNER

An article in the October 11 New York Times attributed the almost universal failure to anticipate our current economic crisis to "insanity" — more precisely, to a psychological inability to give proper weight to past events, so that if there is prosperity today we assume that it will last forever, even though we know that in the past booms have always been followed by busts. But experts on the business cycle, such as Federal Reserve Chairman Ben Bernanke, are not confined to basing predictions on naïve extrapolation. So why did he and other experts, inside and outside of government, neglect warning signs of a coming crash?

Real-estate bubbles are common. The supply of "good" land is fixed in the short run, the housing stock is extremely durable and therefore does not expand rapidly when demand increases, and land and the improvements on it cannot be sold short. And the bursting of a real-estate bubble can lead to bank insolvencies — as it did in Japan in the 1990s — because most real estate has heavy indebtedness, financed by banks or other financial intermediaries, and real-estate debt is a significant fraction of all debt.

When the rise in housing prices began to slow in 2005 after an increase of more than 60 percent since 2000, the press began talking about a housing bubble. Newspaper articles featured such headlines as "Housing Bubble Is Real, So Don't Get Hurt When It Finally Pops," "If Housing Bubble Pops, Look Out!," and "Hear a Pop? Watch Out." Yet in October of that year, Bernanke, then on the Fed's board of governors, denied there was a housing bubble, saying that "these price increases largely reflect strong economic fundamentals." The alarm bells were sounded ever more loudly in the following years. On August 17, 2008 — just a month before the financial tsunami struck — The New York Times Magazine published an article revealingly titled "Dr. Doom" about an economist at New York University named Nouriel Roubini, who, for years, had been predicting with uncanny accuracy what has happened. Two years earlier Roubini had "announced that a crisis was brewing. In the coming months and years, he warned, the United States was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence and, ultimately, a deep recession. He laid out a bleak sequence of events: homeowners defaulting on mortgages, trillions of dollars of mortgage-backed securities unraveling worldwide, and the global financial system shuddering to a halt. These developments, he went on, could cripple or destroy hedge funds, investment banks, and other major financial institutions like Fannie Mae and Freddie Mac."

No one in a position of authority in government, and very few in business or academe, heeded the warnings. In May 2007 Bernanke said, "We see no serious broader spillover to banks or thrift institutions from the problems in the subprime market," though by then many banks and thrift institutions were insolvent. In February 2008 he said, "I expect there will be some failures," referring to smaller regional banks that had invested heavily in mortgage-backed securities, but "among the largest banks, the capital ratios remain good, and I don't anticipate any serious problems of that sort among the large, internationally active banks that make up a very substantial part of our banking system." The financial crisis, when it finally struck the nation full-blown in September 2008, caught the government, the financial community, and the economics profession unawares.

We can get help in understanding the blindness of experts to warning signs from the literature on surprise attacks. Before the Japanese attack on Pearl Harbor, there were many warnings that Japan planned to attack Western possessions in Southeast Asia, and an attack on the U.S. fleet in Hawaii, known to be within range of Japan's large carrier fleet, was a logical measure, on Japan's part, for protecting the eastern flank of its attack on the Dutch East Indies, Burma, and Malaya. The warnings were disregarded because of preconceptions (including the belief that Japan would not attack the United States because it was too weak to have a reasonable chance of prevailing), the cost and difficulty of taking effective defensive measures against an uncertain danger, and the absence of a mechanism for aggregating, sifting, and analyzing warning information flowing in from many sources and for pushing it up to the decision-making level of government.

Similar factors made it difficult to heed the warning signs of the 2008 financial crisis. Preconceptions played an especially large role. It is tempting, indeed irresistible under conditions of uncertainty, to base policy to a degree on theoretical preconceptions, on a worldview, an ideology. But shaped as they are by past experiences, preconceptions can impede reactions to novel challenges. Most economists, and the kind of officials who tend to be appointed by Republican presidents, are heavily invested in the ideology of free markets, which teaches that competitive markets are, on the whole, self-correcting. Those officials and the economists to whom they turn for advice don't like to think of the economy as a kind of epileptic, subject to unpredictable, strange seizures.

And not just Republican officials and the economists who advise them. President Bill Clinton's economic policies were shaped by establishment Wall Street figures, such as Robert Rubin, along with economists like Alan Greenspan, a conservative, and Lawrence H. Summers, a moderate. The many positive experiences with deregulation and privatization, the many economic success stories that followed the collapse of communism, and the many failure stories of countries that curtail economic freedom supported this belief system and made it bipartisan. There hadn't been a depression in the United States since the 1930s, and economists believed and were assuring the public that there would never be another one because they had learned how to prevent depressions. Overconfidence is a common cause of being surprised.

Moreover, taking action to reduce the risks warned against by Roubini and a few others would have been costly. Had the Federal Reserve caused interest rates to rise in order to curtail risky bank lending, that would have accelerated the bursting of the housing bubble — and then, since no one could be certain that it was a bubble, the Federal Reserve would have been blamed for the fall in home values and the increase in defaults and foreclosures. Those benefiting from the bubble would deny it was a bubble, and sometimes they would be right, and if they were wrong but the bubble was pricked before it had expanded to a very large size, there would be great difficulty in proving that it had been a bubble. One can't expect to receive praise, or even to avoid criticism, for preventing a bad thing from happening unless people are sure the bad thing would have occurred had it not been for the preventive effort. If something unlikely to happen doesn't happen (and, by definition of "unlikely," it usually will not happen), no one is impressed. But people are impressed — unfavorably — by the costs incurred in having prevented the thing that probably wouldn't have happened anyway.

And virtually all warnings are premature, because the date of a warned-against event is likely to be irreducibly uncertain. No one — not even Roubini — could predict the day on which the housing bubble would burst, or indeed the week, month, or year. Furthermore, it is impossible to perform a cogent cost-benefit analysis of measures to prevent a contingency from materializing if the probability that it will materialize is unknown. The cost of a disaster has to be discounted (multiplied) by the probability that it will occur in order to decide how much money should be devoted to reducing that probability. No one could have calculated the probability of a financial crisis such as we are experiencing.

Even if the probability of some adverse event is known, it may not pay to try to prevent it from occurring unless the cost if it does occur is likely to be very great. It should have been expected that the bursting of the housing bubble would result in a recession centering on the financial markets, because the banks were so heavily invested in risky home loans. But a recession is not a disaster. A depression is, but a depression would have seemed an unlikely consequence of a housing bubble. By September 2008, however, the probability of a very severe recession was high enough to warrant the government's undertaking costly efforts to try to prevent the risk from materializing. Yet the officials dithered. They dithered because they were surprised by the crisis and had no contingency plans for dealing with it. Dithering in response to a financial crisis is especially costly because of the adverse feedback involved in a depression. Once a spiral of falling demand, layoffs, a further fall in demand, more layoffs, and so on begins, it feeds on itself; it requires no external source of nourishment, no further shock to the economy.

Most people, even most experts, were especially unlikely to be persuaded by prophets of doom in the absence of a machinery for aggregating and analyzing information bearing on large-scale economic risk. Little bits of knowledge about the shakiness of the U.S. and global financial systems were widely dispersed among the staffs of banks, other financial institutions, and regulatory bodies and among academic economists, financial consultants, accountants, actuaries, rating agencies, mortgage brokers, real-estate agents, and business journalists. There was no financial counterpart to the CIA to assemble an intelligible mosaic from the scattered pieces. Much of the relevant information was proprietary; investment banks, hedge funds, and other financial firms conceal information about business strategies that might help competitors, and they soft-pedal adverse information about the firm's prospects. Even the regulatory agencies lacked access to much crucial information about the financial system, because of limitations on their authority that were thought appropriate in an era of deregulation. Lacking authority to regulate new derivative securities such as credit-default swaps, financial regulators could not force disclosure of information that might have revealed how risky the financial system had become.

A focus of reform, therefore, should be the creation of a centralized, unitary financial-intelligence apparatus in government that would have complete and continuous access to the books of all financial institutions. This sounds simple but the details would be complex, and in my view consideration of all nonemergency reform measures should be deferred until the current economic emergency ends, or at least until the recovery has begun. Until then, it is important that the financial sector be spared additional uncertainty concerning its regulatory environment — uncertainty that would exacerbate the tendency of the banks and other financial intermediaries to freeze and hoard in the present unsettled economic conditions — and that the designers of reform not be distracted by the urgencies of responding to the current crisis.

Richard A. Posner is a judge of the United States Court of Appeals for the Seventh Circuit and a senior lecturer at the University of Chicago Law School. This essay is a condensation of a chapter from A Failure of Capitalism: The Crisis of '08 and the Descent Into Depression, to be published in May by Harvard University Press.

SergeantPsycho said:
I don't think I need to state my position, but I'd like to hear everyone else's.

MrCrisp said:

If you're going to start a discussion, especially one without a source or description, you probably should. Otherwise, nobody will take you seriously. Oh wait...

SergeantPsycho said:

My bad, I thought it was common knowledge by now.
Here. Biden claimed that the economy was "Misread" when the stimulus bill was passed and that it was worse than they thought initially. My personal belief is that the Stimulus itself contributed to the lack of job growth. The money to pay back the debt incurred by the stimulus has to come from somewhere, so companies might be afraid to hire new people in the belief that they won't be able to afford to keep them employed once new taxes/tax increases are enacted. I'd like to go on the record as predicting that this won't be the last time this administration "Misreads" Economy.

SergeantPsycho said:

My bad, I thought it was common knowledge by now.
Here. Biden claimed that the economy was "Misread" when the stimulus bill was passed and that it was worse than they thought initially. My personal belief is that the Stimulus itself contributed to the lack of job growth. The money to pay back the debt incurred by the stimulus has to come from somewhere, so companies might be afraid to hire new people in the belief that they won't be able to afford to keep them employed once new taxes/tax increases are enacted. I'd like to go on the record as predicting that this won't be the last time this administration "Misreads" Economy.

motorfirebox said:

y'know, not to be a dick, but who cares what you think? not you, personally, but "you" the fiscal hyperconservative whose answer to every problem is to lower taxes and reduce regulation. what possible value could be gained from considering opinions based on the ridiculous Reaganomics voodoo that got us into this mess in the first place? the underlying paradigm guiding every aspect of your economic philosophy has been irrefutably shown to be crap. who cares what you think?

SergeantPsycho said:

My bad, I thought it was common knowledge by now.
Here. Biden claimed that the economy was "Misread" when the stimulus bill was passed and that it was worse than they thought initially. My personal belief is that the Stimulus itself contributed to the lack of job growth. The money to pay back the debt incurred by the stimulus has to come from somewhere, so companies might be afraid to hire new people in the belief that they won't be able to afford to keep them employed once new taxes/tax increases are enacted. I'd like to go on the record as predicting that this won't be the last time this administration "Misreads" Economy.

SergeantPsycho said:

It's not crap when applied thoroughly and properly, see the "Asian Tigers", Texas and Ireland. You'll have bubbles that burst, sure, but that's a healthy economic adjusting itself, no pun intended.

SergeantPsycho said:
It's not crap when applied thoroughly and properly, see the "Asian Tigers", Texas and Ireland. You'll have bubbles that burst, sure, but that's a healthy economic adjusting itself, no pun intended.

SergeantPsycho said:
My personal belief is that the Stimulus itself contributed to the lack of job growth. The money to pay back the debt incurred by the stimulus has to come from somewhere, so companies might be afraid to hire new people in the belief that they won't be able to afford to keep them employed once new taxes/tax increases are enacted.

Subrosa said:
Employment numbers are notoriously a lagging indicator, (though there is admittedly some debate as to how predictive an indicator it will be in the current economy.) Regardless, the fact is that job losses are generally a result of the health of the economy 4-8 months ago. The idea that somehow the stimulus is preventing people from hiring on new employees NOW is unsupportable and ridiculous.

Biden's statement was simply a way of noting that their targets were off, which is unsurprising considering that no one has ever really seen anything like this. I mean, make all the political hay you want over this, but it means very little.

Katieesq said:

Subrosa, what do you say in response to critics like Krugman, who say that the stimulus isn't sufficient, and the job losses are an indicator of that?

Subrosa said:

I've heard those critiques and think they're noteworthy. I'm certainly not qualified to tangle with Krugman over the economy, but I do think that the idea that the bulk of the effect of the stimulus is still a few months off seems reasonable. I find it hard to believe that if we're going to do a second stimulus that we'd NEED to do it in short order as Krugman seems to suggest rather than a few months down the road. But again, I don't have a Nobel Prize in Economics (yet.)

Katieesq said:
I'd agree with Krugman and Co. if I knew more about where the existing stimulus funds were being spent and if they've been spent yet. This article on France's stimulus suggests that stimulus projects were stalled in this country (though it's worth noting that in spite of that, the article thinks the United State's GDP will suffer less than France's). Knowing how much of the money still needs to be spent could indicate whether a new stimulus is necessary or the initial one hasn't succeeded yet.

SergeantPsycho said:
Biden claimed that the economy was "Misread" when the stimulus bill was passed and that it was worse than they thought initially. My personal belief is that the Stimulus itself contributed to the lack of job growth. The money to pay back the debt incurred by the stimulus has to come from somewhere, so companies might be afraid to hire new people in the belief that they won't be able to afford to keep them employed once new taxes/tax increases are enacted. I'd like to go on the record as predicting that this won't be the last time this administration "Misreads" Economy.

gfvella said:

Most of it has gone to infrastructure I believe. If you want instant stimulus you give tax payers direct hand outs like the labour party did here, which in turn drove record levels of consumer spending. However; the long term economic benefit of such short -term stimulus is dubious, but that is when you big infrastructure projects are meant to kick in according to theory.

Reality is that as Biden said everyone is really playing this by ear, almost day to day.