Do you find it odd that so few economists foresaw the current credit disaster? Some did. The person with the most serious claim for seeing it coming is Dean Baker, the Washington economist. I saw it coming in general terms.

But there are at least 15,000 professional economists in this country, and you’re saying only two or three of them foresaw the mortgage crisis? Ten or 12 would be closer than two or three.

What does that say about the field of economics, which claims to be a science? It’s an enormous blot on the reputation of the profession. There are thousands of economists. Most of them teach. And most of them teach a theoretical framework that has been shown to be fundamentally useless.

“I like this new requirement, a la slocum et al, that to claim success in predicting a collapse you have to predict all the details of how it happened. That’s the kind of optimism which will definitely help us to avoid the next one.

I presume 100 years from now there will be a neo-slocum claiming that climate scientists didn’t predict anything, because they got the final equilibrium height of the oceans 3 cm wrong, or somesuch…”

I am curious if someone a 100 years from now provided a link in which they claimed to have predicted the disastrous consequences of global warming and it looked something like this

“On the other hand, the full-scale meltdown scenario[global environmental catastrophe], while far more plausible today than even a year ago, remains a low probability event.”

“How likely is it to happen? In view of the extent to which standards have been compromised in the financial world, some significant breakdown in derivative markets, leading to the failure of at least some players, seems more likely than not. On the other hand, the full-scale meltdown scenario, while far more plausible today than even a year ago, remains a low probability event.”

and someone objected that the provided quote wasn’t really a very good example of predicting global environmental catastrophe how would you respond?

Plenty of people thought there was a real estate bubble. I thought there was bubble back in 2002 when I bought my house and if you would have asked me what would happen when the bubble burst in 2006/2007 I would have replied bad news for the economy.

Kieran Healy with all his typical charity wrote a post mocking David Bernstein for frequently writing about the real estate bubble.

Here is a link to an instance of Professor Bernstein warning about a real estate bubble back in 2005

http://volokh.com/archives/archive_2005_08_14-2005_08_20.shtml#1124513110

Professor Quiggin’s circle of Cassandras that were correct and disregarded is pretty darn large and diverse.

The group of Cassandra’s who linked housing derivatives with the housing bubble and predicted a very large banking crisis is quite a bit smaller.

Those are pretty crucial details. Not a difference’s of 3 cms in the Oceans height.

Absolutely. As JQ alluded to above, the real choice is not between particular policies or economic beliefs – after all there’s not really going to be any way of positively knowing which innovations are going to be good and which are going to be bad. (Okay, being pedantic, some people might know, but they’ll be unable to persuade a sufficient number of people to make a policy difference).

The real question is simply how much innovation do we allow? And this applies to everything. Medicine, agriculture, AI research, nanotechnology, materials science, physics, chemistry, everything. All of these could have catastrophic long term consequences, and if they do, there will have been people speaking against the innovation who won’t be believed.

There’s no doubt in my mind that you’re correct on both points. The case that has to be made (and I don’t know if it really can be), is whether the gain from dampening the severity of financial crises (which, as a pessimist, I’m convinced are unavoidable) is worth the loss of wealth produced by these innovations.

Moreover, the real problem with choosing stability over wealth is that inevitably we take the stability for granted and see only the lost wealth. It’s a little like taking medicine for severe mental illness. After taking them for a while, you feel normal enough that you can’t understand why you have to take the medicine (and endure the unpleasant side effects).

Not that finance and economics is any different from any other field. Mankind is bright enough to constantly increase our efficiency, which means that the good times are much better, and when the inevitable disaster strikes, we’re much further up the creek without a paddle. To take a page from Homer Dixon, I’d rather take a jet plane than walk, but when the malfunction finally occurs, I’d rather trip over my feet than slam into the ground at 1,000 km/h.

Of course Slocum and SamC don’t care because, as ever, following the predictions of their favourite ideologues only made poor people poorer, and people who care about poor people are just losers or closet commies.

there is discussion upthread of the text following “of course”. I actually nodded and thought “yes of course” so I feel qualified to try to explain. First and simply, there had never been such a huge nationwide increase in house prices deflated by the CPI. The upswing was new and so it was clear that old rules didn’t apply. I believe (and I think this is what John meant) that such a nationwide bubble had not been possible before the new financial instruments were invented, because, back then, mortgage initiators had to bear the risk of “froth,” that is, local bubbles bursting. This caused fear which restrained lending which prevented nationwide house price bubbles.

A way of making the argument is that financiers will risk bankruptcy. If new instruments make them invulnerable to local bubbles then they will lend until there is a national bubble.

Now the claim that a nationwide downturn couldn’t be predicted, because it had never happened happens to be false. Such a downturn had occurred during the great depression. Ah but that was just nominal prices not real prices—which fell sharply nationwide from 1918 trhough 1922. Oh and what about Japan. A nationwide fall in house prices hadn’t occurred in the post WWII USA and therefore was excluded from the models.

Certainly I was reading economists around the web and I heard lots of “it’s going to end” and a fair amount of “I hope it’s going to end softly”. But I didn’t see economists debating seriously any particular evidence of a catastrophic landing. (Most seemed to think a Roubini like outcome was a possibility, but not anything like the certainty necessary to justify painful economic policy.

I honestly can’t see any way of having insulated ourselves from this catastrophe except by massively decreasing the amount of risk taken on every possible front, which would, of course, meant a massive loss of economic wealth. And in the end, probably for no reason. After all, someone somewhere would have taken the risk, reaped massive rewards and ended up taking out all the conservative banks and then taken everyone else with them anyway.

(Can you tell I’m Canadian? We had a moderately well behaved banking system. It didn’t help. We’ll go down the same path as everyone else, except we didn’t make out like bandits while the going was good. Well, at least while we’re eating our catfood we’ll have moral superiority . We’re good at that :-))

Say what? This thread is about finance, so I used a finance example. It’s the same criterion for other fields—if your “prophecy” is so vague that anything that happens will fit into it (next year, some things will get worse), or that you have to ignore most of it in favor of it’s “broad themes” to make it true, or it’s non-falsifiable (someday, you will die) I’m not putting a lot of stock in it. And if your response to the Y2K issue was to buy a year’s supply of canned goods and move into a cave, I am not admitting that “my January 2000 bank statement was wrong” proves that this was a good idea.

I use this rule mostly in talking to people more right-wing than myself. (The various crazy varieties of predicters of the end-times.)

I’m sorry you’ve been wasting your time here for so long. But, on your way out, can I suggest you go short on free market ideology.

(Another standard line of rightwing criticism is “if you’re so confident things will go badly wrong why not back your belief with your own money”. For the same reason: it’s hard to predict the details in advance, and therefore hard to profit on a large scale. Soros, Taleb and others have gone badly wrong trying, but have deeper pockets than I do).

Well, my position is pretty close to Slocum’s, and here’s why.

My criterion is “your picture of what would go wrong has to have been close enough that following it would have made things go better”; else, it doesn’t add anything useful.

If the advice you are giving is “there will be a crash in the US housing market, driving consumption down, the dollar down, and interest rates up”—following your advice would have made me worse off.

But being right about the details matters—it’s not enough to have a general sense of foreboding matters. Returning to the ‘Scary Story’ that Quiggin linked to about securitization:

http://www.johnquiggin.com/archives/000186.html

In it, he specifically identifies the unusual U.S. practice of taking out fixed rate mortgages as a particular problem. But if we had acted on that belief that fixed rate mortgages were dangerous, we would have done the wrong thing, wouldn’t we? If we’d taken actions to discourage fixed rate mortgages and encourage variable rate mortgages, is there really any doubt that the problem would have been worse?

Yes, low-interest rate mortgages drop in value if interest rates rise—but so do low-interest rate bonds. So do T-bills. There are a lot of T-bills being issued and sold right now that may come to be worth much less, and investors stand to lose a lot. Twas ever thus. But, on the other side of the equation, fixed rate mortgages give buyers not only predictability but mortgage costs that decline in real terms over the life of the mortgage (because, for example, a fixed monthly payment of $1200 in 2008 dollars us significantly less than the same $1200 was in 1998 when the mortgage was taken out). With fixed rate mortgages, no borrowers are thrown into foreclosure by unexpectedly high rate resets. So which is more dangerous to the economy, losses to investors on bonds, or massive defaults by mortgage holders? Sure looks like the latter now, doesn’t it? Many proposals now involve moving homeowners from variable into fixed rate mortgages—does Quiggin still think that is a mistake?

Predictions of doom without getting the details right strike me as pretty useless.

The Challenger disaster was in 1986, Columbia in 2003. Sadly a similar story can be told of both tragedies. More pedantically: NASA please, before we start getting Dod, Doe, Usaf, Scotus, etc.

We could try this. e.g. sea level rose 3cm more than predicted because govt policy enabled minorities to emit more co2 than we allowed for in our model!

Isn’t this roughly the Austrian view? Perhaps someone with more economics than I (yes, I’ll make the joke first, that means any and every one) could confirm/rubbish that?