Why we — and everyone — missed the bust

John W. Schoen Senior producer • Profile • E-mail

Maybe it's because there are signs that the housing market could be stabilizing — for now — and the financial markets have gotten past panic mode. But lately a lot of readers complain that those of us who follow these things for a living completely missed the boat on warning readers that it was coming.

When economic journalists miss an $8 trillion housing bubble, I suppose it's to be expected that they will miss other important stories …
— Robert R., address withheld

I was stunned by (this Newsweek article) on how the economists missed predicting the crash when historically it would have been easy to see…
— Dennis M., Colorado Springs, Colo.

Mail like this reminds me of sports talk radio fans berating managers for not pulling the losing pitcher soon enough. No one complains when the same manager gambles and wins. Then he's a genius.

Respectfully, no one can predict a market crash. If they could, there would be no crashes. You might as well ask aloud why governments can't predict riots or businesses can't predict the next consumer fad or TV executives can't predict the next hit show or Web producers predict the next big viral video. What sends the video of one skateboarding dog flooding into millions of inboxes around the world while the next one never gets past the first posting?

The article that caught your eye, Dennis — by Newsweek’s (always insightful) Robert Samuelson — describes the recent folly of a set of economic theories based on mathematical models that many believed had reduced or eliminated the risk of a financial market collapse. The same kind of “new paradigm” thinking was behind the tech bubble and crash of 2000. Likewise, the crash of '87 wasn’t thought possible because of a game-changing invention called “portfolio insurance.” Same movie, different showing.

You certainly could see conditions forming in the middle of this decade that, in hindsight, created a high risk of the housing collapse and recession we're living through. In April 2007, we wrote that rampant mortgage fraud threatened to send millions of homeowners in default. In October 2007, two months before it officially began, we warned readers that a recession might be on the way. It would have been ridiculously irresponsible at those points to "predict" the collapse of the banking industry and the deepest global recession since the 1930s. That outcome was by no means certain.

Crashes and bubbles are the unintended consequence of financial imbalances created by mob psychology. If you can accurately predict the behavior of a mob seized by fear and/or greed, hang out a shingle and charge a fortune. You'll be a billionaire many times over.

Sure, there are plenty of folks now who wonder why so many people — including this columnist — "missed" what is now "obvious." My inbox is full of this stuff. Where were all these soothsayers when we were headed for the cliff?

Of course there are a handful of prognosticators who, in fact, "called" this crash publicly and are now taking credit for their prescience, gleefully linking back to their gloom-and-doom blog posts. They're the same folks who, over the past three decades, have predicted three out of the last 15 crashes ('87, '00 and '08.) If you make enough "crash" predictions, eventually you'll get one right. As the old saying goes, a broken clock is right twice a day.

Over the past several decades there have been multiple "forecasts" that turned out to be completely false alarms. The collapse of the savings and loan industry, for example, brought predictions of a drop in housing prices of as much as 50 percent. It was certainly plausible, given the magnitude of the lending collapse. But aggressive government action, in the form of the Resolution Trust Corp., contained the fallout.

The government's response this time around may have done the same. Or not. We won't know for some time. Until then, send me your predictions and we'll take a look next year and see how well you did.

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