NY Fed Issues Mea Culpa That Nobody Saw at 6PM on Black Friday

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In a report released on Black Friday around 6 PM, when nobody is around, let alone paying attention, except for crazy people like me, the NY Fed posted a mea culpa on just how lousy its economic forecasts have been, a function which I had already performed over a year ago (The Fed – Clueless, Delusional, or Both?). The author of the report stated the crux of the failure thusly:

One source for such metrics is a paper by Reifschneider and Tulip (2007). They analyzed the forecast error performance of a range of public and private forecasters over 1986 to 2006 (that is, roughly the period that most economists associate with the Great Moderation in the United States).

On the basis of their analysis, one could have expected that an October 2007 forecast of real GDP growth for 2008 would be within 1.3 percentage points of the actual outcome 70 percent of the time. The New York Fed staff forecast at that time was for growth of 2.6 percent in 2008. Based on the forecast of 2.6 percent and the size of forecast errors over the Great Moderation period, one would have expected that 70 percent of the time, actual growth would be within the 1.3 to 3.9 percent range. The current estimate of actual growth in 2008 is-3.3 percent, indicating that our forecast was off by 5.9 percentage points.

Using a similar approach to Reifschneider and Tulip but including forecast errors for 2007, one would have expected that 70 percent of the time the unemployment rate in the fourth quarter of 2009 should have been within 0.7 percentage point of a forecast made in April 2008. The actual forecast error was 4.4 percentage points, equivalent to an unexpected increase of over 6 million in the number of unemployed workers. Under the erroneous assumption that the 70 percent projection error band was based on a normal distribution, this would have been a 6 standard deviation error, a very unlikely occurrence indeed.

He then went on to enumerate the 3 big reasons the Fed had gotten it wrong:

  1. Misunderstanding of the housing boom. Staff analysis of the increase in house prices did not find convincing evidence of overvaluation (see, for example, McCarthy and Peach [2004] and Himmelberg, Mayer, and Sinai [2005]). Thus, we downplayed the risk of a substantial fall in house prices. A robust approach would have put the bar much lower than convincing evidence.
  2. A lack of analysis of the rapid growth of new forms of mortgage finance. Here the reliance on the assumption of efficient markets appears to have dulled our awareness of many of the risks building in financial markets in 2005-07. However, a March 2008 New York Fed staff report by Ashcraft and Schuermann provided a detailed analysis of how incentives were misaligned throughout the securitization process of subprime mortgages—meaning that the market was not functioning efficiently.
  3. Insufficient weight given to the powerful adverse feedback loops between the financial system and the real economy. Despite a good understanding of the risk of a financial crisis from mid-2007 onward, we were unable to fully connect the dots to real activity until 2008. Eventually, by building on the insights of Adrian and Shin (2008), we gained a better grasp of the power of these feedback loops.

He then added that perhaps the biggest reason for the failure was “complacency,” with which I heartily concur, but to which I would also add hubris and stupidity.

At the beginning of the piece the author cited a Turbotax Tim Geithner quote: Our best plan is to plan for constant change and the potential for instability, and to recognize that the threats will constantly be changing in ways we cannot predict or fully understand.

Adding to that the author wrote, “The quotations from Keynes and Geithner at the start of this post capture the importance of constantly striving to ensure that policy is robust to unexpected events. As explained in much of the recent work of the 2011 Nobel Prize–winning economist Tom Sargent, the unexpected events for which policymakers need to make provision have the characteristic of being the most likely unlikely bad event. The collapse in housing prices and its propagation to the economy certainly fit this description.”

Somebody Who Didn't Foresee But Chose Not to ActThis is what I would call the “Nobody could have foreseen” fallacy, a tool often used by the professional economist and economic pundit class. I guess that I and the countless thousands of others who frequented this and other bearish websites at the time of the top of the housing bubble, who did foresee what was coming, must be the “nobody” that the pros refer to.

It’s good to be nobody or not so good, because even though nobody took precautions, nobody ultimately took the hit. Because in this case, nobody was prepared for what happened, and nobody took steps to both protect and profit from it, while the rest of the Wall Street seers and the Fedheads, who are all somebody, didn’t foresee it. As a result somebody got their asses kicked. But that hasn’t stopped them, because Uncle Sam bailed them out, spending nobody’s money, and nobody’s children’s and grandchildren’s futures to do it. So in that sense, it’s better to be somebody, even though somebody initially took the loss that nobody saw coming, until the US government bailed them out on behalf of nobody.

I wrote the following comment on the NY Fed Liberty Street blog. I don’t know if it will still be there in the morning, so here it is.

The excuse that most other professional forecasters didn’t foresee it is just that, an excuse. Some professional forecasters did see it. They were derided as Cassandras and dismissed by Wall Street and Fed insiders, who are only beholden to each other, and to their own delusions.

Millions of amateur economic forecasters who frequented the financial message boards and blogs saw what was happening and what was coming. They had one important advantage. They live in the real world, not inside the Beltway, not within the marble halls and equally hardened thought processes of the Fed, and not in the ivory towers of academia, a word which sounds like a disease, because it is a disease. Not only do these environments cause delusional thinking, they attract delusional people. The same is true of policy makers.

I call it elitist personality disorder. It leads to delusions of grandeur, delusions of omniscience and omnipotence, and the unwillingness to take responsibility for failure and incompetence, instead engaging in blame shifting.

Postscript. Yep, less than a half hour later, they pulled my comment. I left a subsequent comment which isn’t fit for a family oriented website like this one.

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  10 comments for “NY Fed Issues Mea Culpa That Nobody Saw at 6PM on Black Friday

  1. Ann
    November 26, 2011 at 10:03 am

    I’m afraid I can’t believe that the somebodies didn’t expect what happened. I’m convinced that they had the bailout planned ahead. There has been a giant shift and consolidation of wealth going on since around the 1980s. I find it hard to believe that giant chunks of wealth just upped and landed in the laps of a few innocent people. Wealth takes working hard and working smart. So does theft. That’s what the somebodies did.

  2. November 26, 2011 at 4:16 pm

    A reader on another website suggested that along with hubris and stupidity, I should have added corruption. He’s right. Being the gentle person that I am (ahem…) I was being kind.

  3. November 26, 2011 at 4:27 pm

    Post Postscript-

    The keepers of the NY Fed website, apparently after getting hammered all day about the removal of my post, PUT IT BACK UP!!!


  4. November 26, 2011 at 4:38 pm

    However, I also want to point out that not only did NY Fed staff get the forecast consistently wrong, so did every single FOMC member and every single district bank president. Not only did all of them get the forecasts wrong every time, they even could not accurately say where the economy was at the time they were surveyed. This, to me is evidence of ingrained delusional crowd behavior. http://wallstreetexaminer.com/2010/07/26/the-fed-clueless-delusional-or-both/

    To their credit, while they could not get the GDP or employment figures correct, they did get inflation largely correct. Congress should return the Fed to the single mandate.

    The idea that the Fed should additionally target GDP, is beyond laughable. It’s bizzaro world stuff. But there are some who take it seriously.

  5. November 27, 2011 at 1:32 am

    It should be added to all of this that the precise quantitative forcasts the Fed’s research staff and FOMC members attempt to make simply can not be made. All we can ever make are qualitative forecasts, based on sound economic reasoning. It was therefore possible to deduce that the housing boom set into motion by the too low interest rates and monetary pumping pursued by the Fed following the collapse of the Nasdaq bubble would result in a considerable bust, one that would likely endanger the whole fractionally reserved banking system, but it was not possible to forecast with anything approaching accuracy how big a decline in economic activity would result, how big a rise in unemployment and so forth – nor was it possible to predict with apodictic certainty when exactly these effects would be observed. It was at best possible to state that the series of interest rate hikes and the concomitant slowdown in money supply growth in the years 2004-2007 would eventually lead to a major bust, comparable to e.g. the real estate bust suffered by Japan after the 1980’s boom. The forecasts issued by the Fed and its staff by contrast continue to be framed in a manner that suggests that such quantitative forecasting precision is possible. See for instance the recent defense of the current loose monetary policy scheme by Boston Fed president Rosengren, which included inter alia an astonishingly precise forecast of the connection between monetary pumping and ‘GDP growth’. This forecast is of course based on empirical data, most of which concern the previous boom period! It is ispo facto disqualified, but that didn’t keep the Boston Fed’s researchers from making it.

  6. dienwodie
    November 27, 2011 at 2:19 am

    Typical NWO fascist pig arrogance..They never thought they would get caught sneaking in their evil plan for one world global tyranny..They are still trying to sneak communism in under the radar by stealing homes they have no legal right to take undeer the guise of debt…which is their massive UNSUSTAINABLE debt, not ours…. Great job calling them out. This is all a part of the FORECLOSUREGATE COVER UP…The illegal theft of our homes and businesses A/K/A Fraudclosures (like a thief in the night) and the robbery of our property rights by this illegal and unconstitutional NWO tyranny must be stopped! They are stealing the homes and businesses of the American people for the UNSUSTAINABLE DEBTS of WALL STREET and the GSE’s…They committed $600 TRILLION in collateral mortgage fraud…That’s right ZERO COLLATERAL BACKING UP THEIR MASSIVE MORTGAGE DERIVATIVE FRAUD…THERE IS APPROX. 8 TRILLION IN REAL ESTATE AND THEY OWE $600 TRILLION TO MOST LIKELY THE TOP 4 THEIVES ON THE PLANET…THIS IS HITLER PLAN PART DEUX..This is America, not Hitler’s Germany..Throw the crooks in prison…Force these criminals to pay the AMERICAN PEOPLE back their stolen wealth and property..THROW OUT ALL OF THE POLITICIANS FROM BOTH PARTIES…WHO ARE COMPLETELY CORRUPT AND USELESS TRAITORS OF AMERICA…! KNOW YOUR RIGHTS…REMEMBER THE MBA ADMITTED ALL OF THE ORIGINAL NOTES WERE DESTROYED…PROPERTY LAW IS POWER!

    • nyquil762
      November 27, 2011 at 5:17 pm

      pater tenebrarum:

      Agreed! Best post of the day. keep them coming.

  7. mel
    November 27, 2011 at 8:54 am

    The people know what happened, now they will know who did it, and how it was done. The arrogance of thinking the “thin blue line” will protect them will only go so far.
    The genie (internet) is out of the bottle, and can never be put back in. The more the unwashed masses learn how we’ve been taken advantage of, in simple speak, no big formulas, quoting other academics etc., the more danger the power elite are in.
    Understanding that economic theory, being based on the fallacy of all things being equal, doesn’t work, is the first step. The rest will follow in due course. Which is rapidly gaining momentum. The price we will all pay for the greed of the few is yet to be determined. But it can’t be good for the status quo.

  8. November 27, 2011 at 9:43 am

    Just the word “econometrics” implies precision. The fact is that it’s fraud. The models spit out numbers based on the modelers preconceived notions and biases. It’s all bullshit.

  9. Paul
    November 28, 2011 at 7:16 pm

    It’s a lose/lose for them in my opinion.

    If they didn’t see it coming then they’re inept at their jobs because I can name half a dozen or so people that were warning of the collaspe of the financial markets and the housing markets for many months before it happend.

    If they did see it coming and they were lying about it so they didn’t ‘scare the markets’ then they are inept at their jobs because the entire purpose of the FED is to see and attempt to fix any disruptions in the market before hand.

    Either way, they failed at doing their jobs and this information only shows how un-needed they are.

    It’s like hiring someone to clean all of the leaves out of your pool in the spring time. After a few hours you find that this person hasn’t pulled any leaves out and he/she is just starring at the water. When you confront this person they say ‘sorry, I was concerned that by removing the leaves I would disrupt the water’ or ‘I was going to remove the leaves, but then I decided that I mis-calculated the harmful effects of the leave so I decided to leave them in’. Either way, the poorboy gets fired!

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