Predicting Crises – First, You Have To Try
Sometimes, I am hard to work with. Now, there are probably plenty of people who would retort, “sometimes?!?” but I would like to make it known that I am only particularly difficult to work with when I am waiting for a macro to run or for some other reason turn my attention to what’s on CNBC.
That’s when I generally start shouting the chyrons that Tout TV has on-screen (a chyron is the little caption that describes “breaking news” or the name of the speaker, or somesuch), like “Intel: Time to Buy?” or “Which Stocks Are Poised To Rocket” or “Stock Market: Should You Go Long, Longer, or Longerer?” (I made that last one up). I know it must break my neighbors’ concentration – and by “neighbors” I mean the people in adjacent buildings – but I really can’t help myself. It just seems like the channel is incapable of considering the possibility that there may actually be a time when stocks should not constitute 125% of your portfolio.
If brought to justice, I am sure the people who guide the programming on CNBC would say “well, research* shows that stocks are the best investment for the long run,” thus relying on mythology to justify their existence. Of course, we can’t hold them guilty for that. After all, many financial market participants have been guilty of the very same thing in the not-too-distant past. Why, I saw today that JP Morgan Jamie Dimon said “we just missed that housing prices don’t go up forever.” Wow, gee, how could we have known? Who would have thought that prices don’t go up forever? We were just as surprised as the next guy.
Of course, the entire Establishment has been in damage control since Day 1 of the crisis, but what shocks and appalls me is the sheer number of enablers. Even some people who seem to be onto a good lead tend pull their punches. I read a piece recently by economic researchers at the San Francisco Fed entitled “Predicting Crises, Part I: Do Coming Crises Cast Their Shadows Before?” Now, the economic research staff at the various Federal Reserve Banks are generally pretty independent – not completely, of course, but they are pretty far removed from the nuts and bolts of policymaking. It isn’t a place for whistleblowers, but this author concluded that there is “evidence suggesting that simple indicators based on asset market developments can provide early warnings about potentially dangerous financial imbalances.”
That sounds like a clear departure from all the whining from the actual policymakers as well as people like Dimon, whose main defense seems to be “hey, Greenspan didn’t see it. Bernanke didn’t see it. How were we supposed to see it?” But this lightweight paper only hints at the notion that the crisis could have been predicted (that being said, one of their primary sources looks to be worth reading but I haven’t gotten to it yet since I’ve been busy yelling at CNBC).
Hey, here’s a very simple argument that is pretty persuasive about the question of whether crises and bubbles can be predicted. The null hypothesis here is that they cannot be identified a priori, but…at least one economist, who was already well-known prior to these crises, did in fact identify the last two bubbles before they burst. What are the odds that, out of the universe of already-known analysts, economists, and policymakers, anyone can predict both of them by pure chance? We’re not talking about a million monkeys pounding on typewriters here (only 535, I believe is the count) – it’s a fairly small universe of people. Out of 600 million nutjobs in the general population of the western world, some people would have gotten that right by chance. But this isn’t a nutjob. It’s someone who actually did analysis, and got the answer right. Twice.
Doesn’t that suggest that the null hypothesis is on shaky ground? It seems reasonable to consider Dr. Shiller a refutation of that hypothesis.
Less work should be done on defending the notion of efficient capital markets (kids, it’s still important to learn about the EMH in the same way that it’s important to learn arithmetic even though you have calculators). More work should be done on identifying unstable conditions and figuring out how to defuse them. I have my thoughts, but then I’m just one of those nutjobs. So far.
Tomorrow we finally get some decently useful economic data, so CNBC can figure out how to spin Retail Sales (Consensus: +0.5%, +0.3% ex-auto) into a tale that commands retail investors to buy eBay. While Retail Sales is a pretty volatile number, the December figure really is worth paying extra attention to since December sales constitute a disproportionately large portion of the year’s retail sales. I am more interested in Friday’s CPI data, because I am an inflation guy (inflation_guy on Twitter, actually), but I will be interested to see if core December sales really did expand despite the dour consumer mood.
* “research” here means “I haven’t read the research, and I haven’t spent any time trying, but someone told me stocks always outperform in the long run.”
