Readers Can Relax, No One Predicted the 'Financial Crisis'
Many years ago the HBO television comedy Curb Your Enthusiasm devoted a rather funny episode to those who choose to “hide” their generosity. In “The Anonymous Donor” Ted Danson, playing himself, manages to discreetly inform a number of well-to-do supporters of a very Beverly Hills, very entertainment, and very lefty environmental group that he’s in fact the anonymous donor of the money that made possible a wing of the organization’s headquarters.
Larry David, the creator of Curb and also its central subject, is miffed at Danson. Having similarly donated a wing, albeit in his own name, few bother to cheer David’s generosity. They’re all too busy celebrating Danson’s “anonymous” contribution that he made sure everyone knew about.
Not terribly ironically, the episode in question was run in 2007, roughly one year before the so-called “financial crisis.” Since that time, others have less-than-discreetly told those in earshot, and well beyond, that they can see around corners. Call them the opposite of anonymous donors; they want you to know who they are.
What’s important is that we all know these people. You know, the ones who called the 2008 “financial crisis” long before it happened. They’re everywhere. So many assure us that they saw it coming, and some even produce written evidence of their alleged prescience in the form of columns, tv appearances, books, etc. What’s comical about this is that while many of these self-proclaimed seers were and still are well-to-do, none are seriously rich today. Few were driving fancier cars, living in more expensive houses, or vacationing in grander places after allegedly seeing what we mere mortals did not. And that’s part of the point.
Those who really and truly saw 2008 ahead of time are extraordinarily rich for having done so. Indeed, so cheap was insurance on mortgages before 2008’s carnage that the purchase of same was going to pay off in a major way for those who saw the trouble ahead of time. Figure that John Paulson turned a $147 million fund into many billions based on his eponymous firm's bet that mortgages would correct.
Why the dis-connect? Why so many seers of 2008, but so few post-2008 fortunes? This one’s easy, and a chapter in my 2015 book Popular Economics is devoted to the “anonymous donors” of the post-crisis age: “If They Tell You They Predicted the Financial Crisis, They’re Lying.” The “crisis” wasn’t an effect of markets in the first place, plus if everyone saw it coming as a growing number say they did, those who actually did see problems ahead (as Paulson did, for instance) couldn’t have expressed their bearishness so cheaply. This would have been true whether all the visionaries invested based on their knowledge, or not. That's the case because markets are always and everywhere pricing information, perceptions, biases, etc.
Back to reality, those who truly saw 2008 before 2008 did rather well for seeing what the deepest markets in the world plainly did not. If there were lots of Paulsons as all the visionaries in our midst suggest there were, the mortgage insurance purchased by Paulson (and few others) once again wouldn’t have been so inexpensive. Paulson and others like him were exceedingly unique, and that’s the point. Notable is that Paulson is the only 2008 seer I’ve ever met with billions (or even millions) to show for it.
So did Paulson predict the “financial crisis”? Not even close. What Paulson predicted was something healthy; that the market for mortgages was going to correct. He sensed (correctly it turns out) in a timely way that more than a few mortgage holders had borrowed more than they would be able to pay back. A market correction would cleanse this mis-allocation. Paulson’s wealth soared for him having predicted the reversal, and the world was made better off by virtue of Paulson’s earned billions signaling to lenders where to cease lending.
All of the above was healthy because, for one, market signals are precious. Paulson didn’t profit from the misery of others (as critics suggested at the time, and still do) as much as his profits saved us from a great deal more misery had more sources of credit directed more of it at housing consumption. Second, housing is consumption, as mentioned in the previous sentence. It’s not investment. A purchase of a house doesn’t render us more productive, open up foreign markets for us, nor does it lead to cancer cures that elongate lives or software innovations that make us more productive, and thus boost our pay. As Adam Smith put it in The Wealth of Nations,
“Though a house, therefore, may yield a revenue to its proprietor, and thereby serve in the function of a capital to him, it cannot yield any to the public, nor serve in the function of a capital to it, and the revenue of the whole of the people can never be in the smallest degree increased by it.”
Which brings us to historian Niall Ferguson’s recent – and rather confident – assertion in the (London) Sunday Times that he “predicted, with considerable precision, the global financial crisis.” Except that Ferguson predicted no such thing, and he surely knows that he didn’t. And he knows why he didn't. Up front, evidence supporting this claim isn’t that Ferguson’s not more well-to-do than he already would be based on his excellent books and speeches. Ferguson didn’t predict the crisis simply because no one did.
Ferguson begins by referencing his June 2006 “observation that interest rate increases by the Federal Reserve would sooner or later have an effect on heavily indebted American households.” So if we forget that banks tend to lead the Fed on rates as is (sorry conspiracy theorists, the Fed can't control prices anymore than any other witless arm of government), there’s not a strong correlation between housing health and interest rates to begin with. Ferguson doubtless knows this from having grown up in the U.K.
Housing boomed there in the 1970s, despite soaring rates of interest targeted by the Bank of England. As a quarterly bulletin from the central bank observed about the 70s, “There was no other general area of economic activity which seemed to offer as a good a prospective rate of return to an entrepreneur as property development.”
We saw the same in the U.S. Alongside aggressive Fed rate increases in the 70s, housing similarly boomed. As George Gilder described the late 70s in his 1981 book Wealth and Poverty, “What happened was that citizens speculated on their homes….Not only did their houses tend to rise in value about 20 percent faster than the price index, but with their small equity exposure they could gain higher percentage returns than all but the most phenomenally lucky shareholders.”
So without going too much into what authored the rush into housing in both the 70s and 00s (hint: check dollar and pound exchange rate policy from Treasury and the Exchequer, and in particular check the direction of each versus commodities), there was most definitely a “flight to the real” that revealed itself in both decades, and amid soaring central bank rates of interest. And naturally the economy slowed each time. Getting into specifics, that housing was among the top asset classes was certain evidence of a weakening economy. Indeed, the rush into tangibles was a flashing sign of reduced economic health simply because it signaled consumption of wealth that already existed, as opposed to equity investment representing future wealth creation. Investment powers economic growth, not consumption.
Ferguson understands all of the above intimately as his 2008 book, The Ascent of Money, made plain. As he explained in it, housing consumption is an obsession among the English speaking. In short, the “crisis” was the rush into housing, while the correction of same signaled a healthy cleansing that in normal times - free of intervention - would have authored a rebirth. Housing was anti-risk since a home loan is backed by a tangible asset that the English speaking once again obsess over. Finance didn’t become risky in the 00s as much as the U.S. and global economy began to slow in response to a lack of risk appetite. A raging housing market is a sign of less investment, and less growth. Any reversal from low-risk housing consumption is and was a logical economic positive.
What’s important is that Ferguson merely predicted a correction, and an economically positive one. Good for him, though commentary back then was somewhat thick with innuendo about an “overheated” housing market. What makes it difficult to give Ferguson too much credit is his use of interest rate machinations from the central bank to bolster his prediction. The 70s once again remind us that housing can boom without alleged Fed support, or that of other central banks.
Furthermore, the correction he predicted wasn’t that big to begin with. As the Wall Street Journal’s Holman Jenkins wrote about the mortgage crack-up as it was taking place, “fluctuations in the S&P 500 wipe out as much wealth every ho-hum day.”
As for the crisis, it had little to do with finance and once again everything to do with government intervention. Ferguson predicted none of the intervention that caused the market crack-up that most associate with crisis. None of this is a knock on Ferguson. No one could have predicted the Bush administration’s utter ineptitude that gave us a market panic.
What’s important up front is that a correction of what was unhealthy (the slow-growth rush into housing consumption) could never have caused a “crisis.” Particularly in markets. Figure that markets price in the future. Always. So a cleansing of anti-growth lending along with the bankruptcy of a few or many financial institutions that misread markets could have only been for the good. Goodness, one of Ferguson's very own Hoover colleagues long ago noted that the Fed had bailed out Citigroup no less than five times in 25 years. As such, the failure of institutions like it could never have caused a "crisis." Taking the previous point further, in the past new employees at Goldman Sachs were presented with a 1950s deal tombstone on the very first day of work; the point being that most of the deal’s underwriters were long gone. Financial companies have long been dying, and dying quickly, for decades. That’s why the business is so prosperous. Failure is the prosperity-inducing cure. Imagine how second-rate Silicon Valley (where Ferguson resides) would be sans endless failure….
Left alone, failed mortgages and their carnage would have ultimately cheered investors always and everywhere pricing in the future. Financial institution failure could once again never cause a financial crisis simply because failure in a capitalist system is a sign of evolutionary health. Except the failure was not left untouched. Rather than allow Bear Stearns to go belly-up in the spring of ’08, the Bush administration and Bernanke Fed intervened. The bailout of Bear created the assumption that all institutions were going to be saved, thus explaining the market hysterics when Lehman Brothers wasn’t saved. Investors assumed a bailout that never materialized. Surprise shook markets, not the bankruptcy of Lehman. Still, if Bear is allowed to collapse, Lehman quickly follows. And investors would have been prepared for Lehman’s collapse.
Add to all this that the Bush SEC decided to ban short-selling on 900 different financial stocks amid the government-manufactured hysteria related to Lehman. Except that short-selling is a bullish signal. It’s the surest sign of huge reserves of buying power building up to catch a falling market as it were. Indeed, short-sellers can only profit from their bearishness insofar as they re-enter the market to buy shares they initially borrowed and sold, only to give them back to the individual borrowed from. Short sellers are ultimately buyers, but in the meantime they provide pricing transparency to investors frantically in need of it. Yet when investors needed transparency the most, the Bush administration decided to render markets opaque.
All that, plus bailouts are never free. Not only do they deprive industry sectors and economies of the cleansing necessary for rebound, they also signal much greater government involvement in the economy going forward. Ok, but the latter had failed impressively in a 20th century that was still very much in the rearview mirror. If markets price in the future, which they do, the future looked bleak as governments around the world (as Ferguson describes it, the “crisis” was “global”) stood to collect on their faux generosity with the money of others. The bailouts that scared the daylights out of investors prefigured the kind of regulation and intervention that has always ended in tears.
Considering all of this, is it any wonder that future-discounting markets went haywire in 2008? Not really. Except that the “crisis” wasn’t financial; rather it was an effect of inept government intervention. Absent the intervention there’s no crisis. There’s just a correction that would have been healthy, and that investors (always seeing into the future) would have cheered.
Applied to Ferguson, readers can decide for themselves how much or how little Ferguson saw before 2008. What’s important is that he did not predict a “global financial crisis.” Only those who predicted with great precision the Bush administration’s witless interventions could have predicted a crisis. And until the “anonymous donors” of modern times produce commentary or books foretelling chaos-inducing intervention in what was healthy, we should kindly dismiss suggestions that they saw around the fall of 2008 corner.