There’s plenty of blame to go around when it comes to our economic mess. The government, Wall Street, the housing industry, mortage brokers and irresponsible home buyers all deserve a share. But let’s not forget the economists. The consensus of economists at universities, think tanks and other institutions failed to warn that this crisis was on the way. So it’s probably time to start keeping a little list of economists who got things very badly wrong.
We’ll start with an unlikely candidate: Alan Reynolds. The Cato institute senior fellow is nothing if not prolific. His writing has appeared in Wall Street Journal, The New York Post, National Review, The New Republic, Fortune, The New York Times, The Washington Post, The Washington Times and The Harvard Business Review, Forbes, Reason and in local newspapers across the country. He’s been a libertarian critic of the Bush administration’s Iraq policy, and a critic of the economic plans of Barack Obama.
But when it comes to our current crisis, Reynolds was just about as wrong as anyone could be. Reynolds spent the middle of the decade criticising economists and writers for bearish forecasts. He was a consistent optimist, confident that warnings about impending economic problems stemming from the housing bubble were simply fear-mongering by opponents of the Bush administration.
As early as 2005, Reynolds was arguing that we had nothing to worry about in the housing market. He thought prices might decline from their heights but that this would have no serious economic consequences.
Here’s an excerpt from his column titled “Housing bubble? No trouble”:
In fact, investor disenchantment with housing could be the best reason for expecting home prices to decline in overpriced areas. That would be unpleasant news for home sellers, but good news for buyers. And what sellers lose when selling one house they often save when buying another. Any risk of loan defaults would be negligible. In hot spots where home prices just rose by 30 per cent, even an unprecedented 25 per cent price drop would have zero impact on any seller who held onto a home for only a year…
In short, we are being asked to worry about something that has never before happened for reasons that have yet to be coherently explained. “Housing bubble” worrywarts have long been hopelessly confused. It would have been financially foolhardy to listen to them in 2002. It still is.”
When this column was criticised by Stephen Karlson on the blog of the Mises Institute, Reynolds was just as dismissive. ” In any event, this is clearly not a national issue,” he wrote in the comments section.
Two years later, as evidence that the mortgage market was running into trouble began to mount, Reynolds was still deeply in denial. He lambasted those warning about the mortgage market as scare-mongering sensationlists. “On economic news, the press tends to be biased toward exaggeration and sensationalism. If some event isn’t a ‘scandal,’ it must be a crisis,'” Reynolds wrote.
In his view, the mortgage crisis was, at worst, a local problem in some over-priced markets.
“Why speculate about hypothetical consequences of falling home prices? Some try to justify such predictions by suggesting lenders are too stupid to distinguish between good and bad credit risks, so the credit supply will dry up for everyone. An even less plausible theory suggests marginal loans to low-income borrowers were the reason for soaring prices of big homes in trendy areas, though most subprime borrowers can barely afford the cheapest condos.”
Reynolds also insisted that the fears weren’t justified by the current state of things, ignoring the clear trend toward broader defaults.
“Sensational stories invariably cite figures from the Mortgage Bankers Association showing 13.3 per cent of subprime borrowers made late payments at the end of 2006 and that 4? per cent face foreclosure. Yet those same figures show, as Jeff Brown noted in the Philadelphia Inquirer, that ‘more than 86 per cent of subprime borrowers are not late in payments, and more than 95 per cent are not in foreclosure.’ Christopher Cagan of First American Core Logic estimates foreclosures will amount to less than 1 per cent of mortgage lending.”
A year later, he was still pounding away at the same themes. “Media hysteria over the mortgage crisis is almost certainly misleading countless people about prospects for the real economy,” Reynolds wrote in April of 2008. (That’s a month after Bear Stearns collapsed.)
That April column is worth quoting at length:
Some papers can’t get anything right. An April 6 New York Times piece (“Almost as if The Sky Were Falling,” on stock prices) claimed that the “focal point for the stock market’s difficulties” is that “banks have been reluctant to lend money to one another, or to anyone else.”
Absurd. If banks have been reluctant to lend money to one another, then interest rates on such loans, like the six-month London Interbank Offered Rate (LIBOR), wouldn’t have fallen to 2.6 per cent from 5.3 per cent a year earlier.
And if banks were reluctant to lend to “anyone else,” then bank loans wouldn’t have increased by 8 per cent (as Fed data say they have) since last August, when the mortgage crisis first emerged.
The phrases “credit crisis” and “credit crunch” are not about bank loans, as most suppose, but about difficulties in selling or valuing exotic securities.
Even there, the hysteria mounts. “IMF Puts Cost of Crisis Near $1 Trillion,” screamed a Washington Post headline April 9. Yet that estimate wasn’t for the United States alone, or mortgages alone. It covered worldwide future accounting losses (amounting to 4.1 per cent) on all sorts of loans and securities, from junk bonds to hedge-fund speculations. For mortgages alone, the IMF estimates losses of $115 billion.
And, again, we’re talking accounting losses — many of them only temporary.
These are paper losses on mortgage-related securities — taken because accounting rules require financial firms to mark the securities down to some estimated “fair value.” These securities still generate ample cash from mortgages — but, as the IMF explained, “Heavy discounting during the crisis . . . produced fair values much lower than their underlying expected future cash flows would imply.”
That is, many such securities are likely to be written up sooner or later.
Some perspective is necessary, too. According to Standard and Poors, write-downs of mortgage-related securities “may reach” $285 billion. Yet losses from the S&L crisis amounted to 3 per cent of gross domestic product — which would be nearly $450 billion today.
Just six months later the total amount of mortgage related write downs from banks and brokerages would be $600 billion. The amount is even larger if you count losses at insurance companies and broader corporate America. Sorry, Mr. Reynolds, you were very, very wrong.
We don’t mean to pick on Reynolds in particular. He’s been very right about plenty of things in the past. And his policy recommendations can be sound. “When politicians use bailouts to protect borrowers or lenders from their folly, they just encourage more folly,” he wrote in 2007. Unfortunately, his misplaced optimism about the housing market and mortgages badly damage his credibility. Who is going to listen to that warning when the guy issuing it was so deeply wrong?
Was Reynolds the worst economist on the housing bubble? Probably not. We can think of dozens of others who were just as badly wrong, and some who were worse. (And, in the coming days and weeks, we intend to name them and put them on our list. Nominate your candidates in the comments section.) But there’s no use denying that this proponent of free markets badly damaged his cause by insisting on talking about how nice the band was as the titantic plunged into the iceberg.
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