Economic forecasting is a métier of the damned.
The greatest of them all – at least by reputation – was miserable at it. Fred Sheehan, writing in Whiskey and Gunpowder, recalled when Alan Greenspan was confronted by Congress after his nomination to head up the US Federal Reserve; Senator William Proxmire was ready for him. The senator had done his homework. He noted Greenspan’s “dismal forecasting record” when he was chairman of the Council of Economic Advisers. Greenspan had, for example, forecast an increase in consumer price inflation of 4.5% for 1978. Instead, the number rose over 9%. He was further off-the-mark than any CEA chairman before, or since… “You broke all records…” said Proxmire.
Proxmire wasn’t cutting the man any breaks. He turned to a copy of Forbes magazine, which described Greenspan’s efforts at forecasting when he was in the private sector: “Greenspan and O’Neil turned in one of the least impressive records of all pension fund advisers.”
“I hope…when you get to the Federal Reserve Board everything will come up roses. You can’t always be wrong,” Proxmire predicted.
The 20th anniversary of those hearings passed last week. Now we see that it was the senator who was wrong; Alan Greenspan was worse than he expected. First, he mistakenly put interest rates up in the early ’90s – probably causing a recession and almost certainly costing George Bush, Sr. his bid for re-election. And then, in the early ’00s, by holding rates far too low for far too long, he almost single-handedly created the worldwide credit bubble we watch with such shock and awe today.
It is a bubble that has made many men rich…and humbled many others. More importantly, it has bloated up the whole global economy into a grotesque and unnatural shape. Asian economies have been growing at breakneck speed, thanks largely to Greenspan’s easy credit. And in the West, an entire generation of middle class householders – particularly in America and Great Britain – has been lured deep into debt. On both sides of the Atlantic, foreclosures and bankruptcies are rising. And all over the world, asset prices are beginning to wobble. And as prices shake and bob, the high priests, bishops and gaudy gods of finance make their predictions.
Mr. Greenspan never gave any hint of seeing what was coming. Even now, he appears not to recognise it for what it is. But he is far from alone. With enough training and motivation, a real professional can learn to miss the obvious.
We mentioned Mr. John Devaney earlier last week. The poor man is selling his 142 foot yacht and has put his house in Aspen up for sale, too. The yacht must be something Mr. Devaney is especially eager to get rid of; its name – Positive Carry – must strike him like a curse. The boat is on the market precisely because his carry went negative…and his hedge fund, United Capital Markets, went into losses.
Dear readers may recall that it was this same Mr. Devaney who described people who took out subprime mortgages as “big idiots” because they’d never be able to make their payments after the mortgages were reset. Yet, at the very same moment, Devaney was buying up millions of dollars’ of CDOs – debt obligations whose value (such as it was) came from the big idiot’s mortgage loans!
Mr. Devaney highlights the problem with trying to figure out when this bash will end. A bubble party is based on the greater fool theory. You buy an asset, confident that a greater fool will come along and buy it from you at a higher price. The party ends only when the greatest fool of all finally arrives. But there seems to be no end to them. They keep showing up!
Surely, the fellow who buys a trashy barrack in a bad part of town using a subprime ARM is asking for trouble. He is a fool to buy more house than he can afford. But so is the fellow who buys a whole inventory of these packaged mortgages. If they were bad for the borrower, sooner or later they’re going to be bad for the lender too. The typical hedge fund manager also leverages his purchase – just like the subprime mortgagee. He might borrow yen or Swiss francs at a low rate and use the money to buy high-yielding subprime debt. He’ll have ‘positive carry’ until the idiots stop making mortgage payments.
And what do you make of the investor who pays fees of ‘2 & 20′ to take part in this mad gamble? What do they expect?
Also in the news this week was Sowood Capital, where Mr. Jeffrey Larson has lost half his clients’ money. Larson was making more than US$17 million-a-year managing money for Harvard University. In 2004, he decided he could make even more by setting up his own hedge fund. He and his partners raised US$2 billion from investors, including Harvard, which put up US$500 million. As of this past Wednesday, more than US$350 million of Harvard’s money was gone.
If the world’s most eminent economists and financial forecasters can’t get it right, who can? No one, of course.
Still, the forecasters can’t help themselves; the masses cry out for insight…for a look into the future. So the Financial Times, the Treasury Secretaries, the Market Strategists, the hedge fund impresarios, and all the lesser gods in the financial firmament offer their predictions.
Is the party really over? Is this The End of the great credit bubble, people want to know? Are we bound for heaven or for hell?
We don’t know; we’ll have to find out along with everyone else.
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