We weren’t alone, of course — Nouriel Roubini, in particular, comes to mind, as does the retired executive that pens the well-read Calculated Risk blog — but we were clearly among the first to focus so intently on the interplay between the primary and secondary mortgage markets. I still remember as far back as Dec. 2006 arguing that the failure of the capital markets would portend a grave crisis for the nation’s economy.
Now that it’s become reality, nearly everyone takes it as gospel that lax lending standards along with a retrenchment in home prices can have a global effect — one, it should be noted, we’re still facing. And that’s what makes recent admissions of key regulators all the more stunning, particularly when the guys who were supposed to be the “smartest in the room” now turn to the press and admit freely that they didn’t see any of this coming.
Add Federal Reserve chairman Ben Bernanke to that list of revisionist historians. “I and others were mistaken early on in saying that the subprime crisis would be contained,” Bernanke said in an cover feature in the Dec.1 issue of The New Yorker magazine. “The causal relationship between the housing problem and the broad financial system was very complex and difficult to predict.”
It may have been “very complex,” as Bernanke suggests, but the current crisis was by no means “difficult to predict.” And anyone selling that line of logic now misses the myriad of voices that wrote in detail about this mess well before it took place. A very basic shift in economic awareness has taken place as the crisis has worn on; nearly everyone has, by now, been introduced to the originate-and-sell model of mortgage securitization, the engine that provided liquidity on a global scale (and reached well outside of the housing sector, it should be noted).
But I can recall in late 2006 hearing economists pontificate that the “subprime mess will be contained,” blissfully unaware of just how embedded mortgage financing had become into the economic and broader financial markets. And, frankly, there is simply no excuse for that sort of oversight; understanding the economic landscape is their primary job, for God’s sake. The size of the bond markets geared towards mortgages alone was/is beyond substantial. The idea that problems in that market could resonate throughout the entire system should not — I repeat, NOT — have been a surprise to anyone.
Least of all the guy that is now being painted by his peers as “the smartest guy in the room.”
Of course, Bernanke’s not alone now in trying to wipe the regulatory slate clean. Fed vice chairman Don Kohn is happy to echo the same sort of flawed logic. “We knew that banks were creating conduits,” he told The New Yorker. “I don’t think we could have recognized the extent to which that could come back onto the banks’ balance sheets when confidence in the underlying securities—the subprime loans — began to erode.”
Really, Don? And why is that? The bitter truth — the pill that no regulator wants to swallow right now — is that most economists and regulators were asleep at the wheel. The idea of self-regulation permeated the environment, perhaps thanks to Greenspan, sure. But even if regulators had decided to clamp down on what was happening, they would have had to at least have some idea of what was actually taking place.
The picture being painted in the rearview mirror now suggests a far worse transgression than a policy misstep: it suggests that key regulators and economists understood little about the secondary mortgage markets to begin with. The reason so few in the financial markets saw this coming is because so few actually understood either how the market was structured, or how far it really reached. And that, to me, is far more troubling than a debate over regulatory ideology and course.
Yet that’s the sort of line of questioning that’s missing from most journalistic inquiries these days, where reporters are more content to dig into how the Fed put its current policies together to respond to the crisis, and where everyone takes it at face value that regulators moved as aggressively as they knew how as part of some decisive response to the financial crisis.
So we have to read about the genius behind Bear Stearns and AIG and Lehman Brothers. We have to read, too, about how the NY Fed’s Tim Geithner — recently tabbed by Barack Obama to lead the Treasury in the next administration — describes Bernanke as “very good at making decisions.”
“We’ve done some incredibly controversial, consequential things in a remarkably short period of time, and it’s because he was willing to act quickly, with force and creativity,” he told The New Yorker.
All of which may be true, but it also obscures the fact that Bernanke didn’t see this coming. (Neither, it should be noted, did Geithner.) And that sort of quick, forceful, creative decision making that’s now being lauded as a character strength? It wouldn’t really have been needed at all, if instead, just one key regulator possessed an altogether different quality: foresight.