It often takes a great deal of courage to admit when you are just plain wrong.Â It takes an even greater amount of chutzpah to admit that you are wrong after your mistake caused years of misery for millions and the true pain hasn’t yet manifested itself.Â With that being said, it looks like the New York Federal Reserve Bank, the most powerful, government aided private bank in the world, has finally done it.Â They actually admitted what everyone has known for years: they were wrong when it came to the financial crisis!Â Via Simon Potter, the Executive Vice President and Director of Economic Research at the NY Fed, writing at the ironically named Liberty Street blog:
Looking through our briefing materials and other sources such as New York Fed staff reports reveals that the Bankâ€™s economic research staff, like most other economists, were behind the curve as the financial crisis developed, even though many of our economists made important contributions to the understanding of the crisis. Three main failures in our real-time forecasting stand out:
- Misunderstanding of the housing boom. Staff analysis of the increase in house prices did not find convincing evidence of overvaluation (see, for example, McCarthy and Peach  and Himmelberg, Mayer, and Sinai ). Thus, we downplayed the risk of a substantial fall in house prices. A robust approach would have put the bar much lower than convincing evidence.
- A lack of analysis of the rapid growth of new forms of mortgage finance. Here the reliance on the assumption of efficient markets appears to have dulled our awareness of many of the risks building in financial markets in 2005-07. However, a March 2008 New York Fed staff report by Ashcraft and Schuermann provided a detailed analysis of how incentives were misaligned throughout the securitization process of subprime mortgagesâ€”meaning that the market was not functioning efficiently.
- Insufficient weight given to the powerful adverse feedback loops between the financial system and the real economy. Despite a good understanding of the risk of a financial crisis from mid-2007 onward, we were unable to fully connect the dots to real activity until 2008. Eventually, by building on the insights of Adrian and Shin (2008), we gained a better grasp of the power of these feedback loops.
However, the biggest failure was the complacency resulting from the apparent ease ofÂ maintaining financial and economic stability during the Great Moderation.
Funny, there is no mention of former Fed Chairman Alan Greenspan’s historical lowering of interest rates from 2001-2003. Â No mention of a literal collapse in money printing come the summer of 2008 after double digit growth just months before.Â Just a weak “we didn’t see it coming but then again neither did anyone else” excuse put out at the inconspicuous time of 6pm on 11/5/2011 (Black Friday).Â Ilene of Zerohedge responds to the laughable post brilliantly:
The excuse that most other professional forecasters didn’t foresee it is just that, an excuse. Some professional forecasters did see it. They were derided as Cassandras and dismissed by Wall Street and Fed insiders, who are only beholden to each other, and to their own delusions.Millions of amateur economic forecasters who frequented the financial message boards and blogs saw what was happening and what was coming. They had one important advantage. They live in the real world, not inside the Beltway, not within the marble halls and equally hardened thought processes of the Fed, and not in the ivory towers of academia, a word which sounds like a disease, because it is a disease. Not only do these environments cause delusional thinking, they attract delusional people. The same is true of policy makers.I call it elitist personality disorder. It leads to delusions of grandeur, delusions of omniscience and omnipotence, and the unwillingness to take responsibility for failure and incompetence, instead engaging in blame shifting.
Indeed, it would seem like Mr. Potter could take a few lessons from the many Austrian economists who predicted the crisis years before it hit.Â Perhaps then he would have a better understanding of the business cycle and how central bank intervention is the cause of it.