As this crisis wears on, fewer and fewer people remember being surprised by it. For example, in a Blogginheads episode, Megan McCardle and Dean Baker both noted they anticipated the collapse even though Baker called for a 10% decline in housing back in 2002, which is about 20% below December 2008 level. But last April, as these problems were becoming apparent, I was at a meeting by the National Bureau of Economic Research, where all the top financial economists got together. Markus Brunnemeier gave a talk on the housing bubble and noted that about $200B in value had been destroyed via the housing price decline, and this represented only a couple percent in the stock market. The implication was the market had already overreacted. The consensus was this was correct, and I must admit I was no different.
I think what is most surprising about this is the accelerator mechanism that propelled a housing bubble into so many other sectors. It destroyed the market value of all sorts of assets, and seems caught in a positive feedback loop. A related puzzle is that the crisis seemed to start in the US, but the US equity market has declined less than most other countries, and our currency has strengthened. One of my favorite bank analysts, Tom Brown, called for a bank stock bottom last summer. I don't feel bad not understanding or anticipating this, because I know many thoughtful people missed it too, and that very few crises are understood in real time. Sure, with hindsight, I'm seeing connections, how a total lack in trust has created declines in market values which cause declines in banks that have to mark more and more of their assets to market, but realistically going back to last year I don't see how I could have anticipated this other than being a permabear, or knowing about the prevalence of NINJA loans. Indeed, maybe that is the missing variable, that one could not have predicted this problem without knowing how crazy mortgage underwriting became.