Sunday, November 02, 2008

Shiller's Warning: Hardly Useful

In today's New York Times, Robert Shiller notes how groupthink led to the subprime crisis, and points out that while Greenspan notes that the warnings among the experts were rather tepid, the Fed ignored many who were worried about the housing bubble. But I'm rather unconvinced the Fed screwed up, given the incredibly equivocal warnings that Shiller highlights. In his own words:
In 2005, in the second edition of my book “Irrational Exuberance,” I stated clearly that a catastrophic collapse of the housing and stock markets could be on its way. I wrote that “significant further rises in these markets could lead, eventually, to even more significant declines,” and that this might “result in a substantial increase in the rate of personal bankruptcies, which could lead to a secondary string of bankruptcies of financial institutions as well,” and said that this could result in “another, possibly worldwide, recession.”

Note the ubiquity of the weaselly 'could' word. Anything could happen: Terrorist Attack with Nuclear weapons, Stock market goes down another 40%, goes up 60%. You name it, it could happen. I don't see how noting various 'coulds' is very helpful, because logically, so many things could happen, noting a 'could' is hardly informative.


Anonymous said...

The central problem is when things are going great, it takes a very strong, independent leader willing to brave indignation and career risk/loss to pull the punch bowl away based on things that COULD happen at the expense of all the good things that ARE happening in the moment (e.g. easy credit and rising home prices).

Anonymous said...

Word. The prevailing mentality rewards idiots like Jim Cramer who speculate so many "coulds" that no matter what happens, their psycho fans can go back to find a quote that shows what a genius they are.

Plamen said...

Agreed on Cramer, and may I quote the blog's author as saying something along the lines of "Cramer's signal-to-noise ratio approaching zero".

It seems Mr Falkenstein shares my visceral abhorrence for "could" in forecasts - one more reason to keep this blog on my Bookmarks toolbar.

When I worked in private equity, they quickly taught me out of this cheap bet-hedging technique - all it took was a couple of times of being asked by a senior lender "Could? Please quantify and explain."