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"Pot Calling The Kettle Black" Classic: Fed Researchers Slam Dishonest Economists

Tyler Durden's picture


Submitted by F.F.Wiley of Cyniconomics blog,

An economist recently recommended that I read a paper by three Fed researchers titled: “Why Did So Many People Make So Many Ex Post Bad Decisions? The Causes of the Foreclosure Crisis.” It was presented at a major conference last year and made the rounds again in the economics blogosphere this year with generally positive reviews. It seems to have been influential.

The authors – Christopher Foote, Kristopher Gerardi and Paul Willen – argue that the financial crisis was caused by over-optimistic expectations for house prices, while other factors such as distorted incentives for bankers played only minor roles or no roles at all. In other words, it was a bubble just like the Dutch tulip mania of the 1630s or South Sea bubble of the early 1700s, and had nothing to do with modern financial practices.

Then the authors make absolutely sure of their work being well-received by those who matter. The financial crisis is surely a touchy subject at the Fed, where the biggest PR challenge is “bubble blowing” criticism from those of us who aren’t on the payroll (directly or indirectly). But Foote, Gerardi and Willen are, of course, on the payroll. They tell us there’s little else that can be said about the origins of the crisis, because any “honest economist” will admit to not understanding bubbles.

Here’s their story:

[I]t is deeply unsatisfying to explain the bad decisions of both borrowers and lenders with a bubble without explaining how the bubble arose. … Unfortunately, the study of bubbles is too young to provide much guidance on this point. For now, we have no choice but to plead ignorance, and we believe that all honest economists should do the same. But acknowledging what we don’t know should not blind us to what we do know: the bursting of a massive and unsustainable housing bubble in the U.S. housing market caused the financial crisis.

We don’t often critique papers like this (who cares about Fed research outside of academic economists?) But what the heck, the bolded sentences above – in particular, the hypocritical reference to “honest economists” – deserve at least a few words of rebuttal.

We’ll limit our comments to two areas. First, we’ll offer a redline edited version of a key section in the authors’ conclusion, mostly to share a different perspective on the financial crisis.  Second, we’ll point out an example of dishonesty from these economists who brazenly claim that their own perspective is the only one that can be called honest.

Where did the bubble come from?

In practice, the authors don’t completely “plead ignorance” about the causes of bubbles as they claim to do.  They offer a few “speculative” ideas about the housing bubble, writing:

One speculative story begins with the idea that some fundamental determinants of housing prices caused them to move higher early in the boom. Perhaps the accommodative monetary policy used to fight the 2001 recession, or higher savings rates among developing countries, pushed U.S. interest rates lower and thereby pushed U.S. housing prices higher. Additionally, after the steep stock market decline of the early 2000s, U.S. investors may have been attracted to real estate because it appeared to offer less risk. The decisions of Fannie Mae and Freddie Mac may have also played a role in supporting higher prices…

This smells to us like a strategy of gently acknowledging criticism (of the Fed’s interest rate policies), while at the same time attempting to neutralize it. The authors imply that low interest rates were an unavoidable byproduct of the Fed’s recession fighting, and then shift some of the blame to foreigners in developing countries before moving on to other possible explanations.

But even if you believe the Fed’s anti-recession measures were worthwhile, the authors’ story is nonsense. It needs corrections for the facts that the Fed continued to slash rates nearly two years after the 2001 recession and then maintained an ultra-easy stance for a few years after that. It also begs the question of why the Fed responded to high foreign savings rates – which were the flip side to U.S. current account deficits and primary source of disinflation – with even greater stimulus.  Moreover, there’s much more to the Fed’s role in the housing boom than these factors.

As we see it, the financial crisis validated certain principles that aren’t reflected in mainstream models but feature in fringe areas such as Austrian business cycle theory or behavioral economics. Economists in these areas offer far more detailed explanations for the housing bubble than the “speculative story” above. For example, recent Nobel Prize winner Robert Shiller filled a whole book with bubble theories. While Foote, Gerardi and Willen would presumably call these economists dishonest, we beg to differ. Borrowing from non-mainstream ideas, here’s our edited version of the excerpt:

edited text from fed paper

If this version is accurate, the Fed’s failures include three whoppers:

  1. Monetary policy was too stimulative throughout the boom.
  2. Two decades of Greenspan/Bernanke “puts” created a mentality that risky bets couldn’t lose (moral hazard).
  3. The Fed applauded rather than stopping the deterioration in lending standards, blithely disregarding its status as only institution that was mandated to set nation-wide lending requirements.

As you might expect, Foote, Girardi and Willen weave a story that either denies or diverts attention from all three failures. One part of the story is their claim that bubbles can’t be explained and anyone who thinks otherwise is dishonest. If the defining feature of the crisis can’t be explained, then it can’t be blamed on the Fed, right?

Other parts of the story are embedded in 12 “facts” that are said to describe the crisis. As written, many of the “facts” are strictly true. Some may have even added to the public debate because they weren’t widely known in policy circles, even as they were understood in the fixed income business. Others, though, can only distort that debate. The worst of the so-called facts are somewhere in between flat wrong and technically accurate but interpreted in ways that don’t stand up to scrutiny.

Lending standards didn’t really change during the boom?!?

We’ll point out a single example, from pages 9-11 of the paper and sub-titled, “Fact 4: Government policy toward the mortgage market did not change much from 1990 to 2005.” In this section, the authors deny that policymakers dropped the ball on lending standards. They don’t mention central bankers explicitly (that would be too obvious?), choosing instead to absolve the Clinton administration of blame for its ill-fated National Home Ownership strategy. Of course, their argument also exonerates the Fed if you happen to believe it.

The argument depends partly on a history lesson that begins like this:

It is true that large downpayments were once required to purchase homes in the United States. It is also true that the federal government was instrumental in reducing required downpayments in an effort to expand homeownership. The problem for the bad government theory is that the timing of government involvement is almost exactly 50 years off. The key event was the Servicemen’s Readjustment Act of 1944, better known as the GI Bill, in which the federal government promised to take a first-loss position equal to 50 percent of the mortgage balance, up to $2,000, on mortgages originated to returning veterans.

The authors then tell a nostalgic tale about loan-to-value (LTV) ratios in the 1950s and 1960s, before skipping ahead to the 1990s and 2000s. For the latter period, we’re told to believe that lending standards didn’t decline in a meaningful way:

Figure 6 shows LTV ratios for purchase mortgages in Massachusetts from 1990 to 2010, the period when government intervention is supposed to have caused so much trouble … But inspection of Figure 6 does not support the assertion that underwriting behavior was significantly changed by that program [Clinton’s National Homeownership Strategy].

Here’s the key chart that goes with this claim:

fed paper figure 6

Here are a few reasons why the thesis doesn’t fit the reality:

  1. The authors share data for only one state (Massachusetts), while failing to mention that it didn’t have much of a housing bust. Consider that Boston is one of only four cities (out of 20) in the S&P/Case-Shiller Home Price Index for which prices didn’t fall by more than 20%. During the bear market period for the full index, the Boston component fell only 16%, less than half the 34% drop in the national index.
  2. The authors’ sweeping argument relies on not only a single state, but also a single indicator (LTV ratios). You might wonder: What were the credit scores of borrowers at each LTV level? How did their incomes compare to monthly mortgage payments? Were their incomes verified? These types of questions need answers before you can draw general conclusions about underwriting behavior.
  3. Even the cherry-picked data – Massachusetts LTV ratios! – doesn’t support the authors’ conclusions. It shows that the incidence of ratios greater than 100% tripled during the housing boom, from about 8% of all Massachusetts mortgages to about 25%. The claim that this change isn’t significant is incredulous.
  4. LTV ratios in the 1950s and 1960s, while interesting, are irrelevant to the early 21st century housing boom. Different era, different circumstances, different implications.

Needless to say, the authors’ attempt at defending fellow public officials falls well short. Lending standards declined sharply during the boom, and this was encouraged by both the federal government and the Fed. No amount of data mining can change these facts.

Overall, the Fed staffers’ paper fits a common pattern. It’s stuffed with enough data to be taken seriously, but inferences are based more on spin than objective analysis. The approach aligns conclusions with an establishment narrative, while protecting the authors’ establishment status. The last thing you would call this paper is an honest piece of research.

Bonus edit

As long as we’re at it, here’s an extra edit, this one offering another perspective on Foote, Gerardi and Willen’s conclusions about our knowledge of bubbles (from the first excerpt above):

edited text from fed paper 2


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Thu, 12/19/2013 - 14:30 | Link to Comment zerozulu
zerozulu's picture

Game of ropes and necks has started.

Thu, 12/19/2013 - 14:45 | Link to Comment jtg
jtg's picture

Remember the Hungarian revolution in 1956, and pictures of communists hung from lamp posts? Whenever I see or hear our sociopathic elites I think of stretching their necks.

Thu, 12/19/2013 - 15:02 | Link to Comment Son of Captain Nemo
Son of Captain Nemo's picture

Ah but when will the American people summon the courage to make the "stretching of necks" a reality?

We love to talk the shit -Don't we? 

And this market and the wars for looting that continue in perpetuity in 'our names' around the globe for the past 60+ only proves that we as citizens won't go any further until all or most of it is completely taken away from us!

Thu, 12/19/2013 - 15:10 | Link to Comment SafelyGraze
SafelyGraze's picture

mister F.F.Wiley:

you swingeth a mighty big bat here in this article

more, please

Thu, 12/19/2013 - 15:25 | Link to Comment Ruffcut
Ruffcut's picture

the cunts of christmas past, present and future.

Thu, 12/19/2013 - 23:38 | Link to Comment G-R-U-N-T
G-R-U-N-T's picture

"This smells to us like a strategy of gently acknowledging criticism (of the Fed’s interest rate policies), while at the same time attempting to neutralize it."

Of course, this is just their way of trying to please everyone, while not taking any direct action to remedy the problem as Congress continues to tax and spend and gives it to them to fix. They are between the prorverbial rock and a hard place moment. Damn if they do damn if they don't scenerio. They need to grow a set of balls, hmm....Yellen may have a problem with that and the Bernanke never had any to begin with!

Thu, 12/19/2013 - 15:14 | Link to Comment Pladizow
Pladizow's picture

"Unfortunately, the study of bubbles is too young...."

Remind me: When did the tulip bubble occur?

Thu, 12/19/2013 - 16:04 | Link to Comment jcaz
jcaz's picture

Exactly-  bubbles in markets have occured since markets began-  his response reeks of his Ivory Tower exposure to the real world......

Or it's the "I'm too stupid to be guilty" reflex kicking in......

Thu, 12/19/2013 - 16:12 | Link to Comment ZerOhead
ZerOhead's picture

1. Monetary policy was too stimulative throughout the boom.


Correction.... stimulative monetary policy WAS the boom...

Thu, 12/19/2013 - 15:12 | Link to Comment NoDebt
NoDebt's picture

This makes about as much sense as having a bunch of Cardinals write an article explaining how the Pope MIGHT have made a little mistake in the era of Papal Infallibility.

Stupid.  Propoganda at best.

Thu, 12/19/2013 - 14:47 | Link to Comment nope-1004
nope-1004's picture

Pot calling kettle black?  I prefer "Thief calling the liar a crook".


Thu, 12/19/2013 - 15:48 | Link to Comment Freewheelin Franklin
Freewheelin Franklin's picture

Game of ropes and necks has started.


Fucking brilliant! 


I LOL'd but it was a melancholy LOL 

Thu, 12/19/2013 - 14:31 | Link to Comment jsgibson
jsgibson's picture

"That's as good as money, sir. Those are I.O.U.'s. Go ahead and add it up, every cent's accounted for."

Thu, 12/19/2013 - 14:33 | Link to Comment Martial
Martial's picture

You can't triple stamp a double stamp!

Thu, 12/19/2013 - 14:52 | Link to Comment G.O.O.D
G.O.O.D's picture

"That's an IOU. This one is for $275,000 for a car. Might want to hold on to that one!"

Thu, 12/19/2013 - 14:34 | Link to Comment DOGGONE
DOGGONE's picture

If one looks at inflation-adjusted asset price histories,
bubbles are VERY apparent!
But of course, if your mantra is The Public Be Suckered ...

Thu, 12/19/2013 - 14:35 | Link to Comment giggler321
giggler321's picture

Hang on, don't question the PHD's most are Feared Revelers

Thu, 12/19/2013 - 14:47 | Link to Comment ILikeBoats
ILikeBoats's picture

I KNOW NUSS-ING!  -- Sgt. Benjamin Schultz Bernanke

Thu, 12/19/2013 - 17:37 | Link to Comment Colonel Klink
Colonel Klink's picture

Yeah where has that ignorant miserable bastard been?

Thu, 12/19/2013 - 14:48 | Link to Comment nickels
nickels's picture

In my village we have a word for economists who claim that they don't understand bubbles. We call them "Liars".

Thu, 12/19/2013 - 15:01 | Link to Comment NIHILIST CIPHER

I'm not sure I can even address this article..............the Fed badly misinterpreted........lending standards didn't really change? WTF?   Gagging reflex just kicked in.  

Thu, 12/19/2013 - 15:03 | Link to Comment ThisIsBob
ThisIsBob's picture

Went target shooting with an economist over the weekend.  His first shot was 2 inches left, second shot shot was two inches right.  "Bullseye!" he said.

Thu, 12/19/2013 - 15:55 | Link to Comment kralizec
kralizec's picture


I hope you are here all week!

Thu, 12/19/2013 - 15:03 | Link to Comment ebworthen
ebworthen's picture

"Baffle 'em with Bullshit" in full force at the FED.

This is called "crazy making", where you tell someone truths and lies mixed with half-truths and half-lies, while maintaining an air of infallibility & utter honesty even though you are a duplicitous manipulator.

It is a trait common in those with Borderline Personality Disorder (the FED and my Ex.).

Thu, 12/19/2013 - 15:05 | Link to Comment chunga
chunga's picture


"Unfortunately, the study of bubbles is too young to provide much guidance on this point. For now, we have no choice but to plead ignorance, and we believe that all honest economists should do the same."

They knew exactly what the fuck they were doing and they know it now. Maybe not "loan officers" or clerks but those at the top of the ponzi food chain knew.

There isn't much left to steal, so how do you steal money from people who don't have any?

Simple...just give it to them.

Throw in this crazy credit default baloney, the GSE cronies "buying" all of this shit with taxpayer debt money, the fedzies QE crap, etc. etc...and you end up with the moast ridiculous fucking story on earth.

This was and is the biggest swindle ever and has also exposed our "court" system once and for all as the tools they are.

Fuck these jerks.

Thu, 12/19/2013 - 15:02 | Link to Comment CrashisOptimistic
CrashisOptimistic's picture

But acknowledging what we don’t know should not blind us to what we do know: the bursting of a massive and unsustainable housing bubble in the U.S. housing market caused the financial crisis.


Oh, look, that flood of abundant crude is above $99 again headed for $100+, and it hitting $150 just 4 months before the 2008 Apocalypse was merely coincidence.

Thu, 12/19/2013 - 15:11 | Link to Comment Pumpkin
Pumpkin's picture

Thieves will lie, and liars will steal.  Makes sense.

Thu, 12/19/2013 - 15:23 | Link to Comment vxpatel
vxpatel's picture

of course the institution defines what 'is' honest, and what is honest is the bedrock of the establishment...all of it corrupt to the core.

Thu, 12/19/2013 - 15:29 | Link to Comment moneybots
moneybots's picture

"Unfortunately, the study of bubbles is too young to provide much guidance on this point. For now, we have no choice but to plead ignorance, and we believe that all honest economists should do the same."


This quote doesn't pass the smell test.

Thu, 12/19/2013 - 15:34 | Link to Comment NoDebt
NoDebt's picture

Did anyone else notice that this entire story completely misses the point?

They no longer cared to even LOOK for a bubble during the housing crisis.  Why?  Let's ask the man in charge while this was all going down:

The Maestro (Alan Greenspan) HAS SAID OPENLY THAT HIS MISTAKE was that he implicitly trusted banks not to do things that would generate short term profits at the risk of systemic collapse.  

HE ALSO SAID that he believed that the risks were so well diversified around the world financial system that it could withstand some very heavy shocks, including, he believed, something even larger than the subprime crisis.  Something he was also wrong about.

NOBODY WAS EVEN LOOKING FOR BUBBLES AT THE FED BECAUSE THEY BELIEVED THEY WOULD NEVER HAPPEN AGAIN AND IT WOULDN'T MATTER IF THEY DID.  In short, hubris.  Enough of it that they believed that even corruption could not bring down their beautiful system.

If the Fed disagrees with this, I'll point out playground rule #1:  YOUR OWN GUY SAID SO.  It's over.  It happened right under the Fed's nose on their watch and it was intentionally ignored.  Assholes.

<drops mic, walks off stage>

Thu, 12/19/2013 - 15:36 | Link to Comment bnbdnb
bnbdnb's picture

If any investor answers an investment question starting with "because the Fed ________ " - you have a bubble.

Thu, 12/19/2013 - 15:43 | Link to Comment logicalman
logicalman's picture

How do you spot an honest economist?

He's looking for a job.

Thu, 12/19/2013 - 15:47 | Link to Comment bozzy
bozzy's picture

Bernanke wants to slither away before TSHTF - just have to hope that American ZIRP victims will find a way past his security at some point and fork and dangle the evil little bastard.

Thu, 12/19/2013 - 15:47 | Link to Comment moneybots
moneybots's picture

"The authors – Christopher Foote, Kristopher Gerardi and Paul Willen – argue that the financial crisis was caused by over-optimistic expectations for house prices, while other factors such as distorted incentives for bankers played only minor roles or no roles at all."


Absolute nonsense.


Greenspan deliberately took lending standards to ZERO.

Greenspan deliberately took the FED rate to 1% and held it there, then moved it up 1/4 point per meeting.

Greenspan deliberately told home buyers to get adjustable rate mortages.

Greenspan deliberately praised bank lending programs (which included liar loans)

Investment banks got leverage waivers

The Bush administration created the Home Ownership Society program

The Bush administration sought to prevent states from prosecuting predatory lending.

The FBI warned congress in 2004, of  MASSIVE MORTGAGE FRAUD


The financial crisis was not caused by over optimistic expectations for housing prices.

Thu, 12/19/2013 - 15:56 | Link to Comment insanelysane
insanelysane's picture

- "deserve at least a few words of rebuttal"

- deserve at least a few words of ridicule.

Fixed it for ya.

Thu, 12/19/2013 - 15:56 | Link to Comment steelhead23
steelhead23's picture

I'm afraid that Mr. Wiley misses a major contributor to the mess - fraud.  I hold that all Magnetar and Aurora trades were frauds - and in 2007, they dominated the market (Yves Smith - Econned).  Yes, the Fed blew the bubble - but they were not alone.  From aggressive real estate agents to mortgage shysters, the housing finance industry devolved into a grand fraud.  Folks love to heap scorn on folks like Joe Cassano for his lax attention to the quality of the securities he was insuring.  But how would he know that GS and John Paulson were thieves?  So, yes, the Fed started the ball rolling with its recession-fighting vigor - but the scale and scope of the crash was abetted by fraud.  Lots and lots of fraud.

But here too, the Fed deserves much of the blame.  It simply didn't understand the game for which it was the croupier - a mortal sin.  It is my understanding that the maestro himself, Mr. Greenspan, strongly opposed regulation of the financial derivatives market when Brooksley Born was ringing the warning bell even though he subsequently admitted that he did not understand either the derivatives market or the risks they posed.  So yes, we should blame the Fed (primarily Greenspan) for the mess, but we should not stop at its affirmative actions, we should also consider its inactions.  As a covert and highly respected mouthpiece for its owners, the big banks, the Fed prevented the kind of regulation that would have reduced the scale of the crash.  We don't let children play with matches.  Why are we letting the Fed play with monetary policy?

Thu, 12/19/2013 - 16:09 | Link to Comment rlouis
rlouis's picture

When the median home price was far above the ability of the median income family to repay at a fully indexed interest rate, and when the most active buyers bought with 0 down, no-income no-asset no-underwiting loans, at artificial start rates, and the loans were packaged and sold off by Wall St. to pension funds and government sponsored institutions, one had to be willfully blind to not see a bubble, or grand theft in progress.  

Do such employees of the Federal Reserve have no shame?  I guess not, one only need look at their employer, who they have choosen to work for.  No shame, no honor, no integrity. But why beat a dead horse.

Thu, 12/19/2013 - 16:21 | Link to Comment lasvegaspersona
lasvegaspersona's picture

...the predictive abilities of their models is so good that we should respect what they say...right...? 100% is good ...right?...

Thu, 12/19/2013 - 16:56 | Link to Comment linniepar
linniepar's picture

Can we end the fed yet? 

Thu, 12/19/2013 - 17:32 | Link to Comment TrustWho
TrustWho's picture

If you listened to Daddy Bernanke's press conference yesterday, you heard a new mantra that these guys used: Central Banks raison d'etre  focused on minimizing the damage from Financial Panics and on this metric they are doing a good job.

Let me get this correct, The Fed starts a panic, The Fed protects the 0.1% of the population from wealth loss and The Fed wants the masses to applaud you as our great savior.....sorry, I think I will pass on this sick arrogant delusion by The Fed. I believe a person or institution can never brilliantly clean up THEIR mess. 

The Fed has initiated a PR campaign that depends on getting the media to believe any bubble is just a force ma·jeure event and the world needs the Fed to fight financial panics. I must thank ZeroHedge for fighting this PR campaign and hopefully we can hold the Fed accountable for their role in creating this financial crisis. 

Thu, 12/19/2013 - 18:42 | Link to Comment Bow Tie
Bow Tie's picture

yellen has that pudding bowl haircut down nicely.

Thu, 12/19/2013 - 19:25 | Link to Comment Reaper
Reaper's picture

Economists are paid apologists for their employer. The question an employed economist asks his employer is, "What do you want the report to say?" The government in July 1999 ordered the bad mortgage loans. The Fed under Greenspan and Bernanke supported those policies with low interest rates and other enabling. Read the press release by Andrew Cuomo, HUD Secretary under Clinton, where the government calls for half of $2.4 trillion dollars in mortgages to given to unqualified applicants. Bush did not reverse these policies.

Thu, 12/19/2013 - 20:13 | Link to Comment honestann
honestann's picture

If the fed cannot understand causes of economic dislocations, then the ENTIRE rationalization for the creation and existence of the fed is eliminated.

Which means, those fed "economists" advocate...

!!!!!  END THE FED  !!!!!

I wonder whether they realize that.

Do they think we are too stupid to notice?

Thu, 12/19/2013 - 23:11 | Link to Comment Playtime's Over
Playtime&#039;s Over's picture

To be honest most are too stupid to notice and of course the fed is........

Thu, 12/19/2013 - 23:44 | Link to Comment Rakshas
Rakshas's picture

How does that go again...... Economics...The science of explaining tomorrow why the predictions you made yesterday didn't come true today. ...... tired but true.


Yeah anyway, the things we do to try to cover our failures is nothing less than stellar in its dishonesty......... delusional all....


Unless and until you understand how money works you will not change a damned thing......... Unknown (actually Mike Ruppert is where i heard it last)



Fri, 12/20/2013 - 11:07 | Link to Comment MagicMoney
MagicMoney's picture

Central bank apologist. I come across this kind of people before. One guy on YouTube was telling me how Alan Greenspan was the greatest Fed Chairman ever, and the cause of the financial crisis was deregulation. He actually sent me a propaganda link to try to sway my views. I had to laugh. I think the guy was a monetarist, or something.  Central bank apologist always try to understate Fed's ability to influence markets as being a passive institution while comically proclaiming such a thing as "greatest Fed Chairman ever".

As Carl Menger said, all things subject to cause and effect. Effects are much more easily seen than the actual causes. Bubbles are not random. They have their cause. Even the Tulip Mania had a cause and effect. People use estimation and speculation to determine future prices. The causes for speculation involve actual causes of price spikes from high demand, or/& shortage, which is relative between the two. Whether people can accurately speculate future prices is another story. Human emotions can exaggerate reality to the point it's not longer reality. It's imaginary. Humans respond to the environment which they live in. They live in the world of cause, and effect.



Fri, 12/20/2013 - 11:12 | Link to Comment Ghordius
Ghordius's picture

+1 for mentioning the great Carl Menger, imho the first and last serious economist

yet I am a central bank apologist, sort of. I do not defend every act of every CB, though

a CB is imho something in between a giant credit card and nuclear power. or weapons. it's about how they are used that makes the difference

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