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“No One Saw It Coming” — REALLY?

Posted By Barry Ritholtz On January 2, 2009 @ 7:48 am In Credit,Derivatives,Federal Reserve,Markets | Comments Disabled

One of the biggest outright lies of this housing, economic and financial collapse is that “No one saw it coming.”

This is a patently absurd comment. Anyone who makes it — and there have been lots and lots of people saying as much –  reveal themselves as either clueless or liars or both.

Today’s WSJ has two articles about the many warnings that were out there. Not just on Blogs, but amongst fund managers, Wall Street Analysts, academics, and Fed economists.

The most striking example is found in Justin Lahart’s column, Mr. Rajan Was Unpopular (But Prescient) at Greenspan Party [1]:

“It was August 2005, at an annual gathering of high-powered economists at Jackson Hole, Wyo. — and that year they were honoring Alan Greenspan. Mr. Greenspan, a giant of 20th-century economic policy, was about to retire as Federal Reserve chairman after presiding over a historic period of economic growth.

Mr. Rajan, a professor at the University of Chicago’s Booth Graduate School of Business, chose that moment to deliver a paper called “Has Financial Development Made the World Riskier?”

His answer: Yes.

Mr. Rajan quickly came under attack as an antimarket Luddite, wistful for old days of regulation. Today, however, few are dismissing his ideas. The financial crisis has savaged the reputation of Mr. Greenspan and others now seen as having turned a blind eye toward excessive risk-taking.”

What exactly was it that professor Rajan was warning about? It reads like a laundry list of precisely what has hit the financial markets:

  1. Incentives were horribly skewed in the financial sector;
  2. Credit-default swaps generated big returns, but failed to consider the risk if defaults occurred;
  3. Banks were holding a portion of the credit securities they created, putting the banking system itself at risk.
  4. Banks might lose confidence in one another;
  5. If that occurred, the interbank market could freeze up. This would cause a full-blown financial crisis.

As we now know, that is precisely what occurred.

That the warnings were there is one thing. That they were ignored at the highest levels reflects the massive failure of our institutions, most notably, the Federal Reserve. Bernanke might get high marks for his handling of the crisis, but its his institution that is behind so many of the bad decisions and missed opportunities. That speaks volumes . . .

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Sources:
Mr. Rajan Was Unpopular (But Prescient) at Greenspan Party [1]
JUSTIN LAHART
WSJ, JANUARY 2, 2009

http://online.wsj.com/article/SB123086154114948151.html

Has Financial Development Made the World Riskier? [2]
Raghuram G. Rajan

http://www.kc.frb.org/publicat/sympos/2005/PDF/Rajan2005.pdf

The Doomsayers Who Got It Right [3]
More Bad News in Store for 2009? Last Year’s Cassandras Are Still Gloomy
JEFF D. OPDYKE
WSJ, JANUARY 2, 2009

http://online.wsj.com/article/SB123086035502948067.html


Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2009/01/no-one-saw-it-coming-really/

URLs in this post:

[1] Mr. Rajan Was Unpopular (But Prescient) at Greenspan Party: http://online.wsj.com/article/SB123086154114948151.html

[2] Has Financial Development Made the World Riskier?: http://www.kc.frb.org/publicat/sympos/2005/PDF/Rajan2005.pdf

[3] The Doomsayers Who Got It Right: http://online.wsj.com/article/SB123086035502948067.html

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