Posts filed under “Really, really bad calls”

Worst Idea of 2009

Shorter Floyd Norris:

“Goldman Sachs is trying to arrange to buy tax credits from Fannie Mae. Obviously, it would buy them at a discount.

Goldman, you may recall, was saved with taxpayer money when the panic spread last year. A naïve person might think such a company would see a patriotic virtue in paying taxes.

Fannie Mae is currently a ward of the government. So this boils down to a proposal to pay Uncle Sam perhaps 15 cents to avoid paying 20 cents to Uncle Sam.

The gall involved in even proposing such a thing is awesome.

I could not possibly agree more — its simply insane . . .

Category: Bailouts, Really, really bad calls

The Hubris of Economics

On Tuesday, the 2nd most emailed article on WSJ.com was Crisis Compels Economists To Reach for New Paradigm.

It is an intriguing look at the problems of the the field of economics. It went, however, way too easy on both the profession and its practitioners. The article fails to ask some very basic questions about the soft science, and does not discuss the fundamental incompetency of many economists.

Given the failures of the profession — failing to anticipate the worst recession in decades, missing the warping effect of the housing boom, not recognizing the credit collapse until too late — a damning indictment of the dismal science might have been more appropriate.

Perhaps I can be of assistance.

There are many areas I would have liked to see the Economics Crisis article explore: The lack of Scientific Method, the mostly awful performance of economists, its misunderstanding of the value of modeling, the bias inherent in Wall Street variant of economics, and lastly, the corruption of economics by politics. I will just touch on some of these; you can fill in much of the blanks yourself.

Let’s start with the basics. Hard “science” — Physics, Biology, Chemistry, and all variants thereto — begins humbly. They try to describe the universe around us by creating theories, and then testing them. These theorems are always preliminary. Even when testing validates them, Science is always prepared — even eager — to replace them with newer theories that are proven to be even more valid.

The humility of science begins with an admission: We know nothing. We seek to learn through experiment and logic, and constantly evolve more and more accurate explanations. Scientific belief evolves gradually over time. Nothing is assumed, presumed, or hypothesized as true. Indeed, research is a presumption that current theories are inadequate or incomplete. The practice of science is a an ongoing search for better explanations, more proof, further verification — for Truth.

Science is the ultimate “show me” state.

Economics has a somewhat, shall we call it, less rigorous approach. Indeed, the arrogance of economics is that it is the polar opposite of Science. It begins with a few basic assumptions, many of which are obviously untrue; some are demonstrably false.

No, Mankind is not a rational, profit maximizing actor. No, markets are not perfectly, or even nearly, efficient. No, prices do not reflect the sum total of all that is known about a given market, sector or stock. Those of you who pretend otherwise are fools who deserve to have your 401ks cut in half. That is called just desserts. The problem is that your foolishness helped cut nearly everyone else’s 401ks in half. That is called criminal incompetence.

Where was I?  Ahhh, our sad tale of the practitioners of the dismal arts.

Starting from a false premise that fails to understand the most basic behaviors of the Human animal, economics proceeds to build an edifice of cards on a foundation of sand. (How could that possibly go astray?) Like a moonshot off by a few inches at launch, by the time the we reach further into time and space, the trajectory is off by millions of miles . . .

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Economics has had a justifiable inferiority complex versus real sciences the past century. It has attempted to overcome this by throwing lots of smart mathematicians at its practice, in an attempt to make the social art seem more “sciency,” and thus  more credible. This had led to lots and lots of formulas and models. The problems is, Economics places way too much weight on these. It creates an illusion of precision where none exists. The belief in their models led to all manner of mischief, from subprime to derivatives to risk management.

Economics forgot George E. P. Box’s most basic rule:

“Essentially, all models are wrong, but some are useful”

Box was a statistician who recognized the fundamental truth of all attempts to depict the universe mathematically: They are inherently flawed.

He also understood that these flawed attempts can at times have value. His insights contextualize what mathematical modelers do — and fail to achieve.

Economics fails at this often.  The belief in the validity of their models — like the theories they are based upon — is the Achilles heel of the profession.

This is not to say there are not good, even great economists (some are even friends of mine!) who foresaw the coming crisis and warned about it. Many are aghast at the rigor mortis in the academic establishment; some are horrified at how poorly the profession has done. Forget forecasting the future, too many economists cannot accurately describe what happened yesterday.

The Behaviorists have been fighting the mainstream for decades now, trying to correct the errors of the basic building blocks of the dismal science.

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Excerpt after the jump.

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Previously:
The Mystery of the Awful Economists
RealMoney.com, 3/2/2005 3:42 PM EST

http://www.thestreet.com/p/rmoney/barryritholtz/10211333.html

(If you cannot access the Real Money piece, click here).

Mystery of the Awful Economists, part II (April 8th, 2005)

http://www.ritholtz.com/blog/2005/04/mystery-of-the-awful-economists-part-2/

Mystery of the Awful Economists part III (April 13th, 2005)

http://www.ritholtz.com/blog/2005/04/mystery-of-the-awful-economists-part-iii/

RIP Chicago School of Economics: 1976-2008 (December 23rd, 2008)

http://www.ritholtz.com/blog/2008/12/chicago-repudiation/

Why Economists Missed the Crises (January 5th, 2009)

http://www.ritholtz.com/blog/2009/01/why-economists-suck/

The Big Picture: On the Efficient Market Hypothesis (2005-09)

The Big Picture: On Prediction Markets (2004-09)

Source:
Crisis Compels Economists To Reach for New Paradigm
MARK WHITEHOUSE
WSJ, NOVEMBER 3, 2009

http://online.wsj.com/article/SB125720159912223873.html

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Category: Markets, Mathematics, Really, really bad calls

Uh-Oh: Economists Say Recovery, Market Gains Solid

No worries! The same people who missed the worst oncoming recession in 80 years, the credit collapse (worst in US), and the market crash are now telling you the recovery is for real. Gee, why does this — Economists expect recovery to stick, see slow, steady GDP rise — not make me more comfortable? “Nearly…Read More

Category: Contrary Indicators, Really, really bad calls

Wolf vs Siegel: EMH Smackdown

You might have missed yet another smackdown yesterday: A debate on the Efficient Market Hypothesis in the FT vs the WSJ: • Martin Wolf: How mistaken ideas helped to bring the economy down (FT) • Jeremy Siegel: Efficient Market Theory and the Crisis (WSJ) My read is Wolf trounced Siegel, but as a non-fanboy of…Read More

Category: Markets, Really, really bad calls

Reckless Strategies Doomed WaMu

It seems to be Real Estate Monday, as a series of intriguing articles have broken recently. First and foremost, the Seattle Times has a fascinating two parter, that you must not miss:  A series of interviews with former WaMu executives and employees, as well as a survey of internal company documents, reveals that management plotted…Read More

Category: Credit, Real Estate, Really, really bad calls, Regulation

Reaganomics vs. Obamanomics

Category: Economy, Really, really bad calls, Video

CATO: Sub-Prime, Rates, Leverage Did NOT Cause Crisis

You gotta love the hard core ideologues: Its almost cute they way they stick to their theories, facts be damned. Cute, except for the amount of damage they caused. (Hmmm, this Kool aid is delicious!) Case in point: The latest work of fantasy from the CATO Institute. They are now insisting that a stricter fed…Read More

Category: Bailouts, Psychology, Really, really bad calls, Regulation

Partisan Economics

David Leonhardt has a terrific piece in the Times today on Bruce Bartlett — “the most persistent — and thought-provoking — conservative critic” of the GOP. The discussion of tax cuts is fat too common sense to be seen in print very often: “His conservatism starts with the idea that high taxes are no longer…Read More

Category: Politics, Really, really bad calls

Birth Death Adjustment Coming Under Fire

One of our favorite bugaboos is finally getting its due: The horrifically misleading Birth Death adjustment. It is finally being recognized in the mainstream as the massive data distorter that it is. The latest BLS analysis and data revision shows that during 2008, the Birth Death adjustment caused NFP payrolls to be  significantly under reported….Read More

Category: Employment, Really, really bad calls

Why Have 2009 Earnings Forecasts Been the Worst Ever?

Jim Bianco has some comments on this year’s horrific analyst misses:

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At Bianco Research, we have demonstrated that earnings forecasts are missing by their widest margin ever in 2009. While we have over 140 years of actual earnings data, IBES earnings estimates date back to 1985.

The chart to below shows the error rates in forecasting operating earnings for both top-down forecasters (strategists) and bottom-up forecasters (company analysts). It measures the forecast one-year forward versus what actually happened one year later. The data covers the period from 1985 to 2002, and unfortunately we have been unable to secure an update. It shows that the largest forecasting errors ranged from +30% in the late 1980s (meaning the forecasters were far too optimistic) to -20% during the recession of 2000 (meaning they were far too pessimistic). Data from 2002 to 2006 is missing, but it is a safe assumption that the earning misses that occurred during this period were not as extreme as the previous records set.

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error rates

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The next chart uses Bloomberg data for bottom-up forecasts. By mixing IBES and Bloomberg forecasts, we risk comparing apples to oranges. But, if the surveys are done properly they are both surveying the same people and should offer a very similar data set. As highlighted on the chart below, the current forecasting error is now near 100%, more than three times the largest error seen from 1985 to 2002. No other period has ever come close to the current period.

Read More

Category: Earnings, Really, really bad calls