Friday, January 13, 2012

Hindsight is 20/20

Todays WSJ features an article highlighting how badly the Fed can read crystal balls. For my new macro students, the Fed is the entity in charge of monetary policy in the U.S.. Some of the main duties of the Fed are to set targets for a key interest rate (what banks charge each other for overnight lending) and to regulate some financial institutions.

WSJ (1-13-2012) Little Alarm Shown at Fed At Dawn of Housing Bust by Jon Hilsenrath, Luca Di Leo and Michael S. Derby

The Fed was certainly not alone in being blind to the coming crisis. They were part of a "mass delusion" according to Michael Lewis, author of  Big Short: Inside the Doomsday Machine. Lewis has written many other bestsellers, including Moneyball.  In the Big Short, Lewis focused not on Bernanke (chairman of the Fed) or CEOs of investment banks. He concluded these people had "no clue what was going on". Instead he focused on the "handful of characters who had seen it coming".

One of 10-20 or so investors in the world who saw it coming was Michael Burry, a doctor turned hedge fund investor.  Burry foresaw problems in the sub-prime markets by reading prospectuses of mortgage securities.

To learn more about who figured out what and when, watch this 15 minute video clip by 60 minutes (March 2010). Lewis concluded the main problem was improperly designed incentives - the short term focus of the bonus system for employees in the financial sector was the ultimate cause of the crisis.

March 2010

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