I have a wonderful expression, printed on an 8 ½- x 11-inch glossy piece of paper, matted, framed, and hanging in my office. It says, “Success is the intelligent use of mistakes.” It was a gift from my wife, who gave it to me after I had dropped the ball on something.
In February 2008, I wrote a column titled “Calm Down: No Recession,” in which I explained why the slowdown in housing and construction activity the prior year was not going to result in a recession of any magnitude, largely because of intervention by the Federal Reserve Board and its chairman, Ben Bernanke. Here was my logic:
- Home prices were down 5 to 10 percent at that point, but if they fell 30 percent, $6 trillion worth of housing wealth would be wiped out. How could anything like that happen?
- Losses on subprime mortgages were only expected to range from $150 billion to $400 billion. The latter would equal about 3 percent of U.S. annual economic output, which is similar, in real dollars, to the losses suffered by S&Ls and commercial banks from 1986-95. Big deal.
- The Bush administration was unveiling a private-sector fix, which included urging big banks to create a new entity to buy some of the mortgage-linked securities. It never happened.
- At the time, housing comprised a much smaller share of the economy than business investment, and exports to a still-strong European economy would offset any contraction. For the entire U.S. economy to contract would probably require a broad decline in consumer spending, which had not happened since 1991. Wrong. Consumer sentiment tanked, housing still is the backbone of our economy, and the wheels came off the economy in the European Union, and it still isn't fixed.
- Most importantly, the Federal Reserve had cut short-term interest rates three times, and was expected to continue to manage rates to assure the economy didn't contract. I wrote that the difficulty of valuing mortgage securities means markets may have been factoring in far larger losses than would actually occur, and that the Fed had more room to cut interest rates. Wrong again. The plunging value of the global portfolio of subprime mortgages crippled international financial markets. Rock-bottom interest rates have not helped.
As things got worse, I felt dumb and dumber. Now I learn with the release of 1197 pages of transcripts of closed-door Fed meetings from 2006, that Bernanke and others were equally clueless, and they have far more resources than I do.
While a handful of Fed officials warned of trouble brewing, most were expecting a manageable slowdown in the housing sector, with little damage to the financial system or broader economy. Bernanke predicted a “soft landing” as 2006 ended, not a housing bust that would trigger the worst financial crisis since the Great Depression.
The transcripts suggest the Fed underestimated the extent to which the housing boom had strained the financial services industry, particularly through exotic mortgage securities.
“We have not seen—and don't expect—a broad deterioration in mortgage credit quality,” the Fed said in June 2006. The transcripts also suggest Fed officials misgauged the potential for housing problems to spill over into the broader economy.
So I'm framing the 2008 column to hang on the wall. And I'm still forming my thoughts on how to make intelligent use of the mistakes our industry made during this recession.