Don't believe the excuses: plenty of people saw the 2008 crisis coming
John Stepek
Senior reporter, Bloomberg | Author, The Sceptical Investor; MoneyWeek's Little Book of Big Crashes
In November 2008, the Queen opened a building at the London School of Economics. With a level of diplomacy that might be more closely associated with her husband, she asked one of the professors there why no one had seen the crisis coming. Specifically, said Professor Luis Garicano, "The Queen asked me, 'If these things were so large, how come everyone missed them?'"
What's interesting is that this still seems to be the accepted narrative. In many of the "ten years on" pieces, we are still being told that nobody saw the financial crisis coming, that it was a bolt from the blue, and that there was no way of preparing for it. And also that the response was absolutely, 100%, the right one.
This, to put it bluntly, is just not true, and I think it's worth setting the record straight.
It’s fair to say "no one saw the financial crisis coming", if by that you mean that no one specifically said "in September 2008, Lehman Brothers will go bust". But I don’t think that’s what the Queen meant when she asked the question.
The reality is that plenty of people (both inside and outside of the establishment) warned that something was up. They warned on specifics, and they warned about it well in advance of the credit crunch taking hold in 2007.
For example, here's a MoneyWeek cover from late 2006.
(I know, I know. But derivatives are hard to visualise, OK?)
Bear in mind that MoneyWeek is staffed by journalists. I like to think that we're informed journalists, but nonetheless, none of us were actually involved in constructing these derivatives ourselves. For us to have known there was something up, someone else had to be flagging up these concerns.
And if you go further back, to take another example, Raghuram Rajan (who went on to become the head of India's central bank) warned very explicitly about the dangers of derivatives in August 2005. He stood up in a room full of central bankers and economic policymakers, and presented a paper entitled "Has Financial Development Made the World Riskier?"
Among other choice quotes from Rajan, there's this one: "If banks face credit losses and there is uncertainty about where those losses are located, only the very few unimpeachable banks will receive the supply of liquidity fleeing other markets. If these banks also lose confidence in their liquidity-short brethren, the inter-bank market could freeze up, and one could well have a full-blown financial crisis."
That's about as close a description of exactly what happened in the run-up to 2008, as you'll find anywhere.
Why you should care about this
This matters. It has nothing to do with bragging rights. It’s not about treating any of these people as "gurus". In fact, so many people "saw it coming", that it’s simply not that big a deal to have expressed concerns ahead of 2007.
And even if you hadn't twigged there was something wrong by that point, it was really very obvious by summer 2007 – here's another MoneyWeek cover, from about six weeks before the queues were forming outside Northern Rock:
The real problem is that the people who DIDN’T see it coming – who failed to accept that anything at all was wrong, or to question the build-up of debt across the global economy – are still among the most influential voices today.
To say that this crisis came completely out of the blue fits their narrative, even although it’s blatantly untrue. Whatever else 2008 showed us, it was that our understanding of the financial system is lacking. We need to make a serious effort to address that.
Instead, we’re at risk of allowing the people and philosophies who aided and abetted the last crisis to continue running the show, and to argue that there was no alternative to the bailouts and a decade of QE, in what amounts to a massive backside-covering exercise.
That’s why the correct answer to the Queen’s question is: “Actually, lots of people saw it coming, but they didn’t fit existing theories, so we ignored them. And we’re still doing our best to ignore them”.
This article is expanded from a previous Twitter thread. You can follow me on Twitter @John_Stepek
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6 年Dear Paul, I read a LinkedIn story a few years ago, and I can't find it (so people help me to credit the right person for the following). If you predict growth, everybody likes you, because we want to believe it. And because everybody prefers growth, everybody will agree with you, and confirm you are right. Two things can happen. Growth will happen, and everybody sends you her or his congratulations for being right. People will start following you and your future predictions. You are an influencer. And everybody likes you. Or it doesn't happen. No growth. Maybe even crimp instead. And everybody will react with reassurance. Didn't we all agree. We all foresaw the increasing market valuation. Just too bad and people keep following you for your next positive prediction. This was just an exception. And everybody still likes you. How different when you have good data to back your crisis prediction. It starts with people won't like you anymore. They make you feel you take away their wealth. And others will dislike you because you tell people they must work harder or different to keep their wealth. And again, two things can happen.
Source your Engineered Components From INDIA
6 年Raghuram Rajan’s book is a brilliant explanation of how and why the crisis developed and unfolded. He’s a great person for anyone to reference. But I haven’t seen anything to date convincing enough on how and why a crisis of similar magnitude will unfold any time soon. Yes, of course, eventually there will be a downturn and everyone wants to have something published in advance so that they can point to their extraordinary predictive capabilities. But I haven’t seen anything convincing yet. To just say everyone is getting too old, population growth is too low, and the debt is higher than ever, these are all interesting, but not a convincing reason for a financial melt down
Independent Analyst
6 年At the same time I am not sure on the logic of having your money 100% in cash in case a crisis happened. There is a saying that forecasters have predicted 8 of the last 3 recessions.? Or something like that.? People are always warning of disaster. China has meant to have been a debt crisis for years and years.? The European Union is meant to have collapsed.? A manager of a hedge fund that shorts stocks once told me that the way to raise money is to forecast a major downturn.? In the long-term it pays to be an optimist as Nick Train points out.? You can always own equities and shift towards defensive stocks. Or just permanently hold defensive stocks.? Then the question of whether the global economy will tank is less meaningful.? On the 10th anniversary of the financial crisis we are getting more forecasts of a major downturn.? Is it any wonder these forecasts are ignored.? The forecasters are just doing it for their 3 minutes of fame.? There is one major hedge fund that has been talking about a major crash for ages and has performed awfully.? Another major macro hedge fund recently closed.? What about all the macro people and stock pickers that got 2008 right?? Their subsequent returns have been pretty awful.? Again I won't name names.? It generally pays to be optimistic and stick to equities.? Although you can always balance away to bonds if you are more cautious.? The genius hedge fund managers etc that predicted 2008 have generally made dire long-term returns.? Getting the macro right once appears to be less important than picking good stocks over the long-term.? Even if getting the macro right on a big call like 2008 right made a lot of hedge fund managers seem like geniuses at the time.
Lead Writer and Analyst at Libertex Group
6 年Great piece John. I could simply add that the key is the catalyst. Fireworks don't usually go off unless you put a match to them. They just hang around dangerous by nature until the blue touch paper is lit! ?Match anyone??
Chairman, New Normal Consulting
6 年Spot on, John"? As you say, "That’s why the correct answer to the Queen’s question is: “Actually, lots of people saw it coming, but they didn’t fit existing theories, so we ignored them. And we’re still doing our best to ignore them”."