Tuesday, February 15, 2011

Bernanke: Hoocoodanode?

by Bill McBride on 2/15/2011 08:56:00 PM

By request, a few excerpts from Fed Chairman Ben Bernanke's testimony to the Financial Crisis Inquiry Commission (ht Brian)

Note: "Hoocoodanode?" means "who could have known?" a running joke on CR (and the name of the comment site).

COMMISSIONER THOMPSON: So no calamity of this magnitude occurs without there being some early signals that something’s going wrong. In the case of this calamity, what were the signals?

Why did we -- and had we acted on them, might we have averted the disaster?

MR. BERNANKE: Well, I don’t know, I have to think about that.

I think there were people -- there were people saying -- including people at the Fed but others as well -- saying, in the year before the crisis, that risk was being underpriced, that spreads were very narrow, that markets seemed ebullient, that liquidity was, in some sense, excessive.
The "year before the crisis"? Come on! How about in 2005 and all through 2006 (there were many many many posts to choose from).
Bernanke: There were -- you know, the way I would put it is, I think there were people -- not necessarily the same people -- identifying various parts of the problems. You know, there were people who were concerned about derivatives, there were people that were concerned about subprime mortgages, there were people concerned about the overall credit environment, there were people who were concerned about off-balance-sheet vehicles.
True. No one identified all the interconnected risks, but I did point out the financial losses could be over $1 trillion (Roubini used my data in a presentation to Congress). It didn't take much from there to realize a large portion of the financial system might be insolvent.
Bernanke: But I think notwithstanding the claims of one or two people out there who are now sort of living on the fact that they, quote, anticipated in the crisis, I would still say that the interaction of these things, the “perfect storm” aspect was so complicated and large, that I was certainly not aware, for what it’s worth -- and it could be just my deficiency -- but I was not aware of anybody who had any kind of comprehensive warning.
I don't know of anyone who got all the specifics correct. And hopefully I'm not "living on the fact" that I called the housing bubble (I think I've done OK over the last few years too).

But looking back ... in early 2005, Professor Jim Hamilton of Econbrowser asked me, if the loans are so bad, why are lenders making the loans? It was obvious that the lenders were just passing them on to Wall Street - and we discussed MBS and CDOs - and Wall Street was selling the pieces to investors. But why were investors buying the loans? It took me some time to piece together that the rating agencies were using historical performance from a completely different lending model (based on direct lender to borrow experience and the 3 Cs: Credit, Capacity, and Collateral) and then applying it to the originate-to-distribute model (with all the inherent agency problems). Perhaps if I had realized that sooner, I could have convinced more people that the ratings were wrong and there was a serious problem. But probably not - some random blogger saying the ratings are wrong? No one would have believed me.

Still it was pretty easy to see that house prices were out of line with fundamentals, and that lending standards were extremely loose (NINJA loans - No job, no income, no assets, mortgage brokers joking "fog a mirror get a loan", etc.). And that should have been enough of a red flag.
Bernanke: There are people identified -- and the trouble is -- and particularly in this blogosphere we live in now -- at any given moment, there are people identifying 19 different problems, crises.
I agree completely with this - there are more imaginary crisis every week than real crisis in a lifetime. But I think people could have known in 2005 and I wish I had done a better job of explaining why.

Best to all