The Cassandra Hunt

Kevin Drum comments, here is Brad DeLong, and Matt Yglesias, and Arnold Kling; they make good points all around.  There aren’t nearly as many Cassandras as you think, once you require more of a person than "having called" the housing bubble.  A simple question is what financial stocks a person had shorted as of, say, November 2007, or for that matter July 2007, and no "my wife wouldn’t let me" is not an adequate comeback.  And if you’re afraid of an unhedged position or margin call just buy some puts.

I plead fully guilty to not having been a Cassandra.  Oddly, I published an entire book in the late 1990s — Risk and Business Cycles(cheaper on Kindle)  — on how excess risk and correlated errors could cause an economy to explode; I’ll tell you more about that soon.   But if anything when it came to running commentary (on this blog, most of all) I was an anti-Cassandra.  First, I was too influenced by the relatively mild housing bubble collapse of the late 1980s.  Second, I did not understand how much fragility the extant degree of leverage implied.

Cassandra’s gift was in fact the source of continual pain and frustration.  That’s one reason why not so many people are Cassandras.

Fischer Black insisted in the mid-90s that the law of large numbers did
not apply to individual economic forecasts of sectoral shifts and thus such errors could not be expected to "cancel out" in the aggregate.  Not so many
people believed him and in retrospect the failure of people to take
Black seriously on this point is further evidence that the point is
indeed correct in many situations.

Addendum: The end of this Kevin Drum post nails it.


I'm looking forward to your comments on this book, and how it relates to the often discussed ABCT.

("You cannot have an opinion on oil unless you have short-or-long contract" is another example of this economists' demand. Whereas I might wonder if those without money on the line might think more dispassionately.)

Ackman made a small fortune shorting ABK. Ron Paul has been warning us since as early as 2000.

"the next major bust, if there is no major interruption such as a global war, will be around 2008."

Fred E. Foldvary. 1997. The Business Cycle: A Georgist-Austrian Synthesis. American Journal of Economics and Sociology 56(4): 521-41, quote at p. 538.

the answer of course is that hordes of people were short, as can easily be found from the public records of short interest on the NYSE. but most of them are perma-bears and gold bugs who've been predicting this collapse since 1982, 1972, or longer. to be a cassandra you can't just be negative all the time, you have to be negative at the right time, for the right reason, and not just because you don't believe in fractional reserve banking.

And also, a lot of short-selling hedge funds that made the right call have been damaged by the Lehman lockup, redemptions by investors with other losses, and increased counterparty risk. It is very difficult to make a successful bet on generalized financial collapse when the only counterparties to the bet might also collapse. Are the people who correctly hedged their CMO risk with MBIA and AIG cassandras?

I knew fact (1) all along, as did a lot of other people. The reason why I didn't know fact (2) is my lack of access to inside information about the trading exposures of financial firms.

I was short Bear Stearns in August 2007 after reading about it in Calculated Risk. The everquest IPO failure was a tip off that Bear Stearns had a lot of bad mortgage paper on its books.

I think shorting the market as whole counts as being a Cassandra because you may not be sure who was the bag holder, but the bag holder was going to drag everybody else down.

Actually I was hunting a cassandra based in Europe. Are you aware of any? I would like to know more on how and why we, europeans, got involved in this crisis...
Any cassandra in Europe?

In other words, in economics as in weather hindsight is always 20/20...

I'm not sure what you mean there John. I'd be wary of the narrative that if there were no Cassandras (narrowly defined) then the problem (also narrowly defined) was unforeseen. If someone just said "these stock P/Es are crazy", "these house prices are crazy", "this consumer borrowing is crazy" ... would they be wrong, or just not a Cassandra?

I nominate Ambrose Evans-Pritchard at the Telegraph..

Since government and government regulation has been growing to unprecedented levels these last few decades, and now we supposedly find ourselves in Great Depression II, shouldn't we then admit that the libertarians were right after all?

I don't know if we can talk about "road to serfdom", but the recent bail-out folly does not bode well for the future.

Should it be a requirement of a Cassandra to *not* have predicted seven of the last one recessions? After all, we don't admire the broken clock.


"my lack of access to inside information about the trading exposures of financial firms"

I must respectfully disagree. Exposures, modeling issues, & over-leverage were discussed in the Financial Times last spring. An offhand example was a consideration of Goldman on an FT blog on April 10, 2008.

Note especially the significant comments by wdm and D: "With paper assets down 10-20% across the board, it’s better having level II or III’s so you don’t have to use market metrics, which would eradicate book net worth across the financial system;" "$96 bln of basically unsaleable, unreckonable assets and a whole $50 bln of shareholders’ equity!" (Emphasis added.)

This is particularly chilling when you recall that people felt Goldman was one of the better-run firms! If this was the situation of the "good guy," imagine thus the bad!

That the whole charade would collapse in Sept. was made clear by an NY Times article on Aug. 4, noting the massive increase in default rates on certain categories of mortgages. Look especially at the graphs. Then think about how that would affect cash flow for banks and MBSs.

Altho' the overall point of the article "While it is difficult to draw precise parallels among various segments of the mortgage market, the arc of the crisis in subprime loans suggests that the problems in the broader market may not peak for another year or two, analysts said" is mistaken, that graph tells the tale for those who understood the basic MBS structure, how it relied upon the steady stream of payments.

The issue with the overall market not heeding this information was that most people — and this includes Tyler and the MSM business types — didn't know enough about how the business had changed and was actually working. Over-confidently reliant on their own judgment, they were 3 years behind the times, and also lacked understanding of the insight power contained in technical comments like wdm's above. This despite the fact that even non-serious players know to scour the FT & NY Times with a toothbrush.

But let's say people don't read newspapers much anymore: would a rational person have been given pause at the fact that last year it seemed like several basic cable channels had a program along the lines of "Flip This House?"

Thus stubydoo, please forgive me when I suggest that lack of knowledge wasn't due to lack of inside access, but rather, a lack of attention, lack of up-to-date business practice, or perhaps lack of understanding of what info was out there.

Actually, now that I think about it, this really links back to Tyler's information post and the need for a prediction market to aggregate such technical & business practice info in a way more concrete to more people.

I was first made aware of the housing bubble by the receptionist at my dentist office in 2005, when she told me houses had gotten so expensive that no one she knew could afford to buy a house anymore, even though they had two incomes. It never occurred to me that the bankers were not aware that it was a bubble and prepared for the fall in prices. Only if you knew what they had done with the mortgages and credit default swaps could you predict this disaster.

Peter Schiff, anyone?

Just wondering: Does publishing a book called Financial Armageddon at the peak of euphoria in March 2007, which correctly anticipated everything that has happened so far, count as having "called" things correctly?
Especially as it was not written by a permabear, but by 25-year Wall Street whose previous (non-bearish) book detailed the dramatic changes that had taken place in the U.S. stock market?

Even Cassandra might have gone long if she believed she could sell her position before the bubble burst.

Steve, did you ever figure out if Mexican immigrants in California were a horrible blight that drove down real estate values and made it too cheap, or if they were a horrible blight that drove up real estate values and made it too expensive?

I don't think you've gotten enough personal credit for predicting that all our problems are the inevitable result of having dirty dark-skinned people in charge of running Wall Street. You saw all the big problems coming from a mile away, and no one listened!

"I nominate Ambrose Evans-Pritchard at the Telegraph.."

Can someone be a Cassandra for arguably predicting a negative event that came to pass, yet predicting countless others which never do? This is AEP's game, as it is Ron Paul's, as it is for much of the "Austrians saw it coming!" crowd. (Although Ambrose, more than others, seems to declare both sides of any issue with such vehemence that it's difficult to pin him down.)

it is consistent for Sailer to claim that they drove up prices and drove down value (eg, long term prices).

The most remarkably prescient investor at present has to be Jim Rogers, not just for his timely and successful shorting of the financials (including Fannie/Freddie and Citi), but also for his call on the impending commodities bull in 1999. A number of other financial commentators have been predicting the implosion of the stock market and general de-leveraging for a while, including Jeremy Grantham, John Mouldin, and John P Hussman. All of the above have been largely spot on with their analysis and expected chain of events.

Of course there aren't that many, that's why there was a bubble!

A market can stay irrational longer than you can stay solvent. Both ways.

Shorts can wipe you out. Cassandras are cautious. We need a better shorting-type mechanism. I don't think puts do it.

The sad thing is I heard Mish and Peter Schiff and read Empire if Debt, even believed them, but didn't listen. It's hard to be a Cassandra, in many ways.

Note on the Peter Schiff video on youtube how people laughed at his predictions. Reputation risk.

On the other hand, I still believe the market is irrationally pessimistic. So, if you believe as I do, the market will be higher a year or two from now, how are you going to short it? That's too much like market timing, which cautious people probably don't do that often.

Screaming from the rooftops is just not typically in the cards, but I like John Hussman's approach.

RIP Tanta: one of the best writers I've encountered on the 'net.

"A true Cassandra as defined by Tyler would have to know 2 things:

(1) that housing prices were going to drop, and
(2) that the majority of large financial firms had exposures such that they would suffer collossal losses in the event of housing prices going down."

*and* have a bunch of spare cash to set up a short position,
*and* be able to maintain that short position (probably getting numerous margin calls; imagine shorting the NASDAQ tech stock index in January, 1999)
*until* the collapse happened,
*and* until the collapse happened strongly enough to pay off.

If the collapse happened a year after one could no longer pay the margin calls,
too bad.

If the collapse happened 'on time', but was a slow, multi-year bleed down (which could
be rather unpleasant; see 'Japan, lost decade'), then one could still lose everything.

However, I do have a nominee: Mark Kleiman, who sold his house in LA in (IIRC) 2007,
because he figured that a housing bubble market was in place.

noname - the comment above about the UST bubble. of course you might be right about 30y Treasuries being a terrible investment on a hold to maturity basis. however it is interesting to note that 30y UST returned more in Nov than the SPX has over past 10 years. perhaps you might look at how extreme bond rally became in Japan for one possible scenario as to how things go in the US. not my central expectation, but worth bearing in mind.

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