"who saw it coming": ej gets a mention at ft.com/alphaville

[jk]

#5 on the list

Who saw it coming and the primacy of accounting

Posted by Tracy Alloway on Jul 13 14:49. Massive hat tip to Chris Cook for pointing out (http://ftalphaville.ft.com/longroom/tables/dismal-science/no-one-saw-this-coming-understanding-financial-crisis-through-accounting-models) this fascinating paper (http://mpra.ub.uni-muenchen.de/15892/1/MPRA_paper_15892.pdf).
In it, Dirk J Bezemer (http://www.rug.nl/staff/d.j.bezemer/index) of Gronington University attempts to show that certain contrarian economic models — and economists — anticipated the credit crisis and the ensuing recession. In contrast, mainstream economic models, and by extension most economists, did not.
We’ll save you the suspense and present you with Bezemer’s list of analysts ‘who saw it coming’ right away. Click to enlarge.
http://av.r.ftdata.co.uk/lib/inc/getfile/9826.jpg (http://av.r.ftdata.co.uk/lib/inc/getfile/9846.jpg)
The entire paper itself, however, and its potential implications for the supremacy of certain economic models makes for interesting reading.
Here’s Bezemer on the purpose of the paper:
[The analysts presented in the table above] belie the notion that ‘no one saw this coming’, or that those who did were either professional doomsayers or lucky guessers. But there is a more important, constructive contribution. An analysis of these cases allows for the identification of any common underlying analytical framework, which apparently helps detect threats of instability. Surveying these assessments and forecasts, there appears to be a set of interrelated elements central and common to the contrarians’ thinking. This comprises a concern with financial assets as distinct from real-sector assets, with the credit flows that finance both forms of wealth, with the debt growth accompanying growth in financial wealth, and with the accounting relation between the financial and real economy.

These are what Dirk Bezemer calls accounting or flow of funds views of the economy. They have certain Austrian School (http://en.wikipedia.org/wiki/Austrian_school) characteristics, like a distinction between financial wealth and real assets, as well as the separate representation of stocks and flows, and modelling the financial sector separately from the real economy. Those are in contrast to traditional neoclassical economic (http://en.wikipedia.org/wiki/Neoclassical_economics) models which tend to focus on equilibriums, according to Bezemer.
A graphical representation of the two systems is below, which demonstrates the idea pretty well. While stuff like finance and real estate feature prominently in the accounting/flow of funds schematic — they are entirely absent from the traditional model:
http://av.r.ftdata.co.uk/lib/inc/getfile/9806.jpg




etc


http://ftalphaville.ft.com/blog/2009/07/13/61656/who-saw-it-coming-and-the-primacy-of-accounting/

[WildspitzE]

http://ftalphaville.ft.com/blog/2009/07/13/61656/who-saw-it-coming-and-the-primacy-of-accounting/

Interesting to see that all too familiar diagram on there (vs. the university taught model), thanks for posting.

Man, the comments section is littered with some scary shit. And then you think, "and then they vote"....

[hayekvindicated]

They didn't mention Marc Faber, George Soros and Jim Rogers - all of whom warned about this well in advance. Soros has a video interview about the housing market back in 2006 which unequivocally pointed to the housing bust.

Rogers put his money where his mouth is and shorted (http://www.youtube.com/watch?v=1j0_AiOXQzw) Fannie Mae and Freddie Mac back in March 06. And Faber pointed out the bubbles way back in late 05.

[cobben]

Good find, nice try to reform economical thinking - but now, isn't the realistic view of academia that new & better ideas will be accepted only after the demise of the current entrenched powers?

[D-Mack]

I haven't read the paper, but looking at the picture it seems to me that they center around the housing bubble. Isn't Ka-Poom a theory from the last century ?

[WDCRob]

He called the housing bubble in 2003 (IIRC), and warned of the debt deflation in 1999 (again, IIRC). But I guess you can't put that in a paper where everyone else is 'predicting' it for 2006.

[metalman]

He called the housing bubble in 2003 (IIRC), and warned of the debt deflation in 1999 (again, IIRC). But I guess you can't put that in a paper where everyone else is 'predicting' it for 2006.

geez... it's a full time job trying to keep the record straight around here. :mad:
the truth... itulip was first in aug. 2002. (http://www.itulip.com/qc082002.htm)..

not only that, the first to explain why...


The list of rationalizations of recent residential real estate price increases usually carted out are as follows.
Low interest rates. These have made homes seem more affordable, despite the increase in prices.
Tight supply. The number of new homes for sale now is lower than it was at the Nasdaq's peak in March 2000.
Aggressive mortgage lending. Lenders have loosened credit standards in recent years, allowing borrowers with relatively high levels of debt to get loans. Borrowers can also make much smaller down payments, in some cases as little as 3%, compared with the more customary 10% to 20% of years past.
Shift in investment strategies. Many Americans, spooked by the stock market over the past year, appear to be shifting money into residential real estate. One indication is that average down payments have actually increased in the past two years, suggesting that many of the buyers are people with large sums of money that they previously would have put into the stock market. In June, according to Economy.com, the average down payment was $34,700, up from $30,500 last June and $28,700 in June 1999.
These factors beg the question, are home prices too high? Phrased another way, are households purchasing homes they cannot afford?



What's "cannot afford" mean when buying a home? The historical average for the cost of a mortgage is 25% of gross income. That's what the banks used to recommend, before they got desperate for households to sell mortgages to. In bubbly real estate market like Boston's today the average mortgage has reached 44% of income.



That's a housing bubble. Period.
ground breaking stuff at the time... old hat now.


then ej told us in 2004 how it will end... (http://www.itulip.com/housingnotlikeequities.htm)

then in jan. 2005 the process of the housing collapse... (http://www.itulip.com/housingbubblecorrection.htm)

then in jun 2005 the top... (http://www.itulip.com/forums/showthread.php?t=606)

then in 2006 the way prices will contract outside in... (http://www.itulip.com/housingpriceregionscascade.htm)

show me rogers', faber's and soros' analysis, pls.

[metalman]

good find, jk. the author of the paper gets partial credit for noting that ej forecast the recession in 2006 'wil arrive in a few years'. he said 'q4 2007' and was very specific about the recession... from oct. 2006... (http://www.itulip.com/forums/showthread.php?t=550)


Once the credit markets roll over, many of the credit bubble driven mega-deals you read about in the paper for the past couple of years, now reaching a crescendo of greed, will go the way of the AOL-Time Warner merger that closed in January 10, 2000, near the top of the equity bubble. Instead of dysfunction in equity based financing as we experienced after the tech stock bubble, we will see dysfunction in credit based financing, the heart of capitalism. Distressed debt will be the order of the day. Every credit dependent industry, especially construction and real estate, will fall hard, but the advertising driven media industry will suffer, as well. Some industries and regions of the US are already in recession, such as the automotive industry, and others are entering recession. In a diversified modern economy, many regions and industries must be in decline together for the entire US economy to be called officially "in recession," but this definition is academic and of little use to most of us.

[metalman]

They didn't mention Marc Faber, George Soros and Jim Rogers - all of whom warned about this well in advance. Soros has a video interview about the housing market back in 2006 which unequivocally pointed to the housing bust.

Rogers put his money where his mouth is and shorted (http://www.youtube.com/watch?v=1j0_AiOXQzw) Fannie Mae and Freddie Mac back in March 06. And Faber pointed out the bubbles way back in late 05.

i bet they didn't get mentioned because soros, faber & rogers are traders? not economists? besides an interview or two they have no analysis to the authors of the paper to review... ej's is all online and google searchable... for anyone who's interested to know the facts from the bs.

[BDAdmin]

They didn't mention Marc Faber, George Soros and Jim Rogers - all of whom warned about this well in advance. Soros has a video interview about the housing market back in 2006 which unequivocally pointed to the housing bust.

Rogers put his money where his mouth is and shorted (http://www.youtube.com/watch?v=1j0_AiOXQzw) Fannie Mae and Freddie Mac back in March 06. And Faber pointed out the bubbles way back in late 05.

"Lucky shots" is far from "insightful predictions".


"Only analysts were included who provide some account on how they arrived at their conclusions. Second, the analysts included went beyond predicting a real estate crisis, also making the link to real-sector recessionary implications, including an analytical account of those links. Third, the actual prediction must have been made by the analyst and available in the public domain, rather than being asserted by others. Finally, the prediction had to have some timing attached to it."


On the basis of Bezemer's four selection criteria, he found only a dozen analysts qualified (http://mpra.ub.uni-muenchen.de/15892/1/MPRA_paper_15892.pdf), includes Janszen's forecast in 2006 and 2007:


“The US will enter a recession within years” (2006). “US stock markets are likely to begin in 2008 to experience a “Debt Deflation Bear Market”(2007)


Bezemer wrote in his research paper: "Eric Janszen is an investor and commentator. He established the iTulip website in November 1998 to parody the then rampant ‘Internet Bubble’ as a speculative mania. He called the top of the dotcom bubble in March 2000 and shut the site down after the dotcom crash of that year; but started it again as the housing market developed into what he believed to be a bubble. In August 2001 Janszen (2001) “expected that after the technology bubble crash the Federal Reserve and government was certain via tax cuts, rate cuts, and stealth dollar devaluation to induce a reflation boom like the 1934 – 1937 reflation created after the 1929 stock market bubble bust. Like that reflation, the stock market after 2001 was unlikely to produce meaningful inflation-adjusted results.”


"In 2006 he [Janszen] wrote in America’s Bubble Economy: Profit When It Pops that the US would enter a recession within years. In December 2007 he [Janszen] warned subscribers to his investment advice that US stock markets were likely to begin in 2008 to experience a “Debt Deflation Bear Market” market that would more or less track the Nikkei during the first year of the Japanese debt deflation, when it lost 40 % from December 1989 to December 1990. The Dow Jones then declined from 13,365 points in December 2007 to 7,880 points in December 2008, losing 42 % of its value. Janszen (2009) writes that “this forecast was uncomplicated if you understood the simple underlying dynamic: US households and businesses, and the government itself, had since 1980 built up too much debt. The rate of increase in debt was unsustainable… Huge imbalances in the US and global economy developed for over 30 years. Now they are rebalancing, as many non-mainstream economists have warned was certain to happen sooner or later, warnings which were argued as alarmist by mainstream economists. The global monetary system … started to come apart in 2007 following the crash of the securitized debt market, that followed the collapse of the housing bubble. It had to come apart anyway; the securitized bond market happened to be the proximate cause.”


As Dirk J Bezemer (http://www.rug.nl/staff/d.j.bezemer/index) wrote in the paper: "In distinguishing the lucky shots from insightful predictions, the randomness of guesses is a feature to be exploited. Random guesses are supported by all sorts of reasoning (if at all), and will have little theory in common. Conversely, for a set of correct predictions to attain ex post credibility, it is additionally required that they are supported by a common theoretical framework."


In Bezemer's study, he "looks to identify a set of predictions which are not only ex post correct but also rest on a common theoretical understanding. This will help identify the elements of a valid analytical approach to financial stability, and get into focus the contrast with conventional models."

You can read Dirk J Bezemer's full extensive research paper entitled "No One Saw This Coming” Online in PDF at ->
http://mpra.ub.uni-muenchen.de/15892/1/MPRA_paper_15892.pdf
MPRA (http://mpra.ub.uni-muenchen.de/15892/MPRA) Paper No. 15892, posted 16. June 2009 / 14:58



* Dirk J Bezemer, a Professor and Faulty of International Economics and Business at the University of Groningen in the Netherlands.

[Chomsky]

You an read Dirk J Bezemer's full extensive research paper entitled "No One Saw This Coming”


Online at http://mpra.ub.uni-muenchen.de/15892/ (http://mpra.ub.uni-muenchen.de/15892/MPRA)

MPRA (http://mpra.ub.uni-muenchen.de/15892/MPRA) Paper No. 15892, posted 16. June 2009 / 14:58



Link doesn't work.

[metalman]

Link doesn't work.

here... try this... (http://mpra.ub.uni-muenchen.de/15892/)

[Chomsky]

Thanks MM.

[FRED]

Link doesn't work.
Read it in PDF online -
http://mpra.ub.uni-muenchen.de/15892/1/MPRA_paper_15892.pdf

[medved]

i bet they didn't get mentioned because soros, faber & rogers are traders? not economists? besides an interview or two they have no analysis to the authors of the paper to review... ej's is all online and google searchable... for anyone who's interested to know the facts from the bs.

What about Doug Noland? http://www.safehaven.com/archive-2.htm
Very much online and searchable. BTW, it would be nice to interview this guy.

However, the main question is not, who gets the credit and who does not. The question is, why the mainstream analysis is so delusional. Having 10-20 very smart analysts shouting FIRE did not help most people.

[metalman]

What about Doug Noland? http://www.safehaven.com/archive-2.htm
Very much online and searchable. BTW, it would be nice to interview this guy.

However, the main question is not, who gets the credit and who does not. The question is, why the mainstream analysis is so delusional. Having 10-20 very smart analysts shouting FIRE did not help most people.

but isn't the answer obvious? these 12 are not collecting a paycheck from the fire econ.

[bart]

However, the main question is not, who gets the credit and who does not. The question is, why the mainstream analysis is so delusional. Having 10-20 very smart analysts shouting FIRE did not help most people.

We differ on the importance of well deserved credit.

If one wants to know why it didn't help most people and why mainstream analysis is so delusional, then listen more to those 10-20 or more analysts that got it right... and get it generally right, year after year. Answers are there.
I hope this doesn't come across as accusatory.



And to follow up on metalman:
"The few who understand the system, will either be so interested from it's profits or so dependent on it's favors, that there will be no opposition from that class."
-- Rothschild Brothers of London, 1853

Tinfoil hate enabled and/or cynical?... perhaps, but also true as so much of human history shows.



And one last item:
According to Aristotle one Greek city state had a fundamental law: anyone proposing revisions to the constitution did so with a noose around his neck. If his proposal lost he was instantly hanged. (from Jerry Pournelle (http://www.jerrypournelle.com/) )

[Jam]

This is an excellent article, great find jk. Definitely worth reading in its entirety. I find the paragraph that starts on page 16 especially illuminating.



By accounting identity, any credit flows to firms and households (through banks’ credit
creation as they lend) exceeding the growth of investment, production and consumption in the real
economy will be held as wealth, and so invested in FIRE sector assets. This extra liquidity inflates
the money value of financial assets and instruments (housing, stocks, bonds, currency, derivative
instruments etc.), so increasing returns on financial investments. Through their rising net worth,
firms and households can - if lending regulations allow - borrow more against their collateral; and
if they believe this to be sustainable, they will. This means that banks create yet additional credit
which is again invested in the FIRE sector, further pushing up asset prices. Each flow of credit has
its balance sheet counterpart in increased debt levels for firms and households. The new situation is
characterized by (a) higher returns on financial assets relative to real-economy investment, and (b) a
larger part of the (say, annual) credit flow going towards debt servicing and financial fees, and a
smaller part to investment in the real sector (see Stockhammer, 2004 for evidence on this). In early
stages of a financial asset boom, the benefits from (1) will more than balance the costs of (2),
especially if future debt servicing costs are discounted or neglected. This encourages a next cycle of
credit flows, debt growth and asset price rises. With psychological mechanisms such as herding
behaviour leading to housing or stock market euphoria - and in the absence of regulation to stop it -
there can be a self-sustained dynamic of credit flows shifting away from the real economy and into
financial asset market, with ever growing financial asset returns and individual net worth figures,
and a growing debt service burden on the real economy. Along the course of this financial boom,
Friedman’s (2009) all-important ‘fraction of the economy's total returns absorbed up front by the
financial industry rises and the function of the financial system in the economy’ changes from
supportive to extractive. Consumption – and the production that depends on it - may become
financed more by fresh credit and debt flows from the FIRE sector based on capital gains than by
real-sector wages and profit. Thus net saving by firms and households may fall and even turn
negative.
An accounting (or balance sheet) view of the economy makes clear that this dynamic – a
bubble – is unsustainable in the sense that it is constrained by the real economy’s ability to service
debt. Yet without policy intervention, it can last for many years or even decades, if starting from
low levels of indebtedness. A burst occurs as investors realize this constraint is approaching or has
been reached. The severity of the impact of a burst will be the larger as real-economy consumption
(and thereby production) have grown more dependent on capital gains rather than on wages and
profit.
I know that iTulip discussed these issues many times over. It's just that for me, personally, it really clicked when I read the above.