All this talk about the crisis and predictions got me thinking….We all know how difficult it is to forecast the future. But every once in a while we see predictions that are so far off the mark that you have to wonder if the forecaster is working with a full deck. Which is actually a great thing because it’s beneficial for the rest of us since we can study these kinds of predictions and understand why they were wrong and what can be learned from them. I often say “it’s only in being wrong that we can learn to be right”.
That said, what were the very worst predictions of the last 5 years and what can be learned from these bad calls? I provide my views below:
3) The municipal bond crisis that never happened.
Meredith Whitney became famous for calling the collapse of many of the banks back in 2008. But that wasn’t the only crisis she predicted during the last 5 years. In 2010 Whitney also said state and local governments looked very similar to the banks in the pre-crisis period and predicted that states were the next systemic risk. She called California the worst state in her analysis and stated that a double dip in housing would lead to bigger problems. None of this actually came to fruition and the states have actually made a stunning turnaround.
Shortly after her famous 60 Minutes interview called “The Day of Reckoning” I said Whitney was wrong (see here) and drawing parallels to Europe that were incorrect. 3 years later many state and local budgets have seen huge improvement and virtually no one is talking about the potential of a municipal bond crisis. The municipal bond crisis simply never happened.
The Lesson: Understanding the monetary system from a macro perspective proved hugely important following the crisis. Those who compared the states in the USA to Europe ended up being very wrong. And the difference was simple. A UNITED States of America is made up of 50 states who all pay into a pool of federal funds. And those federal funds get distributed in a way that substantially reduces the financial burden on any single state. In fact, the poor states (like Mississippi) pay far less into the system than they take out and that system of redistribution actually helps weak states avoid default. This arrangement doesn’t exist in Europe and it’s a big part of why a single currency system doesn’t work there.
For more on this, please read “Why there was no Euro crisis in the USA”.
2) Every single hyperinflation prediction.
There was a bubble in hyperinflation predictions in 2008/9 following the huge fiscal stimulus package in the USA and the supposed “monetization of the debt” which people still believe to this day due to misconceptions over quantitative easing. Personally, I think the hyperinflation predictions have to rank among the very worst economic predictions of all-time because the reasoning was so misguided.
Those who predicted hyperinflation were not only entirely misinterpreting the debt de-leveraging, but were misinterpreting how the monetary system works at an operational level. The chart we most often saw was the chart of M1 money which implied that higher bank reserves would lead to a multiplier effect in the money supply and eventual collapse in the dollar. Of course, it never happened and the USA has been mired in a weak economic environment much more closely resembling deflationary Japan in the 90’s than hyperinflationary Weimar in the 20’s.
The Lesson: There were so many great lessons to learn from this. From the way banks lend money (the money multiplier is a myth) to the way QE works (see here) to the fundamental cause of most hyperinflations (see here). These wrong predictions covered a vast area in understanding the monetary system.
1) “the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained”.
I’m stretching my “5 years here a bit” and I know it’s a distant memory now, but back in 2007 Fed Chief Ben Bernanke made what has to be one of the very worst predictions in economic history when he said subprime was “contained”. Just months later we would end up seeing massive bank defaults due to subprime and a financial crisis that brought the US economy to its knees.
Some people say we owe Dr. Bernanke a great debt of gratitude, but we only owe him a debt of gratitude like a fireman deserves a debt of gratitude after he sees a small fire break out, ignores it and then helps put out a wildfire after it burns down half the neighborhood. I’m often hard on Dr. Bernanke, but only someone with a very short memory wouldn’t be….
The Lesson: Be wary of the predictions made by academic central bankers.
Edit: Honorable mention via the comments section: The ECRI’s recession call in 2011.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.