The Big Picture

Worst Predictions for 2008

Monday, December 29, 2008 | 04:25 PM

In case you missed it, here are several different collections of the worst predictions of the year:

RIP Chicago School of Economics: 1976-2008

Tuesday, December 23, 2008 | 09:35 AM

in Really, really bad calls

Some time ago, I asked if "Milton Friedman was the next economist whose once lauded reputation may soon slide ?"

Turns out it happened much quicker than expected. A long Bloomberg piece, Friedman Would Be Roiled as Chicago Disciples Rue Repudiation, discusses the tarnishment of the Chicago school of thought.

Its long overdue. From the efficient-market theories, to the concept of man as rational profit maximizers, much of the edifice that is was the Chicago school of economics is based on a foundation that is false, disproven or otherwise questionable.

continued here

Worst Calls of 2008

Sunday, November 23, 2008 | 08:09 PM

in Really, really bad calls

I received a call from a journalist asking me what were the worst calls for 2008 -- by the media, by the specific pundits, and others.

My initial reaction was anything Ben Stein said in print, and anything Don Luskin said on Kudlow & Co.

But there are obviously many others, and we are taking names:

~~~

continued here

The Housing Crisis Is Over

Saturday, November 08, 2008 | 09:46 AM

in Real Estate | Really, really bad calls

Mr. Moulle-Berteaux, along with Barton Biggs, is a partner of Traxis Partners, a hedge fund firm based in New York.

They have had a series of disasterous calls recently: Shorting Oil three years ago at $50, and a mere 6 months ago, this horrific call in the WSJ, declaring the end of problems in residential real estate: The Housing Crisis Is Over.

Ouch!

There is an important lesson here for investors. Read this, and them join me at the other end:

The dire headlines coming fast and furious in the financial and popular press suggest that the housing crisis is intensifying. Yet it is very likely that April 2008 will mark the bottom of the U.S. housing market. Yes, the housing market is bottoming right now.

How can this be? For starters, a bottom does not mean that prices are about to return to the heady days of 2005. That probably won't happen for another 15 years. It just means that the trend is no longer getting worse, which is the critical factor.

Most people forget that the current housing bust is nearly three years old. Home sales peaked in July 2005. New home sales are down a staggering 63% from peak levels of 1.4 million. Housing starts have fallen more than 50% and, adjusted for population growth, are back to the trough levels of 1982. Furthermore, residential construction is close to 15-year lows at 3.8% of GDP; by the fourth quarter of this year, it will probably hit the lowest level ever. So what's going to stop the housing decline? Very simply, the same thing that caused the bust: affordability.

The boom made housing unaffordable for many American families, especially first-time home buyers. During the 1990s and early 2000s, it took 19% of average monthly income to service a conforming mortgage on the average home purchased. By 2005 and 2006, it was absorbing 25% of monthly income. For first time buyers, it went from 29% of income to 37%. That just proved to be too much.

Prices got so high that people who intended to actually live in the houses they purchased (as opposed to speculators) stopped buying. This caused the bubble to burst.

Since then, house prices have fallen 10%-15%, while incomes have kept growing (albeit more slowly recently) and mortgage rates have come down 70 basis points from their highs. As a result, it now takes 19% of monthly income for the average home buyer, and 31% of monthly income for the first-time home buyer, to purchase a house. In other words, homes on average are back to being as affordable as during the best of times in the 1990s. Numerous households that had been priced out of the market can now afford to get in . . .

In the past five major housing market corrections (and there were some big ones, such as in the early 1980s when home sales also fell by 50%-60% and prices fell 12%-15% in real terms), every time home sales bottomed, the pace of house-price declines halved within one or two months.

I recall reading it at the time, and saying to myself: "Wow, that is simply awful analysis." Hence, the diary for 6 months later and the current look back.

The logic errors within are myriad: Comparing different time periods and expecting identical parallel results, the failure to recognize how significant the credit crunch was, the extrapolation from past lows to present using insufficient variables, the failure to use traditional metrics of affordability, such as median home price to median income or price of rent versus own ratios, and lastly, the unsupported assumption that a 15% drop over 3 years, after a 100% increase was sufficient to make homes affordable.

If I was grading this, it would get a D minus.

The lesson you should take away when you read dumb things from smart guys running big piles of cash: They are talking their books, and having drank the Kool-aid, have little or no objectivity.

This is a classic example of that.

PERMALINK AND COMMENTS HERE

Source:
The Housing Crisis Is Over
CYRIL MOULLE-BERTEAUX
May 6, 2008; Page A23
http://online.wsj.com/article/SB121003604494869449.html

Follow Up: "It's a great time to buy or sell a home!"

Monday, November 03, 2008 | 11:15 AM

in Psychology/Sentiment | Real Estate | Really, really bad calls

Today's really, really bad call harkens back to November 2006:

Well, they were half right.

When that NAR ad campaign came out exactly two years ago, it was a pretty damned good time to sell a home.

Buying one ?

Not so much . . .

Permalink and comments here.

Previously:
It's a great time to buy or sell a home! (November 3 2006)
http://www.ritholtz.com/blog/2006/11/its-a-great-time-to-buy-or-sell-a-home/

Analyzing why "It's a great time to buy or sell a home!" (November 4, 2006)
http://www.ritholtz.com/blog/2006/11/analyzing-why-its-a-great-time-to-buy-or-sell-a-home/

Ratings agencies: 'Kool-Aid drinking' lapdogs

Thursday, October 23, 2008 | 07:07 AM

in Credit | Derivatives | Real Estate | Really, really bad calls

Conflicts of interest, payola, lax SEC oversight, and just plain old incompetence were responsible for credit rating agencies' "disastrous performance" in assessing risks of mortgage-backed securities. That was the testimony of two former high-ranking officials at Moody’s and Standard & Poor’s in Congressional testimony.

Not only were the methods used to rate structured securities flawed, the profit motive totally skewed the ratings agencies business model. We discussed some of the more outrageous comments yesterday (S&P: We Knew Nothing! Nothing!)

Here's a brief excerpt:

"The three major agencies -- Moody's, Standard & Poor's and Fitch -- were caught in a race to bottom, forced to lower their standards in an attempt to maintain their market share, said Raymond McDaniel, chief executive officer of Moody's, who testified on Capitol Hill on Wednesday.

"We drank the 'Kool-Aid,'" McDaniel wrote in an internal memo released Wednesday.

That race to the bottom was very lucrative in the short-run for the companies, but disastrous for the global economy in the long haul, said Rep. Henry Waxman, D-Calif., chairman of the House Oversight and Government Reform Committee. Waxman said revenues at the three ratings agencies doubled between 2002 and 2007 to $6 billion, while Moody's had the highest profit margin of any company in the S&P 500 for five years running.

The three agencies rate financial securities on the risk that they won't be paid off.

Between 2002 and 2007, the agencies rated a flood of mortgage-related securities issued by Wall Street firms, giving many of the securities a coveted AAA rating at the time, only to downgrade most of them as house prices tanked and defaults spiked. The subsequent collapse in the value of those securities has taken the global financial system to the "brink of the abyss," in the words of the head of the IMF."

Here's another regulatory failure: SEC supervision of the 3 big ratings agencies failed utterly, letting them engage in a form of officially sanctioned payola -- selling their AAA ratings to the highest bidding underwriters. In doing so, the agencies "put the global financial system at risk because they had to be lapdogs, not watchdogs, to survive."

Up next: SEC Chairman Chris Cox gets grilled on his agency's oversight of the credit rating agencies at Oversight and Government Reform Committee hearing.

(With this post, we add the category "Regulation")

Sources:
Ratings agencies 'put system at risk,' CEO says
Testimony shows watchdogs were 'Kool-Aid drinking' lapdogs
Rex Nutting
MarketWatch 5:19 p.m. EDT Oct. 22, 2008
http://tinyurl.com/5fjkpp

Credit Rating Agency Heads Grilled by Lawmakers
GRETCHEN MORGENSON
NYT, October 22, 2008
http://www.nytimes.com/2008/10/23/business/economy/23rating.html

S&P: We Knew Nothing! Nothing!

Wednesday, October 22, 2008 | 03:58 PM

in Credit | Derivatives | Legal | Really, really bad calls

Repeat that headline in your best Sergeant Schultz voice for maximum effect. Then read the testimony of Deven Sharma, President of Standard & Poors in the same voice:

S&P is not alone in having been taken by surprise by the extreme decline in the housing and mortgage markets. Virtually no one -- be they homeowners, financial institutions, rating agencies, regulators, or investors -- anticipated what is occurring. Although we highlighted to investors looming issues we saw in the housing market as far back as early 2006, the reality remains that in publishing our initial ratings on many of these securities we never expected such severe, negative performance in the housing and mortgage markets. There is no doubt that had we anticipated the extraordinary events that have occurred -- and we did not -- we would have utilized different economic forecasts and would not have assigned many of the original ratings that we did . . . (emphasis added)

You decide: Perjury, or mere ignorance?

A significant number of economists, strategists, academics and blogs all forecast the housing disaster way way in advance. Not only me, but Nouriel Roubini, and James Grant and John Paulson and Jim Rogers and Peter Schiff, and lots of sites: Calculated Risk and The Mess that Greenspan Made and ML-Implode and Mish and Housing Doom and NJ Real Estate Report and iTulip, and, well, you get the idea.

But it turns out that two S&P analysts, April 2007, via an IM conversation, were also discussing it:

Rahul Dilip Shah: btw: that deal is ridiculous

Shannon Mooney: I know right ... model def does not capture half of the risk

Rahul Dilip Shah: we should not be rating it

Shannon Mooney: we rate every deal

Shannon Mooney: it could be structured by cows and we would rate it

IM Conversation via House Oversight Committee

Source:
TESTIMONY OF DEVEN SHARMA, PRESIDENT, STANDARD & POOR’S
BEFORE THE COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM UNITED STATES HOUSE OF REPRESENTATIVES
OCTOBER 22, 2008
http://oversight.house.gov/documents/20081022125052.pdf

See also:
Ratings agencies 'put system at risk,' CEO says
Testimony shows watchdogs were 'Kool-Aid drinking' lapdogs
Rex Nutting
MarketWatch 5:19 p.m. EDT Oct. 22, 2008
http://tinyurl.com/5fjkpp

Credit Rating Agency Heads Grilled by Lawmakers
GRETCHEN MORGENSON
NYT, October 22, 2008
http://www.nytimes.com/2008/10/23/business/economy/23rating.html

Can the Fed Pop Bubbles (And If So, How)?

Wednesday, October 22, 2008 | 07:30 AM

in Bailouts | Economy | Markets | Really, really bad calls | Trading

In October 1925, Walter W. Stewart, the Director of Research at the Federal Reserve Board, proposed reducing speculation by member banks pressuring credit to banks lending to brokerage firms. Benjamin Strong, the President of the NY Fed, opposed the idea.

Several years later (1928), Adolph Miller, then the Fed Board's economist, suggested a meeting of NY Banks, for the purpose of commanding an end to their financing of speculation. Ben Strong's successor at the NY Fed, George Harrison, also told the Board in February 1929 that growth of credit in the banking system was far too great relative to total business activity.

The NY Fed opposed any action. As described in The Great Contraction (1929-1933), they enlisted Treasury Secretary Andrew Mellon to help make its case. The NY Bank was successful, and there was no intervention to reduce excess speculation. We obviously don't know how successful these efforts might have been otherwise, but we do know what happened: The 1929 crash, and the Great Depression.

Fast forward 70 years: Alan Greenspan complained that it is too difficult to identify bubbles in real time, and the Fed does not have the ability to safely pop them regardless. He famously stated that it would be easier to clean-up the mess after an asset bubble pops than to try and deflate the bubble on the way up.

As we saw in several articles last week, the Fed is rethinking its stance on popping bubbles. It is significant that the Fed at least be aware of their own behavior, and how it contributes to bubble formation and growth. At the very least, they need to understand how Fed policy can lead to the inflation of bubbles in the first place.

Despite Greenspan's defenses, there are quite a few signs the Fed should look for when attempting to identify asset bubbles, in order to reduce the risk of implosion. Consider these 10 elements to identifying bubbles in real time that the Fed, or anyone else for that matter, can use:

1. Standard Deviations of Valuation: Look for traditional metrics -- valuations, P/E, price to sales, etc. -- to rise two, then three standard deviations away from the historical mean.

2. Significantly elevated returns: The S&P500 returns in the 1990s were far beyond what one could reasonably expect. Consider the years around Greenspan's "Irrational Exuberance" speech:

1995 37.58
1996 22.96
1997 33.36
1998 28.58
1999 21.04

And the Nasdaq numbers were even better.

3. Excess leverage: Every great financial crisis has at its root easy money and rampant speculation. Find the leverage, and speculation wont be too far behind.

4. New financial products: This is not a sufficient condition for bubble, but it seems that every major bubble has somewhere in the mix, new products. It may be Index funds, derivatives, tulips, 2/28 Arms.

5. Expansion of Credit: With lots of money floating around, we eventually get around to funding the public. From Credit cards to HELOCs, the 20th century was when the public was invited to leverage up also.

6. Trading Volumes Spike: We saw it in equities, we saw it in derivatives, and we've seen it in houses: The transaction volumes in every major boom and bust, by definition, rise dramatically.

7. Perverse Incentives: Where you have unaligned incentives between corporate employees and shareholders, you get perverse results -- like 300 mortgage companies blowing themselves up.

8. Tortured rationalizations: Look for absurd explanations for the new paradigm: Price to Clicks ratio, aggregating eyeballs, Dow 36,000.

9. Unintended Consequences: All legislation has unexpected and unwanted side effects. What recent (or not so recent) laws may have created an unexpected and bizarre result?

10. Employment trends: A big increase in a given field -- real estate brokers, day traders, etc. -- may be a clue as to a developing bubble.

While we can debate whether or not the Fed should intervene by popping bubbles, we can all agree that, at the very least, they should not contribute to bubble inflation . . .

Update: October 22, 2008 5:02pm

Jack McHugh adds the following points

--Low credit spreads (indicative of fixed income risk appetites running too high)

--Low and falling lending standards (forward indicator of credit trouble ahead)

--Very low default rates on corporate and high yield bonds (indicates the ease with which even poorly run companies can refinance and creates false sense of security)

--Low equity volatility readings over an extended period (indicates equity investor complacency)

Sources:
Fed Rethinks Stance on Popping Bubbles
JUSTIN LAHART
WSJ, OCTOBER 17, 2008
http://online.wsj.com/article/SB122420268681343047.html

Central Banks Reconsider Doctrine of Preemption
Caroline Baum
Bloomberg, Oct. 15 2008
http://www.bloomberg.com/apps/news?pid=20601039&sid=aLo23EkfmUqE&

Why is Barron's Banned From CNBC?

Monday, October 20, 2008 | 07:42 AM

in Financial Press | Really, really bad calls | Television | Trading

I give Barron's grief whenever I think a columnist or magazine cover is wrong.

But even when some thing rubs me the wrong way, the rest of the magazine is usually filled with worthwhile content: Mike Santoli's Streetwise, Randall Forsyth's, credit writings, Michael Kahn's Technician, The Trader Column, the various interviews, and of course, Alan Abelson. It has been a fixture of my weekend for as long as I have been in the business. I was thrilled to publish there last month.

If it wasn't important, it wouldn't be worth criticizing.

One of the things I enjoy has been the Monday morning CNBC segment called "The Barron's Bounce," usually with Michael Santoli. It dawned on me that I hadn't seen Mike on in sometime, so I started poking around. I was surprised to read via Gawker that ever since the Barron's cover story looking into Jim Cramer's track record (Shorting Cramer) in 2007, all Barron's staffers have been unofficially banned from CNBC.

This decision serves neither CNBC nor its viewers. Legitimate analysis and criticism into anyone's track record is encouraged. When I screw up -- and I do, all too regularly -- I expect to hear about it from readers. If Cramer's nightly stock picks are under-performing, well, that is fair game for any critique.

Let me break ranks for a moment and say something nice about Jim Cramer's show: The most positive aspect of it has been to teach many of the newbies who watch it some basic money management techniques. I've heard Jim discuss diversification, stop losses, the dangers of naked put writing, and other, rarely discussed issues. Yes, I have a hard time with the cult of personality that has evolved around the show, and some of the goofier aspects of the broadcast, but I am not the intended demographic of Mad Money.

The bottom line is that there is a lot more to the show than Cramer's picks. Besides, he is on 5 hours a week, and answers dozens a questions on 100s of stocks. No one can throw out that many responses to that many trading ideas and perform any better than any large mutual fund.That's just the math of discussing that many names.

I would urge CNBC to reconsider this Barron's ban. If you don't find the Barron' content worthwhile, well that's fine. But to respond to criticism in such a heavy handed way makes the network look thin skinned and petty.

Viewers deserve the best guests and viewpoints a network can wrestle up. I cannot see how this serves anyone's interests -- the viewers, Barron's or CNBCs.

This is just one man's opinion . . .

UPDATE : October 20, 2008 10:09 am

I wrote this piece last night, after emailing a few Barron's staffers last week. I saw the NYT piece on the train in this morn, after my piece had posted.

Here is the link tot he Times:

Jim Cramer Retreats Along With the Dow
http://www.nytimes.com/2008/10/20/business/media/20carr.html

Note that the headline references Cramer's mannerisms, not the ratings --w hich are up substantially.

Previously:
Boo-yah! Barron's is Shorting Cramer
http://bigpicture.typepad.com/comments/2007/08/boo-yah-barrons.html

A Memo Found in the Street (September 27, 2008)
http://bigpicture.typepad.com/comments/2008/09/uncle-sam-the-e.html

Sources:
Jim Cramer, Untouchable
http://gawker.com/357174/jim-cramer-untouchable

Shorting Cramer
BILL ALPERT
BARRON'S COVER AUGUST 20, 2007
http://online.barrons.com/article/SB118681265755995100.html

The Economy is Just Fine . . .

Sunday, October 19, 2008 | 08:43 AM

in Economy | Financial Press | Really, really bad calls

Nothing to see here, move along, everything's fine.

That's what Gene Epstein, Barron's Economic Beat columnist, and author of the book Econospinning: How to Read Between the Lines When the Media Manipulate the Numbers, is saying in this week's magazine.

I was unsure as to where to begin in taking apart his column -- its not that it is so densely packed with errors (that's a given). Its that the author's worldview is, well, from a different world than ours.

"THESE ARE HARDLY THE BEST OF TIMES FOR THE U.S. ECONOMY. But they may not be as bad as you think. The credit crisis, stock-market crash and fall in home prices have raised legitimate fears of a nasty and protracted recession. Yet the economy has often proved more resilient than is commonly thought -- and constructive factors that have gotten scant attention should help the U.S. skirt a deep recession. In fact, it's possible that the downturn could prove to be one of the briefest and mildest on record.

The main positive is the huge boost to consumer spending that will come from the decline in energy costs. Although the run-up in oil, which punished consumers in the spring and summer, made front-page news, far less attention has been paid to the benefits of petroleum's recent slide...

The cavalry hasn't exactly swept in to rescue the economy. But the energy benefit could keep a significant recession at bay until reinforcements -- particularly inventory rebuilding -- arrive early next year, and as credit starts to flow more freely."

Where does one begin to fisk this? The Cavalry hasn't swept in? You mean to say that nationalizing the finance sector of the US, guaranteeing $2 trillion dollars in lending an deposits, and cutting rates to 1.5% rates -- thats not the cavalry?

And most economists understand why Oil is down -- its called demand destruction. People stopped consuming it, because they cannot afford to. A global recession is deflating all manner of commodities. This is a bad thing, not a good thing.

This is economic cheerleading way, way beyond the ordinary mindless spinning. Its an entirely different order of magnitude. This guy makes my boy Kudlow look like a depressive.

He believes BLS data may be understating how great things are. In 1996, Epstein raised the question as to whether "millions of U.S. workers may be missing from the government's jobs data." That's right, he thinks BLS actually understates employment. I have never seen any questions about understating inflation, the impact on GDP, or any looking askance at Birth Death adjustment. Its no surprise his over-optimistic economic viewpoint has missed all manner of actual issues that matter to investors.

I don't care about any single wrong view or forecast -- its the methodology and body of work that matters. Rather than dissect Epstein's column line-by-line, it might be more productive to cherry pick a few of his prior columns. These are quite revealing:

Hard, Soft Or No Landing (NOVEMBER 6, 2006) The author wrote: "The stock market's rosy view may be vindicated." Only not so much.

GDP Prospects Flash Green (MARCH 5, 2007) The author forecast: "The economy should grow nicely this year and next."

Why Recession Is Remote (OCTOBER 8, 2007) This was precisely at the peak of the last expansion -- we now know Real Wholesale-Retail trade sales peaked in September 2007, and Real Income hit its cyclical high in October '07. (Employment was December 07, and Industrial Production was January 08).

Housing Isn't Clobbering GDP (OCTOBER 22, 2007) It wasn't ? Then why was Q4 GDP = -0.2%?

Look for Joblessness to Hit 5.2% in Late '08 (DECEMBER 10, 2007) Wildly too optimistic -- the Unemployment Rate rate was 6.1% in September 2008, and is likely to rise.

Outside of Housing, Things Are Humming (NOVEMBER 5, 2007) The credit crisis was already 4 months old when this insightful column came out. Aside from GDP being negative, relying on a dirt cheap dollar raises the question of what happens when that dollar rises -- like it has this past quarter.

Slowdown, Not Recession (FEBRUARY 4, 2008) The irony is that NBER is likely to mark the recession starting no later than February, based on their peak-to-trough definition.

Even Money on Recession (MARCH 10, 2008) That's a small change from the column the month before.

The Great American Savings Myth (MAY 28, 2007) Facts have proven this to be clueless nonsense. "Household net worth -- assets minus debt -- has never been higher." As we warned at the time, asset prices can go down, while debt doesn't -- exactly what happened.

Why GDP Will Keep Growing (SEPTEMBER 29, 2008) Thanks to high Imported Oil prices, GDP looks better than it is (high imported Oil makes the deflator artificially raise GDP.