Who’s to Blame for the Mess?

Question: After 2006, what was the thinking among regulators and financial professionals concerning a scenario in which housing prices fell significantly in many areas of the country? (Arnold Kling, Econlog)

Mark Zandi: I think though, if you go back to '06, there's a broad based belief that house prices would not decline, at least across the nation.  There would be regions of the country, California perhaps, and New York and maybe Florida where we see some price declines, but nothing that would encompass the entire national housing market and get outright price declines. 

I mean, I can remember -- we do a lot of house price forecasting for our clients and in '06, at some point, we forecasted that national house prices were going to decline in '07.  Not by a lot, but b a little bit.  A couple, 3 percentage point decline and that was a big change and created a lot of angst among a lot of our clients saying, "How can that possibly be the case?"  So, of course, it was a couple of 3 percent and it ended up being 30% plus.  So, I think there was this general view, based on historical experience that this just couldn't happen.  At least not to the scale that it obviously ultimately did occur. 

Now, I have to say, unfortunately, because the models were based on looking at house prices relative to people's incomes and house prices relative to effective to apartment rents, the models wanted to say bigger price declines in some big markets.  But I didn't even believe it.  I had a hard time digesting what the models were telling me.  And I felt like, if I came out and said prices were going to decline, that was a big enough statement and I didn't have to say they were going to decline by 23%.  Because then you lose credibility.  And that's also part of the problem in this period because for a number of years, good economists were arguing that house prices were getting inflated, it was speculative that in all likelihood we would at least see them go flat or decline.  But if you say that say, in '05 and then prices continued to rise by double digits, and then you say that again in '06, and then prices rise again in double digits.  Then you lose credibility and no one listens.  And so that became the problem. 

And that's not a typical of the bubble, but that's exactly what happened and why a lot of us lost credibility because we had been arguing that this wasn't sustainable, but we started arguing that too early. 

Question: How did we miss an $8 trillion asset bubble? (Dean Baker, Beat the Press)

Mark Zandi: Well, a number of things.  I think at the root of it was a very new and complex process of financing mortgage lending and other lending altogether.  The process of securitization, which at its core I think has value and is a good thing.  It provides for the more efficient allocation of savings into investment, but I think the problem is no one really understood the process from start to finish.  You had the originators making the loans who were focused on what they did.  You had the investment banks buying the loans and packaging them into securities, and the focused on what they did.  You had the rating agencies looking at the securities and deciding, how is this going to look, and they were focused on what they did.  The regulators were focused on individual aspects of this process.  But no one was looking holistically and saying, "Is this going to work?  Does it make sense?"  And at the end of the day, we made a lot of bad loans because the process didn't make sense. 

Question: Were financial regulators or industry executives equally to blame? (Arnold Kling, Econlog)

Mark Zandi: I think industry executives, they were looking at it only in the broad sense, and they were only focused on their aspect of the process, so they really didn't consider everything in its totality and regulators the same way. 

Now the other problem regulators had was there was a general view in regulatory circles that the market would figure it out.  In a sense the regulators were thinking the CEO's had it figured out and that they didn't need to do much oversight or really consider what the CEO's were doing.  The CEO's in fact, weren't -- because of the way the securitization process was structured, no one really was focused on the entire system, and regulators didn't understand that.  But they thought the market was working properly and the CEO's would get it right.  And of course, that was wrong.

Recorded on November 10, 2009

It was partly the forecasters’ attempts to protect their credibility that put us in this dilemma, says Moody’s chief economist Mark Zandi.

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