As the economic storm of the past two years approached, most economists badly underestimated its intensity — or didn’t see it coming at all. Yet even now, the experts differ about what lessons they have learned from this episode, if any.
The turbulence has been historic: a plunge in home values, a surge of foreclosures, a tidal wave of layoffs. More than 7.2 million jobs swept away, including more than 225,000 in metro Atlanta, where more than 135,000 properties have gone to auction in the past four years, according to First American CoreLogic.
What the experts know matters — to clients making investment decisions, to consumers making household plans and to government officials making policy. But have they learned things that make them more likely to get it right next time? Have they learned anything at all?
“The issue is, what should we do to not let that happen again?” said David E. Altig, director of research at the Federal Reserve Bank of Atlanta. “Certainly, you can’t go through an event like this and not spend some serious time reconsidering the framework in which you are operating.”
Economist Dorsey Farr, a former Fed economist, now principal in Atlanta-based French Wolf & Farr, said the key is seeing how things have changed.
“What forecasters have to do is recognize that we’ve had some kind of regime shift,” he said. “You might need to recalibrate your model for the new regime. Folks who don’t do that must be prepared for some significant forecasting errors.”
What the recession has done is reduce the role of consumers, he said. “And that may be true for a number of years.”
Riding on debt, consumer spending swelled in the years after the 2001 recession. Borrowing both fed the housing boom and was fueled by it. Housing prices and sales jumped year after year. Skeptics called it a bubble — that is, values were not supported by fundamentals.
But many high-profile experts said no, including Federal Reserve Chairman Alan Greenspan and his successor, Ben Bernanke.
Surprised by ‘suddenness’
Watching all this closely, Adrian Cronje said he was worried.
As an investment advisor and economist, he saw trouble with housing, weakness in hiring and he wondered at the way that suspect mortgages were bundled together and sold.
Risky investments grew pricier, even as the housing market headed in the opposite direction. He knew something had to change.
And yet, he was startled when it did.
“What surprised me was the suddenness and the violence with which risk could be repriced,” said Cronje, now a partner and chief investment officer for Balentine LLC. “I got the big picture right. It was just the speed of the adjustment.”
Housing began to cool in 2006 (and then a year later in metro Atlanta), killing job growth and chilling millions of mortgages.
The ripples accelerated. A series of financial firms collapsed, several huge mortgage lenders failed and the stock market lurched downward. The government nationalized some lenders, brokered sales of others and fought off a complete meltdown of the financial system when it let Lehman Bros. fail in the fall of 2008.
“You got panic,” Cronje said. “It shows just how interconnected everything is.”
The lessons, he said: Key institutions, with billions at stake, may not handle risk well. Don’t assume that their problems won’t seep into the broader economy. Beware of debt.
And don’t love your own economic models too much, Cronje said. “There are limits to the modeling.”
Missed or unpredictable?
The Wall Street crisis cascaded through the economy, washing the nation into the deepest, longest downturn in seven decades. In Georgia, the damage was worse than average.
In two years, the state has lost one of every 14 jobs, while government struggled to cope with plunging revenues.
Jeffrey Humphreys, director of the Selig Center at the University of Georgia, said he had long believed the housing market was out of balance. When it slumped, he expected a mild recession.
Then, the financial markets melted down.
“I definitely missed some of that. I missed how risk-management had fallen apart. I knew that it was going on, but not to that degree.”
The lesson: Look beyond the data, he said. “I don’t need to tweak my models. I don’t need to tweak my intuition. I just need to believe it more.”
He pays more attention now, he says, to lesser-known economists.
Yet forecaster Rajeev Dhawan bristles at the charge that economists misread the signals and must revise their approach. The economy was tipped from modest growth to deep and painful recession in a series of turning points that simply were not predictable, he said.
Housing, for instance, did not have to deflate the way it did, said Dhawan, director of the Economic Forecasting Center at Georgia State. “And you can never predict when a bubble will burst, because by definition, a bubble is nonfundamental. And you can’t see a nonfundamental shock coming.”
Collapse of the big financial firms was in many ways like an old-fashioned bank run, he said. “I don’t think we were moving toward the abyss until after Lehman collapse. Bank runs are not predictable.”
Time to change models?
If something is an economic “shock,” it is, almost by definition, impossible to account for it in making predictions. And it is likewise hard to take lessons from something that might never happen again.
But economists disagree. What is a shock? What is unpleasant but not unforeseeable? Just how predictable is a $14 trillion-a-year economy, linked in myriad ways to a complex global system of trade and financing, where goods circle the globe in ships and jets and billions of dollars in capital make the same trip in moments?
“Even moderate recessions tend to be anomalous events that you don’t see coming,” said the Fed’s Altig. “I don’t think you can ever expect the crystal ball to be anything but pretty cloudy.”
Some things are clearer, he said. “I don’t think the correction and decline in the housing market was that much of a surprise.”
Yet some things were — like the way that networks of financing amplified the housing bust into an international crisis, he said. “What might fall into the category of a shock was the spillover effect as a consequence of that [housing decline]. The magnitude of that I certainly didn’t appreciate.”
Economists typically haven’t used economic models that account for the financial system, and that has to change, he said.
The bottom line?
But if the links from financial system to economy are not precise or unprecedented, and if some of the big effects remain hard to predict, then the experts may be left to flavor their analysis with their instincts.
Emily Sanders, president and CEO of Sanders Financial Management in Norcross, said many models ran into trouble in guiding investments.
To protect clients by diversifying portfolios, advisors generally pick assets that are not “correlated,” that is, whose prices do not usually move in parallel.
“But during the last meltdown, there was correlation in just about every single asset,” she said. “A lot of old theories about what’s correlated have gone out the window.”
Maybe economists are too wedded to old methods, maybe the economy hinges on too many things that can’t be measured, maybe there have been too many unpredictable shocks or maybe it’s just too soon to fully understand.
Whatever the reasons, the world of practical economics has not yet caught up, Sanders said.
“There hasn’t been much change from economic forecasters. They are still using the same historic patterns to try and predict the future. The way I look at it, we really haven’t learned much.”
Support real journalism. Support local journalism. Subscribe to The Atlanta Journal-Constitution today. See offers.
Your subscription to the Atlanta Journal-Constitution funds in-depth reporting and investigations that keep you informed. Thank you for supporting real journalism.