In the transcript of that meeting, which the Fed releases five years in-arrears, we see the members complimenting themselves on the "robust" state of the financial markets, suggesting that "the fundamentals of the expansion going forward still look good (Geithner)," and even cracking-wise about builder complaints that housing inventories were "going through the roof." Who knew that madcap humor was in such long supply among practitioners of "the dismal science?" And who knew that actually understanding the underpinnings and fundamental essentials of the economy was in dire shortage?
To be fair, the sole dissenting voice in the blithe disregard of the housing bubble, and the financial chicanery that inflated it, was the then-and-current Fed Chairman Ben Bernanke. He apparently was less concerned about too much growth fueling inflation (Remember inflation? Ask your Dad.), than about the spillover effects of a housing market in-decline. But even his words do not suggest that he understood the difference between a pot-hole and the precipice that the economy was fast-approaching.
Now, I know that this is classic Monday morning quarterbacking, but, well, it IS Monday as I write this. And my purpose here is not specifically to bash the members of that august body, as much as they may deserve it. They reinforced each other's sense of well-being, failed to comprehend the peril, and ultimately didn't do their fundamental job of helping to safeguard the economy of the US, and by a short stretch, the world.
My concern is to understand why their forecasting system failed so miserably that the financial world went to the brink of collapse mere months later. This is important history from which we need to learn, lest it repeat itself.
One possibility is a perceptual bias to which all humans are prone. We tend to make up our minds early, after which we mostly seek easy evidence confirming the correctness of our premature conclusions. Professor Max Bazerman describes that and other tricks we play on ourselves in his insightful book "Negotiating Rationally." The effect is probably exacerbated by the fact that all these great minds trust each other, because, after all, they've all been invited to membership in this uber-exclusive club on their intellectual merits.
But if they know about "inherent bias" in Cambridge, where Bazerman teaches, shouldn't they know about it at the Fed? Better yet, shouldn't they have corrected for it?
There is another human tendency, an almost existentialist approach that assumes that nothing catastrophic will happen on one's watch. People are forever falling asleep at the switch, failing to stand guard, assuming that since nothing happened last time, it won't happen this time, either. I think that's true especially in good times. It's a strange sort of "entitlement mentality" that soothes brains that might better be fevered. Were the Fed members thus lulled by the expansion that had endured for several years?
And what about the models they were evidently using to predict future performance of the economy? Why did they fail to appreciate the existence and implications of the real estate bubble, whatever its causes? Are we doomed to forever 'fight the last war' -- learning lessons only in the aftermath of catastrophe? Even more importantly: have those models at least been corrected and updated to take account of their prior insensitivity to lurking risk of calamitous dimensions?
Finally, I wonder about the make-up of this group. You probably don't get invited to the club by being unnecessarily alarmist, but is the make-up of the group too conventional? These meetings are only made public five years later, so wouldn't it be wise to have a few rabble-rousers in the group – gadflies who might just uncover the fact that the economy was rapidly shedding its clothes? In several recent meltdowns – Enron, Bernie Madoff's Ponzi Inc. come to mind – there was a lone analyst who refused to be misled or reassured, and declined to join the lemming stampede. Where do we find those folks – and how can they get themselves appointed to stand on the wall for us? At minimum, we ought to institutionalize their skepticism among our regulators.
I complained in an earlier blog about the Euro crisis and a relatively new financial system in the EU, whose linkages are fragile and poorly understood. Now, it appears that I have a Lot more than that to worry about, a lot closer to home.
