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Talking back: Subprimes, economic catastrophe and evil robots
Lots of feedback on Monday night's subprime post.

I am wrong, wrong, wrong:

Pat I would like to see you bet your entire portfolio on the chance our positive economic cycle will be extended, especially in light of the recent economic indicators showing increasing downside risk. I remember a monstrous economy called Japan and their banking environment. You should review your notes and return to the boy scout motto; Better to have it and not need it, then need it and not have it. Best of luck. --Mark Anthony

All you've said is that experts are not likely to be correct, let alone always right. Fair enough. But where is the substantiated evidence and reasoning to prove they are talking gibberish? The predictions re housing troubles is only wrong in one major respect: timing. As usual, things take a little longer to pan out. But I've been reading about the expected problems with subprimes and housing decline for 3 years. It's analogous to naysayers against predictions of Dow at 36,000 and New Economy before the dot com bust. Eventually gravity prevails. --Tom Ngi

Pat Regnier must be hurt at his falling home price from this desperate attempt to spin this article. It is ALREADY happening, Pat... Wake up! --Andrew Johnson

For the record, I rent.

I am the sweet, chiming voice of reason:

Big Overreaction! They are confusing true Subprime with hybrid mortgage loans. True subprime has been holding the economy from a true recession.I have 24 years as owner of large mortgage firm. --Scott G.

Pat, As a longtime mortgage broker, 20 years, I read with interest - no pun intended - your story. Very good insight and humor! Tempest in a teapot. --Michael O'Connor

Good points Pat. What continues to amaze me are some of the predictions that point to complete economic catastrophe. Yesterday Bill Fleckentstein said there was about to be a credit freeze in housing. I disagree.There are certainly things to be concerned about, but a complete economic collapse is not one of them.--Nigel Swaby

Should I worry that all these guys are in the mortgage business? Hmmmm.....

Finally, Alexei Turchin of Moscow points me to a paper, "Cognitive biases potentially affecting judgment of global risks," by Eliezer Yudkowsky of something called the Singularity Institute for Artificial Intelligence in Palo Alto, Calif. SIAI is devoted to the development of artificial intelligence and to making sure that the thinking machines we create don't go all Matrix on us. That's right--this paper is, in part, about the risk of killer robots destroying the world! I know it sounds like I'm making fun here, but I'm not. It's a very thought-provoking little essay on how to think about risk.

Bear with me a moment: This really does have something to do with what I said Monday about the risk of subprimes bringing down the economy. Drawing on some of the same psychological literature that Philip Tetlock has, Yudkowsky lays out the basic mental errors people make when trying to predict uncertain outcomes. Then he offers this caution:
Every true idea which discomforts you will seem to match the pattern of at least one psychological error.

Robert Pirsig said: "The world's biggest fool can say the sun is shining, but that doesn't make it dark out." If you believe someone is guilty of a psychological error, then demonstrate your competence by first demolishing their consequential factual errors. If there are no factual errors, then what matters the psychology? The temptation of psychology is that, knowing a little psychology, we can meddle in arguments where we have no technical expertise-- instead sagely analyzing the psychology of the disputants.

...Despite all dangers and temptations, it is better to know about psychological biases than to not know. Otherwise we will walk directly into the whirling helicopter blades of life. But be very careful not to have too much fun accusing others of biases. That is the road that leads to becoming a sophisticated arguer--someone who, faced with any discomforting argument, finds at once a bias in it. The one whom you must watch above all is yourself.
Well said. And I felt slightly chastened as I read this. On Monday, I basically said that experts like Nouriel Roubini are giving us compelling new information and telling us very vivid tales that end in the economy crumbling, but that you shouldn't get too carried away by this because even experts are often blinded by their own great stories. Yudkowsky reminds me that this kind of argument can quickly degenerate into sophistical anti-intellectualism: "Don't listen to that guy. It sounds like he actually might know something."

I've been reading Roubini's blog for a while, and he clearly knows a whole lotta somethings. The counter-argument to Roubini's case is real, but sounds a bit blasé at the moment: Financial markets are mostly resilient, there's still lots of liquidity out there in world, unemployment is low, the Fed's on the case... After last week and the big market drop yesterday, Roubini's going to get a lot of credit for ringing the alarm bell on lender's insanely lax standards and the risk that posed not just to borrowers but to the whole financial system. He deserves that credit. Getting economic predictions right is to some extent a matter of luck and timing (a stopped watch and all that), but Roubini's work would have been valuable even if we weren't sitting here today wondering only how bad things are going to get. A year ago, most of the experts had convincing stories to tell about how everything would be okay. Investors and home-buyers alike needed to hear more about the risks that were building up in real estate, so that they could take steps to protect themselves. Your portfolio and your mortgage payment should never depend upon on best-case scenarios.

Now I risk descending from the sophistical to the banal: Anything could always happen. Duh. But for practical purposes, this is important to keep in mind during volatile, nervous periods like this one. Let's say you find the subprime-crash = recession argument compelling. (After yesterday, I'm 70% there myself.) What would you do about that now? You probably wouldn't be buying an investment property in San Diego. And you might be reluctant to stretch much to buy a bigger house. That's prudent. But would you sell your house ASAP? Dump most of the stock funds in your 401(k) and buy gold or cash equivalents? Bad ideas. I'm not an expert on asset-backed derivatives and how pricing problems might flow through to the wider market for credit. (The whole point about yesterday is that almost nobody understands this stuff very well, including the owners.) But I have spent my entire career covering people who make their living predicting market trends in hopes of investing ahead of them. I've seen the smart ones get it wrong, and not-so-smart ones get wildly lucky. The problem with market predictions isn't that people make factual or even psychological errors, but that markets are very, very complex. The pros struggle with this, and they have a lot more information and money to play with than we civilians do. I hope that a month ago your financial plan took account of the possibility of a housing-led recession; I hope that your financial plan today will work to your advantage if the market survives this bout of volatility. If you did it right, between then and now you shouldn't have had to change much.

Photo of Michael Smith's robot collection by Michael Smith
Posted by Pat Regnier 1:08 PM 4 Comments comment | Add a Comment

Hi Pat,

You say: Let's say you find the subprime-crash = recession argument compelling. (After yesterday, I'm 70% there myself.) What would you do about that now? You probably wouldn't be buying an investment property in San Diego. And you might be reluctant to stretch much to buy a bigger house.

And I think this is a key point. The bigger problem is that for at least five years, nobody has held this point of view. Way too many people did buy the big house and the jet ski and the Hummer and the vacation properties. This message has not gotten through yet and it will take more cases of the media pointing out the dangers of this reckless behavior. The mortgage brokers are not doling out this advice and, based on the rising delinquency data, homeowners have not gotten it elsewhere.
Posted By J. Young, San Francisco, CA : 3:43 PM  

Should I worry that all these guys are in the mortgage business? Hmmmm.....

Pat, thanks for quote.

Should you worry about our intentions? Fair question, but the same could be said about your intentions. You're in the media. You want to capture eyeballs to keep your job. We all have some level of personal interest in the things we publish, but don't question mortgage brokers just because of our jobs. Our professional experience and our willingness to share it is of value, just like any of the other sources you quote.

I think transparency trumps our vested interests. If you write too many stories that turn out to be wrong, you will lose credibility.

The same applies to me and to other professionals in the real estate industry. Clients are just too hard to come by to burn them over and over.

Blog authors face the same risk. Write from a slanted perspective and be proven wrong too many times and people won't ever believe what you write.

I think you're fair enough, but you have to realize the truth always lies somewhere in the middle of two extremes.
Posted By Nigel Swaby, SLC, UT : 1:24 PM  

It's worse than most think. countrywide for example has a retail conforming loan at a 660 score below 90% loan to value. At this score and risk the customer is doing a stated income stated asset loan...Countrywide is still calling this a conforming pool loan...please dont be afraid of subprime...be verey afraid of countrywide. Especially when their CEO is cashing out mega shares.
Posted By john, chicago : 2:03 PM  

Nigel,

Pot. Kettle. Black. I wish I could discuss with you about your views on "Why its different this time" But so far, you have deleted all my comments on the matter at your blog. I'm guessing its because I am an economist.

To the point: The Real Estate market became a Ponzi scheme because these quirky loans could only be self-sustaining in a constantly-appreciating environment. Given that business cycles are ... still existing, the inevitable downturn has flattened this house of cards.
Posted By Stephen, DC : 10:34 AM  

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