I Always Expected Hindsight Bias from the Financial Press

Today the Federal Reserve of the US released transcripts of 2006 meetings. The financial press, always avid for filler and faux outrage, pounced on them. How is it possible that the almighty Fed didn’t see the 2008 recession coming?

From the NYTimes:

The transcripts of the Fed’s Open Market Committee meetings in 2006, released after a standard five-year delay, suggest that some of the nation’s pre-eminent economic policy makers did not fully understand the basic mechanics of the economy that they were charged with supervising. The problem was not a lack of information; it was a lack of comprehension, born in part of their deep confidence in models that turned out to be broken.

“It’s embarrassing for the Fed,” said Justin Wolfers, an economics professor at the University of Pennsylvania. “You see an awareness that the housing market is starting to crumble, and you see a lack of awareness of the connection between the housing market and financial markets.”

“It’s also embarrassing for economics,” he continued. “My strong guess is that if we had a transcript of any other economist, there would be at least as much fodder.”

The Wall Street Journal, in turn, has these articles:

Little Alarm Shown at Fed At Dawn of Housing Bust and
Governor Cautioned Fed About Mortgages. From the latter:

History may show that Susan Bies’s concerns didn’t get enough attention at Federal Reserve policy meetings in 2006.

All the above is a fine example of hindsight bias. Why? Because nobody could have foreseen the magnitude of the crash. Look at the S&P 500 chart for the past five years:

If you click on the chart, you will see that the stock market peaked in October of 2007. Between then and the low of February 2009, it fell close to 50%. This means that the collective intelligence of all the financial analysts did not see the crash coming in 2006 and 2007. If you dig into the archives of the above newspapers and others, the opinions were very divided back then. Some people expected a soft landing, others even thought it would be a good thing for houses to go down in value. From the New York Times itself: Don’t Fear the Bubble That Bursts (March 2006).

Moral of the story: do not pay attention to anything you read in the financial press. Nobody knows anything about the future, nobody can predict it. Of course the pundits will tell you that “they saw it all coming.” Hey, it’s their job.

I Always Expected Hindsight Bias from the Financial Press

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