Experience vs Models

The smart Phd economists at the Fed are actively trying to find new models to use which better reflect things other than the macroeconomic approach they have traditionally used. The Fed completely blew it in 2007-2008. They had no idea what was about to happen. Greenspan claims he did not see it coming and “only five people knew what was about to happen. I have never figured out if that is just his way of covering up his own incompetence at failing to see the greatest economic event in seventy years, or if he really believes it. The fact is it is nonsense.

Models are as we all know, just the output of a set of assumptions and if the assumptions are wrong the output is wrong. It is far better to listen to senior people with deep experience than to rely on mathematical models. In November, 1993, when we were creating the first hotel CMBS program, two of us discussed how in ten or 12 years the whole thing would collapse because Wall St would loosen underwriting and go too far on leverage. In the period 2005-2007, I heard several senior people in the capital markets talk about how this was going to all end in disaster. In May 2007, at the spring ULI conference, I had lunch with the COO of a major REIT, the head of CMBS at a rating agency, the senior MD of a major property brokerage firm and one other person. The lunch discussion was which week the CMBS and capital markets in general would begin to collapse. We agreed it would be around the end of July 2007 which is about when the unwinding of the markets began. When Bear Stearns collapsed I was told the following week that Lehman might be next. In August of 2008 I was hearing that Lehman was going to go Chapter. There were other such stories around through this period and several senior people in the business who clearly predicted the collapse. Many of us could not understand how things went on as long as they did. Several people predicted the collapse fully two years before it actually occurred and kept saying it was coming.