Financial Crisis

Bloomberg View Columnist Noah Smith Is Wrong, Wrong, Wrong

A second viewing of the movie adaptation of Michael Lewis’ The Big Short has prompted me to write the following analysis of Bloomberg View columnist Noah Smith’s hit piece on market oracle Michael Burry.

As most of our readers know, Dr. Michael Burry famously bet against the US housing market back in 2005. In a specular display of testicular fortitude, Burry persevered in the face of blatant market manipulation by Goldman Sachs – who only started pricing his Credit Default Swaps accurately when they themselves got in on the trade – to return a whopping 489% for his investors between November 1, 2000 and June 2008.

Now compare Burry’s spotless track record to Mr. Noah Smith’s, who back in June of 2014 lavished public and unadulterated praise on Japanese Prime Minister Shinzo Abe and Bank of Japan Governor Haruhiko Kuroda’s aggressive economic reforms. As I write these lines, consumer prices in Japan have fallen back below zero as the 2% inflation target remains elusive, and the BOJ – through a policy of reckless, indiscriminate ETF purchases – is now a top 10 holder in 90% of Japanese stocks, in a futile effort to prop up the Nikkei 225 Index. These are hardly examples of “effective leadership”, as Mr. Smith termed Prime Minister Abe’s policies.

The Argument

Smith seemingly doesn’t question Burry’s talent at identifying special investment situations, but is dismissive of his macroeconomic views and “anti-government, libertarian ideology”.

In Smith’s own words:

“Burry repeats a theory of the crisis that has long since been discredited — the idea that the government caused the crisis by encouraging home loans to the poor. Actually, housing bubbles manifested in many countries that had no equivalent to the government-sponsored enterprises Fannie Mae and Freddie Mac, the bubble was driven by middle- and high-income borrowers, and the borrowers who drove up prices were primarily speculators rather than owner-occupiers.” […] “Libertarianism is fine and good, but ideology can distort reality and prevent people from efficiently assimilating the available evidence.”

This is a remarkable piece of illogic, because it is a matter of historical record that the US Government did indeed a) encourage the degradation of lending standards and b) the use of technologies by sub-prime lenders in order to entice borrowers to take loans they couldn’t possibly afford to pay back.

Barney Frank (whom Burry criticizes in an interview with New York Magazine – which became the basis for Smith’s article) has admitted this much, by stating that:

“It was a mistake to push lower-income people into housing they couldn’t afford [at Fannie Mae and Freddie Mac].”

Similarly, in a speech in 2004, then Chairman of the Federal Reserve Alan Greenspan exhorted the virtues of adjustable-rate mortgages over standard fixed-rate loans. In the following year, he mentioned concerns about “froth” in the housing market, but proceeded to assuage the public by claiming that bubbles to be “local and not national”.

Given the interconnected nature of complex systems, it is a fool’s errand to even attempt to pinpoint a single, specific cause for the collapse of the housing bubble in 2007, but it is facetious to claim that regulators and policymakers shouldn’t share a sizable chunk of the blame.

Smith cites an arcane paper published by the New York Fed exploring the “previously unrecognized, but very important, role” of real estate speculators in the collapse of the housing bubble. The crisis, he argues, was caused not by the Government lending to the poor, but rather by middle class punters trying to flip properties to make a quick buck.

No one questions the role that speculative excess played in the whole sordid affair, but Smith’s point can only characterized as immaterial to Burry’s thesis; namely that borrowers (of various degrees of credit-worthiness) abused non-prime credit – a situation that was made possible by a lowering of lending standards mandated, aided and abetted by the US Government.

In fact, as Burry points out in a lecture delivered at Vanderbilt University in 2011:

“Tragically for all of us, the Federal Reserve actually had authority to block any lending activity it deemed deserving of such treatment, but it had absolutely no will to do so.”

The fact that they didn’t, alone, amounts to nothing short of negligent behavior requiring some form of accountability.

The fact that Mr. Smith seems incapable of grasping such simple logic is unfortunate. As a proud member of the Intellectual Yet Idiot Class class he has gone so far down the rabbit hole of ivory tower of intellectualization that he appears to have become completely impervious to the idea of common sense.

Either that or he knows he’s spouting nonsense, but can’t be bothered to stop. Take your pick.

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