My time away from blogging lately has consisted of visiting my wife in the hospital (she’s fine and home now, thank you), coordinating grandparent’s help with our 1 1/2 year old little man, and reading at her bedside. The latter a mix of company for her and rare quiet time for me to dive in to some great books. The book I am currently reading is one whose timing could be no less perfect. It is The Black Swan: The Impact of the Highly Improbable
His book talks about the errors that humans make in viewing the world and events both in corroborating supporting evidence and oversimplifying things - plus a host of other errors that will surely reveal themselves as I conclude this book. It is extremely relevant to the housing fiasco and some of the commentary that we’ve heard from those who continue to postulate that the subprime problem is “contained” and that housing is in for a soft-landing.
Let’s look at a couple of those errors and how they relate to what we’re seeing today:
Corroborative Evidence
Taleb argues that one of our biggest faults as a species is looking for (and accepting) evidence that supports our world view at the expense of the entire body of evidence. He suggests that rather we should look for information that disproves our assumption as a far better method of ascertaining the truth. This plays out daily in the media and on blogs as the “homers” (those in the REIC) point to low rates of foreclosure overall, the stability of home prices and slight reductions in inventories as signs that those of us yelling fire are doing so in a crowded theatre with out reason. Of course the inverse has to be honored as well; that those of us with a pessimistic view need to be alert to signs that maybe an orderly wind-down is, in fact, upon us.
The Narrative Fallacy
We as humans also have a unique habit of over-simplifying things - maybe more than a habit - more likely it is hard-wired in to our DNA; and this causes us to tell each other convincing, simplified stories that allow us to wrap our brains around complex situations. This is clearly what has been happening over the last few years as home prices have continued to rise. Those who have argued that this bubble “is different” from other bubbles use this fallacy to defraud the rest of us. They tell us a simple story of how low unemployment, increased liquidity in capital markets (hah!) and other factors have collided to keep the housing market moving forward-in defiance of other, historical bubbles. It is painfully evident now that the simple storytellers are at best unwitting accomplices - at worst the are much worse.
How is applies to the housing problem:
As the housing, mortgage and now global credit markets unwind it becomes clear that the problems of corroborative evidence and the narrative fallacy have helped push our markets to the point of a violent and precipitous correction; one that is currently ongoing. Those that point to a small percentage of foreclosures or a small percentage of subprime loans are the most guilty. They tell a simple story that paints the problems in to a small, nicely contained corner of the market; where its effects are minimal and that all is right with the world.
It’s a fool’s paradise this version of events. Taleb’s analogy of the turkey who learns that the farmer is a friend bearing food for the first 1,000 days of its life only to go through a “revision of beliefs” on the 1,001 day of its life (the Wednesday before Thanksgiving perhaps?) fits well with the simplified view of the market. For if the events of last week are any indication (with U.S. and European Central Banks “saving the day” with the injection of $200 billion in capital in to the markets - the most since 9/11) this is a much more complex problem. It cannot be explained with a pedestrian statistic sliced to make it look as insignificant as possible. This problem is much more complex; derived from the inter-connectivity of markets, credit, complex and opaque financial vehicles, hedge funds, leverage, Wall Street and main street greed, incompetence, ignorance, arrogance and downright stupidity.
We can continue to tell ourselves the false, simple story of a small, contained problem affecting only a small percentage of homeowners; or we can admit that the evidence we choose is not always as powerful as the evidence we choose to exclude. Further we can admit that the problem is not a simple main street or Wall Street problem; it is an every-street problem that will cause a “Black Swan” event (one so rare that the possibility of its existence is laughable) that will impact our economy and understanding of financial markets and bubbles in ways not yet fathomed. It will rewrite history as a true test of how sound (or fool-hardy) our financial models, matrices and algorithms truly are.
Those that choose the simple story are the ones that will be hurt the most. Read Taleb’s book soon - and stay with me for more of his work and its relationship to this historic time.
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[Source: Blown Mortgage]
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