Dow 36,000

Bryan Appleyard sums up a study by Berkley psychologist Philip Tetlock:

He studied pundits and discovered they were, to a rough approximation, always wrong when making predictions. He took 284 pundits and asked them questions about the future. Their performance was worse than chance. With three possible answers, they were right less than 33 per cent of the time. A monkey chucking darts would have done better.

Part of the problem arises from belief perseverance.  Once we form a theory, we tend to stick to it, even in the face of contradictory information.

Low scoring forecasters exhibited that behavior in Tetlock’s study: they latched onto one big idea and blinded themselves to other drivers of history.  Think about someone who peppers their speech with “moreover” and “all the more so,” continually stretching their idea and denying other interpretations.  This over-reaching makes them prone to exaggeration, such as those who thought Quebec would secede and Canada would consequently disintegrate.

High scoring forecasters, on the other hand, recognized, even flaunted, a probability distribution of events.  These are the people who qualify their arguments with “however” and “but,” those who accommodate opposing theories.  They stitch together a framework of smaller ideas, rather then working down from a Grand Scheme.

27 Ways to Untangle The Financial Crisis

An excellent series of visualizations dissecting the crisis.  Here’s an example (click to enlarge):

What’s Different About This Time

One benefit of bubbles: they usually leave something useful behind.  Despite the grief and anxiety wrapped with the downturn, bubbles fuel innovation at a breakneck pace and finance the infrastructure that vaults the economy forward.

Daniel Gross elaborated on this thesis in his book Pop: Why Bubbles Are Great For the Economy, citing irrational exuberance as the main factor for new commercial developments.  During the post Civil War booms, for example, companies laid out competing and often redundant rail networks.  Fifteen years later, a quarter of the companies landed in bankruptcy.  The same pattern repeated during the ’90s: each major telecommunications company strung enough wire to service the entire nation.  Collectively, they dropped over ninety percent by 2002.

But these busts were like phoenixes: new life arose from the ashes.  The Internet pop directly led to Web 2.0 (Google, Skype, Wikipedia), technologies that gained critical mass after the bubble burst.   Each directly benefited from the cheap excess capacity built during the ’90s.

This time around, the bubbles didn’t produce anything tangible which we can latch onto as consolation.  A rise in house prices reflects paper growth, lost amidst the downturn, and reshuffling CDOs doesn’t provide the country with any lasting contribution.