Tuesday, May 1, 2018

No one saw this coming: Bezemer's misleading paper

I have been directed to [a paper by Dirk Bezemer] on multiple occasions as "documentation" of how the "heterodox" economic community predicted the global financial crisis. It was even cited in the New York Times. The paper is “No One Saw This Coming” Understanding Financial Crisis Through Accounting Models [pdf], and its introduction claims that it's simply a survey of economic models that anticipated the crisis:
On March 14, 2008, Robert Rubin spoke at a session at the Brookings Institution in Washington, stating that "few, if any people anticipated the sort of meltdown that we are seeing in the credit markets at present”. ... [‘no one saw this coming’] has been a common view from the very beginning of the credit crisis, shared from the upper echelons of the global financial and policy hierarchy and in academia, to the general public. ... The credit crisis and ensuing recession may be viewed as a ‘natural experiment’ in the validity of economic models. Those models that failed to foresee something this momentous may need changing in one way or another. And the change is likely to come from those models (if they exist) which did lead their users to anticipate instability. The plan of this paper, therefore, is to document such anticipations, to identify the underlying models, to compare them to models in use by official forecasters and policy makers, and to draw out the implications
Throughout, Bezemer elides the housing bubble in the US, a possible housing bubble in Australia, and the global financial crisis and global recession. As you can see, the abstract appears to be talking about predicting the global financial crisis happening in 2008 (what Rubin is referring to in March of 2008). The housing bubble in the US began to deflate in 2005 as noted by e.g. "mainstream" economist Paul Krugman at the time. Mainstream economist Dean Baker (cited by Bezemer, but only in 2006) had been issuing warnings as early as 2002. Anticipating a housing collapse and recession in one country is not anticipating a global financial crisis or global recession.

The quotes Bezemer supplies to back up his contention that the heterodox community predicted the global financial crisis and global recession are all about the end of housing bubbles in the US and Australia and national recessions (note that Australia did not have a recession, and has not had one for over a quarter century). They're also not entirely from heterodox economists (Baker and Shiller are "mainstream" economists). But more than that — several quotes Bezemer supplies from "heterodox" and post-Keynesian economists are fabricated and taken out of context. I have taken the time to research six (two from Wynne Godley, one from Michael Hudson, one from Jakob Madsen, one from Jens Sorensen, and one from Steve Keen) of the twelve supplied in the table at the end of the paper.

I do want to note that it is Bezemer who is misrepresenting the following people, and — with the exception of Steve Keen — the people quoted don't make claims about predicting the global recession and financial crisis (Godley passed away in 2010).

Wynne Godley

In order to support my claim and collect the evidence in one place, I have copied this section from here. Bezemer's purported quotes of Wynne Godley are:
“The small slowdown in the rate at which US household debt levels are rising resulting form the house price decline, will immediately lead to a …sustained growth recession … before 2010”. (2006). “Unemployment [will] start to rise significantly and does not come down again.” (2007)
These quotes appear in a table at the end of the paper (p. 51) as well as in the text (p. 36), but neither of these quotes appear in the cited references to Godley. The second one doesn't appear in any form in any of the cited papers that could be construed as Godley (2007) — which is great for Godley as unemployment in the US has since fallen to levels unseen in almost two decades. [Update: the source has been found, but it is not one of the cited ones.] The first is cobbled together from a few words in a much longer passage in Godley (2006) linked above:
It could easily happen that, if house prices stop rising or if the financial-obligations ratio published by the Fed continues to rise, the debt-to-income ratio will slow down during the next few years, much as it did in the late 1980s and early 1990s. ... 
The results are a bit surprising, since the apparently quite small differences between debt levels in the four scenarios generate such huge differences in the lending flows. In particular, Scenario 4, the lowest projection, shows that the debt percentage only has to level off slowly and then fall very slightly for the flow of net lending to fall from 15 percent of income in 2005 to 5 percent in 2010. ...
The average growth rates for 2005–10 come out at 3.3 percent, 2.6 percent, 1.8 percent, and 1.4 percent. The last three projections imply sustained growth recessions—very severe ones in the case of the last two. ...
Is it plausible to suppose that the growth of GDP would slow down so much just because of a fall in lending of this size? Figure 7, which shows past (and projected Scenario 4) figures for net lending combined with successive, overlapping three-year growth rates, suggests that it could. Major slowdowns in past periods have often been accompanied by falls in net lending.
Michael Hudson

After being challenged about this by David Orrell in a comment on my earlier post, I chose one additional quote at random as part documenting my claims all in one place. Michael Hudson is an economist at the University of Missouri, Kansas City. Bezemer claims he said:
“Debt deflation will shrink the “real” economy, drive down real wages, and push our debt-ridden economy into Japan-style stagnation or worse.” (2006)
Like in the case of Godley, this quote [pdf] leaves out modifiers and is taken out of context (it doesn't use the words "debt deflation"):
But homeowners are not the only ones who will pay. The overall economy likely will shrink as well. That $200 billion that flowed into the “real” economy in 2004 is already spent, with no future capital gains in the works to fuel more such easy money. Rising debt-service payments will further divert income from new consumer spending. Taken together, these factors will further shrink the “real” economy, drive down those already declining real wages, and push our debt-ridden economy into Japan-style stagnation or worse.
Bezemer leaves out the "further" and "already declining" modifiers that would detract from seeing this as an anticipation of a sudden crisis, but rather a general stagnation like the one Japan was experiencing at the time.

Steve Keen

I noted this in a footnote here, but I want to put it more explicitly. Bezemer quotes Keen:
“Long before we manage to reverse the current rise in debt, the economy will be in a recession. On current data, we may already be in one.” (2006)
The source of the quote is here, and like the case of Godley it is constructed from phrases across several paragraphs (in bold):
The is the story behind Australia's private debt [ed. note: Australia, not global]. It has been growing more than 4 per cent faster than our GDP for 53 years. Back in the 1960s, that meant very little - the ratio of debt to GDP would increase by no more than 1 per cent a year, and it was at comparatively trivial levels anyway. It grew from 27.3 per cent of GDP in 1966 to 28.2 per cent in 1967. 
Forty years later, that ratio is increasing ten times as fast. It is 147.1 per cent now. If the rate of growth doesn't slow down, it will crack 150 per cent of GDP by March 2007, and it will exceed 160 per cent of GDP by the end of 2007. We simply can't keep borrowing at that rate. We have to not merely stop the rise in debt, but reverse it. 
Unfortunately, long before we manage to do so, the economy will be in a recession. The reasons are simple: paying down excessive debt causes borrowers to stop spending - whether that means households that cancel order for the latest LCD TV, or firms that put off that planned expansion of capacity. Income plummets, but debt continues to rise, simply because of the effect of compound interest. The debt to GDP ratio starts to fall only when a substantial slab of income is devoted to paying debt, but that in turn means a serious recession. 
We have suffered two such debt-driven downturns since the end of WWII: the long 1973-1983 recession, when unemployment blew out from a mere 1.8 per cent to over 10 per cent; and the 1990 'recession we had to have', when unemployment exploded from 5.6 per cent to 10.6 per cent in just over 3 years. 
Both recessions were preceded by booms in which private debt rose to previously unheralded levels. During both, the ratio 'headed south', against its long term trend. But the momentum of debt meant that the turnaround in the ratio followed the start of the recession itself. It continued rising, for nine months after unemployment began to rise in 1973, and for a whole two years in 1990. 
So when will this recession begin? On current data, the domestic economy may already be in one - though the China boom has more than compensated for the domestic downturn. What can be done to avoid it? Unfortunately, almost nothing. We have two sources of spending power: what we earn and what we borrow. During a boom, borrowing adds to our spending power - and it's added massively in the last decade, as debt has blown out from 88 per cent of GDP at the end of 1997 to 147 per cent now. But during a slump, once we get on top of the momentum of debt, repayment of debt subtracts from our spending power. This feeds back on income itself, reducing its growth still further, because investment ends, consumer spending drops, and unemployment rises even more.
Keen is clearly talking about Australia; Australia's housing bubble (if it is one) still hasn't popped (despite even more recent warnings in 2016 about the possibility), and Australia has not had a recession in over a quarter century.

Jakob Brøchner Madsen and Jens Kjaer Sorensen

Bezemer's citation of Madsen (another mainstream economist now at Monash University) is at best confused. In the table at the end of the paper, Madsen is cited as:
“We are seeing large bubbles and if they bust, there is no backup. The outlook is very bad” (2005)
In the text, he is cited as saying in 2004 (not 2005):
“There is something completely wrong. We are seeing large bubbles and if they bust, there is no backup. House prices and shares are completely out of proportion. And it will go wrong. … The outlook is very bad for families in Denmark.”
Again, Madsen appears to be talking about Denmark and not the global financial crisis. I will also note that Wikipedia cites Bezemer's paper in the article on Madsen saying he predicted the global financial crisis — it isn't just me that got the implication Bezemer was talking about the global financial crisis using quotes about housing bubbles in particular countries.

Jens Sorensen, a grad student of Madsen's, is not a heterodox economist and the model he uses is not an accounting model per the title of Bezemer's paper. In fact, the model he uses is based on standard asset pricing (see e.g. Cochrane [pdf]). His anticipation of a global recession is actually more defensible as he looked at more data than just the US (including the UK, Norway, and the Netherlands). Bezemer quotes Sorensen:
“The bursting of this housing bubble will have a severe impact on the world economy and may even result in a recession” (2006). 
The quote from Sorensen's thesis [pdf] is actually
When the housing market is above its fundamental value the market at some point will have to adjust and follow the LR trend defined by theory and supported by historical data. The timing of such an adjustment is only dependent on a change in sentiment.  Bursting the bubble has previously and will have severe impact on the world economy and may even result in a recession.
While not as severe a misquote as the ones from Godley or Keen, the context significantly changes the meaning from an absolute prediction to a conditional one. Additionally, the housing "bubbles" Sorensen cites in Norway and the Netherlands still have not "popped" (continued warnings in 2017 at the links), and in 2006 the US housing bubble was already deflating.


  1. I think your first sentence is lacking an object that the word "to" demands.

    1. Totally correct. Copy and past error from the original blog post. Accidentally cropped the first half of the sentence:

      Unfortunately, Godley's policy note linked above is completely mis-represented in a paper by Dirk Bezemer that I have been directed to on multiple occasions as "documentation" of how the heterodox community predicted the global financial crisis.

      I will fix it.

  2. So, did anyone reach out to Dirk? Reading it somewhat positively his quotes are not really changing the substance of matter, but are really, really sloppy. Any professor should know how to cite properly.

    “Long before we manage to reverse the current rise in debt, the economy will be in a recession. On current data, we may already be in one.” (2006)

    should be:

    “[L]ong before we manage [to reverse the current] rise in debt, [...] the economy will be in a recession. [...] On current data, [...] [we] may already be in one” (2006)

    Magnificently ugly, but that's a feature not a bug. Any reader would be triggered to think: with that amount of editing, is that quote really a quote. A whole paper filled with [...] and [additional word] ridden quotes wouldn't be written like that, again: a feature of proper quoting.

    1. I have a feeling direct confrontation on this would not be productive, and that someone he considers a friend (or at least neutral) should let him know. But if I have to be the one, I will do it.

      I'd agree in e.g. the case of Sorensen the misquoting doesn't change the substance drastically. However, in the case of the quote from Keen you mention it should be made explicitly clear Keen was talking about Australia, and also not only was the prediction wrong but the "current data" bit was wrong as well. Australia's housing bubble is still going and it hasn't had a recession since 1991. This makes the quote an example of a *failed* prediction. In a more objective paper, it would still be included but noted as a failure.

      Even in the case of Sorensen, by far the most plausible case and the only one who mentions a *global* recession, two of the four countries he mentions didn't have bubbles that popped (Norway's housing prices are still climbing),


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