The Signal and the Noise: Why So Many Predictions Fail-but Some Don't

by Nate Silver

There were at least four major failures of prediction that accompanied the financial crisis. The housing bubble can be thought of as a poor prediction. Homeowners and investors thought that rising prices implied that home values would continue to rise, when in fact history suggested this made them prone to decline. There was a failure on the part of the ratings agencies, as well as by banks like Lehman Brothers, to understand how risky mortgage-backed securities were. Contrary to the assertions they made before Congress, the problem was not that the ratings agencies failed to see the housing bubble. Instead, their forecasting models were full of faulty assumptions and false confidence about the risk that a collapse in housing prices might present. There was a widespread failure to anticipate how a housing crisis could trigger a global financial crisis. It had resulted from the high degree of leverage in the market, with $50 in side bets staked on every $1 that an American was willing to invest in a new home. Finally, in the immediate aftermath of the financial crisis, there was a failure to predict the scope of the economic problems that it might create. Economists and policy makers did not heed Reinhart and Rogoff’s finding that financial crises typically produce very deep and long-lasting recessions.