The Signal and the Noise: The Art and Science of Prediction

by Nate Silver

The ratings agencies’ shot at redemption would be to admit that the models had been flawed and the mistake had been theirs. But at the congressional hearing, they shirked responsibility and claimed to have been unlucky. They blamed an external contingency: the housing bubble.

In fact, however, the ratings agencies quite explicitly considered the possibility that there was a housing bubble. They concluded, remarkably, that it would be no big deal. A memo provided to me by an S&P spokeswoman, Catherine Mathis, detailed how S&P had conducted a simulation in 2005 that anticipated a 20 percent decline in national housing prices over a two-year period—not far from the roughly 30 percent decline in housing prices that actually occurred between 2006 and 2008.

But in contrast to the activity that was taking place on Main Street, Wall Street was making bets on housing at furious rates. In 2007, the total volume of trades in mortgage-backed securities was about $80 trillion.71 That meant that for every dollar that someone was willing to put in a mortgage, Wall Street was making almost $50 worth of bets on the side.