Response Paper #4

Jessie Latter

GVPT200

11 November 2013

Response Paper #4: Silver Ch. 1

            The first chapter of The Signal and the Noise by Nate Silver, titled “A Catastrophic Failure of Prediction”, focuses on the housing bubble in the 2000’s and subsequent financial crisis of 2008. Silver says that many predictions are wrong because people cannot always objectively decide what is good information, which is what led to preventable catastrophes like the financial crisis. I agree with Silver’s argument that there are three acts that tell the story of the financial crisis as a failure of prediction.

            In act I, Silver argues the inevitability of a decline in the housing market after a boom in real estate prices, thus, creating a housing bubble. Silver says that previous housing booms during the postwar years had seen a dramatic increase in homeownership, unlike the 2000’s who saw only modest increases in homeownership (Silver 31). This “artificially enhanced” housing boom made it easier to obtain mortgages, even though “the 2000’s were associated with record-low rates of savings…” (Silver 31). His next point is that homeowners, not entirely by their own fault, had underestimated the returns on their investment in a house and that they could not put it off until later (Silver 32-3). I agree that the “artificially enhanced” housing boom and unrealistic assumptions by homeowners contributed to the housing bubble because they created a situation that made it easier to obtain mortgages and make consumers overconfident about their ability to pay back loans.

            In act II, Silver argues that leverage contributed to the financial crisis. After the housing bubble collapsed, consumers were wiped out and began to spend less (Silver 34). This decline in the GDP may have caused a recession but it was major banks that had bet on housing in the form of mortgage-back securities, like the Lehman Brothers, that led to a financial crisis when the housing bubble collapsed (Silver 34-5). Silver also argues that banks like the Lehman brothers may have been a lot more cautious about betting on mortgage-backed securities if credit ratings agencies had not vouched for them by handing out AAA ratings (Silver 36). I agree that leverage contributed to the financial crisis because major banks were borrowing money to bet on mortgage-backed securities that they were guaranteed would not default, even though they did when the housing bubble collapsed. If they had not placed these leveraged bets then the United States may have only faced a recession, not a financial crisis.

            In act III, Silver argues that there is always uncertainty when making predictions. Unlike risk, uncertainty “is risk that is hard to measure” (Silver 29). The White House introduced a stimulus package to Congress in 2009 that was eventually agreed upon at $800 billion (Silver 40). Unfortunately, unemployment continued to rise and in October 2009 it hit 10.1% (Silver 40). No economists had predicted the magnitude of the crisis and the White House did not prepare the public for the possibility of failure (Silver 41). Silver argues that betting on the uncertainty of something like the effect of a stimulus package atop the uncertainty of economic forecasts can lead to bad predictions (Silver 42). I agree that there is always uncertainty when making predictions, which is why the White House and economists should not have underestimated the scope of the financial crisis and prepared for the worst possible outcome.

           

Works Cited

Silver, Nate. The Signal and the Noise: Why so Many Predictions Fail--but Some Don't. New York: Penguin, 2012. Print.