Paul Willen has it right (“Bubble? What bubble?” Ideas, Aug. 5). For the last four years, I have been explaining, in class lectures and privately, that you can’t have a financial crisis unless there is high correlation among the investment positions held by the vast majority of financial institutions. That is, when almost everyone is holding securities whose value depends on the same asset, namely, housing prices, the system is vulnerable to a decline in housing prices.
The problem is, as Willen states, that we have no model for forecasting when housing prices will decline (or rise, for that matter). So, quite understandably, investors used the past behavior of housing prices to forecast the future course of prices, and since housing prices had been rising for at least 50 years, concluded that it was unlikely that they would drop sharply.
The Federal Reserve used a more (so-called) sophisticated model, noting that we had full employment, declining interest rates (because China and India were recycling our dollars), good demand for housing, etc., to conclude the same thing.
Those of us who remember 2006-2008 accurately will attest to how sensible it seemed to lend money on houses, even if the buyer wasn’t in the best financial shape, as Willen says. It’s time to stop looking for villains, and focus on the real problem: too much correlated debt.
Now, if we only get the financial authorities to read Willen’s work.