Are most economists naive?

The conclusion that most economists are naive, sometimes dangerously so, is something that has been hinted around at here for years, but now that the Wall Street Journal seems to concur, maybe it's time to stop asking the question and just say it.

Most economists are naive.

Or, maybe they're just too optimistic. Actually, in many cases, the two adjectives describe the same phenomenon - the willingness to suspend belief that something bad is likely to happen (or is already happening) due to a lack of real-world experience.

Merriam-Webster defines the word thusly:

2 a : deficient in worldly wisdom or informed judgment; especially : CREDULOUS
2 b : not previously subjected to experimentation or a particular situation

The nation's housing market is a perfect example of how this naïveté can be dangerous and, more importantly, expensive. Anyone listening to a raft of predictions last summer or fall regarding the future course of the housing boom, and then taking the plunge after rosy talk of an imminent rebound would be sorely disappointed today.

David Lereah, the recently departed and much-discredited chief economist at the National Association of Realtors, serves as a prime example of this.

There seem to be far too many practitioners of the dismal science who simply look at numbers or charts then err on the side of optimism, failing to consider that the numbers and charts represent real people in the real world with all their real faults and real emotions.

The fact that we now live in a world where speculative bubbles are more the rule than the exception does not make their job any easier.

Two stories in the Saturday edition of the Wall Street Journal make this case rather well. Sadly, both are behind the subscription wall, but it really isn't necessary to do much more than read the headline to understand the message.

Economists See Housing Slump Enduring Longer
Downturn Is Expected To Keep Growth Tepid
By JAMES R. HAGERTY, JONATHAN KARP and MARK WHITEHOUSE

Economists are giving up on the idea that the U.S. housing slump will be quick and relatively painless.

Instead, more are concluding, the downturn that began nearly two years ago will last at least through the end of 2007, remaining a major drag on the U.S. economy. The culprits: a glut of homes for sale and growing caution among lenders who now regret being so free with their mortgages during the boom.
...
Late last year, some economists were saying the market would start bouncing back by the middle of 2007. That hasn't happened, partly because inventories of unsold houses have continued to grow and a surge in mortgage defaults has made lenders much more reluctant to grant credit to people with spotty payment histories.

David Resler, chief economist at Nomura Securities International Inc. in New York, says he is surprised by the degree to which speculation caused builders to overestimate demand, leaving a glut of houses and condominiums.

Surprised indeed.

All Mr. Resler had to do was talk to a few prospective condo buyers camped out in front of sales offices around the country in 2004 or spend an afternoon observing the goings-on at the office of a subprime mortgage broker to understand what was really happening.

And, speaking of "subprime", which by now must be a candidate for addition to Merriam Webster in 2008, the world's most famous contemporary economist was in the news again over the weekend.

Did Greenspan Add to Subprime Woes?
Gramlich Says Ex-Colleague Blocked Crackdown On Predatory Lenders Despite Growing Concerns
By GREG IP

Alan Greenspan was arguably the country's most powerful financial cop in his 18 years as chairman of the Federal Reserve. But Mr. Greenspan's regulatory record has received far less scrutiny than his management of the economy.

That may be changing. A former colleague says Mr. Greenspan blocked a proposal to increase scrutiny of subprime lenders under the Fed's broad authority. That added scrutiny might have helped curtail questionable lending practices now blamed for soaring defaults by mostly low-income borrowers. Democrats in Congress are now turning up the heat on regulators, especially the Fed, for failing to do more to stamp out those practices, and the Fed appears increasingly likely to overhaul its approach.

Edward Gramlich, who was Fed governor from 1997 to 2005, said he proposed to Mr. Greenspan in or around 2000, when predatory lending was a growing concern, that the Fed use its discretionary authority to send examiners into the offices of consumer-finance lenders that were units of Fed-regulated bank holding companies.

"I would have liked the Fed to be a leader" in cracking down on predatory lending, Mr. Gramlich, now a scholar at the Urban Institute, said in an interview this past week. Knowing it would be controversial with Mr. Greenspan, whose deregulatory philosophy is well known, Mr. Gramlich broached it to him personally rather than take it to the full board.

"He was opposed to it, so I didn't really pursue it," says Mr. Gramlich, a Democrat who was one of seven Fed governors.

All of this makes me think that comments by your humble scribe appearing in BusinessWeek last year about economists and wedgies offered an excellent insight into this matter:

Do I Deserve a Wedgie?
By Michael Mandel

Seeing that Mike Mandel and Chris Farrell are two of the authors goes a long way in understanding what it's about.... Both of these guys are so far out of touch with Main Street -- one of these days some laid-off worker is going to give both of them a wedgie. --Tim Iacono, commenting on bigpicture.typepad.com

The topic back then was dark matter - the elusive substance that explains how laid off manufacturing workers shouldn't feel so bad.

Fast-forward to mid-2007 and a case could be made that David Lereah might someday soon become uncomfortable in his nether regions were he to meet up with a truck driver who is now upside down on his late-2006 condo purchase after heeding the economist's advice.