Forecasting Failure

White House nominee for post monitoring risk to financial system missed the warning signs of 2008 collapse

• February 21, 2012 5:00 am


President Obama has nominated Treasury Secretary counselor and former Morgan Stanley chief economist Richard Berner to be the first director of the Office of Financial Research (OFR), a new federal office within the Treasury Department, created under the Dodd-Frank Act to provide regulators with improved information to prevent another financial collapse.

The office which Berner would head will "produce, promote and sponsor financial research aimed at developing the analytical tools . . . to assess threats to financial stability" in the U.S. and global economy. However, an analysis of his predictions and research in the run up to the 2008 financial crisis suggests that Berner may not be up to the task.

Berner underestimated the effects of the housing crisis in 2006, as the signs of a looming collapse were first coming into view. In September of that year, Berner, then working for Morgan Stanley, reacted to news of housing and auto-market deterioration with subdued concern. Though housing construction had dropped to a three-year low and automaker Ford’s credit rating had been downgraded, Berner remained cautiously optimistic: "(Housing) activity and big-ticket durables don't march in lockstep anymore, and the ‘wealth effect' is in my view much smaller than the pessimists think."

In November 2006, Berner reacted similarly to news that a residential construction slump was contributing to slowed U.S. economic growth. Ed Yardeni, then the chief economist at Oak Associates, said at the time, "Typically in the past when housing fell into a recession so did the economy." But Berner disagreed, stating that rising wages would allow the economy to escape a recession caused by the collapse in housing. "Income is 10 times more important than wealth" in driving the economy, Berner said.

In March 2007, a stock market downturn led then-Federal Reserve chairman Alan Greenspan to admit that a recession was possible. Berner, however, remained optimistic about some areas of the economy. According to Berner, "Investors should not lose sight of the non-financial supports to growth—including still-vibrant growth abroad and healthy consumer income gains at home." The next U.S. recession officially began in December 2007, according to the National Bureau of Economic Research.

By that point, Berner had finally recognized that a recession was imminent, but his assessment was that the contraction would be "mild." According to Berner, Fed action would likely prevent a recession from becoming too deep or too long.

Even after recognizing that the U.S. was in a recession, Berner repeatedly underestimated its negative effects. In January 2008, he predicted a "mild and short" recession with unemployment peaking at 5.6 or 5.7 percent in January 2009. To the contrary, unemployment rose in January 2009 to 7.6 percent.

In July 2010, only 71,000 jobs were added in the private sector–74,000 less than Berner had predicted. When he made his prediction before the report was released, he told the New York Times that some people think, "I’m out of my mind."

Berner’s nomination to the OFR post currently awaits confirmation from the U.S. Senate. Some Republicans are concerned about the expansive nature of Berner’s potential position.

"The Office of Financial Research is just as powerful and intrusive as the (Consumer Financial Protection Bureau), the other independent agency created by Dodd-Frank," Rep. Randy Neugebauer (R., Tex.) said in a statement last year.  "It has sweeping authority—backed up by subpoena power and limitless assessment authority—to collect ‘all data necessary’ to carry out its duties.  As a result, OFR will have unprecedented, real-time access to a wealth of personal and proprietary corporate data—all in the name of an unattainable goal of preventing the next financial crisis."

Published under: Dodd-Frank, Obama Administration