Wonkblog: Economy, Housing crisis, Federal Reserve, Congressional Budget Office

Why our models missed the financial crisis

The direct loss of wealth from dot-com bust was about the same size as from the housing meltdown. Perhaps even a bit less. So why did one create so much more economic damage than the other?

The difference, writes Peter Orszag, is that the housing crisis took place in “the highly leveraged financial sector.” And that’s why all the models missed the damage it would do: “The macroeconometric models used by the Fed -- like those used by the Congressional Budget Office, the White House and others -- had at best a very rudimentary financial sector built into them.” So “they treated the housing collapse as if it were merely dot-com bust 2.0.” And that’s still the case today, he says. Yikes.

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