What did I know and When did I know it?

In a self-congratulatory blog posting, Paul Krugman asserts that he would probably have been the most alarmist person in the room for the 2007 FOMC meetings about the potential for a really big financial crisis.  But then this isn't saying much as he says the FOMC was complacent.

He then goes on to explain what he saw that made him alarmist and why he has "had a pretty good stretch" since then.

For the record, my stretch over the same period has been vastly superior to Professor Krugman's.

People have been poring over the just-released 2007 Fed transcripts, and the main surprise seems to be how complacent the institution was. 

Some members of the open market committee, including Janet Yellen and, let’s give credit where due, Tim Geithner, seem to have had a sense of dread; but the overall consensus was that nothing really bad would happen. 

The obvious question if you’re a pundit, then, is “How did I do?” And the answer is, not too badly. Yes, I hedged — it was a statement of possibilities, not a straight prediction. But I clearly would have been in the camp of Fed alarmists, and probably the most alarmist of them all. 

It is a matter of public record that I wasn't hedging about the problems in the credit markets.  I was featured in a Bloomberg article on December 4, 2007 on how to actually moderate the impact of and deal with the problems in the financial system.

It seems to me that the really big determinant of whether you were intellectually ready for this crisis was how much attention you paid to events in the late 1990s — the crisis in emerging Asia, LTCM here, and the Japanese liquidity trap. I paid a lot of attention back then (as did Nouriel Roubini), taking the lead in resurrecting the theory of the liquidity trap (pdf) and writing a book, The Return of Depression Economics. 

And the result is that I’ve had a pretty good stretch; the only big thing I got wrong, I think, was in underestimating the stickiness of wages, and hence inflation, and therefore overestimating the risks of actual deflation. 

Professor Krugman and I differ on what it took to be intellectually ready for this crisis.  I think it took an understanding of Economics 101.

Specifically, it took an understanding that the necessary condition for the invisible hand and therefore capital markets to operate properly is that market participants have access to all the useful, relevant information in an appropriate, timely manner so they can independently assess this information and make an informed decision.

It took an understanding that since the Great Depression our financial system has been based on the FDR Framework which combines the philosophy of disclosure with the principal of caveat emptor (buyer beware).

As I was reading the Fed meeting transcripts, what was clear was that nobody in the room understood this necessary condition or the role it plays in our FDR Framework based financial system even though they were well aware that both structured finance securities and bank balance sheets were opaque.

Confirmation of this assertion comes from the Fed's adopting the policy of injecting liquidity into the financial system with the idea that the market would figure out how to value or price the opaque structured finance securities and bank balance sheets.

Hello, the market couldn't figure out how to value or price either structured finance securities or bank balance sheets because they are opaque.

Recognizing that the markets were going to be on life support until transparency was brought to all the opaque corners of the financial system, I have had a much better performance than Professor Krugman since the beginning of the financial crisis.

For example, I knew that the burden of supporting the excess debt in the financial system would swallow both fiscal and monetary stimulus efforts and leave the US economy in a Japan-style economic slump (our economy "grows" only while there is fiscal stimulus and will immediately go back into recession when austerity policies are adopted).

That said... it’s not clear how much difference it would have made if the Fed had grasped the scale of the danger back in 2007.

It makes all the difference in the world because it drives their policy responses.

The big errors came later, after the depth of the crisis was apparent to all, and they came mainly in fiscal and housing policy, not monetary policy.

Actually, there were and still are too many monetary policy errors to mention.

This started with disobeying the father of modern central banking Walter Bagehot's directive that at times of crisis  a central bank lend freely at penalty rates against good collateral.  In 2007, the Fed choose to lend freely at rates they knew the banks would find attractive against bad collateral (I think the term that was used was "dreck").