Here is Potter in his own words:
The economics profession has been appropriately criticized for its failure to forecast the large fall in U.S. house prices and the subsequent propagation first into an unprecedented financial crisis and then into the Great Recession. In this post, I examine the performance of the forecasts produced by the economic research staff of the Federal Reserve Bank of New York (New York Fed) over the period 2007-10 and consider some of the reasons why we, like most private sector forecasters, failed to predict the Great Recession...It is curious that Potter only references a Keynesian when identifying those who warned about the crisis, and not the many Austrian economists who did so:
The staff forecasts of real activity (unemployment and real GDP growth) for 2008-09 had unusually large forecast errors relative to the forecasts’ historical performance, while the forecasts for inflation were in line with past performance. Moreover, although the risks to the staff outlook were to the downside throughout this period, it wasn’t until fall 2008 that a recession as deep as the Great Recession was given more than 15 percent weight in the staff assessment...
...the New York Fed research staff forecasts, as well as most private sector forecasts for real activity before the Great Recession, look unusually far off the mark...
Looking through our briefing materials and other sources such as New York Fed staff reports reveals that the Bank’s economic research staff, like most other economists, were behind the curve as the financial crisis developed, even though many of our economists made important contributions to the understanding of the crisis. Three main failures in our real-time forecasting stand out:
Misunderstanding of the housing boom. Staff analysis of the increase in house prices did not find convincing evidence of overvaluation (see, for example, McCarthy and Peach  and Himmelberg, Mayer, and Sinai ). Thus, we downplayed the risk of a substantial fall in house prices. A robust approach would have put the bar much lower than convincing evidence.
A lack of analysis of the rapid growth of new forms of mortgage finance. Here the reliance on the assumption of efficient markets appears to have dulled our awareness of many of the risks building in financial markets in 2005-07. However, a March 2008 New York Fed staff report by Ashcraft and Schuermann provided a detailed analysis of how incentives were misaligned throughout the securitization process of subprime mortgages—meaning that the market was not functioning efficiently...
Indeed, in the period leading up to the financial crisis, analysts who were suspicious of the stability of the Great Moderation, such as Nouriel Roubini, offered assessments that proved to be significantly more accurate than the point forecasts of New York Fed research staff or most professional forecasters in gauging the potential for unlikely bad outcomes.
Quite interesting is that Potter cites the McCarthy and Peach failure to recognize the developing housing crisis. I responded to the McCarthy and Peach when it was written. At the time, I replied::
...the record climb in housing prices is, indeed, a bubble... the Federal Reserve study fails to consider past declining interest rates as a cause of the bubble. The faulty conclusions reached by Federal Reserve economists Jonathan McCarthy and Richard W. Peach may make many potential new home buyers comfortable about a purchase, when, in fact, we are very near the top of a housing market that will experience substantial declines in prices...At the time, apparently, McCarthy and Peach thought my reply was funny and included this quote from me, in their power point presentation, when they went around the country declaring there was no housing bubble. Under the headline "Opposing View", they would flash this quote from my reply to their view:
They reach the conclusion that because of ....[the] "fundamental factor" of low nominal interest rates, higher housing prices are justified.
But does this mean real estate prices will not drop? Our answer is decidedly no. Indeed, McCarthy-Peach report that "since 1995, real home prices have increased about 36 percent, roughly double the increase of previous home price booms in the late 1970's and late 1980''s." We view this increase as largely the result of the Federal Reserve's lowering of interest rates and the pumping of liquidity into the banking system, thus producing the byproduct of higher housing prices. But by incorporating falling nominal interest rates as a "fundamental factor" that can not be a cause of a bubble, McCarthy-Peach have literally defined the cause of the current bubble from being taken into consideration....
Further, the current structure of many mortgage loans whereby no money down is acceptable and/or adjustable rate mortgages are popular, sets up the possibility that many may walk away from current mortgage commitments down the road as interest rates begin to climb. Indeed, as ARM's rates become more and more burdensome and as housing prices begin to decline, walk away situations are likely to become quite prevalent, thus adding even more downward pressure to the housing market.
It is our conclusion, then, that by defining nominal interest rates as a fundamental factor and not as the Fed induced causal factor of the real estate boom, and by completely ignoring the structural features of current mortgage loans, McCarthy and Peach have blinded themselves to the real estate bubble that does exist. They have set themselves up for perhaps making the worst economic prediction since Irving Fisher declared in 1929, just prior to the stock market crash, that "stocks prices have reached what looks to be a permanently high plateau."
The faulty analysis by Federal Reserve economists McCarthy and Peach may go down in financial history as the greatest forecasting error since Irving Fisher declared in 1929, just prior to the stock market crash, that stocks prices looked to be at a permanently high plateau.I'm sure, at the time, it created quite a chuckle. But, this is the only known case of Fed economists responding to a Fed critique from a blogger. They clearly picked the wrong blog post to respond to. As I have said before, they aren't using that power point presentation anymore.
That wasn't my only warning about the real estate crash. I also wrote An Ex-Girlfriend, a Construction Worker and My Landlord and A Letter to a Friend on the Logic of Real Estate Investing.
Further, Potter notes that the Fed did not give a serious weighting to a recession until, at the earliest, the Fall of 2008. Throughout the summer of 2008, I was screaming that a serious crisis was coming:
I wrote in July 2008:
After growing at near double digit rates for months, money growth has slowed dramatically. Annualized money growth over the last 3 months is only 5.2%. Over the last two months, there has been zero growth in the M2NSA money measure.Again in July 2008, I wrote:
This is something that must be watched carefully. If such a dramatic slowdown continues, a severe recession is inevitable.
We have never seen such a dramatic change in money supply growth from a double digit climb to 5% growth. Does Bernanke have any clue as to what the hell he is doing?
I have previously noted that over the last two months money supply has been collapsing. M2NSA has gone from double digit growth to nearly zero growth .
A review of the credit situation appears worse. According to recent Fed data, for the 13 weeks ended June 25, bank credit (securities and loans) contracted at an annual rate of 7.9%.
There has been a minor blip up since June 25 in both credit growth and M2NSA, but the growth rates remain extremely slow.
If a dramatic turnaround in these numbers doesn't happen within the next few weeks, we are going to have to warn of a possible Great Depression style downturn.
In August 2008, I wrote:
After growing at near double digit rates, Fed money supply growth over recent months has slowed dramatically. Three month annualized M2NSA money growth is at 2.8%. If money growth remains this low we will be in a recession in no time.On September 4, 2008, I wrote:
ALERT: MUST READ Money Growth Plunges To 1.8%
The M2 money supply growth rate continues to plunge.
Data released today by the Fed show the annualized growth rate for the thirteen weeks ending August 25, 2008 for M2 is now at 1.8%. As we have emphasized, this is after early 2008 M2 money supply growth at double digit rates.
If the Fed doesn't reverse engines real fast, the economy will plunge into Depression-like conditions within months, if not weeks.
Extreme caution should be exercised with regard to all long term business decisions. Within six months the economy could look much different. Preserve cash.
I am going to contact Potter to see why he did not acknowledge the warnings of Austrian economists in his report. Especially his failure to acknowledge me, when the Fed was perfectly willing to get a chuckle, via a slide presentation, over my forecast, when I warned that McCarthy and Peach had no clue, and at the time, McCarthy and Peach did not believe for a minute that I was accurate.