Choosing a Financial Advisor, Part 3

“Fiduciary – A Financial Advisor held to a Fiduciary Standard occupies a position of special trust and confidence when working with a client.  As a fiduciary, the Financial Advisor is required to act with undivided loyalty to the client.  This includes disclosure of how the Financial Advisor is to be compensated and any corresponding conflicts of interest.” – Focus on Fiduciary.

In a previous post, I said that, when looking for a financial advisor, you want someone who puts your interests first, i.e. a fiduciary.  This merits further discussion.  By way of example, lawyers, trustees or doctors are considered fiduciaries. On the other hand, stock brokers, insurance agents and registered representatives are not.

According to the National Association of Personal Financial Advisors (NAPFA) web site, Focus on Fiduciary:

Federal and state law requires that Registered Investment Advisors are held to a Fiduciary Standard.  This law requires that an advisor act solely in the best interest of the client, even if that interest is in conflict with the advisor’s financial interest. Investment Advisors must disclose any conflict, or potential conflict, to the client prior to and throughout a business engagement.  Investment Advisors must adopt a Code of Ethics and fully disclose how they are compensated.

Because broker-dealers are not necessarily acting in your best interest, the SEC requires them to add the following disclosure to your client agreement.  Read this disclosure, and decide if this is the type of relationship you want to dictate your financial security:

“Your account is a brokerage account and not an advisory account.  Our interests may not always be the same as yours.  Please ask us questions to make sure you understand your rights and our obligations to you, including the extent of our obligations to disclose conflicts of interest and to act in your best interest.  We are paid both by you and, sometimes, by people who compensate us based on what you buy. Therefore, our profits, and our salespersons’ compensation, may vary by product and over time.”

If you see this disclaimer in your contract, you have been warned that you are not working with a fiduciary.  My question to you is, “Why would you even consider working with someone who has issued you this warning?”

After all, you engage a financial advisor to look after your interests. In my opinion, having a trusted relationship is not possible after you have read the warning quoted above.  Since commissioned representatives receive incentives for selling one investment over another, how do you ever know why someone recommends one investment product to you over another? How do you know what it is actually costing you?

I wholeheartedly agree with NAPFA’s conclusion:

NAPFA has always maintained that an advisor who is compensated solely through commissions faces immense conflicts of interest.  This type of advisor is not paid unless a client buys (or sells) a financial product.  A commission-based advisor earns money on each transaction—and thus has a great incentive to encourage transactions that might not be in the interest of the client.  Indeed, many commission-based advisors are well-trained and well-intentioned. But the inherent potential conflict is great.

I believe that a strict fee-only approach is the best way of working with clients.  I want my clients to consider me as a trusted advisor and true partner, not a salesperson.

To be continued.

photo credit: Rui Almeida (Portugal)

Choosing a Financial Advisor, Part 2

“A Fee-Only financial advisor charges clients directly for his or her advice and/or ongoing management. No other financial reward is provided, directly or indirectly, by any other institution. Fee-Only financial advisors are selling only one thing: their knowledge.” – National Association of Personal Financial Advisors.

In a previous post, I wrote that a fee-only financial planner might be better choice for you than a financial planner who is compensated by commissions. Here is a continuation of an article by the Consumer Federation of America, an advocacy, research, education, and service organization.

The Financial Planning “Name Game”

If a fee-only financial planner is probably your best bet, what about all those other planners out there? As consumers have started to wake up to the conflicts of interest that result from commission-based compensation, more and more financial planners have adopted confusing terminology designed to obscure how they are compensated. Here are a few of the most common that you should be on the look-out for:

Fee-and-commission. This is the now somewhat out of fashion term for a planner who earns a fee for developing a financial plan, then earns commissions selling the products to implement that plan. For years, planners were able to sell this arrangement as being in their client’s best interests on the grounds that they were more objective than commission-only salespeople and more affordable and convenient than fee-only planners.

Since consumers have become more conscious of the total costs of fee-and-commission planning and the incentives commission-dependent planners have to steer them into costly and possibly inappropriate products, few planners now use this relatively candid terminology, though the majority continue to practice in this fashion.

Fee-based. This is today’s more fashionable terminology for fee-and-commission financial planning. The conflicts are the same, but the candor is gone. Some “fee-based” financial planners will tell clients they can work either on a fee-only basis or on a fee-and-commission basis if the client wants to implement the plan through them. Somehow, however, the bulk of their clients end up as fee-and-commission clients. The term “fee-based” is misleading, so you should be wary of those who use it.

Fee-offset. Under a fee-offset arrangement, a planner imposes a fee for drawing up a strategy, then reduces up to 100 percent of that fee to account for any commissions that may be earned in implementing the plan. The problem of commission bias is less obvious, but it remains. After all, if a financial plan costs $2,000 and the planner earns $10,000 in commissions for selling the needed products, he or she will be able to pocket $8,000 in conflict-producing commissions …even after totally offsetting the cost of the original plan.”

Interpretation

How your financial advisor is compensated should be important to you, because being paid a commission results in the (very distinct) possibility of a conflict of interest. Fee-only means the advisor cannot accept commissions. If the financial advisor’s paycheck comes from a brokerage firm, then the advisor is an employee and owes loyalty to the firm. When the paycheck comes directly from you, your interests come first.

As many consumers have discovered, some brokers regularly rely on obfuscation – confusing them with dozens of “facts,” figures and recommendations until their head is reeling. It’s disingenuous for them to suggest that you are not paying a fee, because the mutual fund (or insurance company) pays it. Certainly, no one would assume that the fees come from the benevolent tooth fairy. I call it obfuscation, but that’s really just a polite way of saying that they’re lying to you.

What you really need is someone who will put your financial interests first. This is a good description of someone who acts as a fiduciary.

Since labels for advisors – fee-based, fee-offset – are often confusing (on purpose, in my opinion) your best defense is to ask very pointed questions and expect very direct answers.

Question #1
You: “How are you compensated?”
Advisor: “I am compensated solely by my clients.” Correct answer.
Advisor: “Oh, you needn’t worry about that! My fees get paid by the insurance company or mutual fund.” Incorrect answer.

Question #2
You: “Do you act as a fiduciary?”
Advisor: “I always act as a fiduciary.” Correct answer.
Advisor: “Sometimes.” Incorrect answer.

Question #3
You: “Will you put that in writing?”
Advisor: “Yes, I will put that in writing.” Correct answer.
Advisor: “My word is my bond.” Incorrect answer.

You should be aware that members of the National Association of Personal Financial Advisors sign a Fiduciary Oath.

I actually give my Fiduciary Oath to prospective clients at the first meeting along with the Privacy Notice.

To be continued.

photo credit: emuphoto

Understanding the Financial Crisis, Part 4

“The right blames the credit crisis on poor minority homeowners. This is not merely offensive, but entirely wrong.”… “Lending money to poor people doesn’t make you poor. Lending money poorly to rich people does.” – Daniel Gross.

In previous posts, I covered the causes of the Financial Crisis: poor mortgage lending standards, excessive risk taking by investment banks, and inadequate transparency and regulation. Not discussed in any detail is the role of government policy in causing the financial meltdown.

According to Daniel Gross writing on the web site Slate, the right wing claims the cause of the current problems is government intervention, i.e. “well meaning” social programs that encouraged home ownership by poor and middle class consumers. Gross strenuously objects to this conclusion.

Since fixing any problem necessitates truly understanding the causes of the problem, I am posting the entire article Subprime Suspects published October 7, 2008. (The original post contains links to various referenced articles.)

We’ve now entered a new stage of the financial crisis: the ritual assigning of blame. It began in earnest with Monday’s congressional roasting of Lehman Bros. CEO Richard Fuld and continued on Tuesday with Capitol Hill solons delving into the failure of AIG. On the Republican side of Congress, in the right-wing financial media (which is to say the financial media), and in certain parts of the op-ed-o-sphere, there’s a consensus emerging that the whole mess should be laid at the feet of Fannie Mae and Freddie Mac, the failed mortgage giants, and the Community Reinvestment Act, a law passed during the Carter administration. The CRA, which was amended in the 1990s and this decade, requires banks—which had a long, distinguished history of not making loans to minorities—to make more efforts to do so.

The thesis is laid out almost daily on the Wall Street Journal editorial page, in the National Review, and on the campaign trail. John McCain said yesterday, “Bad mortgages were being backed by Fannie Mae and Freddie Mac, and it was only a matter of time before a contagion of unsustainable debt began to spread.” Washington Post columnist Charles Krauthammer provides an excellent example, writing that “much of this crisis was brought upon us by the good intentions of good people.” He continues: “For decades, starting with Jimmy Carter’s Community Reinvestment Act of 1977, there has been bipartisan agreement to use government power to expand homeownership to people who had been shut out for economic reasons or, sometimes, because of racial and ethnic discrimination. What could be a more worthy cause? But it led to tremendous pressure on Fannie Mae and Freddie Mac—which in turn pressured banks and other lenders—to extend mortgages to people who were borrowing over their heads. That’s called subprime lending. It lies at the root of our current calamity.” The subtext: If only Congress didn’t force banks to lend money to poor minorities, the Dow would be well on its way to 36,000. Or, as Fox Business Channel’s Neil Cavuto put it, “I don’t remember a clarion call that said: Fannie and Freddie are a disaster. Loaning to minorities and risky folks is a disaster.”

Let me get this straight. Investment banks and insurance companies run by centimillionaires blow up, and it’s the fault of Jimmy Carter, Bill Clinton, and poor minorities?

These arguments are generally made by people who read the editorial page of the Wall Street Journal and ignore the rest of the paper—economic know-nothings whose opinions are informed mostly by ideology and, occasionally, by prejudice. Let’s be honest. Fannie and Freddie, which didn’t make subprime loans but did buy subprime loans made by others, were part of the problem. Poor Congressional oversight was part of the problem. Banks that sought to meet CRA requirements by indiscriminately doling out loans to minorities may have been part of the problem. But none of these issues is the cause of the problem. Not by a long shot. From the beginning, subprime has been a symptom, not a cause. And the notion that the Community Reinvestment Act is somehow responsible for poor lending decisions is absurd.

Here’s why.

The Community Reinvestment Act applies to depository banks. But many of the institutions that spurred the massive growth of the subprime market weren’t regulated banks. They were outfits such as Argent and American Home Mortgage, which were generally not regulated by the Federal Reserve or other entities that monitored compliance with CRA. These institutions worked hand in glove with Bear Stearns and Lehman Brothers, entities to which the CRA likewise didn’t apply. There’s much more. As Barry Ritholtz notes in this fine rant, the CRA didn’t force mortgage companies to offer loans for no money down, or to throw underwriting standards out the window, or to encourage mortgage brokers to aggressively seek out new markets. Nor did the CRA force the credit-rating agencies to slap high-grade ratings on packages of subprime debt.

Second, many of the biggest flameouts in real estate have had nothing to do with subprime lending. WCI Communities, builder of highly amenitized condos in Florida (no subprime purchasers welcome there), filed for bankruptcy in August. Very few of the tens of thousands of now-surplus condominiums in Miami were conceived to be marketed to subprime borrowers, or minorities—unless you count rich Venezuelans and Colombians as minorities. The multiyear plague that has been documented in brilliant detail at IrvineHousingBlog is playing out in one of the least-subprime housing markets in the nation.

Third, lending money to poor people and minorities isn’t inherently risky. There’s plenty of evidence that in fact it’s not that risky at all. That’s what we’ve learned from several decades of microlending programs, at home and abroad, with their very high repayment rates. And as the New York Times recently reported, Nehemiah Homes, a long-running initiative to build homes and sell them to the working poor in subprime areas of New York’s outer boroughs, has a repayment rate that lenders in Greenwich, Conn., would envy. In 27 years, there have been fewer than 10 defaults on the project’s 3,900 homes. That’s a rate of 0.25 percent.

On the other hand, lending money recklessly to obscenely rich white guys, such as Richard Fuld of Lehman Bros. or Jimmy Cayne of Bear Stearns, can be really risky. In fact, it’s even more risky, since they have a lot more borrowing capacity. And here, again, it’s difficult to imagine how Jimmy Carter could be responsible for the supremely poor decision-making seen in the financial system. I await the Krauthammer column in which he points out the specific provision of the Community Reinvestment Act that forced Bear Stearns to run with an absurd leverage ratio of 33 to 1, which instructed Bear Stearns hedge-fund managers to blow up hundreds of millions of their clients’ money, and that required its septuagenarian CEO to play bridge while his company ran into trouble. Perhaps Neil Cavuto knows which CRA clause required Lehman Bros. to borrow hundreds of billions of dollars in short-term debt in the capital markets and then buy tens of billions of dollars of commercial real estate at the top of the market. I can’t find it. Did AIG plunge into the credit-default-swaps business with abandon because Association of Community Organizations for Reform Now members picketed its offices? Please. How about the hundreds of billions of dollars of leveraged loans—loans banks committed to private-equity firms that wanted to conduct leveraged buyouts of retailers, restaurant companies, and industrial firms? Many of those are going bad now, too. Is that Bill Clinton’s fault?

Look: There was a culture of stupid, reckless lending, of which Fannie Mae and Freddie Mac and the subprime lenders were an integral part. But the dumb-lending virus originated in Greenwich, Conn., midtown Manhattan, and Southern California, not Eastchester, Brownsville, and Washington, D.C. Investment banks created a demand for subprime loans because they saw it as a new asset class that they could dominate. They made subprime loans for the same reason they made other loans: They could get paid for making the loans, for turning them into securities, and for trading them—frequently using borrowed capital.

At Monday’s hearing, Rep. John Mica, R-Fla., gamely tried to pin Lehman’s demise on Fannie and Freddie. After comparing Lehman’s small political contributions with Fannie and Freddie’s much larger ones, Mica asked Fuld what role Fannie and Freddie’s failure played in Lehman’s demise. Fuld’s response: “De minimis.”

Lending money to poor people doesn’t make you poor. Lending money poorly to rich people does.

Choosing a Financial Advisor, Part 1

“You don’t need 99.9 percent of what Wall Street is selling. It’s expensive, unsuitable, or stupid. Most investments are designed to profit the brokers, banks, and insurance companies, not you.” – Jane Bryant Quinn.

The quality of the financial advice that you get is dependent upon many things, including the training and academic background of your financial advisor. It also depends, in large measure, on how your advisor is compensated. Researching this issue and understanding what best serves your particular interests is a task well worth pursuing. Reading books on financial planning is one way to arm yourself because, in my opinion, it is nothing short of a war. I hope to do my part by providing you with a series of articles on the subject.

If you take the “easy way out” and merely go with the investment firm that has the best (i.e. most expensive) commercials on TV and the glitziest print ads in the local newspapers, consider this. You may be lining the pockets of your advisor, with your gold.

For one purely objective view on the subject, consider the Consumer Federation of America, an advocacy, research, education, and service organization. In an article on choosing a financial advisor, they argue that using a “fee-only” advisor may be your best choice.

Financial Planners

The way in which a financial planner is compensated can directly affect the advice he or she gives clients. A relatively small percentage of the individuals offering financial advice actually get paid exclusively for giving such advice. The majority earn some or all of their income selling mutual funds, annuities, insurance, and other financial products to implement their recommendations. “Advisers” who are also salespeople, however, inevitably face a conflict of interest and will almost certainly be tempted to steer clients into products in which they have a financial interest. The greater the adviser’s dependence on commission income, the greater the conflict. In the end, that conflict could cost you both in out-of-pocket expenses and in the quality of advice you receive.

Long-Term Cost

One of the chief attractions of commission-based financial planning is that it appears affordable. Typically, commission-based planners charge a relatively low fee or no fee, for the “advice,” expecting to earn the real money on the back end, when they sell the products to implement their recommendations. When you buy a product to implement that plan, however, a percentage of the money you spend goes to pay a commission to the planner. Ultimately, the price you pay includes not just the commission itself, but the money it would have earned over time had it been invested. In assessing the costs of financial planning, therefore, you have to include the cost of implementation.

Quality of Advice

The increase in implementation costs is not the only price you pay for commission-based planning. You may also pay in the form of poor advice. After all, when a financial “adviser” earns most of his or her money as a financial salesperson, the product sales tend to drive the process. In the worst case scenario, the planning becomes nothing more than window dressing to attract clients for the real money-making business of selling products. Clients are offered one-size-fits-all plans that inevitably lead to the purchase of a handful of high-commission products.

Even those commission-based advisers who attempt to offer comprehensive financial advice still can find themselves biased by compensation considerations when it comes time to implement their recommendations. After all, the more the adviser lowers the initial fees to attract business, and the more time he or she spends on the planning process, the more he or she must earn in the implementation phase to make that investment of time pay off.

Under such circumstances, even the best of commission-based planners is unlikely to recommend no-load or low-load products, for example. Other less scrupulous planners may recommend an investment, such as a particular mutual fund or annuity, simply because of the special incentives or higher commissions they receive.

The temptation for planners to recommend higher commission products carries another risk for clients. Product sponsors tend to offer higher commissions on those products that are more difficult to sell, because they are riskier. Thus, in pushing higher commission products, the planner may encourage you to take unnecessary risks with your money.

“Fee-Only” May Be Your Best Choice

So, if you are looking for objective financial advice, a fee-only financial planner is probably your best bet. Fee-only financial planners are compensated solely by fees paid by their clients. They can be paid in a variety of ways—a flat fee or retainer, an hourly fee, a percentage of assets under management, or a percentage of income from investments. The key is that they do not accept commissions or compensation from any other source.

Fee-only financial planning does not necessarily eliminate every conceivable form of conflict-of-interest. When fee-only planners “sell” portfolio management services, for example, they may have a financial incentive to recommend those services to clients. The fee-only approach is, however, subject to fewer conflicts than any other form of financial advice. Furthermore, because fee-only planners are compensated solely by the client, there are no hidden third parties in the relationship and thus, no divided loyalties.

Conclusion

I work strictly on a fee-only basis. That was my choice in setting up my practice, as it is the kind of arrangement I would want if I were the client.

Since everyone’s circumstances are different, you may be the rare individual who can best be served by a financial advisor who is compensated by commission. But, you won’t know that unless you get a second opinion. As Jane Bryant Quinn said, “If you don’t know much about investing yourself, it’s hard to tell good advice from bad.”

The majority of fee-only financial planners are members of the National Association of Personal Financial Advisors (NAPFA), an organization started in 1983. To find a fee-only advisor in your area, call NAPFA at 1-800-FEE-ONLYor visit their homepage at www.feeonly.org

To be continued.

photo credit: Office Now

Understanding the Financial Crisis, Part 3

In a previous post, I highlighted Barry Ritholz’s article on how the financial crisis was caused by an “enormous change in lending standards … that took place during the 2002-2007 period. It was more than a subtle shift — it was an abdication of the traditional lending standards that had existed for decades, if not centuries.”

In the November 1st New York Times, Gretchen Morgenson gives details on just how badly one bank behaved during the housing boom. Was There a Loan It Didn’t Like? goes behind the scenes of mortgage lender Washington Mutual.

Briefly, senior mortgage underwriter, Keysha Cooper says she was pressured by bank managers and mortgage brokers “to approve loans, no matter what.”

“At WaMu it wasn’t about the quality of the loans; it was about the numbers,” Ms. Cooper says. “They didn’t care if we were giving loans to people that didn’t qualify. Instead, it was how many loans did you guys close and fund?

When underwriters refused to approve dubious loans, they were punished, she says.

Ms. Cooper started at WaMu in 2003 and lasted three and a half years. At first, she was allowed to do her job, she says. In February 2007, though, the pressure became intense. WaMu executives told employees they were not making enough loans and had to get their numbers up, she says.

“They started giving loan officers free trips if they closed so many loans, fly them to Hawaii for a month,” Ms. Cooper recalls. “One of my account reps went to Jamaica for a month because he closed $3.5 million in loans that month.”

One loan file was filled with so many discrepancies that she felt certain it involved mortgage fraud. She turned the loan down, she says, only to be scolded by her supervisor.

Brokers often tried to bribe Ms. Cooper to approve loans, she says. One offered to pay $900 to send her son to football summer boot camp if she would approve a loan that had been declined by a host of other lenders. “I told him no and not to disrespect me like that again,” Ms. Cooper says.

Hidden fees meant brokers could easily make between $20,000 and $40,000 on a $500,000 loan, Ms. Cooper says.

Ms. Cooper says that loans she turned down were often approved by her superiors. One in particular came back to haunt WaMu.

Vetting a loan one day, Ms. Cooper says she became suspicious when a photograph of the house being bought showed one street address while documents deeper in the file showed a different address. She contacted the appraiser, and recalls that he said that he must have erred and that he would send her the correct documents.

“I was so for sure that it was fraud I wanted to get on an airplane,” Ms. Cooper says.

The $800,000 loan was approved, but not by Ms. Cooper. Six months later, it defaulted, she says. “When they went to foreclose on the house, they found it was an empty lot,” she recalls.

Conclusion

• Ms. Cooper says she was pressured by her managers to approve mortgage loans “no matter what” including  loans that turned out to be fraudulent.
• Kerry K. Killinger, the WaMu chief executive was paid “tens of millions of dollars.”
• “WaMu was seized by federal regulators in late September, the biggest bank failure in the nation’s history.”

photo credit: Jimmy2000

The Financial Crisis: Why Were The Experts Wrong?

“Speculative bubbles are caused by contagious excitement about investment prospects. I find that in casual conversation, many of my mainstream economist friends tell me that they are aware of such excitement, too. But very few will talk about it professionally.” – Robert Shiller.

Robert Shiller is a Professor of Economics and Finance at Yale University and the author of “Irrational Exuberance,” a book that was first published in 2000. In his book, Shiller warned that the stock market had become a bubble and could have a sharp decline, which, of course, it did. In the 2005 update of that bestseller, he stated clearly, “that a catastrophic collapse of the housing and stock markets could be on its way.”

If someone is right once, you could chalk it up to pure luck. But when you’re spot on twice – well, that looks a lot like skill to me.

In today’s edition of The New York Times, in a column entitled Challenging the Crowd in Whispers, Not Shouts, Shiller writes how he felt about going against the consensus, and how many economists might “pull their punches” to avoid being ostracized or at least, losing credibility. This column helps to answer the question Gary Becker and Richard Posner asked: The Financial Crisis: Why Were Warnings Ignored?

Alan Greenspan, the former Federal Reserve chairman, acknowledged in a Congressional hearing last month that he had made an “error” in assuming that the markets would properly regulate themselves, and added that he had no idea a financial disaster was in the making. What’s more, he said the Fed’s own computer models and economic experts simply “did not forecast” the current financial crisis.

Mr. Greenspan’s comments may have left the impression that no one in the world could have predicted the crisis. Yet it is clear that well before home prices started falling in 2006, lots of people were worried about the housing boom and its potential for creating economic disaster. It’s just that the Fed did not take them very seriously.

According to Shiller, the bubble was obvious even to the casual observer.

For example, I clearly remember a taxi driver in Miami explaining to me years ago that the housing bubble there was getting crazy. With all the construction under way, which he pointed out as we drove along, he said that there would surely be a glut in the market and, eventually, a disaster.

But why weren’t the experts at the Fed saying such things? And why didn’t a consensus of economists at universities and other institutions warn that a crisis was on the way?

For the answer, Shiller turns to social psychology and behavioral economics. Briefly, even experts fear ostracism, and many economists use only a limited set of tools regarding speculative bubbles.

The field of social psychology provides a possible answer. In his classic 1972 book, “Groupthink,” Irving L. Janis, the Yale psychologist, explained how panels of experts could make colossal mistakes. People on these panels, he said, are forever worrying about their personal relevance and effectiveness, and feel that if they deviate too far from the consensus, they will not be given a serious role. They self-censor personal doubts about the emerging group consensus if they cannot express these doubts in a formal way that conforms with apparent assumptions held by the group.

Members of the Fed staff were issuing some warnings. But Mr. Greenspan was right: the warnings were not predictions. They tended to be technical in nature, did not offer a scenario of crashing home prices and economic confidence, and tended to come late in the housing boom.

From my own experience on expert panels, I know firsthand the pressures that people — might I say mavericks? — may feel when questioning the group consensus.

I was connected with the Federal Reserve System as a member the economic advisory panel of the Federal Reserve Bank of New York from 1990 until 2004… In my position on the panel, I felt the need to use restraint. While I warned about the bubbles I believed were developing in the stock and housing markets, I did so very gently, and felt vulnerable expressing such quirky views. Deviating too far from consensus leaves one feeling potentially ostracized from the group, with the risk that one may be terminated.

In 2005, in the second edition of my book “Irrational Exuberance,” I stated clearly that a catastrophic collapse of the housing and stock markets could be on its way. I wrote that “significant further rises in these markets could lead, eventually, to even more significant declines,” and that this might “result in a substantial increase in the rate of personal bankruptcies, which could lead to a secondary string of bankruptcies of financial institutions as well,” and said that this could result in “another, possibly worldwide, recession.

I distinctly remember that, while writing this, I feared criticism for gratuitous alarmism. And indeed, such criticism came.

I gave talks in 2005 at both the Office of the Comptroller of the Currency and at the Federal Deposit Insurance Corporation, in which I argued that we were in the middle of a dangerous housing bubble. I urged these mortgage regulators to impose suitability requirements on mortgage lenders, to assure that the loans were appropriate for the people taking them.

The reaction to this suggestion was roughly this: yes, some staff members had expressed such concerns, and yes, officials knew about the possibility that there was a bubble, but they weren’t taking any of us seriously.

I based my predictions largely on the recently developed field of behavioral economics, which posits that psychology matters for economic events. Behavioral economists are still regarded as a fringe group by many mainstream economists. Support from fellow behavioral economists was important in my daring to talk about speculative bubbles.

Speculative bubbles are caused by contagious excitement about investment prospects. I find that in casual conversation, many of my mainstream economist friends tell me that they are aware of such excitement, too. But very few will talk about it professionally.

Why do professional economists always seem to find that concerns with bubbles are overblown or unsubstantiated? I have wondered about this for years, and still do not quite have an answer. It must have something to do with the tool kit given to economists (as opposed to psychologists) and perhaps even with the self-selection of those attracted to the technical, mathematical field of economics. Economists aren’t generally trained in psychology, and so want to divert the subject of discussion to things they understand well. They pride themselves on being rational. The notion that people are making huge errors in judgment is not appealing.

In addition, it seems that concerns about professional stature may blind us to the possibility that we are witnessing a market bubble. We all want to associate ourselves with dignified people and dignified ideas. Speculative bubbles, and those who study them, have been deemed undignified.

In short, Mr. Janis’s insights seem right on the mark. People compete for stature, and the ideas often just tag along.

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