At "A Dash" we have frequently cited the work of Doug Kass, a colleague at TheStreet.com. Even before we contributed to RealMoney, we were paying customers to get Doug's work. We found it to be a source of trading profits, as long as you understood the perspective.
We were therefore a bit surprised when Doug, writing on RealMoney Silver (where we can make no reply), took issue with our conclusions in an article about a survey. Discussing reasoning and conclusions is fine, of course, but his comment was completely lacking in substance -- nothing about the article in question!
Instead, Doug engaged in an ad hominem attack. Here is a key quote:
You (and many others) have been dead wrong on the magnitude of the drop in housing while the housing Cassandras have been dead right. (Just go back to your site and reference your reaction to my housing "hyperbole" several years ago.)
Those are the facts. They are not debatable.
We are delighted to see this statement of the issue. Since we have no ability to reply where Doug wrote, we will have to write here. As we have often done in the past, we invite Doug Kass to write something in response. We promise to publish it without any edits.
Let us examine the quantification question. But first, a bit of background on the housing issue.
Our Position on Housing
In the days before we were writing on this blog, we sent a quarterly newsletter to our investors. Here is a quotation from the issue of June, 2005:
Is there a bubble? We see some disturbing facts, all signs of market tops.
People who were formerly day-traders in stocks or had good jobs in software development are now going into real estate.
If you tried to look at housing like a stock, using a PE ratio (rent/price), the number is about 35, 75% above the historic norm and double that of the major stock market averages.
Average folks with absolutely no real estate experience are buying properties with interest-only mortgages expecting to make their profits on appreciation.
We can smell some toast burning here.
We advised our clients against over-investment in real estate and those who followed our program for individual investors did quite nicely in stocks. Doug Kass was not the only one seeing a problem in housing; he was just too early -- way too early -- in predicting the impacts. (Check out Doug's timing here).
The "Batman" Chart
Since the issue is quantification, not direction, a great example to consider is Doug's prediction about personal consumption from a year ago. He had this impressive chart with a distinctive pattern that we called "Batman" around our office. The time period and the scales had been adjusted to give a false illusion of a strong correlation. Here is the original chart.
Doug highlighted this chart in his column multiple times and took it on CNBC calling it a .9 correlation. Charts of this sort are very dangerous for investors. They do not understand statistics and causal modeling. They are especially susceptible to visual evidence.
We reconstructed the data and did the calculations. In one of the best articles we have ever written, we showed the problem in this analysis from a causal modeling perspective. We expect this article to have a prominent place in our forthcoming book in the "Misleading Charts" chapter.
The obvious implication was that PCE would rapidly decline to below the 2% growth rate. We analyzed the intermediate results in this article where we showed that the prediction had failed. We think that Doug was a victim on this entire story. Someone sent him this chart -- someone with dubious quantitative skill -- and convinced him to go with it. He should have renounced it at some point.
Current Chart Update
The most recent evidence, one year after the original article, is even more dramatic. As one might expect, the lending restrictions of banks have increased dramatically. The changes are actually off of the scale. The Fed altered the question to split out lending on qualifying mortgages versus subprime and Alt-A. Bending over backwards, we have used the prime mortgage series in the chart.
As one can readily see from the chart, the precipitous change in lending standards (Doug used an inverted scale so that tighter standards would match lower PCE) did not result in a similar decline in Personal Consumption. The direction was correct. As we stated in the original article this is called a "spurious relationship" by those who do causal modeling. A weakening economy causes all sorts of effects that do not have a causal relationship.
Doug Kass never cited this chart again, nor did any of the other blogs who picked it up. The conclusion from this chart is inescapable:
Kass grossly overestimated the impact on Personal Consumption in March, 2007. As he says, "Those are the facts. They are not debatable."