For the Past Two Years, Predicted Rate Increases Have Not Materialized.

The problem with the thinking behind this incorrect commentary is what is termed the normalization of deviance. We typically experience this when our car brakes gradually lose effectiveness but we constantly adjust and never realize the deviance until the brakes are adjusted. The Challenger disaster of 1986 is another famous example of this rationalization.

More recently, the rise in adjustable rate mortgage delinquencies, both prime and subprime, was evident by late 2006, see my presentation “Supervisory Challenges at the Mid-cycle of the Economic Expansion Nov. 6, 2006. Note also that this presentation was made long prior to the failure of Bear Stearns in March 2008 and almost two years before Lehman. Overlooking the deviance of mortgage delinquencies then, interest rates over the past two years, and more recently, the rise in inflation on a year-over–year basis, has caused decision makers to ignore trends at their own, their shareholders’ and voters’ peril…

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