Are bailout proposals based on good forecasts?

Scott Armstrong and Kesten Green have their doubts over whether U.S. government proposals to buy $700 billion of bad loans are based on scientific forecasts of the outcomes of reasonable alternative policy options, including doing nothing.

Assume that you are considering investing $700,000 and that this is a large sum for you. Experts give you the names of two reputable investment houses of long standing. When you visit the first of these, Benjamin Investment, Inc., the manager recommends Bailout Bonds as an excellent investment for you. He gives you what sound like good reasons for his recommendation and reassures you that he is very confident in his advice, which is based on the analysis of top experts. He urges you to act swiftly to avoid missing out.

As a cautious investor, you visit the other investment house that was recommended to you, Franklin Investment, Inc. Franklin's manager advises you that Bailout Bonds would be a poor investment and that you would be better off holding on to your money than putting such a large some into such a speculative investment. Like Benjamin's manager, Franklin's manager provides good reasons and she too is confident in her advice.

Given the conflicting advice, you decide to check the track record of each of these investment houses. Fortunately, numerous academic studies have been published on the accuracy of each firm's investment recommendations since 1930. Each firm retains the advice of some of the best experts in the world. You find that on average, the Benjamin experts have been right for 50% of their forecasts – and wrong on 50%. Interestingly, the Franklin experts have exactly the same performance record.