The great economist John Kenneth Galbraith once said, "The only function of economic forecasting is to make astrology look respectable."

Speaking of former Fed Chairman Alan Greenspan, another economist quipped, "He was the greatest, the Maestro. Only if you look at his record, he was wrong about almost everything he ever predicted."

The Wall Street Journal once proclaimed, "If pilots' vision were as bad as economists', Amtrak would be profitable."

There's a reason economics is called "the dismal science." Truth is, it's not even a science. It's hardly an art. It's a blind gaggle of confusion, trying to make sense of a very unpredictable world. The majority of predictions never come true.

It's worth noting a few of those failed predictions -- not to point and laugh, but to learn. I never bought the perception that yesterday's news was useless. It provides a snapshot in time that shows how people analyzed the future. Looking back at failed predictions can be a great learning tool, teaching us how to avoid the same mistakes in the future.

Here are 10 eye-openers from the financial crisis.

10. Bernie Madoff (2007)
 "In today's regulatory environment, it's virtually impossible to violate rules. This is something that the public really doesn't understand. ... It's impossible for a violation to go undetected, certainly not for a considerable period of time."

Actually, this was probably the best prediction of the financial crisis, but it highlights a widespread flaw in Wall Street mentality: profits today, to hell with tomorrow.

9. Former Treasury Secretary Hank Paulson (April 2007)
 "I don't see (subprime mortgage market troubles) imposing a serious problem. I think it's going to be largely contained."

The lesson here is that financial mayhem is never contained. If you see one cockroach in the kitchen, you're chronically infested. Every financial crisis in modern history, from the Great Depression, to LTCM in 1998, to the housing bust of recent years, to the current euro crisis, spread beyond the borders of those guilty of causing the mess.

8. AIG financial products head Joseph Cassano (August 2007)
 "It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of these [credit default swap] transactions."

Those transactions nearly bankrupted AIG (NYSE: AIG) months later, in a financial nuclear explosion that pulled everyone from Goldman Sachs (NYSE: GS) to Citigroup (NYSE: C) to Bank of America (NYSE: BAC) into the mix. The lesson: Tail risk -- the really big risk that's hard to measure -- is the single most important kind of risk you can think about. Take whatever worst-case scenario you can think of, multiply it by 100, and prepare for it.

7. National Association of Realtors chief economist David Lereah (2006)
"The good news is that inventory levels are improving and housing supply will come closer to buyer demand in 2006. We expect a healthy and more balanced market next year." 

Of all the bad predictions Lereah made, I picked this one because it underscores an important aspect of bubbles. Lereah may have been right in his prediction that demand was coming in line with supply. But what he missed that demand itself was a bubble. If supply and demand are in line, but demand is being driven by a bunch of myopic idiots plowing into real estate only because they want to flip it two months later, the market is out of balance.

6. Kevin Hassett, American Enterprise Institute (June 2008)
 "The Federal Reserve and Congress have delivered a ton of economic stimulus, and that stimulus is set to juice up an economy that has been weak, but not terrible. If everything goes according to plan, the economy will grow faster in the second half of the year, and a recession will have been avoided."

The recession began seven months before Hassett made that remark. A few takeaways:

  1. In general, really well thought-out stimulus (a rare breed) will only blunt, not prevent, a recession.
  2. Educated economists remain oblivious to recessions in the middle of them.
  3. Nothing ever goes according to plan.

5. The Washington Times (January 2005)
 "Although the overworked analogy between housing and tech stocks sounds dramatic, it is quite preposterous. 'The downside of this [housing] bubble,' said [economist Stephen] Roach last month, is 'potentially far worse than that of the equity bubble.' Really? After March 2000, the Nasdaq stock index plummeted from about 5,000 to 1,000. Does Mr. Roach mean to imply $500,000 houses might likewise drop to $100,000? Not likely."

In some parts of Las Vegas and Miami, that's actually about what happened. The Washington Times clung to a false notion that houses were special -- that they couldn't possibly suffer from the boom-bust cycle of something like dot-com stocks. But they can. Any asset can become grossly overvalued.

4. Former Sen. Phil Gramm (July 2008)
 "[T]his is a mental recession. ... We have sort of become a nation of whiners. You just hear this constant whining, complaining about a loss of competitiveness, America in decline ..."

Some downturns truly are just psychological in nature. The (very short) post-9/11 slump, for example. But what we faced in 2008 was the real deal. People couldn't pay off their debts. Banks couldn't raise capital. Companies couldn't roll over commercial paper. There was nothing mental about it. It was a real, tangible decline.

3. Ben Stein, August 2007
 "The financials, as I keep saying, are just super-bargains. Like Merrill Lynch ... a couple days ago it was trading at seven times earnings. Financials typically trade at a low P/E, but this is a joke. This stock ... they might as well be putting it in cereal boxes and giving it away. That's how cheap it is."

There are two kinds of bubbles. One is a valuation bubble, like Cisco (Nasdaq: CSCO) or Amazon.com (Nasdaq: AMZN) during the dot-com boom. The other is an income bubble. In income bubbles, valuations can look attractive, but the way a company makes money -- in Merrill's case, hawking subprime slime to widows and orphans -- is a bubble waiting to burst. That's what Stein, and many others, missed.

2. Alan Greenspan (May 2005)
 "The use of a growing array of derivatives and the related application of more-sophisticated approaches to measuring and managing risk are key factors underpinning the greater resilience of our largest financial institutions. ... Derivatives have permitted the unbundling of financial risks."

Finance is probably the one industry where innovation is mostly problematic. Banking should be easy: Lend money to people who can pay you back. Most attempts to complicate it beyond that are steps toward instability.

1. Yours truly (June 2008)
In the summer of 2008, RBS predicted that stocks would fall 20% over the following three months. They were almost perfectly right. I balked.

"A hefty subset of the S&P 500 ... is doing quite well," I wrote. "For the entire index to fall 20% would mean that either companies that are still doing well will tank, or the ones that aren't will be virtually wiped out -- and both outcomes seem pretty extreme at best."

Whoops. I was dead wrong about many things. First, most companies weren't doing "quite well." Second, companies can be wiped out. It's worked that way for thousands of years. And third, markets are totally unpredictable. 

So when someone makes a bold forecast, nod your head and say, "That's nice." Many people you think are crazy will turn out to be spot-on.

Got any bad predictions of your own? Fire away in the comment section below.

Check back every Tuesday and Thursday for Morgan Housel's columns on finance and economics.