What if the Fed sleeps again?
Of late, Ben Bernanke has been arguing that the crisis was caused by a poor regulatory structure, and that the answer is a souped-up Federal Reserve with more power to bring banks to heel. This is revisionist history, at best. My question on financial regulation has long been 'does it work if the Federal Reserve does not want to enforce it,' and for good reason: That's exactly the situation we saw in the run-up to the financial crisis. I'll tag in David Leonhardt for this bit:
In 2004, Alan Greenspan, then the chairman, said the rise in home values was “not enough in our judgment to raise major concerns.” In 2005, Mr. Bernanke — then a Bush administration official — said a housing bubble was “a pretty unlikely possibility.” As late as May 2007, he said that Fed officials “do not expect significant spillovers from the subprime market to the rest of the economy.”
The fact that Mr. Bernanke and other regulators still have not explained why they failed to recognize the last bubble is the weakest link in the Fed’s push for more power. It raises the question: Why should Congress, or anyone else, have faith that future Fed officials will recognize the next bubble?
On some level, it's intrinsic to the very definition of a bubble that the empowered regulators don't perceive a problem. If they did perceive a problem, the bubble would get popped. Alan Greenspan might not have had all the powers he would like, but had he been walking around saying that housing prices are unsustainable and probably a bad investment, and had he raised interest rates to cool the economy, the situation today would be very different. That, again, is why I'm interested in automatic stabilizers like limits on leverage and an FDIC-style package of insurance, examination, and regulation in the so-called shadow banking market (the market where banks and professional investors lend and loan to each other).
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Ezra Klein
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January 6, 2010; 10:38 AM ET
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Posted by: staticvars | January 6, 2010 5:17 PM | Report abuse
Imagine the outcry from the left if the Fed had acted to choke off the housing bubble by raising interest rates. Unemployment would have jumped with the decline in business investment. We woud have heard how the Fed was cutting off access to homeownership by minorities and low-income individuals, for the benefit of wealthy investors. It would have been denounced as financial redlining.
Posted by: tomtildrum | January 6, 2010 5:58 PM | Report abuse
Imagine the Fed were in the grip of an ideology, unable to think (as an Institution) that bubbles are worth acting against, and that the efficient market hypothesis is always true. Imagine a disciple of Ayn Rand at the helm. Or guys who believe that extreme concentrations of wealth are healthy, and requisite for economic growth. Imagine they can't tell the difference in Finance and Production....
Oh, wait...
Posted by: mrbill30560 | January 6, 2010 8:40 PM | Report abuse
Tomtildrum: You may very well be right that we would have heard such things. But this would most likely have been from Wall Street shills who have long been adept at clothing the most abusive lending practices in terms of populism and democratizing capitalism. An honest observer of politics knows that even though politicians might phrase their arguments in terms of opportunity for the poor that is seldom the constituency they have in mind since the poor often don't bother to vote and they sure as heck don't write large checks to their campaign.
Aside from that, my understanding is that since lending standards are within the regulatory authority of the Fed, by tightening lending standards they could have took some air out of the housing bubble by tightening standards rather than raising rates. Whether that would have led to another bubble in another sector is a different question.
Posted by: seldomused | January 6, 2010 11:34 PM | Report abuse
To the question of "what if the Fed sleeps again," I guess the answer is that the somnolent chairman will get another term--and in fact be emboldened to demand more power.
Posted by: TomPhilpott | January 7, 2010 9:09 AM | Report abuse
"On some level, it's intrinsic to the very definition of a bubble that the empowered regulators don't perceive a problem."
I don't think that's true. I think critiques like Leonhardt assume that the Fed DID know, but didn't act because the pressure NOT to pop bubbles (for people like Bernanke) is so great. As has been analogized before, no one wants to be the one to take the punch bowl away.
Greenspan is a different kettle, in that his ideology didn't allow him to acknowledge that which was plain to many other professionals. In some sense you could say he "didn't know," but I think there's a strong argument that he could have/should have.
In any event, I'm in agreement with your last point, even if we arrive at it differently, and that is on the wisdom of automatic stabilizers. Regulators, for a host of reasons, should not be counted on to act affirmatively on bubbles. Indifferent, arbitrary rules are the way to go.
Posted by: roquelaure_79 | January 7, 2010 2:02 PM | Report abuse
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I wouldn't care so much about their failure to stop asset bubbles, it's really not their job, but there is no excuse for them pushing interests rates so low as to further inflate them, and the support for the GSEs FHLMC and FNMA which were just waiting to show up on our collective balance sheet. I think the American Dream needs a slight clarification, 100% LTV is not home ownership.