The bubbles continue. \u00a0Remember the quote from How\u00a0Markets\u00a0Fail? During the past forty years, there have been 124 systemic banking crises around the world. These were credit-driven boom and bust cycles. There were three of them in the U.S. from 2000 to 2010. \u00a0Boom and bust cycles are \u00a0absolutely destined to continue, which means, for us investors:<\/span><\/span><\/span><\/strong><\/p>\n 1. \u00a0Cut way back on our borrowing. <\/span><\/span><\/span><\/strong><\/p>\n 2. Focus on the worst evntuality.<\/span><\/span><\/span><\/strong><\/p>\n 3. Stick with reasonably liquid assets. <\/span><\/span><\/span><\/strong><\/p>\n 4. Play with the bank’s money.<\/span><\/span><\/span><\/strong><\/p>\n We are on the way to another bubble. I can smell, feel it. It’s coming. By maintaining, ultra-low interest rates, the Fed is encouraging another bubble. \u00a0I was thinking about the next bubble as I read this piece.<\/span><\/span><\/span><\/strong><\/p>\n Fed Missed This Bubble. Will It See a New One?<\/strong><\/p>\n By DAVID LEONHARDT. New York Times, January 6, 2010<\/p>\n If only we’d had more power, we could have kept the financial crisis from getting\u00a0so bad.<\/p>\n That has been the position of Ben Bernanke, the Federal Reserve chairman, and\u00a0other regulators. It explains why Mr. Bernanke and the Obama administration\u00a0are pushing Congress to give the Fed more authority over financial firms.<\/p>\n So let’s consider what an empowered Fed might have done during the housing\u00a0bubble, based on the words of the people who were running it.<\/p>\n In 2004, Alan Greenspan, then the chairman, said the rise in home values was\u00a0“not enough in our judgment to raise major concerns.” In 2005, Mr.\u00a0Bernanke – then a Bush administration official – said a housing bubble was “a\u00a0pretty unlikely possibility.” As late as May 2007, he said that Fed officials\u00a0“do not expect significant spillovers from the subprime market to the rest\u00a0of the economy.”<\/p>\n The fact that Mr. Bernanke and other regulators still have not explained why\u00a0they failed to recognize the last bubble is the weakest link in the Fed’s push\u00a0for more power. It raises the question: Why should Congress, or anyone else,\u00a0have faith that future Fed officials will recognize the next bubble?<\/p>\n Just this week, Mr. Bernanke went to the annual meeting of academic economists\u00a0in Atlanta to offer his own history of Fed policy during the bubble. Most of\u00a0his speech, though, was a spirited defense of the Fed’s interest rate policy,\u00a0complete with slides and formulas, like (pt – pt*) > 0. Only in the last\u00a0few minutes did he discuss lax regulation. The solution, he said, was “better\u00a0and smarter” regulation. He never acknowledged that the Fed simply missed\u00a0the bubble.<\/p>\n This lack of self-criticism is feeding Congressional hostility toward the Fed.\u00a0Mr. Bernanke is still likely to win confirmation for a second term, based on\u00a0his aggressive and creative policies once the crisis began. But Congress hasn’t\u00a0decided whether to expand his regulatory authority and is considering reining\u00a0in the Fed’s other main mission – setting interest rates.<\/p>\n A once-marginal proposal – from Representative Ron Paul, the Texas Republican\u00a0– that would give Congress the power to review interest rate decisions recently\u00a0passed the House and will soon be considered by the Senate.<\/p>\n Economists are generally horrified by this idea. If Congress could force Fed\u00a0officials to answer questions about every interest rate move, the process could\u00a0easily become politicized. A politicized central bank is a first step toward\u00a0runaway inflation.<\/p>\n But politicizing monetary policy isn’t the only mistake Congress could make.\u00a0It also could end up going in the other direction and handing Fed officials\u00a0more power without asking them to grapple with their failures.<\/p>\n When Mr. Bernanke is challenged about the Fed’s performance, he often points\u00a0out that recognizing a bubble is hard. “It is extraordinarily difficult,”\u00a0he said during his Senate confirmation hearing last month, “to know in\u00a0real time if an asset price is appropriate or not.”<\/p>\n Most of the time, that’s true. Do you know if stocks will keep going up? Is\u00a0gold now in the midst of a bubble? What will happen to your house’s value? Questions\u00a0like these are usually an invitation to hubris.<\/p>\n But the recent housing bubble was an exception. By any serious measure, houses\u00a0in much of this country had become overvalued. From the late 1960s to 2000,\u00a0the ratio of the median national house price to median income hovered from 2.9\u00a0to 3.2. By 2005, it had shot up to 4.5. In some places, buyers were spending\u00a0twice as much on their monthly mortgage payment as they would have spent renting\u00a0a similar house, without even considering the down payment.<\/p>\n More than a few people – economists, journalists, even some Fed officials –\u00a0noticed this phenomenon. It wasn’t that hard, if you were willing to look at\u00a0economic fundamentals. You couldn’t know exactly when or how far prices would\u00a0fall, but it seemed clear they were out of control. Indeed, making that call\u00a0was similar to what the Fed does when it sets interest rates: using concrete\u00a0data to decide whether some part of the economy is too hot (or too cold).<\/p>\n And Fed officials could have had a real impact if they had decided to attack\u00a0the bubble. Imagine if Mr. Greenspan, then considered an oracle, announced he\u00a0was cracking down on wishful-thinking mortgages, as he had the authority to\u00a0do.<\/p>\n So why did Mr. Greenspan and Mr. Bernanke get it wrong?<\/p>\n The answer seems to be more psychological than economic. They got trapped in\u00a0an echo chamber of conventional wisdom. Real estate agents, home builders, Wall\u00a0Street executives, many economists and millions of homeowners were all saying\u00a0that home prices would not drop, and the typically sober-minded officials at\u00a0the Fed persuaded themselves that it was true. “We’ve never had a decline\u00a0in house prices on a nationwide basis,” Mr. Bernanke said on CNBC in 2005.<\/p>\n He and his colleagues fell victim to the same weakness that bedeviled the engineers\u00a0of the Challenger space shuttle, the planners of the Vietnam and Iraq Wars, Which is why it is likely to happen again.<\/p>\n What’s missing from the debate over financial re-regulation is a serious discussion\u00a0of how to reduce the odds that the Fed – however much authority it has – will\u00a0listen to the echo chamber when the next bubble comes along. A simple first\u00a0step would be for Mr. Bernanke to discuss the Fed’s recent failures, in detail.\u00a0If he doesn’t volunteer such an accounting, Congress could request one.<\/p>\n In the future, a review process like this could become a standard response\u00a0to a financial crisis. Andrew Lo, an M.I.T. economist, has proposed a financial\u00a0version of the National Transportation Safety Board – an independent body to\u00a0issue a fact-finding report after a crash or a bust. If such a board had existed\u00a0after the savings and loan crisis, notes Paul Romer, the Stanford economist\u00a0and expert on economic growth, it might have done some good.<\/p>\n Whether we like it or not, the Fed really does seem to be the best agency to\u00a0regulate financial firms. (It now has authority over only some firms.) As the\u00a0lender of last resort, it already has a vested interest in the health of those\u00a0firms. The Fed’s prestige also tends to give it its pick of people who want\u00a0to work on economic policy.<\/p>\n “The Federal Reserve has unparalleled expertise,” Mr. Bernanke told\u00a0Congress last month. “We have a great group of economists, financial market\u00a0experts and others who are unique in Washington in their ability to address\u00a0these issues.”<\/p>\n Fair enough. At some point, though, it sure would be nice to hear those experts\u00a0explain how they missed the biggest bubble of our time.<\/p>\n
\nand the airline pilots who have made tragic cockpit errors. They didn’t adequately\u00a0question their own assumptions. It’s an entirely human mistake.<\/p>\n
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