Thursday, May 29, 2008
According to this report($) in the Financial Times from earlier in the week, it seems that former Fed chief Alan Greenspan remains, in the words of Bloomberg columnist Jonathan Weil, "almost childlike in his idealism" - at least when it comes to asset bubbles.
Central banks should be wary of trying to deal more aggressively with future asset price bubbles in case they suppress innovation and growth, Alan Greenspan has warned.Haven't we had enough innovation and turmoil in the last ten years?
"If we want rapid growth in productivity, innovation, standards of living, we may have to accept that there will be periods of turmoil," the former chairman of the US Federal Reserve told the Financial Times.
Rather than try to suppress bubbles, he said, policymakers should ensure that financial institutions were well enough capitalised to withstand the hit from bursting bubbles as well as other shocks.
After successive bubbles in stocks and then in housing, what we probably need now is a good "innovation holiday".
Bubbles, Mr Greenspan argued, were often the by-products of innovation - such as the commercialisation of the internet in the 1990s, or advances in housing finance in the 2000s.So, in this childlike, idealized parallel world, "innovations" in mortgage finance are still considered a good thing and advances in housing finance that pushed the homeownership rate from 67 percent to over 70 percent was well worth the effort.
To ask regulators to suppress bubbles would be to ask them either to prevent innovation or to second-guess the value the market puts on it.
"Micro-meddling undermines the basic function of a financial system - that is to direct the savings of society towards its most productive capital investments," he said.
Does anyone believe that anymore?
As for second guessing the value assigned by markets, maybe more people should have second guessed home values in 2004 and 2005 - maybe we wouldn't have such a mess on our hands in 2008.
Financial crises "of necessity are unanticipated - if they are not, they are arbitraged away", he said. "We have many international financial stability forums and none of them anticipated the problems of August 9 2007."Mr Greenspan said the most sensible thing to do was "to increase the capacity of our financial institutions to absorb shocks in general. That means more capital".He should talk to his new employer at Paulson & Co. who made a fortune betting on a subprime collapse last year.
Maybe the real problem is that we need more and smarter arbitragers.
And lastly, some good news - the era of bubbles is over...
In any event, Mr Greenspan said, "I think the probability of sparking another bubble in the next 10 years is very low."Well, one thing is sure, the Greenspan period is over.
Bubbles, he said, required low long-term interest rates, low inflation and macroeconomic stability. They were "a feature of the disinflationary period that followed the end of the cold war".
Mr Greenspan believes that period is over.