Wikinvest Wire

Alan Blinder is (belatedly) making sense

Sunday, June 15, 2008

It's not often that Alan Blinder and your humble scribe can agree on something and it's not often that some well known figure allows a 1,125 x 1,500 pixel image of himself loose on the internet so anyone can enlarge it and maintain good resolution.

[Note: See the bottom of this post for the image - placing it just below the Read More... link would just be too cruel a thing to do to readers on a Sunday afternoon. Also see Hank Paulson's hi-res photo that is still up over at the Treasury Department making sure to brace yourself first. Why do they do this???]

But, Alan Blinder, former vice chairman of the Federal Reserve and professor of economics at Princeton University, wrote a surprisingly cogent op-ed piece for today's New York Times about asset bubbles and how a central bank should deal with them.

He almost goes so far as to say there are good asset bubbles (technological advancements such as the internet bubble) and bad asset bubbles (out-of-control credit creation such as the housing bubble) and that the Fed should respond to the two differently.

I would argue that the central bank’s proper role is fundamentally different in the two types of bubbles. Here’s why:

When bubbles are not based on bank lending, the Fed has no comparative advantage over other observers in distinguishing between rising fundamentals and bubbly valuations. It may see bubbles where there are none, or fail to recognize them until it’s too late — or probably both.
But a bank-centered bubble is starkly different in both respects.

As long as the central bank is also a bank supervisor and a regulator, it is extraordinarily well placed to observe and understand bank lending practices — much better positioned than almost anyone else. Beyond merely knowing more, part of a bank supervisor’s job is to make sure that banks don’t engage in unsafe and unsound lending, and to scowl at or discipline them if they do.
Apparently, not allowing asset bubbles to form is still off of the Blinder radar - Alan Greenspan would probably have been better served to "lean against" the 20+ percent stock market gains back when he first noted the "irrational exuberance" of the mid 1990s.

Recall that Mr. Blinder was formerly a Greenspan sycophant going so far as to co-author a 94-page paper(.pdf) in mid-2005 - at the height of the housing bubble - in which you only have to flip through a few pages to read this:
"While there are some negatives in the record, when the score is toted up, we think he has a legitimate claim to being the greatet central banker who ever lived."
And, of course, on page 84 one can read:
Principle No.8: Don't try to burst bubbles, mop up after.

First of all, you might fail - or bring down the economy before you burst the bubble... Furthermore, bubble bursting is not part of the Fed's legal mandate, and it might do more harm than good. Finally, the "mop up after" strategy seems to work pretty well.
Mybe he's revised this paper to incorporate recent events such as the near world-wide meltdown of the entire credit industry and the popping of the largest asset bubble the planet has ever seen.

Here's the photo:

Now aren't you glad you had to scroll down to see it?

This week's cartoon from The Economist:
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fish said...

So mopping up after now includes cleaning up investment banks balance sheets by letting them unload their toxic paper for treasury notes?

Hmm who knew?

Anonymous said...

What a cop-out. The housing bubble was a regulatory problem and not a monetary policy problem. As if everyone should have just behaved themselves for an extended period of time waiting for the economy to heal itself while real interest rates were negative and you could only get one percent in a savings account. Monetary policy at the time was just begging people to take risks, so they did. The fact that there wasn't a regulator in sight made things much worse than they would otherwise have been, but without the low interest rates, the housing bubble would never have become so big.

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