Wikinvest Wire

Paul Volcker on popping asset bubbles

Sunday, March 01, 2009

This item from the WSJ Economics Blog was left over from last week, but it's just too good to be left behind. It seems that former Fed Chairman Paul Volker had a few unkind words for the policies of his successor during last week's Joint Economic Committee hearing.

The former Federal Reserve chairman weighed in on a debate over the role of government officials in popping bubbles. “The first and most fundamental lesson of the crisis is that future policy should be alert to, and take appropriate measures to deal with, persistent and ultimately destabilizing economic imbalances. I realize that is a large and continuing challenge of international as well as domestic proportions, but it is the essence of prudent economic management,” Volcker said.

He didn’t specifically mention the Fed, but discussion has been heating up over whether the central bank should act pre-emptively to pop bubbles. Volcker’s successor at the Fed, Alan Greenspan, famously stood against such a policy. “[T]he degree of monetary tightening that would be required to contain or offset a bubble of any substantial dimension appears to be so great as to risk an unacceptable amount of collateral damage to the wider economy,” Greenspan said in 2002.
It's probably safe to say the theory behind the non-interventionist policy is now debunked.

Mr. Volcker is no "Johnny come lately" on this subject, penning the memorable Washington Post opinion piece "An Economy on Thin Ice" back in 2005.

The year before, as documented in this report, he went so far as to predict a 75 percent chance of a financial crisis within five years.

It turns out that was very prescient and quite bold. Anyone predicting a financial crisis in 2004 was routinely laughed off the stage - we had just entered a new era of seemingly limitless and endless "wealth creation" through "innovation" in financial products.

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This week's cartoon from The Economist: IMAGE
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8 comments:

Nick said...

Now what would have been truly bold, prescient, and accurate would be to comment about how the injection of $800 billion of printed money into the economy by the federal government, the trillion dollar bank bailout, and the multi-trillion dollar backdoor Fed bailouts are causing massive economic imbalances which are probably worse for the long-term health of the economy than the bubble/correction ever was. You'd get a lot of points in my perception for being an Obama adviser, but being bold enough to point out that glaringly obvious fact.

staghounds said...

Thi is, sadly, typical- wanting government to tinker with economic matters is STUPID.

Pop bubbles? How? First, how to identify them? At what point does an industry or business change from a "success" to a "bubble"?

Who decides?

Just how do you explain the "popping" decision to the "poppees"?

"You people who are about to buy houses with 5% mortgages- that's too cheap. You're going to have to pay 8%."

"You people with the Amazon and Ebay stock- the value is too high. We're going to use the power of your own government to cut your assets."

You'd never sell that, there would be blood in the streets!

Wait- that's what they already do to the value of cash...

Anonymous said...

staghounds,

You generally know a bubble exists in the market when your next door neighbor advises you on how to profit from it.

Anonymous said...

so dumping 3 trillion more into the AIG and bank and car companies is SMARTER how??????

Anonymous said...

If you believe the government should intervene during market downturns/crashes like it is now and has in the past, then you must also agree that the government should intervene during upturns/euphoria.

How do you identify a bubble? The inverse of the way you identify a downturn/crash. e.g, if 20% drop in market results in government intervention to prop up businesses/market, then 20% rise in markup results in government intervention to dampen euphoria.

I'm not saying I'm for intervention, but if the government is going to intervene in the market, it must be at both ends, otherwise it will ultimately result in the imbalances that got us into this mess.

One such imbalance is the fear/greed imbalance. If the government intervenes only during market downturns then the fear side of the equation gets lighter - e.g., confidence in a "Greenspan PUT".

Mathlete said...

Government just needs to stay away. It pumps the bubbles with monetary policy, and then needs to pop them. Why not stop the bubble blowing?

All the megabubbles, from John Law, South Sea, 1929, tech stocks, etc., were government supported.

Also, I don't see how this can ever work. Succesful investing, i.e. recognizing bubbles, requires contrarian behavior. Democracy is not a contrarian form of government. A better solution might be to return to constitutional monarchy. At least if someone proposed that, I'd know they were serious.

Anonymous said...

Didn't need to use monitary policy to pop bubble. All Greenspan had to do was enforce the common sense laws already on the books: Truthfully state your income and prove it when applying for a bank loan. If you lie you go to prison (already the law). Add in honest appraisals and a 10% down payment and a good chunk of this crisis would have been avoided. I doubt even Ayn Rand would have objected to these common sense practices. Not heavy handed leftist stuff just common sense. If a theme of Rand was throwing those who don;t carry their weight off the lifeboat then suggest Greenspan be the first to get thrown off.

Anonymous said...

Would someone ask Greenspan/Bernanke if they think they fixed the housing bubble? Greenspan has spoken in an interview that his low mortgage rates did NOT set up this failure. I think that his 18 rate increases did indeed have an effect, therefore, I would contest his opinion, and suggest that his 3 % mortgages should get the full credit they deserve... When HE raised rates until the mortgages being held throughout the industry had to be discounted, and that discount cut into the prinicpal of the loans, the holders no longer had a full 100% value of the properties. Chew on that, and answer the challenge Greenspan!

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