Interest Rate Roundup

Friday, March 14, 2008

The sad reality we face today -- and what it should teach us about the danger of asset bubbles

As I sit here and contemplate the truly astounding headlines crossing the tape lately, I want to go back to something I've been saying for a long, long time ...

The only way to prevent the pain of popping bubbles is to prevent bubbles from inflating in the first place!

I have expressed my displeasure several times over the Federal Reserve's stated policy of ignoring asset bubbles as they inflate, most notably last May before this meltdown really got underway. Policymakers claim they don't target asset bubbles because:

A) They shouldn't substitute their judgment for the market's


B) It's impossible to identify bubbles except in hindsight anyway.

The better solution — in their view — is to come in and try to mop up the aftermath by slashing rates and taking other steps.

The polite way of describing that policy? Nuts. Just plain nuts.

I mean, if you asked 100 people on the street whether dot-com stocks and the Nasdaq overall were caught up in a large bubble in 1998-99, you'd have heard 99 answer yes. And if you asked another 100 people whether the housing market was in bubble-land in 2004 and 2005, you'd get the same thing: A resounding yes from just about everyone.

You could see it in the statistics. You could see it all around you in everyday life — the Miami condo parties, the buyers camping out to snap up three, four, or five homes at a time, the 5%-per-quarter increases in home prices. Respectable economists and analysts everywhere were warning that we were courting disaster.

The idea that the Fed couldn't identify that we were in a bubble — one that called for aggressive regulatory and monetary policy action to counter it — is simply not credible. Because nothing was done back then, the bubble wasn't nipped in the bud, and a future "pop" was all but guaranteed. As a result, we are now left to cope with waves of foreclosures, hundreds of billions of dollars in writedowns and losses, and potential bank and broker failures/bailouts. Policymakers are also being forced to throw everything but the kitchen sink at the problem.

So where do we go from here? I want to believe we can turn things around. I want to believe that all these policy actions ... the aggressive construction cutbacks we're seeing from the major home builders ... lower home prices ... lower interest rates ... and everything else will help turn the tide eventually. I still think that can happen as we head into 2009 and beyond (I'm writing off 2008).

But I have to tell you, it's hard to eliminate that nagging voice in the back of my mind — the one that says there's an outside chance of a long economic slog ... something akin to what Japan faced in the 1990s after that country's twin stock and real estate bubbles popped. Let's hope not.


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