All Bubbles Are Equal, But Some Are More Equal than Others

Columbia University Professor and former Federal Reserve official Frederic Mishkin wrote a much-discussed Op-Ed in the Financial Times yesterday. In it, he asks:

Are potential asset-price bubbles always dangerous?

He answers this question with a no, noting that some asset bubbles are more dangerous than others because of their connection to debt and credit. I agree with his delineation and assertion that some asset bubbles are more dangerous than others. But, his conclusion that the non-credit variety of asset bubble — what he calls the “pure irrational exuberance bubble” — is not dangerous is false. This is the same blinkered thinking which led to Nasdaq 5000 and its crash. Experience demonstrates that all asset bubbles are dangerous, some asset bubbles are more dangerous than others. Think Animal Farm: All bubbles are equal, but some bubbles are more equal than others.

The real question Mishkin attempts to answer is whether the Federal Reserve (where he once worked) or any other central bank should target asset prices so as to prevent bubbles from taking form.

Because the second category of bubble does not present the same dangers to the economy as a credit boom bubble, the case for tightening monetary policy to restrain a pure irrational exuberance bubble is much weaker. Asset-price bubbles of this type are hard to identify: after the fact is easy, but beforehand is not. (If policymakers were that smart, why aren’t they rich?) Tightening monetary policy to restrain a bubble that does not materialize will lead to much weaker economic growth than is warranted. Monetary policymakers, just like doctors, need to take a Hippocratic Oath to “do no harm”.

Are we to take this seriously? Even Alan Greenspan is showing more realism in the wake of our latest bubble. This man is outright dangerous. Don’t be fooled; his piece is a plant. We have some serious asset bubbles forming right now and he is looking to give intellectual cover to the watch-the-bubble-and-clean-up-after-the-mess policy we saw on display in the late 1990s. Yves Smith thinks there is a connection between his statement and likely Federal Reserve policy.

What I find interesting is how the Federal Reserve under Greenspan had an explicit policy of targeting asset prices as a means of reflating the economy. Yet, Mishkin is saying they should not target asset prices as a means of deflating the economy. This is what is called monetary policy asymmetry, otherwise known as the Greenspan Put. So, in effect, Mishkin is arguing for us to continue with business as usual. This is one of the more loathsome pieces of prattle I have witnessed since the financial crisis began. I hope no one takes this man seriously. I am ashamed that he is a professor at the business school I attended.

I would be remiss if I didn’t point out his equally absurd piece of research on Iceland’s economy before it collapsed. he wrote a piece called “Financial Stability in Iceland” with Tryggvi Herbertsson which stated:

Our analysis indicates that the sources of financial instability that triggered financial crises in emerging market countries in recent years are just not present in Iceland, so that comparisons of Iceland with emerging market countries are misguided.

No Mr. Mishkin, your analysis is misguided. It was with Iceland and it is here again. See below for a real analysis on Iceland from Willem Buiter and Anne Sibert which we can take seriously.

As I have been saying, you can get wildly different conclusions from two people based on the same facts and largely the same analysis. It goes to philosophical predisposition. What this FT article by Mishkin demonstrates is that no amount of real world evidence of the havoc that bubbles wreak will dissuade these ivory tower ideologues from supporting failed economic policy.

Sources

Not all bubbles present a risk to the economy – Frederic Mishkin, FT

Financial Stability in Iceland (pdf) – Icelandic Chamber of Commerce

The collapse of Iceland’s banks: the predictable end of a non-viable business model – VoxEU

Central Banks Can Do Better Than Just Mopping Up – Caroline Baum, Bloomberg

Comments

[Nick36:]

Whenever there is a bubble, there is always somebody building up debt and leverage to fuel it.

In the present speculative bubble, it's various governments and the Fed who are building up leverage and borrowing a lot of money.

The current $1.4 trillion per year US government deficit is nothing to sneeze at. And the Fed is loading up its balance sheet with all kinds of debt securities too.

Debt is debt. And it needs to be repaid regardless of whether it's private entities or governments who owe the money. But it's not really the governments who owe the money. It's the taxpayers.

The taxpayers are now leveraging themselves up to fuel the most recent speculative bubble. And things won't go well for taxpayers when this latest bubble bursts. Because the financial system hasn't been reformed. Banks are now gambling with taxpayer money. And if they loose. Then taxpayers will pay.

Nov 10 10:19 AM

[Gary A:]

6 dollar gas isn't dangerous because we pay with cash? That is pretty funny. What are those Fed guys smoking anyway?

Nov 10 10:28 AM

[tripleblack:]

LOL, the self-delusionary abilities of our new lords and masters in Washington when it comes to cherished icons like ultra-expensive fuel (and all the wondrous new revenue which would flow therefrom) are nothing short of surreal.

Its a Fellini film loop.


On Nov 10 10:28 AM Gary A wrote:

> 6 dollar gas isn't dangerous because we pay with cash? That is pretty
> funny. What are those Fed guys smoking anyway?

Nov 10 10:36 AM

[Dialectical...:]

There is something elegant and unintentionally revealing in the notion that "if policy makers were so smart (that they could understand the market) they'd be rich." You can't invite a bunch of friends over for dinner and then when you serve them a bad meal say, "Look if I could cook I'd own a restaurant." By the same token you can't be responsible for setting economic policy but demure, "Look if I understood how any of this worked I'd be rich, okay?"

Nov 10 10:52 AM

[Dialectical...:]

I wondered the same thing... Have we seen a bubble that didn't involve credit? Surely as high returns are "guaranteed" in one place, money is borrowed from other places more cheaply and put into the higher yielding return. The dot com bubble was full of financing that allowed ideas such as lightbulbs.com to take form. A laboratory clean example of a fund that explodes 500% but then settles back to 50% returns might look like a harmless bubble, but there are people borrowing to participate in the run up to 500% and there are inevitably pipers to be paid when it comes back to earth. It may be the problem with the idea that a non-credit bubble is not dangerous is that there is no such thing as a non-credit bubble.


On Nov 10 10:19 AM Nick36 wrote:

> Whenever there is a bubble, there is always somebody building up
> debt and leverage to fuel it.
>
> In the present speculative bubble, it's various governments and the
> Fed who are building up leverage and borrowing a lot of money.<br/>
>
> The current $1.4 trillion per year US government deficit is nothing
> to sneeze at. And the Fed is loading up its balance sheet with all
> kinds of debt securities too.
>
> Debt is debt. And it needs to be repaid regardless of whether it's
> private entities or governments who owe the money. But it's not
> really the governments who owe the money. It's the taxpayers.
>
>
> The taxpayers are now leveraging themselves up to fuel the most recent
> speculative bubble. And things won't go well for taxpayers when
> this latest bubble bursts. Because the financial system hasn't been
> reformed. Banks are now gambling with taxpayer money. And if they
> loose. Then taxpayers will pay.

Nov 10 11:05 AM

[Jeff Nielson:]

The author's observations are correct - and obvious.

This begs the question: why are few pointing the finger at "Helicopter" Ben - who was engaging in MUCH more obvious market-pumping as CHAIRMAN of the Federal Reserve.

How can anyone forget his "Goldilocks economy"? This was his propaganda-line at the PEAK of the U.S. housing bubble: markets and house-prices would go up forever, despite the fact that anyone who had ever attended an economics course (and UNDERSTOOD the material) knew that this bubble was obviously unsustainable.

Then, AFTER that bubble burst, he continued his "pumping" with his equally ridiculous propaganda-line of a "soft landing".

None of this was discussed during the (supposed) "debate" about whether he should be reappointed.

Compared to Bernanke, Mishkin's current comments (as someone with no official status) are from an irrelevant "nobody".

I applaud the author for denouncing Mishkin, however Bernanke is STILL Chairman of the Fed, and STILL nothing but a shameless shill for Wall Street.

If Mishkin is "dangerous", than Bernanke himself is a "financial weapon of mass destruction".

There has been far to little condemnation of Bernanke for his role as chief-facilitator of Wall Street fraud, and too little condemnation of Obama for reappointing a man who is not only obviously unqualified for his job - but completely bereft of integrity.

Nov 10 12:25 PM

[lotogo:]

I finished reading Professor Mishkin's FT op-ed piece about an hour ago and was shocked by the casual shallowness of his comments overall. "Ivory tower idealogue" hits the target dead center, I think.
I suspect Mr. Mishkin, and many others at the Fed sharing his benign bubble view, have never been on the receiving end of a bubble at a personal, painful level.
This involves the dumping of large numbers of dedicated, capable and hard-working employees in the street with no jobs, often after they've invested large portions of their productive adult lives working to advance a business plan that is no longer viable.
All bubbles, not unlike icebergs, are deadly dangerous. Those who man the bridge on our financial ship of state, the Fed, might better serve us if they were required to personally observe and participate in the many business layoffs now underway. Failing that, those who have influence on the Fed can help more by keeping casual musings about the relative size and probable impact of Fed-induced financial icebergs in the business waters to the ivory tower.

Nov 10 12:35 PM

[Andrew Butter:]

RE: This man is outright dangerous. Don’t be fooled; his piece is a plant.

You are absolutely right, that was a good reference you dug up on Iceland.

My argument is that the Dot.com begat the housing bubble and that where the US stock-market bottomed was simply the inevitable down-wave of the Dot.com bubble.

Nov 10 02:19 PM

[Dialectical...:]

I think you could be right. If you look at when "McMansion Fever" began, it was about the time all these "brilliant" and newly rich day traders and dot-com entrepreneurs wanted to spend some of their newfound wealth. Housing prices first rose a result of this demand and then were further fueled by the easy to get no doc and exotic mortgages. But in some sense there would have been little market for exotic loans if so many folks didn't need them because price to income ratios got so far out of whack. And I think that was around the time of the dot com. Good theory. And if true, it shows how "harmless" the dot com bubble really was...


On Nov 10 02:19 PM Andrew Butter wrote:

> RE: This man is outright dangerous. Don’t be fooled; his piece is
> a plant.
>
> You are absolutely right, that was a good reference you dug up on
> Iceland.
>
> My argument is that the Dot.com begat the housing bubble and that
> where the US stock-market bottomed was simply the inevitable down-wave
> of the Dot.com bubble.

Nov 10 03:02 PM

[a fat panda:]

"I am ashamed that he is a professor at the business school I attended."

That is one way to cut down on those pesky calls from the alumni office for contributions.

Iceland is a classic story. You are going to hear Mr. Mishkin say that comparing Iceland and America is irrelevant because the US is more dynamic, world-power, blah, blah, blah.... He is going to say that the US is just too big to feel the effects of economic gravity.

Nov 10 04:37 PM

[a fat panda:]

It is virtually impossible for a bubble to form without credit right down to the bubble in baseball cards. The bubble forms because rising prices creates rising demand. That demand has to be fueled by something,and there will always be players on the margin willing to put debt on the table to play. That debt fuels higher prices which creates more demand.

It may not be the largest bubble ever, but debt played a nice role in the baseball card bubble. Debt opened stores,and helped buy inventory. Chances are that purchases were made on credit cards. If it doesn't seem like a bubble to you, it may be because you weren't close enough to see it played. I saw a friend of mine buy his kid a Mark McGuire rookie card for his college education fund. That is a irony-bubble if I ever saw one.

Nov 10 04:51 PM

[Gary A:]

I assume that was a pre steroid revealed Mark McGuire card! That is what happens when people have too little information. Goldman Sachs would have been shorting that card, lol!


On Nov 10 04:51 PM a fat panda wrote:

> It is virtually impossible for a bubble to form without credit right
> down to the bubble in baseball cards. The bubble forms because rising
> prices creates rising demand. That demand has to be fueled by something,and
> there will always be players on the margin willing to put debt on
> the table to play. That debt fuels higher prices which creates more
> demand.
>
> It may not be the largest bubble ever, but debt played a nice role
> in the baseball card bubble. Debt opened stores,and helped buy inventory.
> Chances are that purchases were made on credit cards. If it doesn't
> seem like a bubble to you, it may be because you weren't close enough
> to see it played. I saw a friend of mine buy his kid a Mark McGuire
> rookie card for his college education fund. That is a irony-bubble
> if I ever saw one.

Nov 11 11:18 AM

[Al-USA:]

Excellent article by Mr. Harrison and comments, such as Mr. Nielson's. I will forward this article to all my contacts, keep up the good work.

Nov 14 11:09 AM