Things Always Change and People move On
I ran across a thoughtful post over at Housing Doom Tuesday that I wanted to spend a minute on:
Where Have All the Bubble Bloggers Gone?
It’s been nearly three and a half years since I put up Doom’s first, rather uninspiring post. [In my defense, it was only a test.] We were joining the ranks of a number of "bubble bloggers".
Bubble bloggers were for the most part, regular folks who saw an insane real estate market and said, "It’s going to crash, and someone should say something". Some, like HousingPanic, Ben Jones and Patrick had inspired a national audience, others were smaller and more local. There was a lot of comradery in those days. We’d check each others posts, and add each other to the blogroll. We had fun taking potshots at the likes of Lereah and Mozillo and watched the data in our local markets.
This morning I read Chuck Ponzi’s Top 10 signs you’ve been following the housing bubble too long. Chuck, we’re you writing about me?
In the comments section I chimed in with:
Great observations. I think plenty of writers have given up because everything is the same now day in and day out. I know I started my site about 2 years ago hoping to influence the credit bubble and bring more attention to it. Of course everything went as many of us thought, until the government stepped in.
Instead of reform we get bailouts. Instead of a banking system overhaul we get permanent support for failed management. Instead of economic security we get the Fed leveraging the entire country to keep Citi (NYSE:C) in business.
I have a hard time finding things to write about now that any notion of moral hazard was thrown away. Of course the next collapse should be the final one, so there will not be anything to blog about then either.
I appreciate the work this site does and check every day.
It has become a challenge to find writing topics. Every day is the same since about May 2009. Forget anything being changed at the structural level, the plan is clear that permanent support for the banking system is standard policy and there will not be anymore thinking about it.
It is discouraging as well to see story after story remarking that this market is clearly a bubble driven by banking liquidity, low volume pump jobs, and a falling dollar as if these things are an acceptable way to operate.
As such, leave topic ideas in the comments section as I have had problems finding much worthy to write about at all.
How Closely Aligned are Government Policies and the Banking System?
I had wanted to spend some time covering an opinion piece by former Fed Governor Frederic Mishkin, but once again I am front runned before I can get home to write.
Still, this story directly confirms a long held belief of this writer so I will cover the Mishkin commentary anyway. I will break the article up into pieces and look at what is relevant.
Not all bubbles present a risk to the economy
There is increasing concern that we may be experiencing another round of asset-price bubbles that could pose great danger to the economy. Does this danger provide a case for the US Federal Reserve to exit from its zero-interest-rate policy sooner rather than later, as many commentators have suggested? The answer is no.
You did not think there would be any circumstances that would require the Fed to raise rates ever again did you? Good. Moving on...
Are potential asset-price bubbles always dangerous? Asset-price bubbles can be separated into two categories. The first and dangerous category is one I call “a credit boom bubble”, in which exuberant expectations about economic prospects or structural changes in financial markets lead to a credit boom. The resulting increased demand for some assets raises their price and, in turn, encourages further lending against these assets, increasing demand, and hence their prices, even more, creating a positive feedback loop. This feedback loop involves increasing leverage, further easing of credit standards, then even higher leverage, and the cycle continues.
Eventually, the bubble bursts and asset prices collapse, leading to a reversal of the feedback loop. Loans go sour, the deleveraging begins, demand for the assets declines further and prices drop even more. The resulting loan losses and declines in asset prices erode the balance sheets at financial institutions, further diminishing credit and investment across a broad range of assets. The resulting deleveraging depresses business and household spending, which weakens economic activity and increases macroeconomic risk in credit markets. Indeed, this is what the recent crisis has been all about.
And here we get the first piece of the puzzle. Mishkin thinks a credit driven bubble is dangerous because when it goes bad, the financial institutions take a hit. This will be important in a moment, but back to the article:
The second category of bubble, what I call the “pure irrational exuberance bubble”, is far less dangerous because it does not involve the cycle of leveraging against higher asset values. Without a credit boom, the bursting of the bubble does not cause the financial system to seize up and so does much less damage. For example, the bubble in technology stocks in the late 1990s was not fuelled by a feedback loop between bank lending and rising equity values; indeed, the bursting of the tech-stock bubble was not accompanied by a marked deterioration in bank balance sheets. This is one of the key reasons that the bursting of the bubble was followed by a relatively mild recession. Similarly, the bubble that burst in the stock market in 1987 did not put the financial system under great stress and the economy fared well in its aftermath.
Here the translation is that any bubble that does not harm the banking system is really ok, creative destruction and all that. Who cares about bagholders of Pets.com, the banks unloaded all their shares and scooped a huge fee for the IPO. If Pets.com goes bust only retail traders will be hit, and at last check they are unable to deploy "tanks in the street" in financial Armageddon. Moving on:
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 materialise 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”.
This guy is a gem in the rough I tell you. The old "how could we have known?" defense. Add to this Mishkin's own statement that if economic heads at the Fed were smart at all they would be rich. I think they are all indeed filthy rich, but what's the point? As for doing no harm, what US institution did the following:
-goosed the money supply before the Y2K hoax which led to a spectacular blow off top in the stock indices?
-goosed the money supply in response to said blow up in an attempt to mop up their own mess
-goosed the money supply in such a way that has never been seen before in the history of the USA in order to mop up the mess from the goosing from the last time.
The answer is the US Fed, so it is clear they tend to do a bit of damage. I will gladly accept the dissolution of the Fed so that they in fact "do no harm". More from the piece:
Nonetheless, if a bubble poses a sufficient danger to the economy as credit boom bubbles do, there might be a case for monetary policy to step in. However, there are also strong arguments against doing so, which is why there are active debates in academia and central banks about whether monetary policy should be used to restrain asset-price bubbles.
But if bubbles are a possibility now, does it look like they are of the dangerous, credit boom variety? At least in the US and Europe, the answer is clearly no. Our problem is not a credit boom, but that the deleveraging process has not fully ended. Credit markets are still tight and are presenting a serious drag on the economy.
Tightening monetary policy in the US or Europe to restrain a possible bubble makes no sense at the current juncture. The Fed decision to retain the language that the funds rate will be kept “exceptionally low” for an “extended period” makes sense given the tentativeness of the recovery, the enormous slack in the economy, current low inflation rates and stable inflation expectations. At this critical juncture, the Fed must not take its eye off the ball by focusing on possible asset-price bubbles that are not of the dangerous, credit boom variety.
So should the Fed target asset bubbles? Mishkin says maybe they should, but then again plenty of people in the halls of universities say no, so we will just leave it at that. Cannot argue with that logic.
I have written before that the technology stock bust focused its losses on the individual by wiping out their stock portfolios. The banks made cash on the way up and down raking in transaction fees and IPO floats. The banks were not impacted by the bust to any major degree. In response, the Fed lowered rates to try and put a floor under the stock market, and then lowered rates again after 9/11 to support markets even more.
But the stock games were done. Nobody wanted to replay that ride. And it is here that things get interesting. Banks went crazy with real estate loans and engineered whole new ways to expand residential lending to never before seen levels.
Of course we already know what has happened. The difference this time is that the banks themselves are sitting on the losses, not your average retail stock holder. It was almost as if the average joe wanted to get back at Wall Street for selling them RedHat (NYSE:RHT) at $500. The only problem is that the banks will not have to sustain these losses like regular people, on the contrary, the regular taxpayer will now pay for the banking losses via bailouts and backstops.
It truly is a case where the banks cannot lose. If nobody can see the embedded problem of such an arrangement, then they need help.
So Mishkin can speak about things in the abstract all he likes, as if there are no real world examples he could glean some facts from. The Fed is filled with others that think just like him. This is what passes for government leadership these days.
Mishkin's entire opinion piece is wrong. This equates to a defense of the Fed's inability to get anything right for over 15 years and then running away instead of taking a serious look in the mirror and thinking about changing.