Posted on 04/17/2009 4:58:59 AM PDT by TigerLikesRooster
Yellen says policymakers need to pop bubbles
By Laura Mandaro, MarketWatch
Last update: 8:01 p.m. EDT April 16, 2009 Comments: 99
SAN FRANCISCO (MarketWatch) -- San Francisco Federal Reserve President Janet Yellen said late Tuesday that central banks need to deal with bubbles in asset prices before they get too big, although monetary policy may not be the best tool for the job.
Letting them go unchecked "can lead to grave consequences," she said in prepared remarks for a conference held in honor of economist Hyman Minsky in New York.
"Episodes of exuberance, like the ones that led to our bond and house-price bubbles, can be time bombs that cause catastrophic damage to the economy when they explode," said Yellen, a voting member this year of the Federal Open Market Committee.
The FOMC has cut interest rates close to 0% and, by buying up debt and making special bank loans, has pumped about $1 trillion into the U.S. financial sector. It meets against next week. "I would not advocate making it a regular practice to use monetary policy to lean against asset-price bubbles," she said. "However, recent experience has made me more open to action."
(Excerpt) Read more at marketwatch.com ...
Ping!
How is the government going to recognize a bubble versus regular and appropriate market action?
And even if they do recognize a bubble, how are they going to deflate it? There were people who recognized the mortgage loans were out of controll, but the democratic congress did not want to deal with it and stayed in denial.
Price Controls are double-plus ungood.
Fed has been controlling price of money(interest rate), or directly controlling money supply for ages. Their meddling contributed to bubbles, too.
When transactions on commodity assets like houses trade at large multiples of affordability you have a clear indicator of a bubble. When stocks trade a 40:1 PEs and never below 14:1 when the historical range is 7:1 to 14:1 you have an asset bubble.
You find me a bubble, and I'll find you government intervention somehow causing it...
I have been reading editorials in the Wall Street Journal, Barrons, et al, for at least 10 years warning about the danger of over-leveraged derivatives, hedge funds, credit default swaps, the carry trade, and under-capitalized banks. The savvy professionals knew EXACTLY what was going on and many openly admitted that they KNEW the risk was high and that they expected the government to bail them out in case the Bubble burst. Now they want the taxpayers to foot the bill. Bankruptcy is the answer. As for foolish investors who bought mortgage backed securities, NEXT TIME, READ THE PROSPECTUS!
That's a logical way of approaching it. But if you look at the historical rates of return, you might well conclude that stocks historically have been undervalued and 7:1 to 14:1 is inadequate.
During periods of higher projected economic growth, you would expect stocks to trade at higher PE ratios. I'd argue that if you expect inflation, that stocks should trade at higher PE ratios, since earnings will eventually adjust with inflation, whereas a bond or dollar holdings will not.
There are an awful lot of factors, that I'm not sure the government could get right.
Take for example housing bubbles. An affordability ratio would likely be the ratio of the average house price to the average salary.
But we choose to live in larger houses, does that change the ratio?
In California there was a supply shortage and demand drove the prices up. Is that a bubble? Who's to say that the shortage will eventually resolve itself, and therefore the price bubble needs to be deflated?
There have been claims that housing would increase because the supply of raw materials are decreasing relative to the demand for housing. That would logically drive the price up. Suppose that assumption is true how does government take that into account. Do they raise the ratio based on the assumption? Or do they stick with the historical norm and try to deflate housing prices until shortages actually appear in the raw materials market.
Maybe gov't should inflate housing prices in the north and deflate housing prices in the south based on global warming projections. And while they are at it, maybe they should deflate coastal properties, since global warming will sink them, and inflate properties that are 20feet above sea level and adjacent to the sea.
There are so many variables that I don't see government getting it right. I think that is best left to the market.
What I do think is that gov't needs to take a harder look at the use of leverage in the market and signs of market manipulation. Bulgaria caught Soros' funds manipulating the market during last September's banking crisis. I bet if you look closer, you'd find his funds doing the same thing in all markets.
the problem is that nobody knows that a particular trend is a bubble until after it bursts. what this does is create an environment where the government kills an entity whenever it gets successful.
Step 1: The Fed should not keep interest rates so low for a long time which created the bubble. The housing bubble couldn't have happened without Greenspan essentially giving away money.
The foundation of the problem is in legislation which is controlled by forces outside the businesses affected. Washington Mutual, Chase, Countrywide, etc. reacted to market conditions and profit opportunities, much of which they did not create or control. When the market is governed by political considerations ginned up by the media or pressure groups, businesses can only react as best they can, either to protect themselves or jump to take advantage of new opportunities.
My manager at an earlier job objected to some of the subprime instruments proposed as profitable items for the company. He said they would blow up and destroy the company. He was told that the new proposed vehicles were too sophisticated for him to understand and to sit down and shut up.
If businesses aren’t willing to follow sound business practices because the lure of quick and cheap profits is too tempting, then bubbles are going to happen as a matter of course. Managers must decide with their minds and with their sense of morality and common sense, not by emotion. They must not dismiss our misgivings just because a clever idea comes up and seems to color those concerns as trivial or old-fashioned. To do so is to betray their mission which is to create greater value for the stockholder and protect their interests.
Caution should have been the rule under those conditions, given that the climate was set up by politicians. Managers should have isolated the proposed drastic new ideas on a test population before unleashing it to the world at large, to see what would happen. But at the time, the subprime loan environment was seen as the opportunity of a lifetime and everyone was clamoring to be part of it.
Fannie Mae and Freddie Mac were there to back up the banks, but someone should have had the foresight to say, “What if the worst happens and the GSEs fail?” There were rumblings about them failing in 2005. I guess everyone hoped the music would never stop or that they’d have a safe chair to fall into when it did.
Using Deming’s booklet Managing Transformation as a guide, the crisis was precipitated by a series of events and bad decisions that violated every one of Deming’s principles:
* Allowing leadership decisions that were top-down (the banking committees in congress, the management of AIG and banks deciding to go all out in subprime loans and extremely risky derivative products) without any input from the middle or lower management levels or consideration for what would happen to the customers who held these mortgages or CDS instruments if the worst happened.
* Engaging in short term gains without regard for long term consequences - Next-Quarter thinking about sales and profits and complete disregard for the consequences that might occur later than two years beyond the moment.
* Setting arbitrary targets for sales and profits instead of considering how these new instruments could backfire and destroy the company and the policy holders.
* Selling derivative instruments as insurance against bad loans without collateral or reserves to back up the insurance (cheap components and services).
* Being willing to pass these instruments along the chain hoping the Greater Fool would be left holding the bag (Fannie and Freddie, the bank down the street, the next counterparty on the CDS, etc.).
Either ignorance of or willing disregard for these principles led to the crisis. The sad thing is, we are doing the same things to “resolve” the crisis instead of employing sound thinking to move to a new level of decision making and creating a new basis for the economy. We need to let the entities that made the bad decisions fail as the consequence for their inability to foresee the problems they themselves made. We are making the same mistakes Japan has made since the 1990s: trying to spend public money to preserve the entities that were hurt by their own decisions, to try to revive the “good old days” and bring back the conditions of the earlier fake prosperity by preserving them from failure.
“I wonder what made her make this comment at this time.”
Probably the fact that Mr Bubbles, Alan Greenspan, has retired.
“Fannie Mae and Freddie Mac were there to back up the banks, but someone should have had the foresight to say, “What if the worst happens and the GSEs fail?”
Fannie and Freddie had no role in backing up banks. Their job was purchasing FHA/VA conforming loans from originators, and that worked fine. They became at risk when they moved beyond conforming loans.
There actually was no taxpayer guarantee for either GSE. But our rulers decided they would make us guarantee Fannie and Freddie. I suspect it was because China owns a huge investment in both and it was considered bad form to stick them with huge losses. Much better to impoverish the average American rather than our Chinese pals.
Are they going to play with corn and ethanol again?
Did Greenspan take on a new consulting job after the FED? Did that new job generate any significant bucks for him?
I think he just gives speeches.
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