Did the Fed screw up handling the housing bubble, thus causing the economic crisis? Can it do better next time? These urgent questions have been batted around frequently, but now there's a new question: is spotting and addressing bubbles even possible? Here are the thoughts of heavyweight economic journalists, economists, and financiers as they debate the best way of preventing another crisis:
- Fed Screwed Up, Need a Review The New York Times' David Leonhardt kicked off discussion with a column arguing that spotting the last bubble "wasn't that hard, if you were willing to look at economic fundamentals. You couldn't know exactly when or how far prices would fall, but it seemed clear they were out of control." He thinks Fed officials "got trapped in an echo chamber of conventional wisdom," and so "what's missing from the debate over financial re-regulation is a serious discussion of how to reduce the odds that the Fed ... will listen to the echo chamber when the next bubble comes along. A simple first step would be for Mr. Bernanke to discuss the Fed’s recent failures, in detail." Ultimately, "the Fed really does seem to be the best agency to regulate financial firms," and the best for managing bubbles:
Fed officials could have had a real impact if they had decided to attack the bubble. Imagine if Mr. Greenspan, then considered an oracle, announced he was cracking down on wishful-thinking mortgages, as he had the authority to do.
- Not Bubbles, But Leverage You can't stop bubbles, argues The Washington Post's Ezra Klein. "Bubbles have always been with us and they will always be with us, at least unto the seventh generation of cyborg-humans. Yea, verily." Bubbles are about human nature, he says, "And there's nothing really wrong with that: The bursting of the tech bubble didn't damage the economy so much as it brought it back into line with its fundamentals." The problem is when bubbles don't burst harmlessly, and both he and Think Progress's Matt Yglesias adopt economist Joseph Gagnon's argument that the difference between an okay bubble and a disastrous bubble is what the finance world knows as "leverage." Regulating leverage is the key.
- Agreed--Can't Stop Bubbles, But You Can Limit the Damage Edward Harrison, writing at Credit Writedowns, offers a slightly more technical set of proposals. He agrees with a point he says Alan Greenspan and economist Mark Thoma share: spotting bubbles is tricky, and shouldn't be the focus of regulation efforts. Instead, the "goal," he argues, "should be to devise a way to prevent contagion when individual companies, sectors of the economy, or regions collapse without having a significantly negative effect on long-term growth or income and wealth distribution." But Harrison doesn't focus as much on leverage as do others. Instead, he favors options like "set[ting] up robust bankruptcy resolution process for all private sector companies, especially in the financial sector and including hedge funds and too-big-to-fail institutions."
- Even If You Could, Fed Certainly Couldn't, argues The Atlantic's Daniel Indiviglio, who points out that the Fed's "mission statement includes keeping unemployment as low as possible. Even if the Fed had seen statistics indicating that a dangerous housing bubble might be forming in 2005 and decided to take action--can you imagine the political fallout if it caused a recession resulting in a few percentage points rise in unemployment?" If we are to have any chance of managing bubbles--far from certain, Indiviglio says--the best bet would be "a new, independent agency charged with exactly that task."