Caroline Baum
Commentary. Caroline Baum is a columnist for Bloomberg News. The opinions expressed are her own.
04/19 12:35
A Conference on Asset Bubbles by Bubble Sponsor:
By Caroline Baum
New York, April 19 (Bloomberg) -- What delicious irony! A conference on asset bubbles sponsored by the folks who sponsor them.
Next week, the Federal Reserve Bank of Chicago, in conjunction with the World Bank Group, is holding a three-day conference entitled, ``Asset Price Bubbles: Implications for Monetary, Regulatory and International Policies.''
``A distinctive feature of the last two decades has been the prolonged buildups and sharp collapses in asset markets (such as stock, housing, and exchange markets) in the industrialized and developing world,'' the Chicago Fed said in announcing the event on its Web site. ``This volatility has sparked an intense debate in academic and policy circles regarding the appropriate monetary and regulatory response to these dramatic shifts.''
The conference planners showed true flair in their selection of program topics, ranging from the whimsical (``Tropical Bubbles: Asset Prices in Latin America, 1980-2001'') to the practical (``Asset Prices Should Not be Targets of Monetary Policy'') to the topical (``Bubbles in Real Estate Markets'').
Federal Reserve Chairman Alan Greenspan should be particularly interested in the session on real estate bubbles. He downplayed the idea of a housing bubble in testimony to the Joint Economic Committee of Congress on Wednesday, arguing that the analogy to ``the building and bursting of a stock-price bubble is imperfect.''
Cheese Fondue
Real estate sales involve ``substantial transactions costs,'' not to mention the ``significant financial and emotional costs'' of moving from one part of the country to another, the chairman said. These costs pose ``an obvious impediment to stimulating a bubble through speculative trading in homes.''
It's an elegant argument. It's also full of holes.
``So, I guess we've never had a housing market bubble in the past, huh, Al?'' said Bill Fleckenstein, president of Fleckenstein Capital in Seattle, in his daily Market Rap. ``And I guess those impediments also kept the Japanese from having a housing bubble as well.''
In all fairness, the chairman anticipated Fleckenstein's response, saying that transaction costs don't preclude a bubble developing in the housing market or home prices declining. Because the turnover of homes is smaller than that of equities, however, a boom and bust is less likely, Greenspan said.
One wonders if any central banker ever takes credit for creating an asset bubble. After all, there can be no bubble without excess credit creation. And there can be no excess credit creation without the active or passive consent of the central bank.
Counterfeit Trader
If there were no central bank, increased demand for credit would push up the price of credit. The higher price (interest rate) would, in turn, deter new borrowers.
``If you decide you want to borrow more, and borrowers and lenders were in equilibrium before, presumably you would have to pay more to borrow now,'' said Paul Kasriel, director of economic research at the Northern Trust Corp. in Chicago. ``That would induce me to cut back on my spending. It's really a transfer of spending power.''
Today most, if not all, central banks set policy by targeting an overnight interest rate, passively satisfying the banking system's increased demand for credit by pumping out sufficient bank reserves to keep the funds rate steady. That way, we all can borrow and party.
``Think of the central bank as a counterfeiter,'' Kasriel said. ``He can give you a better deal than your neighbor. He can go into the back room and print it up. You can have all you want at the current price.''
Tarry Now, Hurry Later
While Mr. Greenspan is comfortable holding short-term rates steady for the two to four months he says is necessary to determine the economy's true trajectory, there's a risk in holding short-term rates too low for too long.
``The risk is you have to move in a hurry when things get going,'' said Paul DeRosa, a partner at Mt. Lucas Management Co.
There's another risk. Artificially low rates, which seemed necessary following the Sept. 11 terrorist attacks, are no longer needed. While the strength of the expansion may be uncertain -- some economists still subscribe to the idea of a double-dip -- the economy no longer requires life support. A 1.75 percent overnight rate, which is the benchmark for all short-term rates, sends the same wrong signals that triggered the stock market boom of the late 1990s. Cheap credit is not the cure for a hangover resulting from over-indebtedness on the part of businesses and consumers.
Given the concerns about corporate governance, conflicts of interest and the reliability of earnings, another stock market bubble right now is unlikely. Investors don't repeat history so quickly. (Give them time, however, and tulips may yet look like a grand investment.)
While Greenspan says a housing bubble is much less likely than an equity one, I doubt he wants to put his thesis to a real- time test |
