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Matt Taibbi has rightly directed our attention towards the talent, organization, and power that together produce damaging (for us) yet profitable (for a few) bubbles. Most of Taibbi's best points are about market microstructure—not the technological variety usually studied in mainstream finance, but more the politics of how you construct a multi-billion dollar opportunity so that you can get in, pull others after you, and then get out before it all collapses. (This is also, by the way, how things work in Pakistan.)
In addition, of course, all good bubble-blowing needs ideology. Someone needs to persuade policymakers and the investing public that we are looking at a change in fundamentals, rather than an unsustainable and dangerous surge in the price of some assets.
It used to be that the Federal Reserve was the bubble-maker-in-chief. In the Big Housing Boom/Bust, Alan Greenspan was ably assisted by Ben Bernanke—culminating in the latter's argument to cut interest rates to zero in August 2003 and to state that interest rates would be held low for "a considerable period". (David Wessel's new book is very good on this period and the Bernanke-Greenspan relationship.)
Now it seems the ideological initiative may be shifting towards Goldman Sachs.
As Bloomberg reported on August 5th, "Goldman economists, led by Jan Hatzius in New York, now see a 3 percent increase in gross domestic product at an annual rate in the last six months of this year, versus a previous estimate of 1 percent. The new projections were included in a research note e-mailed to clients."
Goldman's public thinking, of course, has been that we face such slow growth that interest rates should be kept low indefinitely. There is, in their view, no risk of inflation—and no such thing as potentially new bubbles (e.g., in emerging markets). The adjustment process will go well, as long as monetary policy stays very loose—it's back to Bernanke's 2003 line of thinking.
This line of reasoning has been very influential—reinforcing Bernanke's commitment not to tighten monetary policy in the foreseeable future and fitting in very much with the Summers model of crisis recovery (see the second item). Just a couple of weeks ago, in his July 14 report, Jan Hatzius argued, "further stimulus remains appropriate" and "the appropriate debate is not whether fiscal and monetary expansion is appropriate in principle but whether it has been sufficiently aggressive." I don't know if he has revised this line in the light of the big upward revision in his growth forecast or whether he is still saying, "Ultimately, we do expect further stimulus, but it may take significant disappointments in the economic data and the financial markets before policymakers move further in this direction."
Much faster growth than expected is, of course, in today's context a good thing. But it also brings complications. If you keep monetary policy this loose for much longer, you will feed bubbles. And if you encourage even looser monetary and fiscal policy, there will be a costly reckoning not too far down the road.
Monetary policy orthodoxy under Greenspan did not care about bubbles in the least. Now we have massively damaged our financial system, our real economy, and our job prospects, this view is under revision.
Of course, in principle you should tighten regulation around lending but, just like 2003-2007, who is really going to do that: the US, China, the G20? On this point, all our economic leadership is letting us down—although they are getting a powerful assist from people like Goldman (and Citi and JP Morgan and almost everyone else on Wall Street.)
Also posted on Simon Johnson's blog, Baseline Scenario. Following was previously posted on Baseline Scenario.
John Dugan: Consumer Advocate Or Bank Defender? (August 5)
In a quote potentially for the ages, John C. Dugan, Comptroller of the Currency since 2005, told the Senate Banking Committee yesterday, enforcement of consumer protection laws "should stay with the bank regulators, where it works well."
This is a bold statement. Does Mr. Dugan have any evidence to support the idea that consumer protection vis-à-vis financial products currently works well? A close reading of his written testimony to the Senate Banking committee reveals none.
On p.18 of his testimony, he does have a good statement of the broader issues (emphasis added).
"Today's severe consumer credit problems can be traced to the multi-year policy of easy money and easy credit that led to an asset bubble, with too many people getting loans that could not be repaid when the bubble burst. With respect to these loans—especially mortgages—the core problem was lax underwriting that relied too heavily on rising house prices. Inadequate consumer protections—such as inadequate and ineffective disclosures—contributed to this problem, because in many cases consumers did not understand the significant risks of complex loans that had seductively low initial monthly payments. Both aspects of the problem—lax underwriting and inadequate consumer protections—were especially acute in loans made by nonbank lenders that were not subject to federal regulation."
The "especially acute" in the last sentence may be correct, but we know that many regulated banks (covered by all the existing regulators) participated in exactly the same rip-offs of consumers—which created the basis for a financial system meltdown.
Remember that the OCC supervises over 1,500 national banks, which includes many that have run into serious difficulties recently (a full list is not easy to find, but start here and here; or use this search; the list includes Citi, BoA, Wells Fargo, etc).
The heart of Mr. Dugan's objection to the Consumer Financial Protection Agency (CFPA) as proposed appears on p.25,
"The Proposal would vest all consumer protection rulewriting authority in the CFPA, which in turn would not be constrained in any meaningful way by safety and soundness concerns. That presents serious issues because, in critical aspects of bank supervision, such as underwriting standards, consumer protection cannot be separated from safety and soundness."
My favorite statement comes at the end.
"Our experience at the OCC has been that effective, integrated safety and soundness and compliance supervision grows from the detailed, core knowledge that our examiners develop and maintain about each bank's organizational structure, culture, business lines, products, services, customer base, and level of risk; this knowledge and expertise is cultivated through regular on-site examinations and contact with our community banks, and close, day-to-day focus on the activities of larger banks."
Is this why almost all our major banks essentially failed in 2008?
