August 15, 2014
In one of the more remarkable shows of chutzpah in modern economic policy, Martin Feldstein and Robert Rubin penned a joint oped in the Wall Street Journal warning that the Fed needs to take seriously the risk of asset bubbles. The basis for the chutzpah is that this column is appearing in the summer of 2014 instead of the summer of 2004, when it could have saved the United States and the world from an enormous amount of suffering.
Had these men written a similar column in 2004 warning about the housing bubble (as some of us were desperately trying to do at the time) it undoubtedly would have received enormous attention in both the policy and financial community. Both men were considered the pillars of economic wisdom for their respective parties. Feldstein served as head of the Council of Economic Advisers under President Reagan and had trained most of the other leading lights of conservative economics. Rubin has served as Treasury Secretary under President Clinton and had advanced the careers of figures like Larry Summers and Timothy Geithner.
Unfortunately, instead of warning of the bubble, they were profiting from it. Rubin was a top executive at Citigroup, which was one of the biggest actors in the securitization of subprime mortgages. Feldstein was on the board of AIG, which was issuing credit default swaps on mortgage backed securities with a nominal value well into the hundreds of billions.
For what its worth, their current warnings are misplaced. The Fed has to concentrate on trying to promote growth and getting people back to work. The risk from inflated asset prices that they identify are primarily a risk that some hedge funds and other investors may take a bath when asset prices (like junk bonds) move to levels that are more consistent with the fundamentals.
Unlike the housing bubble, these inflated asset prices are not driving the economy. This means that the economic repercussions of a decline in the price of assets like junk bonds will be largely limited to the losses of the people who invested in them. That is the way a market economy works. People make bets and some lose, so what?
It is also worth noting that Federal Reserve Chair Janet Yellen is far ahead of Feldstein and Rubin on the problem of bubbles. Last month she warned of the over-valuation of some assets in her congressional testimony. Since then the price of these assets, notably junk bonds, has fallen, reducing the potential risk they pose to the financial sector. It makes far more sense to deal with out of line asset prices by trying to use targeted actions to bring them back into line than to throw millions of people out of work, and reduce the bargaining power of tens of millions more, by raising interest rates.
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