David Leonhardt had a fantastic front pager in the New York Times yesterday that was such a compelling read, I re-read it to try and absorb anything I missed the first time. The article Fed Missed This Bubble. Will It See a New One? looked at the case made by the Fed to enhance its regulatory power.

David asks the question for the Fed:

If only we’d had more power, we could have kept the financial crisis from getting so bad.

But power and authority had nothing to do with whether they could see a bubble.

In 2004, Alan Greenspan, then the chairman, said the rise in home values was “not enough in our judgment to raise major concerns.” In 2005, Mr. Bernanke — then a Bush administration official — said a housing bubble was “a pretty unlikely possibility.” As late as May 2007, he said that Fed officials “do not expect significant spillovers from the subprime market to the rest of the economy.”

I maintain that because of human nature, mob mentality, or whatever you want to call it, all regulators drank the kool-aid just like consumers, rating agencies, lenders, investors and anyone remotely connected with housing. Regulators are not imune from being human.

Once the crisis was upon us, the Fed and the regulatory alphabet soup woke up and began drinking a lot of coffee.

David concludes:

Which is why it is likely to happen again.

What’s missing from the debate over financial re-regulation is a serious discussion of how to reduce the odds that the Fed — however much authority it has — will listen to the echo chamber when the next bubble comes along.


I think this whole thing started with the repeal of Glass-Steagal where the boundaries between commercial and investment banks which were set during the Great Depression, were removed. Commercial banks had cheap capital (deposits) and could compete in the Investment Banking world. But Investment banks could not act like commercial banks. Their access to capital was more expense motivating them to get their allowable leverage ratios raised significantly. One blip and they go under.

Tags: , ,

5 Responses to “Regulators Are Human. That’s Precisely Why Bubbles Are Not Preventable”

  1. There was enough Kool-Aid to go around and we all had some, it kept us delusional, everything looked so pretty. I can’t recall anyone really seeing this coming in its entirety.

    How can there be annual price increases of 10%-30% or more every single year and no one wonders about the endgame? It did used to concern me, though not enough apparently, that these non-stop every year price increases would out strip peoples earning ability even in Manhattan.

    For a while it did, there was a period of time when we seem to have used up or scared off all the wealthy buyers in New York.

    The principal of the firm I was with last year finally said in March 2009, “We have to stop telling people that things are good.” That firm specializing in high end properties, shuttered in April.

    We’re in the thick of it now and seem to prefer the thought that our current situation is unique and that it’s never been this bad.

    But this has happened before, it’ll happen again. I hope the next time we see the precipice before we all take the Lemming plunge. I know I’m sticking with straight coffee, thanks but no thanks on the Kool-aid.

  2. Well, I’m not quite on board with this theory of the innate human inability to predict the future as being the problem. Although I agree it has some merit. However, the seminal problem was not in the housing sector.

    If it is possible for Bernake to de-politicize banking regulation by placing the FED in charge, then I agree that it should be done. Banking, de-regulated, brought use this crises, and the housing stuff was the visible part of it. We should now be able see it for what it was and I’m surprised anyone is still talking about the “housing bubble”.

    The lenders manipulated the demand signals for their own gain. The underlying problem really has little to do with whether housing prices go up or down. If the housing industry had not been the vehicle another would have been found.

    We should, however, understand permanently that human greed will create excess, with not always good results for all.

    The free market idealogy that gripped the Greenspan years puposefully ignored the problems that greed run rampant has always brought us and emphasized the belief that the free market would correct the greedy, those who perrenially take way more than they deliver. Well, I guess it could be said by the free market purist that the recession or bubble popping is the correction.

    I like Jonathan’s theory that the problem began with deregulation of an industry that was regulated for extremely good cause. The only thing closer to Wall Street’s heart than money is more money and we have known that for a long, long time. How anyone thought that less scrutiny of the Street and it’s lending industry would bring us a more healthy economy just doesn’t read history.

    The guy is right, we can’t accurately read the tea leaves, but if the banking industry is asking for more regulation, less regulation or anyting else we should beware that it most likely is designed to cost us all.

    If the regulation has to be placed in the FED to circumvent admistrative or congressional eviceration then that is where it should be. But, we have got to have regulation and enforcement.

    Now for the really pressing question, how do we prevent the appointment of another FED chairman who shares the Greenspan idealogy?

    I don’t think we can survive another version of the free market. Not too soon anyway.

  3. Banking is a self sufficent industry that should take its lumps. They are the real winners in all of this from stealing from the people to getting bailed out to stealing again.

  4. Bob Stahl says:

    I’m very interested to see what regulatory changes will be enacted. It’s true that regulators are humans and bubbles aren’t preventable, but it didn’t have to be so bad. The Obama Administration promised new regulations — we’ll see if he delivers.

  5. Nice post. I hope Pres. Obama will do his promise about the regulations.