A sentence from the abstract is particularly interesting: “We conclude by arguing that economic theory provides little guidance as to what
should be the “correct” level of asset prices —including housing prices.”

My comments:

This is the latest effort from The Federal Reserve which questions whether asset bubbles,  in this case the Housing Bubble, can be accurately identified as they form.

While one may argue as to whether economic theory can accurately spot asset bubbles, there definitely is a chronic need to do so – as well as to take proper remedial action.  As I wrote in an April 8 post, “Our societal inability to spot and prevent asset bubbles is problematical.”  We simply can’t afford to go through numerous asset bubble booms and busts.   This issue is especially critical now given that there are numerous large asset bubbles currently in existence on a global basis.

A Special Note concerning our economic situation is found here

SPX at 1079.47 as this post is written

From the story: “The health-care products firm sold 10-year bonds with an interest rate of 2.95%, or a risk premium of 0.43 percentage point over comparable Treasurys.”

The story provides an overview of the strong market environment for both corporate and junk bonds.

My view is that the entire corporate bond market is in a bubble.  This bubble is related to the bubble in U.S. Treasuries which I have previously commented upon.

A Special Note concerning our economic situation is found here

SPX at 1092.54 as this post is written

While most people wouldn’t think of the bond market as having bubble characteristics, nonetheless such a bubble has developed.

The article mentions several vulnerabilities the bond bubble faces.  I would add that a major vulnerability is a repricing of risk due to perceived asset quality, due to a variety of issues.

back to <home>

SPX at 1086.84 as this post is written

chart courtesy of StockCharts.com

(one can click on the chart to enlarge the image)

Maurice Walker’s accompanying comment:

“The Keynesian Cure Never Works

The US had a massive malinestment (An investment in wrong lines which leads to capital losses. Malinvestment results from the inability of investors to foresee correctly, at the time of investment) in housing induced by affordable housing mandates, easy money from the Fed, and Fannie and Freddie guaranteeing mortgages that they had no business guaranteeing.

You cannot get over a debt infused recession with more debt. You have to work off the malinvestment. This is why the Keynesian cure never works. Just look at Greece.

But instead of working off the malivestment, we are trying reinflate the housing bubble with more spending. We are trying to reinflate the economic bubble with the stimulus package.

The Fed has to keep pressing the accelerator faster and faster to main tain the same simulative effect. But if the keep doing this it will cause inflation to arise. Additionally, the Fed already engineered a runaway expansion of the monetary base, that will generate explosive inflation. The borrowing needs of Obama’s record-shattering deficits will only exacerbate the effect. We are moving from a housing bubble to a government debt bubble that is going to ultimately collapse the dollar.”

_____

back to <home>

SPX at 1092.58 as this post is written

Of course, investing in bubbles can be profitable.  As I wrote in the December 3, 2009 post, “Investing in bubbles can be extremely profitable on the way up; however, for the “long” investor they can produce huge losses if one doesn’t time the exit appropriately.”  History has shown that the (vast) majority of investors don’t time the exit appropriately.

While I have extensively written of how problematical the asset bubble situation is today, it should be noted that others have written to the contrary.   The April 25 2010 post concerning work by Frederic Mishkin and an April 27 article by James Picerno are two prominent examples.

back to <home>

SPX at 1085.04 as this post is written

This is from a September 26, 2005 speech he gave in which he speaks about how negative “shocks” may impact the economy.  I find this quote interesting as it is an example of, among other things, how one can overlook the severity of embedded risks in a bubble environment:

“How significant and disruptive such adjustments turn out to be is an open question. Nonetheless, as I have pointed out in previous commentary, their economic effect will, to a large extent, depend on the flexibility inherent in our economy. In a highly flexible economy, such as the United States, shocks should be largely absorbed by changes in prices, interest rates, and exchange rates, rather than by wrenching declines in output and employment, a more likely outcome in a less flexible economy.”

This next quote is from his “The Crisis” paper, p. 45:

“‘…history has not dealt kindly with the aftermath of protracted periods of low risk premiums.’”

back to <home>

SPX at 1217.28 as this post is written

In that speech, he refers to Frederic Mishkin’s speech of May 15, 2008.  It should also be noted that Mishkin offered similar thoughts in a Financial Times op-ed of November 9, 2009.

There is much I can comment about in each of Mishkin’s commentaries about bubbles.  For now, I will limit myself to the following:

Here is a passage from the aforementioned 2008 speech which I found most interesting:

“…monetary policy should not try to prick possible asset price bubbles, even when they are of the variety that can contribute to financial instability. Just as doctors take the Hippocratic oath to do no harm, central banks should recognize that trying to prick asset price bubbles using monetary policy is likely to do more harm than good. Instead, monetary policy should react to asset price bubbles by looking to the effects of asset prices on employment and inflation, then adjusting policy as required to achieve maximum sustainable employment and price stability. This monetary policy response should prove sufficient to prevent adverse macroeconomic effects of some types of asset price bubbles.”

I interpret this (and other points in his speech) as (in effect) saying that monetary policy shouldn’t be used to prevent bubbles, but it should be used to “clean up the mess” should they “pop.”

This “mindset” seems to be prevalent now among policy makers.

I believe this overall “treatment” of bubbles is frightfully perilous, has already created immense damage, and will end very badly.

It appears as if not only are we (as a nation) downplaying the risks of bubbles, but also are continually unable to identify their existence.

As I wrote on March 29: “I strongly disagree with those who think that bursting bubbles are not something to be unduly concerned about….While it may be pleasant to ignore the existence of bubbles, and downplay the potential significance of their bursting, I believe that the existence and prevalence of bubbles in today’s worldwide economy is perhaps the largest threat to achieving Sustainable Prosperity.”

back to <home>

SPX at 1217.28 as this post is written

Although there are many parts of this speech with which I disagree, I found this speech noteworthy and interesting.

I could make exhaustive comments about many parts of this speech.  However, for now, I will comment on two aspects:

This speech continues the trend of other Federal Reserve (as well as a general widespread perception) statements that imply that there is an institutional belief at The Federal Reserve that there are no asset price bubbles in existence now, or at least not in the United States.  Dudley does say that “I am going to be a bit of a heretic and argue that there is little doubt that asset bubbles exist and that they occur fairly frequently.”  However, he does not name any that are currently in existence – he just talks of those in the past.

Our societal inability to spot and prevent asset bubbles is problematical.  As I have stated before, there are many bubbles in existence now, and they represent a grave danger to our economic system.

Another interesting statement that Dudley makes is the following, which is very noteworthy not only to investors but to others (including policy makers) as well:

“…a bias toward optimism may also play an important role. Studies have found that most people believe that they are above average in terms of their acumen, be it as investors, car drivers or in other activities.⁵ This overconfidence may cause some people to keep investing in the asset, even when they are skeptical about its valuation because they are overly confident that they will anticipate the end of the bubble and be able to get out in time.”

Dudley’s speech also references a 2008 speech by Frederic Mishkin of which I may comment upon later.

back to <home>

SPX at 1176.38 as this post is written

I found the video to be most interesting.  Greenspan elaborates upon his recent “The Crisis” paper, which I mentioned here.  As well, he discusses many other issues.

While there is much I can comment upon in this interview, I want to focus on a key phrase he mentions with regard to what is now happening:

“You can see the whole blossoming of finance.”

I believe this to be the most notable of all of Greenspan’s famous phrases.

I think we are seeing a blossoming – not of “finance”, but instead of (hyper)bubbles.  I think there are many bubbles of severe magnitude throughout the worldwide economy.  I have previously written of these bubbles in a variety of posts.

I strongly disagree with those who think that bursting bubbles are not something to be unduly concerned about.  In fact, Greenspan says in the interview, “Remember that the bursting of the bubble by itself is not a big catastrophe. We had a dot-com bubble, it burst, and the economy barely moved.”

While it may be pleasant to ignore the existence of bubbles, and downplay the potential significance of their bursting, I believe that the existence and prevalence of bubbles in today’s worldwide economy is perhaps the largest threat to achieving Sustainable Prosperity.

back to <home>

SPX at 1166.59 as this post is written

The four purported bubbles mentioned in the article are Gold, oil, the stock market, and Treasuries.  I have discussed each of these markets, with the exception of oil, in previous posts.

I found the logic and discussion in the article interesting, although I did not agree with various aspects of the article.  I especially disagree with the logic about housing, for reasons I have recently written about.

It is very important for investors to understand whether the markets they are investing in are indeed experiencing bubbles.   My previously written posts are found under the “Bubbles” Category.

Of course, the existence and prevalence of bubbles also has massive ramifications for the economy, especially when viewed from the standpoint of Sustainable Prosperity.

back to <home>

SPX at 1137.15 as this post is written