Wednesday, May 21, 2008

Can the Fed beat a bubble?

Hardly. Says Dan Gross in Slate.

"….So how could the Fed stop bubbles? One way might be for Federal Reserve chairs and other officials to use their credibility to talk down investors from making poor bets. But even on its best days, the market doesn't listen to reason. During a bubble? Forget about it. A bespectacled jargon-dispensing economist standing astride the rails and yelling stop isn't likely to have much effect on a runaway locomotive. Alan Greenspan gave his famed irrational exuberance speech on Dec. 5, 1996. But the Dow Jones Industrial Average and the NASDAQ ran up 82 percent and 288 percent, respectively, in the three years after the speech—before popping….

…..The Federal Reserve is an organization much like any other—run by human beings with fallible judgment, driven by consensus, and less than congenial for ontrarians. In bubbles, skeptics are always marginalized while the promoters are anointed as seers. And when a bubble gets loose, it infects every institution: banks, the media, and, yes, the Federal Reserve. The Fed, in the person of Alan Greenspan, failed to diagnose the Internet bubble accurately, and it misjudged the housing bubble, too. The Fed, in the person of Ben Bernanke, failed to see the credit mess coming. And once that crisis hit, the Fed failed to accurately gauge its scope and depth. When the party really gets going, we all drink from the same punch bowl…."
Bubbles occur because no two minds think alike, yet are easily influenced. Everyone abhors herd syndrome but has it ever stopped? Accept bubbles as natural phenomenon like rain or sunshine. Perhaps it's a bit like life itself that has ups and downs. Attempts to regulate nature have only met with disaster. So the best way to deal with a bubble is to acquire stronger defenses when the storm rages. We will have casualties, but it will leave some scope for faster rehab - in preparation for the next one.

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