Housing, Credit, Inflation...oh my!

Mr. Greenspan on the current credit crisis.

I would add only one thing to Mr. Greenspan's comments. In his book he outlines how past recessions were a matter of disjointed supply and demand. People would get exuberant, stuff would fly off the shelves, and the next thing you know, demand would drive off a cliff. Stores and companies then must work off the excess inventory to "unwind their positions", slashing prices and laying off workers to get by.

He predicts, and I think correctly so, that just-in-time inventory practices and digital commerce have lessened the likelihood of these types of recessions. The last two recessions have been asset bubble based (assuming we are in a recession). Fine. I'm not a fan of more regulation or nationalization (thanks Mr. Summers) in general. What I am a fan of is the Fed using moral suasion on the upside of the next bubble.

The chief issue with an asset bubble is that it involves the masses. In past recessions, Ma and Pa only got involved in recession making if they owned their own store and kept too much stock on the shelves. In the last two recessions, we have all been accomplices in bubble making, and the masses are obviously too foolish to manage ourselves in a mania, no matter how recent the previous asset collapse.

If that is the case then the Fed needs to talk people off the ledge earlier. Greenspan did it cryptically and perhaps prematurely with his "irrational exuberance" comment several years before the dot-com crash. Having missed the mark on the first round, Greenspan joined the ranks of the anti-pessimists, and point-by-point outlined exactly why we were not in the midst of a housing bubble...several months before the contraction began the during the 2nd half of 2005. Bernanke soon thereafter took up the mantle of the swaggering, tobacco chewing, anti-inflation sheriff. "We have nothing to fear but inflation itself."

I completely agree that it's not the Fed's job to value asset prices. That's an incredibly complex problem, and the Fed can't be spooking the markets either. I'm not even blaming the Fed for this last round either...how were they to know it would be this bad? So if the Fed can't attack "inflated prices", what recourse do they have? They need to strike at the ideas of which bubbles are made:

Idea 1: In 2000, "This is a new economy where stock prices only go up."
Fed: Wrong, stock prices go up and down. Now as ever, we must be sure that there is underlying value and underlying income to justify our asset valuations. Markets with irrational expectations have always met with disappointment.

Idea 2: In 2003, "Home prices never go down."
Fed: Wrong, home prices are like all other prices and can go down just as easy as they can go up.

Idea 3: In 2004, "A home is the best investment you can make."
Fed: Wrong, a home is shelter. You pay money, you get shelter. If you're lucky, a home is a form of forced savings and you sell for a bit more than you paid. More dangerously, you must not view a home as an investment because it comes unhinged from the real cost of shelter (the vulgar term is "rent"). A decline in housing prices is viewed entirely different by our culture and our government than is a decline in other assets like stocks. This is especially clear now since people cry "Save my home!" not "Save my investment!"