Commentaries

from Rolfe Winkler:

Lunchtime Links 12-18

(Reader note: still working on

MUST READ -- Strict framework leaves room for maneuver (Masters/Jenkins, FT) While this subject may seem a little dry, it's the Basel Committee in Switzerland that will lead the way when it comes to how banks measure capital and how much they need to have. I'll offer more detailed thoughts on this later today.

Saab to be shuttered (Reuters wire) More creative destruction in the auto industry. In the end, the best Saab could do was sell the intellectual property for the 9-5 and 9-3 sedans...

China central banker says harder to buy Treasuries (Xin/Subler, Reuters) How ironic. The current account deficit is shrinking as the import/export imbalance with China is shrinking. So we're not stuffing as many dollars down China's throat which it is forced to recycle into Treasuries. Watch out for calls to buy Chinese so that the Treasury can finance its deficits! ;)

China asset bubbles will burst on inflation (Chen, Bloomberg)

Greenspan backs deficit reduction commission (Ferraro/Sullivan, Reuters)

Harvard swaps are so toxic, even Summers won't explain (McDonald/Lauerman/Wee, Bloomberg)

Bubble, bubble toil and trouble

NEW YORK, July 29 (Reuters) – The Federal Reserve seems to be volunteering to be top bubble burster. In a recent speech, Bill Dudley, the president of the Federal Reserve Bank of New York, overturned more than a decade of Fed orthodoxy by claiming it was the central bank’s duty to defuse asset price bombs before they detonate.

As the United States struggles with the fallout from the bursting of the housing and credit bubbles, the Fed may win applause for being proactive. By the time the next one starts to inflate, however, Fed officials may regret they raised their hand. Doing the job properly will certainly make them unpopular and there is no guarantee that it will even work.

But this is no reason not to try. Reducing violent swings in asset prices would be a hugely valuable service. As the latest crisis demonstrated, asset manias can devastate the banking system, stop the economy dead in its tracks and decimate the wealth of Americans.

The first problem the Fed would face is in identifying bubbles. A bubble is a market where assets become overvalued relative to the future returns they offer. Sadly, without a crystal ball, pinning down future returns is difficult. This was Alan Greenspan’s chief objection to targeting asset prices, although his famous “irrational exuberance” speech suggests he knew a market mania when he saw one. Having identified a market delusion, the Fed would then face a political hurdle. Asset price surges create wealth. They are popular. Politicians see them as a vindication of their policies.

A Fed chairman who dared to tighten policy to slow house price appreciation would need nerves of steel. “Even a slight change in regulation on housing and you get upwards of 30,000 angry letters,” says Vincent Reinhart, a former Fed official.

Finally, the Fed would face practical problems. Monetary policy is a crude tool. Try to crack a nut with a large hammer and you may end up breaking the table. Alternatively, you may damage the table and fail to hit the nut altogether — undermining the economy without puncturing the bubble.

Despite the difficulties, Dudley is right to be positive. While one measure alone might not have slowed house price growth, a host of small steps might have helped contain the problem.