Monday, October 13, 2008

Bubbles begetting bubbles

To me, it is apparent that the cause of the current financial crisis is the Federal Reserve's attempt to avoid a recession after the collapse of the dot-com bubble. They weren't able to avoid it, only delay it, and now the bill is coming due, with interest. I am concerned that the current interventions may repeat the mistakes of the past, and avoid substantial hurt now only to cause greater hurt later.

Unlike my esteemed colleague, I don't think that government intervention by itself is the source of the problem. It can cause numerous problems, but I don't think government intervention in the markets is the source of bubbles. I would be less worried about catastrophic hurt further down the line if the hurt today is severe enough. That means primarily two things: property values have to at least fall back to long-term trends (possibly as measured by the ratio of household income property value), and the banks have to see a lot of their shareholder value evaporate. That can be due to bank collapses, share price collapses, or, more likely, some combination of the two.

I can't find the link, but I read an analogy of the financial crisis to forest fires. Under normal circumstances, forests have fires on a semi-regular basis. That thins out the trees, burns out all the accumulated underbrush, fallen branches, etc. It's generally not a big problem, in aggregate. However, when there are humans in the equation, they put out the fires. The trees grow more thickly and the combustible elements have a chance to build up. The forest fires aren't avoided so much as delayed. What happens in the end is a catastrophic fire that rages and burns everything down.

That's sort of how I see the current situation. I want the fire to burn long enough to thin out the trees and to burn out all the flammable underbrush. I don't want it to wipe everything out. There needs to be enough destruction to purge all the crap that has accumulated over the last 2 decades since the last "real" recession, in the early 1990s. Obviously, I don't want to see the whole world burn. Another analogy that I won't belabor is chemotherapy. You have to suffer a lot to completely kill the cancer; you don't want to just wound it, because then you've injured yourself, but you haven't actually fixed anything.

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Anonymous Anonymous said...

Undeniably busts and booms are part of the natural economic cycles. I never meant to imply otherwise.

However, the government's role in the latest boom and bust is undeniable. Had they had different policies, the current situation would look much different. In fact, the word "crisis" might even not have been used.

Look at the dotcom boom versus the housing boom. The first bubble was technology driven: the imagination of possibilities outran reality.

But what drove the housing bubble? If you give any serious amount of thought to it, the government's role is much stronger.

October 13, 2008 at 7:19 PM  
Blogger Ketan said...

Note that my very first sentence attributed the housing bubble to the government, specifically the Federal Reserve.

October 13, 2008 at 7:34 PM  
Anonymous Anonymous said...

Sure. I guess we basically agree then.

October 14, 2008 at 7:53 AM  

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