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Home Publications Blogs Beat the Press Martin Feldstein and Robert Rubin Discover Bubbles

Martin Feldstein and Robert Rubin Discover Bubbles

Friday, 15 August 2014 04:26

In one of the more remarkable shows of chutzpah in modern economic policy, Martin Feldstein and Robert Rubin penned a joint oped in the Wall Street Journal warning that the Fed needs to take seriously the risk of asset bubbles. The basis for the chutzpah is that this column is appearing in the summer of 2014 instead of the summer of 2004, when it could have saved the United States and the world from an enormous amount of suffering.

Had these men written a similar column in 2004 warning about the housing bubble (as some of us were desperately trying to do at the time) it undoubtedly would have received enormous attention in both the policy and financial community. Both men were considered the pillars of economic wisdom for their respective parties. Feldstein served as head of the Council of Economic Advisers under President Reagan and had trained most of the other leading lights of conservative economics. Rubin has served as Treasury Secretary under President Clinton and had advanced the careers of figures like Larry Summers and Timothy Geithner.

Unfortunately, instead of warning of the bubble, they were profiting from it. Rubin was a top executive at Citigroup, which was one of the biggest actors in the securitization of subprime mortgages. Feldstein was on the board of AIG, which was issuing credit default swaps on mortgage backed securities with a nominal value well into the hundreds of billions. 

For what its worth, their current warnings are misplaced. The Fed has to concentrate on trying to promote growth and getting people back to work. The risk from inflated asset prices that they identify are primarily a risk that some hedge funds and other investors may take a bath when asset prices (like junk bonds) move to levels that are more consistent with the fundamentals.

Unlike the housing bubble, these inflated asset prices are not driving the economy. This means that the economic repercussions of a decline in the price of assets like junk bonds will be largely limited to the losses of the people who invested in them. That is the way a market economy works. People make bets and some lose, so what?

It is also worth noting that Federal Reserve Chair Janet Yellen is far ahead of Feldstein and Rubin on the problem of bubbles. Last month she warned of the over-valuation of some assets in her congressional testimony. Since then the price of these assets, notably junk bonds, has fallen, reducing the potential risk they pose to the financial sector. It makes far more sense to deal with out of line asset  prices by trying to use targeted actions to bring them back into line than to throw millions of people out of work, and reduce the bargaining power of tens of millions more, by raising interest rates.

Comments (11)Add Comment
What, Me Worry?
written by Ellis, August 15, 2014 9:36
I am glad to see that Dr. Baker is so sanguine about the prospects for any dangers in the financial sector.

But some have expressed concern:
Back in May, Christine Lagarde, the head of the IMF, openly admitted to an audience of bankers in London that she was worried about the increasing concentration of banking capital since 2008 and by the “time bombs” that these banks were fostering.

In the Financial Times, some officials openly expressed alarm over how much money companies have been borrowing to fund dividend increases.

By the Fed handing those bankers even more money is like trying to fight a fire with gasoline.
written by Dryly 41, August 15, 2014 10:29
It seems to me that if messers Rubin and Feldstein were even semi-serious about restoration of a safe and sound financial system they would advocate a return to the restrictions on interstate branch banking passed by a Republican Congress and signed into law in 1927by President Calvin Coolidge with Andrew W. Mellon and Herbert Hoover his Secretaries of Treasury and Commerce. There were two main objectives of these Republicans: first, to protect small banks on whom the real economy depended from predators, and, second, to prevent the concentration of economic and political power they witnessed in the person of J.P. Morgan. This was the starting point for New Dealers who kept this law and built on it. It was repealed in 1994 by the Clinton administration which created "Too Big Too Fail" financial conglomerates which basically rules the political and economic system today.

Messers Rubin and Feldstein might also advocate the return of the "strict supervision" aspects of Glass-Steagall that were repealed in 1999 also in the Clinton administration(they did, however, keep deposit insurance and only repealed the "strict supervision" measures designed to meet the "moral hazard" created by the deposit insurance). They could advocate the separation of commercial and investment banks and restore the restrictions on speculative activities by banks.

They could advocate the "strict supervision" of the "shadow banking" system that grew during the Reagan and Clinton administration.

Rubin and Feldstein are not really serious about restoring a safe and sound financial system. Elizabeth Warren and Simon Johnson are.
Chutzpah? How About A RICO Indictment?
written by Larry Signor, August 15, 2014 11:01
Is it really necessary to delineate the crimes of Rubin or the narcissistic economics of Feldstein? They are two of the six people most responsible for the Great Recession (that is not to say there were no other culprits). These two "gentlemen" belong in a federal penitentiary. The Wall Street Journal is merely guilty of chutzpah.
"People make bets and some lose, so what?"
written by Bill, August 15, 2014 11:54
I worry that the hedge funds are so leveraged up that we don't know what ticking time-bombs are there. A small but significant example was LTCM. So since we allow systemic risk to profligate, it's not unreasonable to worry that a bubble popping will expose harmful investments.

This doesn't absolve Rubin or Feldstein of their sins.
written by Peter K., August 15, 2014 11:57
But LTCM, '87 and the tech stock bubble didn't really hurt the economy as the housing bubble did. That's Baker's point.
written by JDM, August 15, 2014 1:24
That's precisely the problem: that what happens to rich people is considered a far more important part of the economy than what happens to the middle class and poor. These present bubbles, as Dean points out, create a potential big problem for the rich but not everyone else (ie., the vast majority of people). Somewhere along the line we made the mistake of pretending stock market reporting was economy reporting. (As I remember, this was helped in earnest by Reagan-era reporting but actually started somewhat earlier, when large interest rates were being paid in money market funds.). We need to have reporting about the economy that isn't dominated by the numbers for the Dow and S&P. I don't know how we get the media to do that, but making whatever noise we can can only help.
Housing Bubble II
written by JayR, August 15, 2014 9:23
Why are Martin Feldstein and Robert Rubin talking about this now? It is not because they are nice guys but rather they want to be able to say that they saw this problem coming. There is currently a housing bubble and also commercial real estate bubble. Yes it may not yet be as big a bubble as last time but given the currently weak and debilitated state of our economy this smaller bubble could actually do more damage when it pops then we had last time.
spotting bubbles is hard
written by Bill, August 16, 2014 4:36
With all due respect, I recall that your paper calling a housing bubble (11% to 22% over priced) came out in the middle of 2002, not 2004. And that people that bought in 2002 have generally done fine. If someone as intelligent and well informed as you (I'm being serious, not sarcastic) can be wrong on a bubble call, I have to disagree with the recommendation that the Fed or anyone else make policy based on bubbles. The Fed should focus on full employment and inflation.
Fed should not make monetary policy based on bubbles
written by Dean, August 17, 2014 7:22

I picked 2004 rather than 2002 just to take the 10-year mark. I still think I was right about a bubble in 2002. (Inflation-adjusted house prices are roughly flat with 2002 levels.) I would not, and did not, advocate that the Fed raise interest rates to attack the bubble in 2002. I suggested that it should both use regulatory powers and public warnings about house prices. The economy was quite weak at the time and needed the boost from low rates.

FWIW, I doubt that house prices would be as high as they are today if we had more normal interest rates (5-6 percent 30-yr mortgages). We have low rates today because of the bubble collapse and resulting fallout. So, I don't feel I made a mistake in my 2002 warning.
written by dick c, August 17, 2014 9:07
Martin Feldstein and Robert Rubin Discover Bubbles? My first thought is that they must have been drinking champagne.
Fed and bubbles
written by Bill, August 17, 2014 5:58
I'm glad you didn't/wouldn't advocate higher interest rates to try to reduce housing prices in 2002. I have to say "reduce housing prices" instead of "attack the bubble" because a 0% real fall in prices over 12 years seems like fairly solid proof that there was no bubble as of 2002. There probably was evidence of the sort of fraud that led to the bubble in the ensuing years and it's a pity that nothing was done to root that out then, and so little has been done even to date. I think most studies show little correlation between housing prices and interest rates. Which makes sense when you think about it. That is, assuming mortgage rates rise to 5%-6% in the next couple of years, I'd expect us to concurrently see a lower unemployment rate and finally some wage gains. So net-net, I'd expect housing prices to move more or less with inflation. And by more or less, I mean that I'd be somewhat surprised to see housing prices track inflation or any other index closely. To conclude, I think that when most people read a prediction that something is a bubble, they assume that this is also a prediction that prices will eventually fall and that after the fall that the prices will not bounce back to that same level even while the economy is underperforming its potential. Without that sort of implied prediction, I think calling something a bubble is meaningless. Kind of like the hyperinflation predictors who have changed the definition of inflation to mean money supply.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.