Paying the Price for the Fed’s Success
By JAMES GRANT
New York Times
HIGH finance, like some unreliable common stock, goes lower and lower. How did so many experts misjudge so badly? How could the supposedly “contained” subprime mortgage problem metastasize into a global financial panic (some days to the down side, other days to the up side)? And after this drama, what?
Ben S. Bernanke, the chairman of the Federal Reserve, inadvertently warned of the coming troubles four years ago. Speaking to fellow economists in Washington, he described the peace and quiet that, for 20 years, had been gradually settling over the American economy. Compared to the 1970s, recessions were mild and scarce, he noted. Inflation, that bane of yesteryear, was dormant. Economic growth was no longer spasmodic but smooth and almost predictable. The name he gave to these manifold blessings was the Great Moderation, and he thanked the Fed, in which he then served as a governor under Alan Greenspan, for helping to bring them about.
But it was actually the Great Complacency that Mr. Bernanke had put his finger on. In finance, to borrow from the economist Hyman Minsky, nothing is so destabilizing as stability. The paradox is easily explained. Profit-seeking people will take more financial risk when they believe the coast is clear. By taking bigger chances, however, they unwittingly make the world unsafe all over again.
Anxious people don’t ordinarily get in over their heads; it’s the confident ones who do. And nothing builds confidence like the belief that a greater power has conquered the business cycle and laid inflation low. In such happy circumstances, a calculating human will take out a bigger mortgage, build a bigger hedge fund or attempt a gaudier corporate buyout. That is, he or she will borrow more money, or, as they say on Wall Street, lay on more leverage.
(Continued here.)
New York Times
HIGH finance, like some unreliable common stock, goes lower and lower. How did so many experts misjudge so badly? How could the supposedly “contained” subprime mortgage problem metastasize into a global financial panic (some days to the down side, other days to the up side)? And after this drama, what?
Ben S. Bernanke, the chairman of the Federal Reserve, inadvertently warned of the coming troubles four years ago. Speaking to fellow economists in Washington, he described the peace and quiet that, for 20 years, had been gradually settling over the American economy. Compared to the 1970s, recessions were mild and scarce, he noted. Inflation, that bane of yesteryear, was dormant. Economic growth was no longer spasmodic but smooth and almost predictable. The name he gave to these manifold blessings was the Great Moderation, and he thanked the Fed, in which he then served as a governor under Alan Greenspan, for helping to bring them about.
But it was actually the Great Complacency that Mr. Bernanke had put his finger on. In finance, to borrow from the economist Hyman Minsky, nothing is so destabilizing as stability. The paradox is easily explained. Profit-seeking people will take more financial risk when they believe the coast is clear. By taking bigger chances, however, they unwittingly make the world unsafe all over again.
Anxious people don’t ordinarily get in over their heads; it’s the confident ones who do. And nothing builds confidence like the belief that a greater power has conquered the business cycle and laid inflation low. In such happy circumstances, a calculating human will take out a bigger mortgage, build a bigger hedge fund or attempt a gaudier corporate buyout. That is, he or she will borrow more money, or, as they say on Wall Street, lay on more leverage.
(Continued here.)
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