Global Agenda: Bubbles and blame

We live in the immediate aftermath of thebursting of two of the biggest financial bubbles in history (if not thebiggest), namely the housing bubble and the credit bubble. Barely nineyears ago, the greatest stock market bubble in history - theInternet/ mania - climaxed. There have been other, morelocalized bubbles, too, in China a couple of years ago and in Japan 20years ago. This is, in many ways, a bubbly age.

Itis therefore hardly surprising that the new fashion is to seek bubblesunder every nook and cranny. Headlines in the international mediaregularly hail something or other as "the next bubble." In Israel, thisvery week, an equity analyst at one of the large local investmenthouses made headlines by accusing the Bank of Israel of creating abubble in the local housing market, by holding interest rates very low.

This, it is now often claimed, is the very crime that theerstwhile hero and demigod, Alan Greenspan, committed as chairman ofthe Federal Reserve Board when he cut interest rates from 6 percent to1% and held them at what was then considered an amazingly low rate fora long time - thereby flooding the financial system with vast amountsof cheap money, which inflated the housing and credit bubbles.

Israel has seen its bubbles, too - and was an enthusiastic andleading participant in the mania, although it missed outcompletely on the housing/credit bubbles. But there is only a remotechance that this country will experience a bubble in housing, or inanything else, any time soon.

Housing prices are indeed rising, but not everyprice rise, or even full-scale boom, is a bubble. And when there is abubble, don't expect economists, equity analysts, or anyone else whouses spreadsheets and models as their main tools, to identify it foryou. On the contrary, expect them to explain patronizingly why "thistime, things are different," and why, according to some newmethodology, the patently insane prices are, in fact, perfectlyjustified - and likely to go much higher.

The basic fact about bubbles is that they are not economic orfinancial phenomena but rather stem from processes belonging to thefields of sociology and mass psychology. All bubbles require that alarge population, often an entire country, or even, as in the creditbubble, an entire civilization, loses its collective rationality,detaches itself from accepted behavioral norms and willingly suspendsits natural disbelief in absurd concepts.

In short, bubbles play out in la-la-land - andnowhere else. True, the mechanics of financial bubbles require theready availability of a huge supply of cheap money, so that thefinancial part of the bubble is an essential condition, butnevertheless quite insufficient in itself. Right now there is a hugeamount of cheap money available around the world, but no bubble existsthat encompasses a large population.


As for the indictment against Greenspan, he is indeed guilty ofmany things, including failing in his primary task of the conduct ofmonetary policy. But whereas an entire generation of economists andfinanciers has grown up with the belief that the financial system isthe arbiter of the fate of individuals and nations, and that thecentral bank is the linchpin of the financial system, there are still afew professional economists who have the intellectual ability andhonesty to know and accept the limitations of their profession and itstools.

One such economist is Robert Shiller, whose objective analysisof the US housing market led him to identify the problems and warn (invain) against the impending disaster years in advance. Yet he hassufficient humility to admit that mainstream economic analysis,grounded as it is in assumptions of rational behavior, cannot handlebubbles and that the new field of "behavioral economics" is essentialto understand these phenomena. And he has adjusted his thinking andwork accordingly.

Shiller also punctures the simplistic "Greenspan is thevillain" argument by pointing out that the housing markets in the USand the UK followed remarkably similar paths in the decade prior to thecrash. Yet the monetary policies pursued in the two countries werequite different. In other words, very cheap money is not THE cause ofthe bubble and the central bank is not the primary guilty party.Rather, it is the entire society, leaders and led, professionals andlaymen, that is to blame for taking leave of its senses and attemptingfinancial suicide.

Not surprisingly, that's not a popular approach, because theaverage guy wants to hear that he was a victim, not a willingaccomplice. But, unpalatable as it may be, it's the truth - about allbubbles, including both the recent ones and future ones.