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A Bubble In Search of a Pin


Should Greenspan, Bernanke, and the entire Fed have seen it coming?


And again from the NFIB, small businesses see very tight credit conditions, which makes it hard for them to expand (see chart below). The headlines this week from the Fed banking survey said that banks were prone to be less tight, but the NFIB writers went deep into the report. What they found is that very large banks are willing to be less tight in their lending standards. Smaller banks were, in fact, not as easy. Loan demand is falling. Consumer credit actually declined slightly in December, after plunging in November. If you can't count on Americans to buy during Christmas, the world is in fact moving to the New Frugal.

All of this isn't the stuff that robust recoveries are made of. We drift back into Muddle Through the last half of the year, I think. And if Congress doesn't act to postpone or mitigate the enormous tax increases due in 2011, we slip back into recession. It will be a policy error of major magnitude to raise taxes with 10% unemployment and a weak economy.

A Bubble in Search of a Pin

This Time Is Different, by Carmen M. Reinhart and Kenneth Rogoff is a book you should buy and read, especially the last four to five chapters, and try to get your Congressperson to read it as well, so he or she can see what happens to countries that run up their debt. It makes no difference if it's small or large, the end result is the same.

Last week we looked at the role of confidence in allowing governments to borrow money. This week we ask whether Greenspan and Bernanke, along with the entire Fed, should have been able to determine whether a bubble was building in the US economy and lean against it, preventing the debacle we're now in. Reinhart and Rogoff gently come down on the side of those who think they should have, and that we need to implement changes in our institutions. Others, as we'll see, aren't so gentle. Let's look at a few selected paragraphs (all emphasis mine).

As we will show, the outsized US borrowing from abroad that occurred prior to the crisis (manifested in a sequence of gaping current account and trade balance deficits) was hardly the only warning signal. In fact, the US economy, at the epicenter of the crisis, showed many other signs of being on the brink of a deep financial crisis. Other measures such as asset price inflation, most notably in the real estate sector, rising household leverage, and the slowing output -- standard leading indicators of financial crises -- all revealed worrisome symptoms. Indeed, from a purely quantitative perspective, the run-up to the US financial crisis showed all the signs of an accident waiting to happen. Of course, the United States was hardly alone in showing classic warning signs of a financial crisis, with Great Britain, Spain, and Ireland, among other countries, experiencing many of the same symptoms.

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