11 Dec 2012

Sumner Believes in Government-Created Bubbles and Ticking Time Bombs

Federal Reserve, Inflation, Scott Sumner 32 Comments

This is kind of an inside baseball post, so if you don’t “get it,” just move on with your life. Anyway, those who read Scott Sumner closely, especially his incredulous responses to Austrian critics of the Fed, should be puzzled by his latest post in which Scott writes:

Back in the early 1990s lots of liberals I knew argued that the S&L fiasco showed the need for “re-regulation.” And so we re-regulated banking. I argued that the fix would not work, as it didn’t address the core issue—moral hazard. I suggested that Fannie and Freddie were time bombs waiting to go off.

You’ll have to take my word for all that. But not for my 2009 prediction that Obama’s policy of pumping up FHA was another time bomb waiting to go off. His solution to the financial crisis caused by reckless sub-prime lending was to try to use government levers to inflate another sub-prime bubble. The bubble has not arrived yet, but three years later even the New York Times is worried about FHA…

Back in the 2000s lots of market monetarists I knew argued that the Great Recession showed the need for expansionary Fed policy. As so Bernanke inflated more than all previous Fed chairs combined. I argued that the fix would not work, as it didn’t address the core issue–government tinkering with interest rates. I suggested that Bernanke’s inflation was a time bomb waiting to go off.

You’ll have to take my word for all that. But not for my 2009 prediction that Bernanke’s policy of pumping up housing was another time bomb waiting to go off. His solution to the financial crisis caused by reckless monetary policy was to try to use reckless monetary policy to inflate another sub-prime bubble.

Remember kids, Scott Sumner doesn’t believe in bubbles. Except when he does. And then he snaps at you for not reading him carefully.

32 Responses to “Sumner Believes in Government-Created Bubbles and Ticking Time Bombs”

  1. Matt Tanous says:

    How is Sumner saying, “I suggested that Fannie and Freddie were time bombs waiting to go off.” consistent with his claim that there was no housing bubble?

    I contend all of this confusion is a result of Sumner holding to the absurdity that is the EMH.

    • Jason B says:

      “consistent with his claim that there was no housing bubble?”

      Whoa, whoa, whoa………………Scott Sumner doesn’t think we went through a housing bubble?

      • Matt Tanous says:

        That’s basically what I got out of the blog post he wrote here: http://www.themoneyillusion.com/?p=8063

        This is also Murphy’s interpretation, as he wrote here: http://mises.org/daily/4904

        “Ah, but Sumner has an answer: There was no housing bubble, at least if that term is to have any operational meaning.”

        • Jason B says:

          That post was a massive boondoggle. What I came away with was that Sumner didn’t know where bubble predictors were for bubbles that turned out not to be bubbles. Vaguery has competition.

  2. Jonathan M.F. Catalán says:

    Markets are efficient,* except when public–private firms are involved; everyone else knows the fully informed price.

    * I mean in the context of the efficient market hypothesis.

    • Matt Tanous says:

      Which efficient market hypothesis? The one where arbitrage happens rapidly, or the one in which there are no bubbles and no errors in pricing judgement over time?

  3. Tel says:

    There’s no need to worry about FHA it is all sorted. Why do you think the Fed is buying mortgage backed securities? Just say, “back door bailout.”

  4. William Anderson says:

    So, people like Krugman claim that the “untrammeled” free market created a huge financial bubble all by itself (because every regulator in the Bush administration was a disciple of Ayn Rand), but the “solution” is for the Fed to purchase those worthless securities in order to prop up the very markets where there were bubbles. In other words, to try to create a new bubble to replace the old one? And this is the best the Ivy League has to offer?

    My Auburn degree is looking better all the time….

    • Matt Tanous says:

      “In other words, to try to create a new bubble to replace the old one?”

      “To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.” – Paul Krugman, “Dubya’s Double Dip?”, The New York Times, 2 August 2002

      But, yeah. He claims that was a joke, and the free market did it. I suppose we will ignore the fact that he implicitly admitted then that the Fed can and does create booms and busts, and not the market. Apparently, the Austrian theory of the business cycle is only right when Greenspan is trying to use the Fed to “save” the economy by inflating a bubble….

      • Joseph Fetz says:

        “He claims that was a joke”

        Yeah, that was his third and latest explanation. First he said that he never said it, then he said it was taken out of context, now he says it was “obviously” a joke.

        • Mike T says:

          But Joe, there are some other gems from back in ’01, all from different interviews. And of course Krugman knew exactly where rates should have been and for how long so that housing prices didn’t climb higher than he would have otherwise liked. So I’m sure he could wiggle his way out this as well. He’s a slippery fella. Those phlogiston theorists who were warning that this very policy would lead to a housing bubble and credit crisis are obviously not worthy of serious debate. After all, according to his comment in the last quote below, we solved the problem of future business cycles! Oops…

          “During phases of weak growth there are always those who say that lower interest rates will not help. They overlook the fact that low interest rates act through several channels. For instance, more housing is built, which expands the building sector. You must ask the opposite question: why in the world shouldn’t you lower interest rates?”

          “Economic policy should encourage other spending to offset the temporary slump in business investment. Low interest rates, which promote spending on housing and other durable goods, are the main answer.”

          “The good news about the U.S. economy is that it fell into recession, but it didn’t fall off a cliff. Most of the credit probably goes to the dogged optimism of American consumers, but the Fed’s dramatic interest rate cuts helped keep housing strong even as business investment plunged.”

          “However, let’s give credit where credit is due: Mr. Greenspan has cut rates since then. And while some of us may have been urging him to move even faster, the Fed’s four interest-rate cuts since the slowdown became apparent represent an unusually aggressive response by historical standards. It’s still not clear that Mr. Greenspan has caught up with the curve — let’s have at least one more rate cut, please — but the interest-rate cuts do, cross your fingers, seem to be having an effect.
          If we succeed in avoiding recession, this will mark a big win for let- bygones-be-bygones, and a big loss for crime-and-punishment. And that will be very good news not just for this business cycle, but for business cycles to come.”

        • skylien says:

          To be fair: What they really believe is that:

          1: The FED/Government can stimulate the economy by creating artificial demand which is fake supply (like alien defense lasers) or could be called a bubble.

          2: This bubble of course needs to burst, or be deflated slowly later on. Yet this bubble should (and here comes the magic) ignite real demand (= real supply*1) and real growth in the economy that is strong enough to allow the FED and Government to deflate the artificial demand unnoticeable.

          This implies that a Keynesian assumes that the capital/price/liability structure is sustainable in the economy and no large shifts need to take place to clear any imbalances in the economy *2. So only some mental problems (animal spirits) of the market participants are the cause for the slowdown in the economy or at least are the cause the economy doesn’t go back to normal as they expect it should.

          Of course I have not seen anyone show how they actually know that the capital/price/liability structure is fine (is in accordance to the value scales of the market participants). They can’t obviously.

          *1: What is real supply: Alien defense lasers definitely aren’t for sure (currently). Houses broadly spoken are but only to a certain degree. It depends on the relative supply to other goods. Yet only a real market process can discern real supply from fake supply. Exactly this process which is impaired the most due to any stimulus project by the CB and government.

          *2: The only exception sometimes is over all wage rates (like in Greece now). Some imbalances are just really obvious. Yet that is a far cry from being able to spot if the capital/price/liability structure is fine or not.

  5. Lord Keynes says:

    “Back in the early 1990s lots of liberals I knew argued that the S&L fiasco showed the need for “re-regulation.” And so we re-regulated banking. “

    No, they weren’t properly re-regulated

    Instead, the trend to deregulation continued with these acts:

    Riegle-Neal Interstate Banking and Branching Efficiency Act (1994)

    Financial Services Modernization Act of (1999) (Gramm-Leach-Bliley Act)

    Commodity Futures Modernization Act (2000).

    The SEC’s Voluntary Regulation Regime for Investment Banks (2004)

    • Major_Freedom says:

      Regulators and lawmakers have subjective expectations and are subject to fundamental uncertainty. It is possible for them to not know what the correct quantity of credit should be, the correct quantity of credit that goes to the housing market specifically, what the interest rates should be, what size of a credit line to the Treasury should be open to Fannie and Freddie, what size of an implicit put option should be on Fannie and Freddie debt, etc, etc.

      “Not properly regulated” is just an evasive way of saying “I admit the regulations in place were horrible.”

    • John S says:


      If repealing Glass-Steagall was such a bad thing, then why didn’t European-style universal banking cause major financial crises?

      I’m not implying that FSM Act of 1999 wasn’t a cause of the financial crisis; I’m reserving judgement w/o further info. I’m just genuinely interested in your answer.

      • John S says:

        Re: Europe and financial crises–I mean in the complete post-war era, not just the last decade.

        • guest says:

          From Tom Woods’ _Rollback_:

          Page 57

          The prohibition on “dealing” in securities meant that banks could not acquire securities for the purpose of selling them, but they could acquire them to hold because they believed them to be good investments; banks could later sell them when they concluded they were no longer good investments or when they simply needed cash.

          Gramm-Leach-Bliley repealed only this last part of the earlier legislation, thereby making it possible for a commercial bank and an investment bank to coexist under the umbrella of a common holding company. It did not repeal the provision preventing banks from underwriting or dealing in securities. Commercial banks continue to operate under the same Glass-Steagall restrictions that have existed since 1933.

          Many commercial banks held large portfolios of mortgage-backed securities, but it wasn’t some “repeal” of Glass-Steagall that allowed them to accumulate those portfolios. They were always allowed to do so.

          Page 58

          So what deregulation can critics have in mind? “I would challenge anybody to point to something important that was deregulated during the last eight years,” writes Carnegie Mellon’s Allen Meltzer. “The last major financial deregulation was the 1999 act that President Clinton signed, removing the Glass-Steagall provisions separating commercial and investment banking. No other country in the world separates commercial and investment banking, and none of them have problems on that account. Nor have we had problems on that account.”

          The Glass-Steagall Myth Revisited

          The so-called repeal of the Glass-Steagall Act of 1933 in 1999 is sometimes blamed for the financial crisis. Glass-Steagall was not in fact repealed. Only the provision prohibiting a commercial bank and an investment bank from being controlled by the same holding company was repealed.

        • John S says:

          Thank you for the link, but I’d like to see LK specifically explain why universal banking didn’t lead to financial crises in Europe.

          • Matt Tanous says:

            I doubt he will. LK is not known for explaining his nonsense. He might link you to a blog post he wrote that says basically the same thing – that there was some deregulation mixed in with the piles and piles of new regulation, so clearly it must be the reason why the system failed.

      • Lord Keynes says:

        (1) the European banks did fuel real estate bubbles in numerous countries (e.g., UK, Ireland, Spain), though admittedly did not create mass subprime mortgages in their domestic economies on anywhere near the scale of the US, and the question of why they didn’t would require individual study of each country because, despite a general similarity in banking practice, individual countries have different regulatory systems. Furthermore, even Europe did have a much stronger degree of regulation pre-1980. They had the similar neoclassically-inspired deregulatory bills over the past 30 years.

        (2) I am not sure why you say “why didn’t European-style universal banking cause major financial crises?” On the contrary, the Europeans did have a major financial crisis. The European banks were more heavily exposed to US CDOs and MBSs than US banks were, and took heavy losses, e.g., Credit Suisse, Natixis, UBS, Royal Bank of Scotland, HBOS, Barclays, BayernLB, IKB Deutsche, Industriebank, Deutsche Bank. That required bank bailouts in some nations and lender of last sort monetary operations.

        (3) The Europeans are now seeking to implement ” Glass-Steagalll” style regulation precisely because their previous model has been called into question:


        “Banks in the European Union should quarantine their risky trading activities from their everyday savings and lending operations, as a way to safeguard the financial system and avoid future bailouts at taxpayers’ expense, a panel of financial experts recommended Tuesday. ….

        But the proposal is an indication of how intent many policy makers have become on responding to recent bank failures in Britain, Spain and elsewhere that have left European governments with huge debts, stymied growth and stifled the region’s recovery from its lingering debt debacle.


        • Major_Freedom says:

          (1) The Euro is not able to be as inflated as the dollar because the dollar is the world’s de facto reserve currency. The US real estate market could become more pronounced because most of the inflation money is exported to other countries, thus keeping a lid on domestic price inflation. The Euro on the other hand would be less likely to be exported, thus raising price inflation sooner, and thus curbing the price inflation reacting ECB sooner.

          (2) Ask where they got the dollars to buy MBS and CDOs.

          (3) The regulation cannot stop bubbles, because European regulators and lawmakers have subjective expectations, and are also subject to fundamental uncertainty. Regulation isn’t pure and perfect.

          • Ken B says:

            MF, after your Hayek remark I’m worried, and now it’s been hours since you posted. Are you dead?

            • Major_Freedom says:

              This isn’t a cult, Ken B. One is allowed to disagree with what Austrian economists have to say, and still be a good guy.

              Hayek believed that one is “free” if one is able to reliably expect, and adjust to, acts of force by others.

              Hayek also believed that coercion arises on the basis of a refusal to exchange with others (he only said this is the case in certain circumstances, but nevertheless there is nothing in the logic that prevents it from being applied by anyone at their will).

              Excuse me while I say that these are not only wrong, not only a horribly flawed set of ideas, but also something that I think everyone should think is insane.

              • Bob Murphy says:

                Also, it’s fine to rip Hayek. If you rip Rothbard, then you might be sleeping with the fishes.

              • Tel says:

                You must admit that in real world circumstances, moral compromise is more common than most people admit.

                This happens with religious groups who are willing to reinterpret their scripture now and then (and Rothbard said as much). It also happens with courts and lawmakers who are willing to rubberise their principles when a difficult special case comes along — legislate broadly, enforce selectively, as the saying goes.

                Rothbard was a Euclidean man of straight edges, square corners and clean cuts. Hayek was more of a messy fractal kind of guy… but nature is more fractal than Euclidean.

              • Anonymous says:

                “Rothbard was a Euclidean man of straight edges, square corners and clean cuts. Hayek was more of a messy fractal kind of guy… but nature is more fractal than Euclidean.”

                Are you sure to rely on fractal reality to determine justice among humans? I’d rather take clear cuts – less bamboozelment more sense.

            • :D says:

              “Rothbard was a Euclidean man of straight edges, square corners and clean cuts. Hayek was more of a messy fractal kind of guy… but nature is more fractal than Euclidean.”

              Are you sure to rely on fractal reality to determine justice among humans? I’d rather take clear cuts – less bamboozelment more sense.

        • Jason B says:

          I just want to make sure this is understood: The provisions made by GBL in ’99 to Glass-Steagall was the linking of commercial and investment banking under a single holding institution. Of the institutions that failed, none were linked. You had Washington Mutual, Countrywide, Indy Mac, which were mortgage/thrift banks, obviously underwritten by F&F standards. And then you had Bear, Lehman, and almost Merrill, which are purely investment banks. We also had AIG, but its neither investment nor commercial. So the GBL partial repeal of Glass-Steagall is void as an argument for the failings of certain institutions.

        • John S says:

          LK, you told me (on freebanking.org):

          “For decades when interest rates were low, the Western world had no massive asset bubbles or serious financial crises. Before that period, financial crises were ubiquitous.

          Once the system of effective financial regulation was transformed by neoclassicals and policymakers influenced by neoclassical theory, financial instability has once again become a problem.”


          From this I can only conclude that you believe financial deregulation (such as Gramm-Leach) is the key factor leading to financial instability and crises, and that interest rates are insignificant. But if this is true, then why did Europe, with its universal banks, not experience major financial crises until the last decade, when interest rates were harmonized across Europe after the introduction of the Euro?


          How can you be sure that it was deregulation, and not the sudden lowering of PIIGS’s interest rates to Germany’s level (despite widely differing macroeconomic fundamentals), that fueled the private debt explosion in Europe over the last decade? We can’t say with complete certainty that Interest rate harmonization was the primary factor, but on what grounds can you rule it out completely?

          At the very least, it does not seem 100% certain that there is a causal relationship between financial crises and the presence or absence of Glass-Steagall type regulations.

          LK: “I am not sure why you say ‘why didn’t European-style universal banking cause major financial crises?’ ”

          I explicitly stated that I was referring to the entire post-war period, not just the last decade.

        • John S says:

          LK, you wrote:

          “Furthermore, even Europe did have a much stronger degree of regulation pre-1980.”

          Which specific regulations? Honestly, everyone needs to stop talking about “deregulation” and “re-regulation” in the abstract. It does no good to say “deregulation = bad, strong regulation = good”–certainly, some regulations have good effects and others have bad ones!

          As John Cochrane put it: “If you just say regulation versus no regulation that becomes an undergraduate 2 A.M. bullshit fest.”


  6. Major_Freedom says:

    Bubbles are fine, as long as only EMH believers use the term, and as long as you don’t blame the Fed during periods when NGDP is not crazy high.


    NGDP growth was pretty stable during the 1990s and 2000s (other than the slight drop during the 2001 recession, and the large drop 2008 (which was past the housing burst anyway)).

    Thus, in order to protect the NGDP targeting theory from yet another criticism, it must be the case that bad things simply can’t occur during those periods because of monetary policy specifically.

    We have to look everywhere else but the Fed for the cause(s) for this. If we start including monetary policy as responsible for the S&L or housing bubbles, then not only would that show that NGDP targeting is seriously problematic, but it will also put MMs into the Keynesian “let’s impose a permanent quasi-bubble” camp, and it will mean having to take intellectual responsibility for at least the “minor” rise in unemployment post-2006, but before all hell broke loose in late 2008. All those people who lost their jobs because of the housing bust, can rightly hold MMs partially responsible, because MMs wanted stable NGDP growth, despite the problems that arose.

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