A panel of blue chip authorities, including former Treasury Secretary Larry Summers, legendary investor George Soros, and well respected economists such as Stephen Roach and Nouriel Roubini were sharply critical of the stewardship of central banks in recent years, particularly the Fed.
We’ve noted before that not all central bankers were asleep at the switch. Australia’s retired Reserve Bank Governor Ian Macfarlane used a combination of private scolding, public statements, and a wee interest rate tightening to let some air out of the lucky country’s housing bubble, which by every measure was worse than our own. Macfarlane has also spoken and written about the problems that asset bubbles present to monetary authorities (big issue: they are popular while in progress and central banks lack a clear mandate to tackle them). But why has Macfalane been virtually alone among the officialdom in talking about this problem, and why hasn’t his message gotten greater play?
The U.S. Federal Reserve and other central banks are partly to blame for the financial-market slump that’s now threatening to derail the global economy, said investors and former policy makers at the World Economic Forum.
“It’s hard to give central banks a very high grade over the last couple of years on recognition of bubbles and actions taken to address them in the policy or regulatory spheres,” said former U.S. Treasury Secretary Lawrence Summers in a panel in Davos, Switzerland. Billionaire investor George Soros said central banks have “lost control” of financial markets.
The Fed, which yesterday announced its first emergency rate cut since 2001 as U.S. recession fears rose, has been criticized for paying too much attention to economic growth and not enough to so-called asset price bubbles. By cutting rates to protect growth when bubbles burst, the Fed only encourages investors to take bigger risks in the future, said Morgan Stanley’s Stephen Roach.
“It’s a dangerous, reckless and irresponsible way to run the world’s largest economy,” said Roach, chairman of Morgan Stanley in Asia, who was also in Davos…..
“Central banks lost control of the situation when they allowed financial institutions to develop new financial instruments which they themselves didn’t understand,” said Soros.
Greenspan and Bernanke counter that it’s too difficult for central banks to spot bubbles before they emerge and raising rates to curb higher housing or stock prices would risk derailing the rest of the economy.
Nor was the Fed alone in slashing rates at the start of the decade. The ECB cut its benchmark to 2 percent in 2003, the lowest since the aftermath of World War II, and the Bank of England reduced its key rate to a 48-year low.
While house prices surged in the U.K., Spain and Ireland, those booms have now withered as contagion from the subprime collapse spreads.
Some Davos attendees came to the Fed’s defense, saying it’s difficult to identify bubbles and more attention should be paid to better regulation.
“We could pierce bubbles but we’d pierce a lot of non- bubbles and take a lot out of gross domestic product,” said John Snow, also a former Treasury Secretary and now chairman of Cerberus Capital Management LP. “We need to reform regulation.”
The ECB nevertheless argues that it may be possible for central banks to “lean against the wind” by raising rates in the early stage of a bubble to head off future gains.
“It’s good for a central bank to ease when the risks are of a crash in the global economy, but that means you have to have a more systematic approach to asset bubbles,” said Nouriel Roubini, founder of New York-based Roubini Global Economics LLC, in Davos. “If we have a `Greenspan put’ or a `Bernanke put,’ then we will create over and over again a distortion of excessive debt and leverage.”