Last week Martin Feldstein and Robert Rubin made their case for the gold medal in the economic policy category of the “show no shame” contest. Their entry took the form of a joint op-ed in The Wall Street Journal warning that the Fed needs to take seriously the risk of asset bubbles growing in financial markets.
Those familiar with Feldstein and Rubin will instantly appreciate the bold audacity of this entry. They are, respectively, the leading intellectual lights of the Republican and Democratic Party economic policy establishments.
Feldstein was the chair of the Council of Economic Advisors under President Reagan. He also was president of the National Bureau of Economic Research for thirty years and a professor and chair of economics department at Harvard. Almost all of the country’s top conservative economists have either directly studied with Feldstein or one of his protégées.
Robert Rubin was instrumental in creating a solid Democratic base among the Wall Street set. He was rewarded for his efforts with top positions in the Clinton administration, including a stint as Treasury Secretary from 1995 to 1998. Larry Summers and Timothy Geithner both advanced under his tutelage and he continues to be a source of economic wisdom for President Obama and other top figures in the party.
Given their enormous stature, Feldstein and Rubin undoubtedly expected their joint bubble warning to have considerable weight in economic policy circles. Of course this raises the obvious question, why couldn’t Feldstein and Rubin have joined hands to issue this sort of bubble warning ten years ago in 2004 about the housing bubble? If they used their influence to get a column about the dangers of the housing bubble in The Wall Street Journal in the summer of 2004 it might have saved the country and the world an enormous amount of pain.
And of course it was easy to see that the housing bubble posed enormous dangers to the economy, as some of us were trying to point out at the time. Nationwide house prices had already risen to more than 50 percent above trend levels by 2004 with no remotely plausible explanation in the fundamentals of the market. The collapse of standards in the mortgage market was an open joke, as people talked about “NINJA” loans, which stood for no income, no job, and no assets.
Furthermore it was easy to see that the housing bubble was driving the economy. Residential construction was rising to record highs as a share of GDP when demographics would have predicted a declining share. And consumption boomed, as the wealth effect from bubble generated housing equity drove the savings rate to record lows. When the bubble burst, the lost construction and consumption would create a massive gap in demand that the economy has no easy way to fill.
It would have been great if Feldstein and Rubin had used their stature to warn of the dangers of the housing bubble in 2004, but they were otherwise occupied. Feldstein was on the board of AIG (yes, that AIG), where he was pocketing several hundred thousand dollars a year for his services. Rubin was a top executive at Citigroup, which was one of the biggest actors in the securitization of subprime mortgages. He walked away with over one hundred million dollars for his work. So it was easy to see why Feldstein and Rubin could not have been bothered a decade ago to warn about the housing bubble.
Making matter worse, their current warnings are completely misplaced. The Fed has to concentrate on trying to promote growth and getting people back to work. The risk from the inflated asset prices that they identify are primarily a risk that some hedge funds and other investors may take a bath when asset prices (like junk bonds) move to levels that are more consistent with the fundamentals.
Unlike the housing bubble, these inflated asset prices are not driving the economy. (They wrongly imply that the stock market is in a bubble, by noting its record high. In fact, if the stock market had risen in step with the trend growth of the economy, it would still be 10-20 percent below its 2007 level.) This means that the economic repercussions of a decline in the price of assets like junk bonds will be largely limited to the losses of the people who invested in them. That is the way a market economy works. People make bets and some lose, so what?
It is also worth noting that Federal Reserve Chair Janet Yellen is way ahead of Feldstein and Rubin on the problem of bubbles. Last month she warned of the over-valuation of some assets in her congressional testimony. Since then the price of these assets, notably junk bonds, has fallen, reducing the potential risk they pose to the financial sector. It makes far more sense to deal with out of line asset prices by trying to use targeted actions to bring them back into line than to throw millions of people out of work, and reduce the bargaining power of tens of millions more, by raising interest rates.
So there you have it: two extremely prominent political figures who got rich off the housing bubble, now taking time from their busy schedule to call on the Fed to raise interest rates and destroy millions of jobs. In the “show no shame” contest, this looks like a real winner.