Are We Already Planting the Seeds of the Next Financial Crisis?
The wreckage of the housing bubble and the banking crisis haven’t yet been cleared away completely, but already there are hints of renewed speculation - warning signs of a problem that often arises when central banks try to bolster weak economies.
Expanding the amount of money in circulation is, of course, beneficial in the short run because it stimulates business activity and takes some of the pressure off overextended borrowers and banks. But easy money also encourages risk-taking and temporarily pushes the prices of safe investments up to unsustainable levels, thereby creating the potential for future financial crises.
This problem last occurred - with catastrophic results - in the years following the 2000 technology stock crash, when Federal Reserve Chairman Alan Greenspan repeatedly stoked the money supply. That did help revive the U.S. economy, but it also fueled a bubble in home prices that contributed greatly to the 2008 banking crisis. Moreover, Fed officials seemingly failed to recognize this side effect as it was happening. Around the time the housing bubble peaked in 2006, Fed Vice Chairman Timothy Geithner (now the Secretary of the Treasury) summed up the official outlook: “This, on balance, still leaves us with what looks like a relatively balanced set of risks around what is still a quite favorable growth forecast.” In retrospect, that assessment was much too blithe. Indeed, in testimony before Congress in October 2008, Greenspan himself acknowledged that he had underestimated the risks of his policies.
Is current Fed Chairman Ben Bernanke making the same mistake - risking future bubbles because he is trying to compensate for a past one? Obviously, it’s too soon to tell. But Bernanke has already gone further than previous Fed officials in one respect, at least. Traditionally, Fed Chairmen have refused to tip their hand. Alan Greenspan once famously remarked: “Since becoming a central banker, I have learned to mumble with great incoherence. If I seem unduly clear to you, you must have misunderstood what I said.” Bernanke, by contrast, has bluntly announced that he will hold down interest rates close to zero until 2014. That may be intended as a confidence-building measure, but it will also make speculators feel more secure. Consider these signs of a growing appetite for risk: