- REUTERS/Kevin Lamarque
Former Federal Reserve chairman Ben Bernanke doesn’t see any bubbles forming in global markets right right now.
But he doesn’t think you should take his word for it.
And even if you did, that isn’t the right question to ask anyway.
Speaking at a Wall Street Journal event on Wednesday morning, Bernanke said, “I don’t see any obvious major mispricings. Nothing that looks like the housing bubble before the crisis, for example. But you shouldn’t trust me.”
Bernanke also elaborated on how, perhaps, the Fed should’ve been thinking about bubbles in the run up to the housing crisis.
In the period leading to the 2007-2008 housing crisis, home prices in the US exploded higher. And while certainly many folks thought there was a bubble simply because of the rapid appreciation, Bernanke says that the Fed was merely asking the question, “Is it a bubble or not?”
But wondering if home prices are bubble doesn’t really help anybody, because even if you get the answer right, you haven’t thought through the problem completely.
“One of the thing I learned from our experience in the crisis with respect to the housing bubble is the Fed spent a lot of tim debating is it a bubble, is it not a bubble, and if it is a bubble how big is it? That wasn’t the right way to think about it. The right way to think about it would’ve been: We don’t know if it’s a bubble, but it might be, and if it bursts, what’s the worst thing that could happen. And I think that looking at the worst case scenario is the right way to do it and we didn’t do enough of that.”
In this analysis, Bernanke is basically conceding that the Fed didn’t do enough risk management.
The reason the bursting of the housing bubble was so damaging to the financial system is that billions of dollars of assets – namely mortgage-backed securities – were marketed as “safe” when they in fact turned out to be toxic.
And so in the end it didn’t matter whether the Fed saw a too-fast and unsustainable appreciation in home prices or not, because the home price appreciation and resulting deflation in and of itself wasn’t the trigger for the crisis. What triggered the crisis was the evaporation in value of derivative products tied to the value of the mortgages attached to these houses.
Bernanke added that while investors might want to ask themselves if, say, stock prices are overvalued or undervalued – and he says an argument could be made either way, probably – the job for the Fed is to ask whether a decline in the price of stocks (or any other asset) would cause broad harm to the economy.
If the answer is yes, then this matters. If not, then you (merely) have investors losing money.