Semi-Daily Journal

Oh, this is a bit sticky, but...

Doesn't Stiglitz also go after Rubin, for pressuring various regulatory powers not to step up surveillance of corporate accounting practices? That, it seems to me, would have been a legitimate approach to taking some of the air out of the bubble. It also would have made effecient allocation of resources more likely, so there could have been less froth and more value created from the boom. Word is that corporate accounting practices, though perhaps no longer as prone to outright criminality, is right back to all the legal jiggery-pokery that can be managed...and off we go, on an "earnings" driven rally.

How about just raising the margin requirements and not promoting the idea that "the New Economy was bringing with it a new era of productivity increases"? Would that have had a dampening effect on the bubble, without raising unemployment? Would it make Stiglitz's criticism consistent?

You rightfully criticize Sitglitz for arguing the FED was running tight money too soon and for arguing the FED was running tight money too late, but notice that this kind of inconsistent FED bashing is done over at National Review routinely by Lawrence Kudlow. The ntext thread above on the logic of Clinton's fiscal policies was excellent. Alas, Stiglitz has lately tried so hard to be fair and balanced, he's getting a lot of attention from the Bush cheerleaders. It seems they are abusing his statements to excuse Bush's fiscal failures.

The criticism is wrong. The Fed is too blunt a weapon to use on a stock bubble. A scalpel aimed at the bubble sector is needed. A hammer to the entire economy is not.

A market characterized by greedy CEOs, bankrupt coporate ethics, corrupt accountants, unscrupulous brokers, financial advisors with conflicts of interest and a national media more concerned with serving its advertizers than its viewers all helped to create the dot.boom. The solution was more transparency, better analysis and information not higher interest rates. If 60% of the people in the US can believe that Saddam was responsible for 9/11, what might they be induced to believe about the more nebulous stock market??

From Greenspans irrational excuberance speech to the long-term capital peak the S&P 500 PE rose 800 basis points while long rates fell and inflation improved and fed funds barely rose. The fed was absolutely correct that it would have had to raise rates enough to severly damage the economy to prick the stock bubble-- see my article in the spring Business Economics. Changes in margin requirements not accompanied by monetary policy changes has never worked. In the late 1990s fed policy was almost exactly what the mechanical application of historic decision rules would have generated if you use the spread between the cpi and the unemployment rate as a
Taylor rule.

Greenspan has agreed with Spencer on the margin requirement question in Congressional testimony. It is possible to disagree with the view, but not to say that the Fed didn't consider it. They did, and found the method lacking.

The question then becomes, why not give higher margin requirements a whirl anyway? If there is no effect, then no harm done. If there is very little effect, then it was better than nothing. In order to argue against a higher margin requirement, there ought to be an evident cost associated with its use. If a higher margin requirement is completely ineffective, what's the cost?

The argument against using margin requirement is if they failed it would give investors even more confidence and lead to even more speculation.

"The argument against using margin requirement is if they failed it would give investors even more confidence and lead to even more speculation."

Foolish argument. There would have been a flood of warning following such a move that would have subdued professional investors.

"How about just raising the margin requirements ..."

As Greenspan himself stated at the time, raising margin requirements by itself would have done little because only 1% of stock was on margin and there were ample other sources of financing available for the small portion of the 1% that would have been affected by an increase in margin requirements.

As Greenspan also said, raising margin requirements would have been effective only when conjoined with increasing interest rates, as a signal that the Fed was serious about the raising rates and that the rate increases were aimed directly at deflating the stock market -- which inevitably would have had a serious effect on the real economy, which he didn't want to risk.

"If a change in margin requirements were taken by investors as a signal that the central bank would soon tighten monetary policy enough to burst a bubble, then there might be the appearance of a causal effect. But it is the prospect of monetary policy action, not the margin increase, that should be viewed as the trigger. In a similar manner, history tells us that 'jawboning' asset markets will be ineffective unless backed by action."
-- AG

As I recall, Authur Leavitt(?), head of the SEC under Clinton, tried to effect some major accounting reforms but was completely stymied, not least by DLC senators such as Lieberman, and presumably lacked any strong backing from his own administration- since what would have been the political percentage in it for Clinton?

But everybody and their grandmother knew, after the Dow went from 3500 to 6000 in a relatively short time and continued on to gain better than 20% per annum, that there was a danger of a bubble forming, then forming more likely than not. After all ,there was already the example of Japan behind us. The major clue started in 1997, when corporate profits as reported by the Treasury Dept. started to diverge from corporate profits as reported in corporate financial statements. And the much ballyhooed achievement of our dear departed leader in finally balancing the budget- for one year there was a non-Social Security surplus of $40 billion- was in some large measure actually financed by revenues from this bubble.

Now I take it that the stock market bubble amounts to a major market failure. A large amount of capital spending was misallocated and effectively wasted, while there was a recessionary effect on the economy as a whole. Shouldn't the discussion be focused on how such occurences can be limited, if not prevented? Granted raising interest rates amounts to throwing the baby out with the bath water and raised margin requirements are for too small to be suffiecient, what other policies or regulations might be appropriate and effective? Can the economy be managed with mid-to-long-term considerations in view or do only immediate balances and short-term political advantages count? And am I the only one who finds it disturbing the Americans must persistently rely on foreign capital to finance the investment that meets its consumption demand, a pattern that began with Reagan's tax cuts/deficits and has persisted ever since? One can blame corrupt Japanese banking practices and rigid European labor markets for their less attractive prospects, but, at the end of the day, are the outsized needs of American consumers, who structurally form such a large part of the U.S. economy, really so much more valuable than the needs of the rest of the world? Dismal science, indeed.

john c. halasz, with Snow pressing for market determined exchange rates I'll assume you aren't suggesting that the U.S. is demanding that foreign economies subsidize their currency exports. Thus, other than addressing the distortionary impacts what exactly is the U.S. supposed to do about the merchanilist policies of so many trading partners? Why exactly should we object to the subsidized boost in GDP?