In the current downturn, something more unsettling than a traditional swing in the business cycle appears to be at work: The United States has become increasingly prone to financial bubbles — huge, seemingly irreversible rises in the value of one sort of asset or another, followed by sudden and largely unforeseen plunges.
What makes bubbles so dangerous is that their consequences, when they burst, are wider, often more damaging, and certainly more unpredictable than those of ordinary downturns.
“We are more prone to bubbles than we used to be,” said John H. Makin, a former senior Treasury official with several Republican administrations and now a scholar with the conservative American Enterprise Institute in Washington.
“The old-fashioned recession, where the consumer ran out of gas or there was an economic policy mistake, doesn’t seem to occur much anymore,” said Alice M. Rivlin, a former vice chair of the Federal Reserve and Clinton administration budget director. “As we’ve seen from recent events, bubbles seem to be playing a bigger role.”
Good article showing the clear link between how market excesses have been incorporated into financial system risks. The only thing missing is an analysis of the current situation where the federal government has been complicit in the overextension of credit to mortage applicants, especially due to insufficient regulation of Fanny Mae and Freddie Mac. Sure it would be nice for the government to discern when a bubble is occuring, but it would be even better to not cause them.
Tom [#1]: Good points.