Wednesday, October 15, 2008

Bernanke Reconsiders Bubbles

Now that Chairman Bernanke is getting valuable first-hand experience in treating the aftereffects of an asset bubble, he acknowledges that it pays to prevent one from inflating in the first place.

Officials should review how supervision and interest rates can minimize the ``dangerous phenomenon'' of bubbles in housing, stocks and other assets that risk bringing the financial system and economy down with them when they burst, Bernanke said.

We have no idea whether the Chairman reads his critics. Note to Ben: It's tougher than it looks. First you have to admit that abnormally low interest rates encourage reckless borrowing.

The article also reveals the extent of his headaches in bailing out "too big to fail" institutions:

The U.S. faces ``a very serious too-big-to-fail problem,'' in which the insolvency of a large financial company could threaten a market collapse, Bernanke said in reply to an audience question. ``There are too many firms that are in some sense systemically critical.''

Mr. Bernanke, the solution is to let failures work they way they always have: Equity shareholders lose their investment, creditors become the new shareholders, and the firm continues to operate under the supervision of bankruptcy courts.