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U.S. and global policymakers mull asset bubble fallout
Sunday September 1, 11:39 am ET

By Glenn Somerville

JACKSON HOLE, Wyo., Sept 1 (Reuters) - It sounds like an airy topic for top global central bankers, but bubbles weighed heavily on the minds of those gathered at this Rocky Mountain resort to mull how to keep a shaky global expansion afloat.

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The United States is still feeling tremors from the stock price collapse since 2000 and some analysts warn a similarly inflated condition may be developing in soaring home prices, which made Federal Reserve Chairman Alan Greenspan's choice of keynote topic for this year's conclave a resonant one.

The question of whether interest-rate policies or fiscal measures like lower taxes or investment incentives can best spur growth equally preoccupies policymakers in the United States, Europe and Japan in a period of constrained growth.

The economy is still suffering the lingering after-effects of the stock market tumble and the blows it struck to business investment and consumer confidence.

"We are looking at the biggest stock asset deflation since the 1930s," economist Allen Sinai of Boston-based Decision Economics Inc. said after the invitation-only meeting ended.

"It's severe and significant, it is some $7 trillion of loss, maybe $7-1/2 trillion of lost net worth to Americans in equities, so far offset by an increase in residential real estate asset wealth," Sinai added.

Greenspan told the assembled audience of bankers, academics and economists on Friday that policymakers had little chance of spotting bubbles -- unsustainably high asset prices -- in advance. Even if they did identify them, there was little a central bank could do to fix them safely and effectively.

Tackling those who criticized the Fed's lack of action during the 1990s stock market run-up, Greenspan said the U.S. central bank could not have prevented the plunge in stock prices that set in during 2000 after a go-go decade without forcing a severe economic contraction.

Some critics have said the Fed let the stock market surge so strongly that the steep drop that followed was inevitable.

"The notion that a well-timed incremental tightening could have been calibrated to prevent the late 1990s bubble is almost surely an illusion," the 76-year-old Fed chief said in what appeared to be at least partly a defense of his legacy at the helm of the Federal Reserve since 1987.

Indeed, the regulation of asset prices do not typically fall inside the Fed's purview, though Greenspan's address indicated he and other central bankers were taking fresh stock of the potential for bubble behavior and its effects on economic activity in future.

Economist Lyle Gramley of Charles Schwab and Co. said it was significant that Greenspan and deputy governor of the Bank of Japan, Yutaka Yamaguchi, both focused on the difficulty of dealing with the aftermath of broken asset bubbles.

Yamaguchi, whose country has had to deal with both real estate and stock price bubbles that popped in the late 1980s, said there was no escaping a hard aftermath -- a condition for which Gramley said policymakers must steel themselves.

"So if you think that asset price bubbles may become an enduring part of our future, then it's incumbent upon you to decide what's the appropriate course of policy to deal with them and that I think is the way our Fed officials are proceeding," by trying to determine whether better warning-systems can be devised, Gramley said.

Japan's 12-year-long economic malaise was one of the sideline issues preoccupying meeting participants, with one background paper prepared for the gathering declaring that "getting Japan out of recession/depression arguably remains the world's most urgent monetary-policy task."

The U.S. economy currently is the engine for global growth, with Japan in stagnation and Europe lagging, but analysts note there are potential soft spots for the United States, too.

Sinai said he sees some dark parallels between the stock-price run-up in the 1990s, which led to companies using debt excessively, and to home-price surges that has led homeowners to leverage themselves with more debt and to flock to real estate purchases after bailing out of stocks.

"It's a bit of the gold rush, tulip craze, dot-com psychology," he said, referring to buying behavior in real estate markets. "That's what I mean by bubble-like ... I'm very concerned about that as a risk to the economy."

The Fed stoutly maintains that no real estate bubble is in sight and that home price rises are supported by low mortgage rates, rising personal incomes and demographic factors such as strong levels of immigration that supports demand for housing.

Some participants in the Fed symposium, sponsored by the regional Kansas City Federal Reserve, criticized the Fed for not acting on some excesses that were becoming apparent in the late 1990s, possibly at least blunting the impact of the eventual tumble in stock prices.

Henry Kaufman, president of New York-based Henry Kaufman and Co., suggested that there were signs in financial markets that should have served as warnings to policymakers.

"What should the Fed have learned from the deterioration in the credit quality of business corporations? And how should it have responded to that, if at all? " Kaufman asked rhetorically during a break from the sessions. "There's been no discussion of that -- unfortunately."

Under the burden of reduced business investment and dampened consumer enthusiasm, the U.S. economy may face a period of prolonged slower growth, several participants said -- though no one foresaw a slide back into recession, a so-called "double-dip" slump.

Since the nine months of economic downturn in 2001, the U.S. economy has managed a modest but often patchy recovery.

A newly minted member of the Fed's policymaking Federal Open Market Committee, Ben Bernanke, said in an interview that the Fed was fully aware of risks to the U.S. expansion but said he anticipated steady growth.

"The most likely scenario is that the economy will continue to recover but at a not robust pace.

"The fundamentals are in place for a recovery but there are downside risks," Bernanke added. "The Fed must be vigilant."


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