The Alarming Parallels Between 1929 and 2007

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Robert Kuttner testified yesterday before the House Financial Services Committee, his commentary is eye opening. The Alarming Parallels Between 1929 and 2007

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The most basic and alarming parallel is the creation of asset bubbles, in which the purveyors of securities use very high leverage; the securities are sold to the public or to specialized funds with underlying collateral of uncertain value; and financial middlemen extract exorbitant returns at the expense of the real economy. This was the essence of the abuse of public utilities stock pyramids in the 1920s, where multi-layered holding companies allowed securities to be watered down, to the point where the real collateral was worth just a few cents on the dollar, and returns were diverted from operating companies and ratepayers. This only became exposed when the bubble burst. As Warren Buffett famously put it, you never know who is swimming naked until the tide goes out.



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So when things are booming, the financial engineers can advise government not to spoil the party. But when things go bust, they can count on the Fed to rescue them with emergency infusions of cash and cheaper interest rates.





I just read Chairman Greenspan's fascinating memoir, which confirms this rescue role. His memoir also confirms Mr. Greenspan's strong support for free markets and his deep antipathy to regulation. But I don't see how you can have it both ways. If you are a complete believer in the proposition that free markets are self-regulating and self- correcting, then you logically should let markets live with the consequences. On the other hand, if you are going to rescue markets from their excesses, on the very reasonable ground that a crash threatens the entire system, then you have an obligation to act pre-emptively, prophylactically, to head off highly risky speculative behavior. Otherwise, the Fed just invites moral hazards and more rounds of wildly irresponsible actions.



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