Former Top Economic Officials Fret About Asset Bubbles

Catherine Hollander

The stock market is soaring, the housing market is rebounding, and even the job market is showing signs of life (well, mostly). But a number of the country’s former top economic officials worry about potential dangers on the horizon created by the very agency that’s trying to rescue the labor market.

At an event hosted by The Atlantic on Wednesday, three former economic officials, whose terms spanned from the Carter through the George W. Bush presidencies, warned about the downsides of the easy-money policies the Federal Reserve has pursued since the financial crisis. The men appeared separately but successively, and each weighed in on why the central bank risked causing the next crisis as it mopped up from the previous one.

Paul Volcker was up first. The six-foot-seven former Fed chairman is famous for breaking the back of inflation in the late 1970s and early 1980s, but at a cost: The country suffered back-to-back recessions and unemployment climbed into the double-digits as a result of the high interest rates Volcker used to tamp down soaring prices. In some sense, he did the opposite of what current Fed Chairman Ben Bernanke has done. To ward off deflation and jump-start the moribund labor market, Bernanke cut the Fed’s benchmark interest rate to zero in 2008 and has pursued unconventional policies to drive down longer-term rates ever since.

Volcker warned that such prolonged easy-money policies could “encourage elements of speculative activity undermining the very process of restoring sustainable growth and financial stability.” In other words, the central bank risks creating a bubble, the potentially devastating consequences of which were most recently felt in the 2007-09 crisis. Not all bubbles grow so large or pop so dramatically as the housing market did in 2007, but the reasons to worry about the possibility were made clear.

Robert Rubin, who was Treasury secretary under President Clinton, issued a similar warning about signs of speculation at Wednesday's event. Rubin referred to something known as “reaching for yield,” a term that applies to investors taking on more risk in their quest for better returns. This becomes more common during low-interest periods, such as the present, when traditionally safe assets offer lower rewards. “I think as you go out the risk curve, the reaching for yield is not just yield on bonds, but it’s how safe, how secure people feel about where rates will be and this may be that—perhaps probably is—affected by the nonconventional measures of the Fed and I think you may be seeing some excesses,” he said. Rubin added that he had “no opinion” on whether the current stock-market highs reflected the makings of a bubble or were a sign of economic strength to come (investors are forward-looking).

Lawrence Lindsey, a former Fed governor and economic adviser to President George W. Bush, spoke last. His warning focused on the budgetary effects of the Fed’s low interest-rate policy. With low interest rates for borrowing, the government has no incentive to cut back on its spending, but when the Fed winds down its balance sheet, which has swelled since the crisis, interest rates will soar, Lindsey said. The cost to the government of making the now-higher interest payments on its debt will “break the Treasury,” said Lindsey, who was named to the Fed's Board of Governors by Bush's father and served at the central bank during the 1990s.

“The path that we’re on now is an unsustainable path,” Lindsey said.

Bernanke and other Fed officials have described the potential risks of the bank’s accommodative policies, but the Fed chief has made clear he believes the benefits continue to outweigh the costs. Eleven out of 12 voting members of the Fed’s policy committee agreed at their most recent meeting in January, and the central bank is expected to stay the course when officials convene again next week.

CORRECTION: An earlier version of this story incorrectly stated which president appointed Lawrence Lindsey to the Federal Reserve Board. He was nominated to the Fed by President George H.W. Bush.