Bill Dudley Hits Refresh On Yahoo Finance, Discusses Asset Bubbles

Tyler Durden's picture

Dudley talks theory, avoids practice, when discussing the driving force behind today's market - the biggest asset bubble reflation in history. Although to be fair, Dudley does destroy the concept of efficient
markets and notes that when we enter the irrational exuberance everyone
piles on the same side of the trade, only to realize there is nobody to
sell to when the bubble pops. Dudley says nothing to indicate that Fed pundits are anything beyond theoretical puppets of Wall Street, whose sole purpose is to reflate the market to the highest possible point before recent events catch up with Wall Street surreality. And we quote, courtesy of Geoffrey Batt: state of emergency in Thailand, Kyrgyzstan and parts of South Africa, increasing violence in Iraq and Pakistan, bombing in India, multiple bombings in Russia, imminent Greek default, talk of Iran invasion, Karzai claiming he may join the Taliban, South Korean ship attacked and destroyed, Israel considering using nukes as a preemptive weapon, UK elections, massive banker backlash, and so much more. Yet all investors care about is whether the iPad's WiFi can penetrate 1 inch of drywall (ignoring that by buying apple shares, they are selling life insurance on Steve Jobs), and whether everyone can pretend just long enough that there is nothing moving this market but excess liquidity, before it all unravels with the 1% of the population that has profitted the most long taken profits and relaxing on a beach in a non-extradition Pacific island.

Full Dudley speech below, for what it's worth.

Asset Bubbles and the Implications for Central Bank Policy

William C. Dudley, President and Chief Executive Officer [and former Goldman Sachs Managing Director]

Thank you for that kind introduction. Today I want to tackle a
difficult subject: How should central bankers deal with potential asset
price bubbles. As always, my remarks do not necessarily reflect the
views of the Federal Open Market Committee or the Federal Reserve

As I see it, we need to reexamine how central banks should respond
to potential asset bubbles. After all, recent experience has
underscored the fact that poorly regulated financial systems are prone
to such bubbles and that the costs of waiting to respond to an asset
bubble until after it has burst can be very high.

Today, I will try to define some of the important characteristics of
asset price bubbles. I will argue that bubbles do exist and that
bubbles typically occur after an innovation that has created
uncertainty about fundamental valuations. This has two important
implications. First, a bubble is difficult to discern and, second, each
bubble has unique characteristics. This implies that a rules-based
approach to bubbles is likely to be ineffective and that tackling
bubbles to diminish their potential to destabilize the financial system
requires judgment.

Despite the fact that it is hard to discern bubbles, especially in
their early stages, I conclude that uncertainty is not grounds for
inaction. Instead, the decision whether to act depends on whether
appropriate tools can be deployed to limit the size of a bubble and
whether the benefits of acting and deploying such tools are likely to
exceed the costs.

That cost-benefit calculus, in turn, depends crucially on the tools
we can deploy to limit the growth of bubbles and the consequences when
they burst. In this respect, I will argue that, in most cases, use of
the bully pulpit and macroprudential tools, such as rules limiting
loan-to-value ratios or leverage, are likely to prove superior to
monetary policy.

Turning to the first issue of whether there are asset bubbles, I am
going to be a bit of a heretic and argue that there is little doubt
that asset bubbles exist and that they occur fairly frequently
. By an
asset bubble, I mean price increases (or declines) that become unmoored
from fundamental valuations. I want to be clear that I am
distinguishing this from price movements that are tied to changes in
fundamentals. I know this runs afoul of the efficient markets
hypothesis—which in this context would argue that if a bubble were
obvious, then people would take the other side and the bubble would not
occur in the first place.

There are several reasons why this argument does not hold in
practice. First, it is not always easy to take the other side. There
may be constraints on the ability to short the asset in question. Such
limits on the ability to short sell can arise for many reasons. For
some assets, short selling in size might simply not be possible because
the markets are not sufficiently developed. Also, even if there were
instruments that can be used to go short, it may not be an easy trade
to undertake. For example, if a bubble builds up over many years and
market participants’ compensation is based on year-to-year performance,
there may be disincentives to take the short side. Compensation schemes
and other practices that skew incentives may create a bias to simply
“trade with the market.”

Second, bubbles may simply emerge from the way market participants
process information and trade. Experimental work done by behavioral
economists has shown that people often trade in ways that generate
price bubbles.
In many carefully controlled experiments in which the
intrinsic value of the asset could be determined with certainty,
participants still bid prices up far above fundamental valuations, with
the bubbles being followed by sharp declines in prices.

Let me give you an example of one of the seminal studies of this
type. In this experiment, all investors start with an identical asset
that pays the same dividend generated from a known probability
distribution at the end of each trading period.1 This means
that all participants know the expected value of the dividend stream
with certainty. The participants are allowed to buy and sell these
assets from one another. In this framework, if all participants were
fully rational, then trading should occur only at intrinsic values
based on the expected dividend stream. But this is not what happens in
practice. In 14 of the 22 experimental runs, prices rose significantly
above fundamental valuations and these price bubbles were followed by
crashes. When traders in these experimental runs were “experienced,”
meaning that they had participated in the experiment before, the
probability of a bubble was reduced, but not eliminated. The authors
conclude: “What we learn from the particular experiments … is that a
common dividend and common knowledge thereof is insufficient to induce
initial common expectations. …” The lack of common initial expectations
leads to a willingness to trade to try and earn capital gains above
fundamental value.2 Relaxing the conditions in these types
of behavioral studies to admit more uncertainty about fundamental asset
valuations works to enhance the propensity for bubbles by increasing
the degree of divergence in participants’ initial expectations.

Lastly, over the past few decades, there simply have been too many
episodes in which asset prices have dramatically overshot on the upside
and then violently corrected to suggest that the behavioral studies
conducted in the laboratory do not also have real world counterparts.
In the United States, these include the run-up in the value of the
dollar in the mid-1980s, the stock market rise and crash in 1987; the
compression of spreads due to convergence trades in the run-up to the
Long-Term Capital Management debacle in 1998; the technology stock
market boom of the late 1990s; and the credit and housing price bubble
and crash of recent years. All these episodes were marked by
spectacular price booms, followed by subsequent collapses.

An examination of some of these recent bubbles suggests that while
asset bubbles are idiosyncratic in terms of their causes, institutional
features, duration and severity, they often share several significant
features. These shared features are important in assessing how policy
might be used to temper incipient bubbles in the future.

In my view, asset bubbles often come about through a particular
sequence of events. First, there is typically an innovation that
changes the fundamental valuation in a meaningful, but uncertain way.3
Asset valuations associated with the innovation change (as they
should), but there is significant uncertainty about how valuable the
innovation will turn out to be. This leads to a divergence in
expectations concerning how much the fair value of the assets should
increase. I believe that this uncertainty about what constitutes fair
value is important in fueling the bubble.

For example, the technology stock market boom in the late 1990s
coincided with the development of the Internet, which fostered the
reorganization of many business processes and generated significant
productivity improvements. At the time, it was unclear just how
significant the innovation would be or how successful the companies
would be that sought to take advantage of it. On the one hand, there
were companies such as Cisco, which sold the “shovels”—the routers that
enabled the Internet to work—that were very successful. On the other
hand, there were companies such as Webvan, which sought to use the new
technology to revolutionize the delivery of grocery supplies and
services, and that failed miserably.

Similarly, the recent housing boom was driven by two innovations:
(1) in housing finance, where subprime lending made mortgage credit
available to households that were much less creditworthy, and (2) in
structured finance instruments such as collateralized debt obligations
(CDOs). The first innovation significantly broadened the availability
of mortgage credit to households. The second innovation reduced the
cost of this credit. Cash flows from the underlying mortgage assets
were apportioned among senior and junior tranches. These tranches,
which had been rated by the rating agencies, were then distributed to a
wide range of investors. This structured finance innovation, in turn,
was supported by innovations in the shadow banking system. Securities
lenders, structured investment vehicles and conduits bought the highly
rated tranches of the structured financed products and financed these
assets in the wholesale short-term funding markets.

The second element common to many asset bubbles is a surge in
economic activity in the particular sector associated with the
innovation. In the case of the technology stock market boom, there was
a surge in business investment in technology goods and services. In the
subprime/structured finance boom, there was a surge in demand for
housing as credit availability increased sharply. This surge in
activity is important because it reinforces the notion that the
innovation is indeed significant and that “this time is different.”

Third, there is often a positive feedback mechanism that tends to
reinforce the belief system that underpins the extreme valuations
associated with the boom.
[better known as CNBC] Without this, the boom isn’t likely to
persist for long or push valuations far above what is justified by the
fundamentals. As a result, the asset price movements are unlikely to be
big or broad enough to threaten financial and macroeconomic stability.

During the technology stock boom there were a number of reinforcing
mechanisms. One important reinforcing mechanism was the strong notion
that those who got to the market with their new Internet innovations
would achieve large first-mover advantages. This perception was due to
the fact that successful Internet-based models could expect to achieve
strong network effects, which created significant barriers to entry and
the prospect of extraordinary profits. Amazon might be a good example
of a company that (eventually) succeeded at this.

In this environment, many firms—both well-established companies and
start-ups—invested heavily in the new technology. The ensuing sharp
rise in investment in technology equipment and software led in turn to
rapid earnings growth, which helped (for a time) to sustain
stratospheric valuations.

In addition, the sharp rise in stock prices led to a re-assessment
of the appropriate equity risk premium. The higher that stock prices
rose, the more people thought that equities had little risk. Everyone
could become a millionaire with little risk or effort.4

Similarly, in the subprime/structured finance boom, there were
several important positive feedback mechanisms. In particular, the
surge in credit availability drove up the demand for housing and pushed
up housing prices. This increase in demand caused the default
experience associated with such lending to be very low, reinforcing the
notion that subprime lending was not very risky. It also reinforced the
demand for the complex CDOs secured by such assets. During the boom,
the structured finance models appeared to be sound because losses on
the underlying subprime mortgage loans were low and because the
correlation rates in performance across different assets in the pools
were low, just as the models had assumed.

Fourth, the proportion of market participants who believe that a
particular episode of asset price increases are justified by the
innovation tends to rise as the boom persists. Those that had doubts
about the importance of the innovation or the persistence of the gain
in asset prices lose confidence in their opinions as they underperform
and lose business and market share. Those who believed that the large
gains in asset prices were justified by the innovation and who
benefited from those beliefs become more dominant. Casual investors see
the large rise in prices and jump in. This shift is important because,
in markets, prices are driven by the marginal investor. As new and
often less well-informed investors plunge in to participate in the
boom, they can overwhelm the so-called “smart money” that gets
frustrated after having lost repeatedly trying to take the other side.

In this respect, a bias toward optimism may also play an important
role. Studies have found that most people believe that they are above
average in terms of their acumen, be it as investors, car drivers or in
other activities.
5 This overconfidence may cause some people
to keep investing in the asset, even when they are skeptical about its
valuation because they are overly confident that they will anticipate
the end of the bubble and be able to get out in time.

Fifth, asset bubbles occur more easily when it is difficult to short
the assets.
[Making the SPY Hard To Borrow is a pretty good example] For example, the technology stocks associated with initial
public offerings were very difficult to short because the available
supply or “float” was small—a high proportion of the shares in the
companies were held by the original venture capital investors and
subject to lock-up periods before the shares could be lent out to short
sellers or sold. Similarly, housing is notoriously difficult to short.
The option of selling one’s home in order to rent is expensive not only
in terms of time and effort, but also in terms of transaction costs.
And, shorting complex structured finance products was difficult because
there were no standardized instruments; the securities rarely traded
and were very difficult to value. It was not until the development of
the ABX indexes—which allowed investors to buy and sell credit default
swaps on pools of structured finance obligations—that investors had a
vehicle that allowed them to short subprime mortgage-backed securities
more easily.6

Asset bubbles often come to an end when the basic belief system is
contradicted by events. This can happen very naturally as a matter of
course because economic fundamentals deteriorate, or because there is a
change in rules or regulations that disrupts the balance between supply
and demand. In the technology boom, this might occur because each
company cannot get to the market first. So even if there is a
first-mover advantage, not everyone will be able to take advantage of
it. Over time, the failure to achieve first-mover status becomes
evident and valuations adjust to reflect this, or lock-up provisions on
Internet stocks expire, leading to a large increase in supply that
leads to a sharp fall in prices.7

In the housing boom, the end came about for several reasons. One
limiting factor was that the rise in home prices outstripped income
growth. Thus, for the boom to persist, underwriting standards had to be
continually relaxed; only in this way could a new cohort of first-time
buyers qualify for big enough mortgages to be able to “afford” to buy
their homes. The difficulty in replenishing the pool of new home buyers
limited how fast demand could keep rising. In addition, the rise in
home prices led to an explosion of supply especially in areas like
Arizona, Florida, Nevada and inland California, where buildable land
was plentiful.

As supply caught up to demand, this led to a downturn in prices.
Once this occurred, the poor underwriting standards associated with
subprime mortgage lending became apparent. Subprime borrowers could no
longer easily refinance or sell the house at a higher price and repay
the original mortgage. As Warren Buffett reportedly once quipped: “Only
when the tide goes out do you discover who has been swimming naked.”

So what does this analysis imply for a central bank that might want
to limit the development of such bubbles? The first conclusion is that
assessing whether there is a bubble or not or the size of the
prospective bubble is going to be very challenging. Because there is an
innovation, asset values should rise, but by how much? It is difficult
to assess what is the new, appropriate valuation after an important
innovation. For example, consider some questions that might have arisen
relative to the technology bubble: What does the Internet mean for
technology investment? How many of the new business startups will
survive and prosper? Is an Amazon rare? How fast will the volume of
Internet traffic grow and for how long?

Similar questions arose with respect to the recent housing bubble:
How much will subprime lending increase the demand for housing? How
will this increase in demand translate into prices? What will the
default rate be once demand growth slows? What is the appropriate
correlation rate in terms of the loss experience across the different
subprime and Alt-A mortgage pools that should be used in assessing the
value of collateralized debt obligations? How are such correlations
likely to differ in the boom versus in the bust?

This uncertainty means that policymakers can never be sure about the
existence, size or persistence of an incipient asset bubble. As a
result, this task of dealing proactively with bubbles will be very

So what should the policymaker do? I think the first step is for the
policymaker to work hard to investigate what is generating the sharp
rise in prices for the asset in question. Sustained price increases are
a symptom of changes in demand and supply. The policymaker needs to
develop a perspective about whether these demand and supply changes are
realistically sustainable to the extent implied by market prices. In
particular, carefully analyzing the assumptions that underpin sustained
increases in asset prices—which might be symptoms of a bubble—and
considering the risk that these assumptions might be wrong is
important. Also, looking carefully at the dynamics of the system on
which the beliefs are based may be useful. In particular, are the
dynamics of the system reinforcing or dampening? If the dynamics are
reinforcing, then there is greater likelihood of an asset bubble.

The next step is for the policymaker to evaluate what tools might be
available to curb the imbalances that have been identified. The
idiosyncratic nature of the innovations and belief systems associated
with particular bubbles implies that the tools used to respond to each
bubble will likely have to be different and tailored to the features of
the particular bubble in question.

Finally, the policymaker needs to conduct a careful cost-benefit
analysis, weighing how successful a particular policy might be in
restraining the rise in asset prices versus how costly it would be to
remain passive, letting the bubble grow and then potentially burst
disruptively. Many factors will affect the outcome of this analysis
including the magnitude of the potential asset bubble and whether the
potential asset bubble is occurring in the equity or debt markets.

In this analysis, the policymaker is likely to find that compared
with equity market bubbles, credit market bubbles are more prone to
generate higher costs when they burst. Thus, the benefits of preventing
credit bubbles from forming and collapsing are likely to be higher.

Credit bubbles that burst threaten the stability of the financial system much more directly than equity bubbles.8
That is because much of the debt is held by banks and securities
dealers that are highly leveraged. As a result, when the bubble
deflates, it can take the financial system with it. In contrast,
because most equities are held on an unleveraged basis by investors,
such as pension and mutual funds, a sharp decline in equity prices will
not typically threaten the entire financial system. A comparison of the
consequences of the technology stock market crash in equities versus
the mortgage debt market crash strongly supports this thesis. Although
the wealth loss was roughly comparable, the bursting of the housing
bubble had a much greater negative effect on the financial system and
the macroeconomy.

In this cost-benefit analysis, the central bank must understand that
it will make mistakes.
[Such as both Greenspan and Bernanke repeating, over and over, that asset bubbles were not created by Fed policies] On one hand, it may fail to temper bubbles that
turn out to be disruptive when they collapse. Or, on the other hand, it
may try to temper price movement that it thinks are bubbles but are not
bubbles at all. The costs of these types of errors much be weighed
against the potential benefits of tempering an asset bubble and
limiting the damage from its subsequent collapse.9

So what are the tools with which the policymaker should respond? As
I see it, there are three broad sets of tools available: 1) The bully
pulpit; 2) macroprudential tools; and 3) monetary policy. Let me now
discuss each of these in turn.

The first tool available is to simply lean against the wind of
conventional wisdom by speaking out about the dangers associated with
the incipient bubble. The policymaker could point out the assumptions
embedded in the rapid rise in asset prices and question the accuracy of
the assumptions. Obviously, the policymaker might be ridiculed by true
believers about the lack of understanding about the important nature of
the innovation. But I suspect that over time, a proactive central bank
that laid out the risks clearly would gradually gain credibility with
market participants. Use of the bully pulpit would allow the central
bank to signal its concern. This might shift the risk/reward trade-off
by raising the risks that the talk might foreshadow more forceful
action. That, by itself, could temper behavior. Announcement effects
can be very powerful, especially when they can be followed by changes
in policy.

The second set of tools includes those that are macroprudential in
nature. I would define macroprudential tools as regulatory and
supervisory actions that are not applied on a firm-specific basis.
These include tools designed to temper demand or increase supply in the
asset subject to the bubble or to increase the ability of skeptics to
take the other side of the market in which the bubble may be occurring.
For example, to counteract a housing bubble, tools available might
include limiting loan-to-value ratios, limiting debt service-to-income
ratios or increasing the taxes on housing transactions. Several Asian
and some European countries have used such tools to limit speculative
real estate activity, apparently with some success, although the
counterfactual cannot be known by definition.10 To limit a
subprime lending boom, the authorities might wish to enforce strict
underwriting practices, including verifying purchasers’ incomes and
enforcing rigorous appraisal valuations. Increasing the ability of
investors to short the assets in question might also be helpful.

In terms of macroprudential tools, I’d also include tools that
influence how the financial system operates and functions. Such tools
might include supervisory measures that set liquidity and capital
requirements for financial institutions and other intermediaries. They
might also include tools that try to limit the overall buildup of
leverage in the financial system. For the equity market,
macroprudential tools might include margin rules for cash, options,
futures and equity over-the-counter derivatives. For the fixed income
market, such tools might include raising the haircuts charged to
securities dealers on their repo financing; raising the haircuts that
the securities dealers assess against the collateralized borrowings of
their customers as part of their prime brokerage business, or raising
initial margin requirements on OTC derivatives transactions.

Macroprudential tools are undoubtedly difficult to use effectively
in practice. For example, it is difficult to judge their impact. If,
for example, loan-to-value ratios for single-family mortgages are
lowered by 5 percentage points, how big an impact will this have on
housing demand? There also is a risk that the rules or regulations will
simply be circumvented. For example, investors might move to
instruments or to off-shore regimes with less stringent margin and
leverage restrictions. Thus, it is important that the authorities have
the ability to apply the macroprudential tools broadly throughout the
financial sector.11

None of this is going to be easy. A lot more work will be required
to develop a portfolio of tools that could be used, that would be
effective and would not be subject to significant evasion or unintended

In terms of the use of macroprudential tools, let me briefly take
note of another issue that requires significant consideration—the issue
of governance. Who controls all these tools? Who decides when the tools
will be deployed and how extensively or intensively? Having a
sufficient toolkit seems like a good idea. But lodging all this
authority within a single entity or institution might not be practical
or desirable.

The final tool available to the central bank is monetary policy.
This tool is not likely to work as well as macroprudential tools
because it is too broad. Typically, monetary policy will not address
specifically the sources of the changes in supply and demand that are
driving the bubble and, obviously, monetary policy will have big
effects elsewhere.

Some argue that monetary policy should “lean against” incipient
asset bubbles. The notion is that by pursuing a slightly tighter
monetary policy, the central bank would take out insurance against the
risk that the rise in asset prices is a bubble and that its busting
would be disruptive. Although this sounds attractive, it critically
depends on how expensive the insurance is relative to the losses that
the insurance protects against. It is not clear to me that a modest
tightening in monetary policy beyond that needed to achieve full
employment and price stability in the absence of a bubble would
represent a favorable cost-benefit trade-off. The costs of the
deviation from the optimal monetary policy in terms of lost output and
employment might be high relative to the benefits of a somewhat smaller
bubble. This seems likely to be the case in most instances. Historical
experience does not suggest that bubbles are very sensitive to the
level of short-term interest rates.

That said, there is some evidence that a tighter monetary policy
will reduce desired leverage in the financial system by flattening the
yield curve and reducing the profitability of maturity transformation
activities.12 To the extent this is true, that may imply a
somewhat more favorable trade-off in “leaning against” a bubble. More
research is needed on this subject. For now at least, monetary policy
appears to be inferior to macroprudential tools that seek either to
limit the size of prospective bubbles or to strengthen the financial
system so that it is more resilient when asset prices fall sharply.

In conclusion, let me underscore the challenge that central bankers
face in combating asset price bubbles. Doing so effectively requires us
to be successful in both identifying the incipient bubble and in
developing and implementing a response that will limit bubble growth
and avert a destructive asset price crash. This is not easy because
asset bubbles are hard to recognize in real time and each asset bubble
is different. However, these challenges cannot be an excuse for
inaction. Recent experience strongly suggests that asset bubbles exist
and that their collapse can be very damaging to the financial system
and the macroeconomy.

In my view, a proactive approach is appropriate when three
conditions are satisfied: First, circumstances should suggest that
there is a meaningful risk of a future asset price crash that could
threaten financial stability. Second, we have identified tools that
might have a reasonable chance of success in averting such an outcome.
Third, we are reasonably confident that the costs of using the tools
are likely to be outweighed by the benefits from averting the
prospective crash. When these three conditions are satisfied, we should
be willing to act. [
now, as for the truth, the Fed will do nothing until the economy implodes. And that is a Guarantee]

Thank you for your kind attention.


Vernon L. Smith, Gerry L. Suchanek, and Arlington W. Williams. 1988.
“Bubbles, Crashes, and Endogeneous Expectations in Experimental Spot
Asset Markets.Econometrica 56, no. 5 (September): 1119-51.

a more restrictive experiment in which speculation is not possible,
bubbles and crashes still occur. See Vivian Lei, Charles N. Noussair,
and Charles R. Plott. 2001. “Nonspeculative Bubbles in Experimental
Asset Markets: Lack of Common Knowledge of Rationality vs. Actual
Irrationality.” Econometrica 69, no. 4 (July): 831-59.

might argue that an innovation is not a necessary condition for an
asset bubble. For example, the run-up of the dollar in the mid-1980s
was not associated with any particular innovation. Instead, a sharp
shift in fiscal policy led to high real interest rates that stimulated
a strong demand for the dollar, which caused the dollar to appreciate
sharply. This eventually unwound as the dollar's rise undercut U.S.
trade competitiveness. This caused the U.S. economy to slow, interest
rates to decline and the dollar to fall. The lack of experience with a
floating exchange rate regime undoubtedly played a role here. The world
moved to a floating exchange rate system in the early 1970s. There was
not much experience with how an expansive fiscal policy would affect
exchange rates. This undoubtedly increased uncertainty about the
sustainability of the dollar's appreciation.

fact, one book, Dow 36,000, which was published in 1999 shortly before
the stock market peaked, argued that “fair value” for the Dow Jones
Industrial Average should be 36,000 because the appropriate risk
premium for the equity market versus Treasury bonds should be zero.

actually applies to a broad range of activities, not just investing.
For a more general treatment of this issue of overconfidence and other
ways in which economic agents depart from complete rationality, see
Richard Thaler. “From Homo Economicus to Homo Sapiens.” 2000. Journal of Economic Perspectives 14, no. 1 (Winter): 133-41.

is not to argue that short positions could not be established at all.
Monoline guarantors, AIG Financial Products and some securities dealers
were willing to sell protection in the form of credit default swaps on
some of these assets. Michael Lewis examines how some investors managed
to take positions that benefitted from a collapse of the housing bubble
in The Big Short: Inside the Doomsday Machine.

7See Eli Ofek and Matthew Richards. 2003. “Dotcom Mania: The Rise and Fall of Internet Stock Prices.” Journal of Finance LVIII, no. 3 (June): 1113-37.

8This argument has been made by many others. See, for example, Frederic Mishkin. How Should We Respond to Asset Bubbles? May 15, 2008.

example of a sustained rise in asset prices that was not a bubble is
the bull market in U.S. equities that began in the 1950s. At the start
of the sustained rise in equity prices, stock dividend yields exceeded
the yields on Treasury bonds and this was perceived as normal, partly
reflecting the searing experience of the Great Depression. Instead,
corporate earnings rose relatively steadily, supporting dividend
growth. This observation led investors to bid up stock prices and push
down dividend yields and this proved—more or less—sustainable. Even
today, the yield on the S&P 500 index is below the 10-year Treasury
note yield.

10However, in the recent crisis, the
different outcomes in the United States and Canada might be
instructive. Canada had a tougher regime in terms of mortgage
underwriting standards. Also, Canada had imposed an overall leverage
limit on its banks, which helped to limit the amount of gearing in the
financial system. Both of these differences may help to explain why the
Canadian financial system and macroeconomy were less affected by the
global financial crisis than the United States.

11Imposition of tighter rules and regulations may also be politically unpopular.

12Adrian, Tobias, Arturo Estrella, and Hyun Song Shin. 2010. Monetary Cycles, Financial Cycles, and the Business Cycle. Federal Reserve Bank of New York Staff Reports 421.




Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Cyan Lite's picture

I don't get the "refresh on Yahoo Finance" reference...

Steak's picture

meaning he actually looked at the market..."turned on a tv" would have been the appropriate 80's-90's reference

hedgeless_horseman's picture

In this cost-benefit analysis, the central bank must understand that it will make mistakes.

Good luck with that requirement.  Programmed to blame others.  Has he not watched the Beard speak?

hedgeless_horseman's picture

In this cost-benefit analysis, the central bank must understand that it will make mistakes.

Good luck with that requirement.  Programmed to blame others.  Has he not watched the Beard speak?

Blindweb's picture

Sometimes it's a bubble that pops, but sometimes orbit is reach (ht fofoa).  Sometimes your idea is a flop, but sometimes it's revolutionary.  There's no way to know ahead of time.  People are pretty much as efficient as they can be.  (Evolution is really slow)  The more resources you use to analyze the future the less you have for spending on production now.  Bubbles are just an inevitable part of life.

dcb's picture

this man is a whore and disgusting. I knew that before he got his current job. the trend contonues. geither, friedman, now dudley. Guess whore ha to be on your cv to get this job. when is the us going to get rid of these terrorists and make them stand trial

GFORCE's picture

Such a long winded pile of jargon from Dudley but Tyler's explanation was far more clear and far more relevant. The no volume ramp and the all news is good news, continues in essence amidst sovereign default, geopolitical crisis and inflating commodity prices. The recovery gathers pace but the market uses every piece of positive news to add another 100+ points to the dow and at some point, efficient pricing goes out the window.

The same price action was seen late '07 and the outcome will be the same. Late 2010 and 2011 will be a bloodbath for the ponzi reflation as the dominoes fall.

Tic tock's picture

I love the way this is a Central bank issue.. to stem the risk-taking.. "risk / reward" - does Dudley think the Fed can make finance balance risks over the longer term, what are they going to do, file reports once a decade? The whole point in having large banks is thatthey are supposed to have a longer-term perspective, they're supposed to return somewhat lower ROE, a by-product of world where valueis added in greater measure than inflation (supply of money outlook). And instead we have large, non-hedge variety balance-sheet allocations to diminishing-yield-chasing instruments. Quite simply,the biggest Banks went out and built a bubble whichis the very thing that big banks should be against doing.. one thought to fix this mess, takethe Fed inflation target, any increase in ROE above that for the TBTF, before salaries and after dividends, is a tax-receipt; exempt muni-bonds from said treatment (asin income from which remains untaxed).     

mark456's picture

Good linux hosting option package offered by ucvhost which not only provides the best in terms of hosting packages but also believes in truly being there for the customer, 24x7. cheap hosting Moreover , they offer unlimited bandwidth as well as nearly 1GB storage along with database maintenance, email facility along with storage, availability of sub domain and many other important features for a very low price. windows hosting Thanks forex vps