In August 2005, the Jackson Hole Economic Policy Symposium was to be the last for Federal Reserve Chairman Alan Greenspan, set to retire in January 2006. This was the occasion to pay homage to the luminary whose 15-year career spanned the ideological divide between Paul Volcker and Ben Bernanke.

Raghuram G. Rajan, the precocious chief economist of the International Monetary Fund, was asked to present a paper on how the financial sector had evolved under Greenspan’s tutelage. Rajan was aware of the solemnity of the occasion and knew that others would be breathless in their praise of securitization, deregulation, the emergent concept known as the “Greenspan put,” and other tools of financial creativity and exposition that were spawned during the maestro’s reign.

In his research, Rajan became increasingly aware that the rationalization for securitization was critically dependent upon assuming, ceteris paribus, that everything else remains the same, which, inconveniently for economists, it never does. Securitization spurred competition among the big commercial and investment banks, which in turn boosted the incentives to take on more complex forms of risk. Further, those incentives were skewed, with asymmetrical payoffs going to the winners and with losers being punished by a figurative slap on the wrist — except for the occasional colossal failure. The securitization subset of credit-default swaps, insurance against bond defaults, were viewed at the time as posing little risk for the underwriters — until AIG’s spectacular collapse in 2008. The more Rajan dug, the more he unearthed a financial system that was built atop a veritable sinkhole. So what was Rajan to say at Jackson Hole?

Circling back, the novel idea of the “Greenspan put” was built on the premise that the Fed was ill-equipped to determine precisely when to pop a bubble. It might prematurely and inadvertently bring an expansion to an end, costing the economy both output and jobs. The put signaled that the Fed would ignore escalating asset prices and stand ready to pick up the economic pieces when the bubble bursts. It has been apparent since 1996, however, that the Greenspan put was less a solution for asset bubbles and more a root cause of them.

The housing bubble of the early 2000s is but one conspicuous historical example. From 2000 to 2006, the Case/Shiller median house price index spiked from $100,000 to $185,000, before fading to $135,000 in 2012. Securitization amplified a comparatively benign house-price decline into the Great Recession. Central bankers have tended to underestimate or become complacent about the complexity of the interaction of asset markets and the economy. Today the house-price index stands at $306,000, 225% above 2012 prices. As per the Greenspan script, the Fed remains mute. Perhaps the central bank believes that with securitization partially denuded, any fallout will be less than the implosion from the last bubble? The combination of antisocial incentives and the shortness of financial memory has been a toxic brew in the past. Wishful thinking is not a strategy.

Feeling like a “Christian who had wandered into a convention of half-starved lions,” Rajan delivered his paper, “Have Financial Developments Made the World Riskier?” With breathtaking rapidity, the audience became demonstratively hostile. Former U.S. Treasury Secretary Lawrence Summers, whom we’ve quoted in the past, called the warnings “misguided” and Rajan himself a “Luddite.” As it turned out, the imminent threat to stability that very few saw was in plain sight.

Symposium: August 27, 2010

Five years later, on Friday, August 27, 2010, at exactly 10 a.m., Ben Bernanke took the stage at the Jackson Hole Economic Policy Symposium. That was when quantitative easing (QE) was codified as a permanent addition to the Fed’s toolbox. There was no Raghuram Rajan in the house to warn of the dangers.

Symposium: August 25–27, 2022

At the first annual Jackson Hole Symposium to be conducted in person since the pandemic, Fed Chair Jay Powell is making his fifth appearance, also at precisely 10 a.m., on a Friday as well. Keynoting in the posture of most Fed chairs who preceded him when shifting policy, Powell seeks a Goldilocks outcome following the current tightening phase, with the economy neither expanding nor contracting by very much as the Fed does its shtick in trying to put the inflation genie back in the bottle. The script will be a little more complicated as Powell also attempts to restore his credibility. At the virtual conference last year, he doubled down on his contention that inflation would be temporary.

Financial pundits will be examining Powell’s words in microscopic detail for nuanced clues as to how he’ll navigate fighting inflation without pricking the “everything” asset bubble.

Conspicuous by his absence in all such symposiums since 2006, a spoiler like Raghuram Rajan will never again get the opportunity to present a prescient but politically putrid paper in such a setting. The fault lines have been, quite literally, papered over since 2008. All manner of discontinuities were enabled when the cost of money was strong-armed to near zero. Hidden fractures still threaten the world economy.[1] Like Rome’s Nero, pundits and policymakers ponder…

Undeterred, we, along with our partners at Palm Valley Capital Management, will continue writing about the risks that seemingly no one else wants to discuss. Despite our diminutive size (or, who knows, perhaps because of it?), we will speak truth to power. Investment-wise, we don’t have to pop bubbles; we only must avoid them. As the managed interest rates in the economy free its mass from the gravitational pull of the organic forces of supply and demand, its orbit becomes increasingly erratic and anything can happen.

With a complex system in such a critical and destabilized state, almost anything that transpires will threaten social and economic stability. We believe that from those ashes will emerge the first unmitigated and untrammeled expansion in several decades. This is not because the reigning powers will be uninterested in trying to manage it, but because they will have become powerless.  Please put us in the camp of long-term, unrepentant optimists.

[1] Rajan, Raghuram G., Fault Lines: How Hidden Fractures Still Threaten the World Economy. 2010. Princeton University Press.

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