Preventing the Next Bubble
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The United States has managed to survive the bursting of a giant real estate bubble. Although many are still trying to digest the losses and Listen to Audio

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are struggling with the aftermath, now is the time, before the memories start to fade, to figure out how to prevent the next bubble, not just fight the battles of the last one. One essential part of this task is to add countercyclical factors to credit markets. How could this be done? How can the overoptimistic expansion of debt, leverage, and risk, including debt promoted by the government, as mortgages were, be addressed? Would the financial reform legislation currently before Congress prevent a new bubble? Given the record of repeated overexpansions followed by crises throughout financial history, can the next bubble actually be prevented? These and related issues were addressed by expert panelists: Representative Bill Foster (D-Ill.), member of the House Financial Services Committee; Jay Brinkmann, chief economist of the Mortgage Bankers Association; AEI visiting scholar John H. Makin; Allan Mendelowitz, former chairman of the Federal Housing Finance Board; and Mark Zandi, chief economist of Moody's AEI resident fellow Alex J. Pollock moderated.

Event Summary

WASHINGTON, JUNE 14, 2010--Five experts gathered at AEI Monday to discuss the effects of the most recent real estate bubble and its implications for preventing future bubbles. They addressed the factors that led to the development of the bubble and whether it could have been identified and resolved before it escalated into a full-fledged crash. They also discussed a number of implementation strategies to mitigate the effects of the bubble and whether it merits government intervention. Pointing to the causes of the bubble, Mark Zandi, chief economist of Moody's, argued that there are three predominant conditions for a bubble: a quick increase in the price of an asset relative to GDP growth, a substantial rise in activity and transactions, and a push for more leverage. In response to these underlying causes, Representative Bill Foster (D-Ill.) suggested a simple dampening solution in which minimum down payments are made equal to a constant rate plus the increase in real regional housing prices over the past three years. In effect, the countercyclical increase in down payments would encourage stricter underwriting rules and limit overall volatility in the housing market. While the panelists identified different factors contributing to the decline in the market, they all agreed that recognizing and resolving a financial bubble is a difficult and complicated process. The more pertinent issue is how policymakers should react to the recent bubble and which specific strategies should be implemented to prevent a repeat in the future.

  • "In approximately a period of eighteen months, $17.5 trillion of household net worth was destroyed. About $6 trillion has been recovered since the massive intervention of our economy, but this is the largest destruction of wealth in human history, and it's hard to overstate what we're living through."
    --Bill Foster, U.S. House of Representatives (D-Ill.)

  • "Bubbles will always be with us, as will the dream of effortless wealth enhancement because that's what bubbles are about. Bubbles are exhilarating. . . . When you're dealing with bubbles you're dealing with human nature."
    --John H. Makin, AEI and Caxton Associates

  • "I think that it is possible to spot bubbles. I think that with the creation of the Office of Financial Research and the regulatory reform legislation that is currently in the conference committee, the government will have an entity with the capability to . . . assess bubbles and assess whether the bubbles represent systemic threats rising to a level that would warrant a policy response. It is really tough because the very same people who are today criticizing government policymakers for not having intervened to reduce the bubble would be criticizing the very same policymakers if earlier in this decade they had intervened to prevent the bubble because everyone would have seen their opportunity to make quick gains quashed and they would have found that an unforgivable offense."
    --Allan Mendelowitz, Federal Housing Finance Board
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Speaker biographies

Bill Foster was elected in March 2008 as representative of Illinois's fourteenth congressional district. Before being elected congressman, Mr. Foster worked as a researcher at Fermi National Accelerator Laboratory (Fermilab), where he discovered the top quark, the heaviest known form of matter. He also led the team that designed and built several scientific facilities and detectors still in use today, including the Recycler Ring, a giant particle accelerator. He has been elected a Fellow of the American Physical Society, received the Rossi Prize for Cosmic Ray Physics for the discovery of the neutrino burst from Supernova SN1987a, received the Particle Accelerator Technology Prize from the Institute of Electrical and Electronic Engineers, and was awarded an Energy Conservation award from the U.S. Department of Energy for his invention and application of permanent magnets for Fermilab's accelerator.

Jay Brinkmann is chief economist and senior vice president of research and economics for the Mortgage Bankers Association (MBA), where his responsibilities include economic forecasting, mortgage industry analysis, the benchmarking of industry profitability, and analysis of legislative and regulatory issues. He joined MBA in early 2001 and headed MBA's research group. He was named chief economist in 2008. Immediately prior to MBA, he worked in Fannie Mae's portfolio strategy group. He has published articles on bank regulation and capital requirements in various academic journals and on the op-ed page of the Wall Street Journal and is frequently quoted in print and electronic news outlets on real estate topics.

John H. Makin is a visiting scholar at AEI. He is also a principal at Caxton Associates. Mr. Makin has been an adviser to numerous U.S. government agencies, the Federal Reserve System, and the Bank of Japan. He is a member of the Council on Foreign Relations and the Economic Club of New York. Mr. Makin joined AEI in 1984 after a distinguished career in academic research. He is the author of numerous books and articles on financial, monetary, and fiscal policy, and he writes AEI's monthly Economic Outlook.

Allan Mendelowitz is a founding member of the Committee to Establish the National Institute of Finance. Previously, he served on the board of directors of the Federal Housing Finance Board from 2000 to 2009 (as the board's chairman from 2000 to 2001), and he was the executive director of the U.S. Trade Deficit Review Commission, a congressionally appointed bipartisan panel. Mr. Mendelowitz has also served as vice president of the Economic Strategy Institute and as an executive vice president of the Export-Import Bank of the United States. From 1981 to 1995, Mr. Mendelowitz was managing director for international trade, finance, and economic competitiveness at the U.S. Government Accountability Office. He was formerly an economic policy fellow at the Brookings Institution and on the faculty of Rutgers University. His articles have appeared in the Journal of Business, National Tax Journal, the Journal of Policy Analysis and Management, the Financial Times, and American Banker.

Alex J. Pollock has been a resident fellow at AEI since 2004, focusing on financial policy issues, including housing finance, government-sponsored enterprises, retirement finance, corporate governance, accounting standards, and the banking system. Previously, he spent thirty-five years in banking, including twelve years as president and chief executive officer of the Federal Home Loan Bank of Chicago. He is the author of numerous articles on financial systems and the organizer of the “Deflating Bubble” series of AEI conferences. In 2007, he developed a one-page mortgage form to help borrowers understand their mortgage obligations. He is a director of Allied Capital Corporation, the Chicago Mercantile Exchange, the Great Lakes Higher Education Corporation, the International Housing Union for Housing Finance, and the chairman of the board of the Great Books Foundation.

Mark Zandi is chief economist of Moody's Analytics, where he directs research and consulting. Mr. Zandi's research interests include macroeconomics, financial markets, and public policy. His recent research has focused on the determinants of mortgage foreclosure and personal bankruptcy, analyzed the economic impact of various tax and government-spending policies, and assessed the appropriate policy response to bubbles in asset markets. Mr. Zandi also conducts regular briefings on the economy. He is often quoted in national and global publications and interviewed by major news media outlets and is the author of Financial Shock, an exposé of the financial crisis. His forthcoming book, Paying the Price, provides a road map for meeting the nation's daunting fiscal challenges. Mr. Zandi has frequently testified before Congress and has advised the Obama administration as well as Senator John McCain's presidential campaign.

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Preventing the Next Bubble
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