Former AIG Director Martin Feldstein Warns Of Stock And Housing Bubbles

That’s one of the things we learn from reading Robert Samuelson’s Washington Post column today, although Samuelson identifies Feldstein only by his professorship at Harvard, not his moonlighting work on AIG’s board. (In addition to requiring a massive government bailout during Feldstein’s tenure as a director, AIG was also rocked by an accounting scandal that forced the resignation of its Maurice Greenberg, its longtime CEO.) I’m one of those old-fashioned types who think that track records should matter in assessing the accuracy of economists’ assessments, which is why it is appropriate to mention AIG here.

While it would have been enormously valuable if a person of Feldstein’s prominence had warned of the housing bubble back in 2003 or 2004, before it had grown so large as to pose a major threat to the economy, his warning now is off the mark according to some of us who did see the earlier bubbles. High stock prices and housing prices are justified by extraordinarily low interest rates we have been seeing in the last decade.

While this could change (interest rates could rise) it would not be nearly as harmful to the economy as the collapse of the housing bubble in 2007-2009 or the collapse of the stock bubble in 2000-2002. Unlike in those two earlier periods, the high asset prices in these markets are not driving the economy. Investment and housing construction are not especially strong, so there is no reason to think they would plummet even if prices in both markets were to fall 20 or 30 percent. Consumption is somewhat high, and could fall back 1-3 percentage points of GDP in response to the loss of wealth implied by these sorts of declines. That would slow growth, but need not lead to a recession.

Samuelson also repeats the myth of the second Great Depression, telling us:

“Bernanke’s quick response to the financial crisis (along with Treasury Secretaries Henry M. Paulson and Timothy Geithner) arguably averted a second Great Depression. That, obviously, was a big deal. In the 1930s, unemployment peaked at 25 percent.”