Sunday, April 15, 2012

New bubble grows, with Fed's help

James Saft article

The founders of Instagram, Kevin Systrom and Mike Krieger, ought to get down on their knees every night and pray in gratitude to Ben S. Bernanke. That is because Mr. Bernanke, the Federal Reserve chief, has been crucial in creating an atmosphere in which two 20-somethings can sell an 18-month-old company with 13 employees and no significant revenue for $1 billion.

Facebook agreed Monday to pay $1 billion in cash and stock for Instagram, which develops photo-sharing applications, just a week after the infant company closed a funding deal valuing it at a paltry $500 million. Although Mr. Bernanke and the Fed will not get a cut of the cash, the past 15 years show exactly how much credit they deserve for such bubble valuations.

Twice since 1997, the Federal Reserve has eased policy after disruptions to financial markets, and twice, speculative bubbles have grown up in the aftermath. It is looking increasingly as if social media technology shares are the third in the series. In 1998, after the Asian financial crisis, the hedge fund Long-Term Capital Management nearly failed and required a Fed-orchestrated bailout. Although no Fed money was used in the rescue, it was followed up shortly with a cut in interest rates intended in part to calm the waters. That sent a clear signal to the market: the Fed has your back.

It should come as no surprise that subsidizing speculation gave rise to more speculation, but this time on a larger scale. The Internet bubble rose rapidly and burst just as rapidly, after which there was a sustained campaign by the Fed to lower interest rates. The Fed, led by Alan Greenspan, had already halved rates to 3 percent by the time of the Sept. 11, 2001, attacks, and it ultimately took them to just 1 percent.

That set the stage for the housing bubble -which, fanned by low rates, hugely exceeded in size the manias that had come before it. When the housing bubble burst, the global financial system nearly failed, and Mr. Bernanke's Fed took rates virtually to zero before starting a multipronged campaign of quantitative easing -purchasing of long-term debt to hold down interest rates -that is still going.

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