Bubbles Are Hard to Burst

Henry Farrell’s review of Fintan O’Toole’s Ship of Fools: How Stupidity and Corruption Sank the Celtic Tiger helps us understand why it’s so unlikely that government officials will do a good job of “popping” asset price bubbles:

As a recent report by three National University of Ireland economists emphasizes, Ireland’s financial institutions did not fall prey to exotic financial instruments, but to lax regulation and bad business judgment. The report is tactfully silent regarding the reasons why Irish regulators made “obviously flawed” judgments, although its mention of the fact that “most large property developers in Ireland have been very closely connected to the ruling political party, Fianna Fáil,” offers some clues. […]

A 1973 report argued that local authorities ought to be able to purchase land compulsorily at current market value plus 25 percent to stop speculators from manipulating the market and making windfall gains. Government after government agreed with this proposal in principle, throughout the 1970s, ’80s, ’90s, and 2000s — but curiously, implementing legislation was never introduced. In O’Toole’s description, Fianna Fáil “would sooner have personally insulted the Pope, Nelson Mandela and Mother Teresa” than offended the land speculators who helped fund their party. By the early 2000s, not only Fianna Fáil but the state itself needed to keep the property market buoyant. If the party ever stopped, both would face serious holes in their finances.

Once a bubble collapses, it’s easy for the bystander majority to adopt a smug attitude toward the people who got most in over their heads. But as long as the boom is ongoing, the circle of beneficiaries is quite large. High stock prices in the late 1990s and high home prices in the mid-2000s undergirded a lot of economic activity that translated into more jobs and higher compensation quite broadly. And this all helps make incumbent politicians look like geniuses. Recall not only Bill Clinton’s high approval ratings circa 1999 but also the way every nineties governor was portrayed as a brilliant pragmatist who’d managed to create jobs through a savvy combination of tax cuts and targeted investments in education and infrastructure. Who’s going to pull the plug on that?