Still More On Boom-and-Bust

I've made a couple posts in the past talking about how we seem to operate in a boom-and-bust environment.
If you look at the first link, reader Wanna provided another comment supporting his position. I quote:

Wanna said...

Philosophically speaking boom and bust are a way of life and that is the way it should be. Fed should not try to anticipate a boom and nip it in its bud. How would the Fed know in advance that a bubble is going to happen. These things are evident only in hindsight (which of course is 20/20 for TV and market pundits). Fed's job as Greenspan and Bernanke have said before should be that of a mopper rather than a boom-breaker.

Wanna said...

http://blogs.forbes.com/streettalk/2010/02/02/death-taxes-and-market-crashes/?partner=dailycrux

Please see the above link (sent to me by someone else). Boom and bust are inevitable. If something is running very smooth its cause for concern as it might point to under-utilization of resources i.e. a smooth running economy almost by definition would not be utilizing its resources to the optimum.

"Boom and bust are inevitable". To some extent, I disagree. I think Wanna is right that philosophically, in the big picture, boom-and-bust is a fact of life. Nations rise and fall, etc. However, the assumption in his argument is that boom and bust on a smaller time-scale is a natural condition. In fact, there is nothing natural about our markets and economies: these are artificial, man-made constructs that we control. As such, their "natural" behavior is controlled by governments and societies and can thus be purposefully influenced.
For example, there is no economy in the world that optimally uses its resources (another argument used by Wanna to justify boom-and-bust). A simple example is that most countries, if not all, have a defense sector. Generally, contracts in this sector are handed out by governments to corporations within their jurisdiction, for security purposes. This inherently is a market that does not allow maximum competition, which usually leads to bloated contracts that are not at all optimal. Will this ever change? No. It is a security issue.
There are probably myriad other examples of how there truly is no such thing as a completely free-market society. Other than in the jungle, such an environment does not exist. We work in an artificially constructed system, and I don't think anyone wants to go to a Lord of the Flies society.

As such, I still hold to my view that we should work hard to improve government regulation and oversight of markets. I have admitted in the past that the government cannot do everything:

Not all bubbles can be prevented, not all idiocy can be controlled. However, the government has a responsibility to control what it can.

This includes viewing with suspicion markets that seemingly don't stop going up, and making sure that the mechanisms propelling them forward are not fundamentally unsound. This type of government regulation would likely not have done anything to prevent the dot com bubble we saw in the late 90's, as that seemed to be an issue of poor speculation by private investors without any serious underlying corruption. However, it could have mitigated the housing bubble in which triple-A ratings were given to fundamentally bad bundles of mortgages that banks then wildly speculated on. Curbing the boom would, I think, minimize the following bust, and I fail to see how that would be a bad thing. This would require that Bernanke not in fact be only a mopper, but instead an active regulator looking out for dangerous financial or economic activity.

Indeed, the final paragraph of the link Wanna provided speaks to my view:

Leverage, of course, just makes things worse. Or maybe that's not so obvious to everyone. The authors note that financial firms tend to blow up every 20 years or so, and that's to be expected given their high leverage and propensity to come up with innovative new products that nobody understands. The bankers' less imaginative counterparts, who make real things people can actually use, tend to carry less leverage. "In a sense, Corporate America seems smarter than the financial firms in managing its long-term risks," the authors write. Ah, but how can you earn a fat year-end bonus that way?