Fed Bashing: Unfair and Costly

I ended my previous post, Jobless Recoveries: A Look Back, by raising a question; how does the same monetary policy that fosters disinflation in the general economy foster an inflationary bubble in only one sector? By easing monetary policy, the Fed intended to address a very weak labor market, a jobless recovery that threatened to turn back into recession and disinflation that threatened to morph into deflation. But, if the Fed was creating too much money, why was the money spent only on housing?

It is taken as given these days that the Fed created the housing bubble. If this is true, then it must follow that the Fed is responsible for the bursting housing bubble, the ensuing financial crisis and subsequent recession. But, as I recall, the Fed did not create the housing bubble. It was the collateralized subprime loans, not a reversal of home prices, that caused the problems. Maybe there were too many loans, but, if so many had not been bad loans, air could have come out of the bubble without devestation.

“The Fed made me do it. With interest rates so low, I had to stretch for yield.” Okay. Stretching for yield is one thing. Making and selling mortgage loans that were obviously bound to default is quite another thing. Can we seriously blame that on the Fed? My Japanese Haiku summarizes that position in only 17 syllables:

 If regular loans
Don’t earn enough to suit us
Maybe bad loans will 


Subprime loans triggered the crisis and recession. Other things like too much debt and leverage made the problem worse, but didn’t cause it. Yet everyone seems to have forgotten the cause and are focusing on second-order effects. Congress seems to think banker bonuses were the primary culprit.

I’m beating this dead horse because the casual and careless accusations that “it’s all the Fed’s fault” has caught on with an angry public and thus with Congress. The institution that did the most to save our financial system is about to be punished for it.

“But the Fed failed in its regulatory role. It didn’t see the crisis coming and nip it in the bud.” We’ve either forgotten or just don’t want to be reminded that the Fed’s regulatory and supervisory role is with state chartered member banks and bank holding companies. The Comptroller of the Currency is the regulator and supervisor of national banks. Neither one had jurisdiction over the non-regulated mortgage brokers that made most of the subprime loans or the large investment banks that packaged and sold obviously bad loans as securities. The distinction only blurs with the large commercial banks that affiliated with investment banks, such as Citi and J.P. Morgan Chase. Otherwise, the term “banks” does not fit, and it’s unfair to about 8500 banks across the country to use that term.

Fannie Mae and Freddie Mac played a crucial role by establishing the standards for the mortgages it would guarantee or buy. Those standards were progressively relaxed at the behest of Congress. Alan Greenspan cautioned many times that those institutions posed a threat and should be limited in their size and scope. Congress, however, “didn’t pick up what he was laying down.” (From a Toni Price song.)

Fed bashers who really care about their country should be more cautious lest they get what they pray for.

Comments (8)

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  1. David Kloth says:

    This is one of the most intelligent and insightful analyses and explanations of our recent economic collapse that I’ve read. It’s become all too easy to bash the Fed, the “banks” and the fat-cat, greedy “bankers” as the causes of the recession.

    Your comments correctly lay blame on the unregulated pieces of the financial puzzle and Congress for failing to establish regulations for them. We also can blame Congress for allowing Fannie and Freddie to loosen loan standards to such an extent that sub-prime mortgages were created.

    In summary, BRAVO!

  2. Dan says:

    Isn’t it the Feds who put the pressure on the banks to loan money to more minorities, and more people with bad credit? Didn’t they then end up loaning money to people without identification, or social security numbers? I believe is was the Feds, so they are to blame for most of the housing crash.

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  4. John B says:

    Bob are the assets in the “Fed balance sheet” included in the “monetary base” (m0)? Or does the “monetary base” only include US coins and paper currency?

  5. W.C. Varones says:

    Everyone from Congress to the Administration to Fannie and Freddie and Wall Street to lenders and appraisers was either corrupt and/or incompetent.

    That does not mean the Fed was not grossly negligent. The Greenspan/Bernanke Fed actively encouraged the last bubble while denying it was a bubble, and they trying their hardest to create a new bubble to cover up their mess.

  6. Robert Monical says:

    Just found your blog today. Very nice.

    I have to disagree with this statement: “It is taken as given these days that the Fed created the housing bubble.” I think the general belief is that the Fed did not prevent the housing bubble. Indeed, the Fed (at least Dr. Greenspan) was on record supporting securitization as a good way to diversify risk.

    Sadly, given its preference for impossibly low interest rates, it appears that the Fed will be as unable to prevent the next bubble as it was unable to prevent this one. At 0% interest, we all have to stretch for yield.

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  8. deb says:

    “Subprime loans triggered the crisis and recession. Other things like too much debt and leverage made the problem worse, but didn’t cause it.”

    You do the math. If memory serves me, all the subprime loans put together that have defaulted do not come close to measuring the size of the crisis. The problem was trading huge sums of derivatives of these products around the world effectively bankrupting a large number of companies trading these products had the taxpayer not bailed most of them out instead of letting them fail. Subprime loans – poo –nobody cared about the little guy taking a bad loan and still nobody does, they are falling like flies, as they should. But it’s the big boyz and banksters financial games that took the wealth of the middle class away via a long list consequences including the stock market crash, higher future taxes to help save their asses, job losses, and lower home equity.

    Read it and weep: http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom/

    “the scarcity of truly crappy subprime-mortgage bonds no longer mattered. The big Wall Street firms had just made it possible to short even the tiniest and most obscure subprime-mortgage-backed bond by creating, in effect, a market of side bets. Instead of shorting the actual BBB bond, you could now enter into an agreement for a credit-default swap with Deutsche Bank or Goldman Sachs.”