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.