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While The Federal Reserve Slept


Binya Appelbaum had a great piece on Sunday explaining the Federal Reserve's disastrous reluctance to regulating subprime mortgages. The key moment here came in 2000, when Ed Gramlich, one of the Reserve's 12 governors, directly asked Alan Greenspan to regulated the subprime market. "Greenspan said that he disagreed with Gramlich," reports Appelbaum, "telling him that such inspections would require a vast effort with no certainty of results, and that the Fed's involvement might give borrowers a false sense of security."

Put simple, Greenspan's logic was that the Federal Reserve should not regulate because regulation might not turn up wrongdoing, and if it did turn up wrongdoing, it might not be able to correct it. "In hindsight, both of these reasons are ludicrous," comments Felix Salmon. "Policework, by its very nature, involves a lot of effort and no certainty of results. That doesn’t mean there shouldn’t be any policing."

But then, there's something vaguely tautological about saying the revered Chairman of the Federal Reserve did not attack his bubble. After all, if Alan Greenspan, a regulator we literally nicknamed "The Maestro," had devoted himself to speaking out against the bubble, there likely would have been no bubble, and thus no pop, and thus no stories.

This continues to be my question about financial regulation: what do you do if the Chairman of the Federal Reserve doesn't want to regulate? Much of the discussion focuses on providing regulators with the appropriate tools, but I'm much more interested in the portions of the package that are automatic -- that work even when the rest of us are convinced by the soundness of the latest bubble. After all, you can't have much of a bubble if the regulators and the market's most trusted wise men don't believe in it. Yet you still have bubbles. The most important role for financial regulation is as a safeguard for when our collective judgment fails.

Photo credit: Brendan Smialowski -- Bloomberg News Photo .

By Ezra Klein  |  September 29, 2009; 10:15 AM ET
Categories:  Financial Regulation , Solutions  
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That same question -- "what do you do if the Chairman of the Federal Reserve doesn't want to regulate?" -- is being paraphrased this morning by a Senator from West Virginia in connection with health care regulation.

In response to his "Who would be checking?" question (#3), he received the answer that State Insurance Commissioners would continue to be responsible, leading him to follow-up with the same question posed in relation to finance regulation.

I must admit, I have the same question: if a regulator is, in fact, opposed to the law of the land, what recourse do we have as citizens?

Posted by: rmgregory | September 29, 2009 11:00 AM | Report abuse

What is that package / structure which is effective even when Fed Chairperson does not want to stop the bubble? Decision making by majority on Feb Board? I believe it is there already in some form.

What about something called Basel 'counter cyclical' bank reserve requirements? If bubble starts building up, higher % of reserves are required whereas when deflation is there, % is smaller. Since any financial asset (and hence in the end bubble) will translate on bank books when 'white economy' is all pervasive ('black economy' is where due to corruption you do not have details on taxable accounts i.e. bank books; like say infamous Nigerian corruption); Basel bank reserve requirements may have teeth.

Did that glob fest called G20 talk anything along these line? Or was it all 'hot air' and no action?

Else, we are for sure destined some another bubble and Fed at 'sleep'; no matter how insistently Rep. Frank wants us to believe that he and Congress will deliver on these promised permanent regulations.

Posted by: umesh409 | September 29, 2009 11:37 AM | Report abuse

Ezra writes "Ed Gramlich, one of the Reserve's 12 governors"

The Board of Governors of the Federal Reserve has only seven members. There are 12 reserve banks. (Actually, currently the board has only five members, two governorships being vacant.)

Posted by: thehersch | September 29, 2009 12:30 PM | Report abuse

Yes, but what if there is no single failure mode? There is almost certainly no way to construct regulation that corrects all problems, and does not exacerbate problems. Hence the need to rely on human judgment.

In that kind of environment, Greenspan's reasoning was sound. Indeed, the problems of irrational exuberance were largely outside of his patch - the ratings agencies, and the system of relying on them, instead of underlying information, was the problem.

Posted by: albamus | September 29, 2009 2:19 PM | Report abuse

Alan Greenspan is personally responsible for the misery and impoverishment of millions of people.

If he had not wanted to be a regulator, he should have resigned his position. He agreed to do the job; to not do so is complete lack of integrity.

Surely Randians believe that The Great Individual is still required to have a minimum of integrity and either meet their contractual commitments or publicly rewrite them, no?

Posted by: Dollared | September 29, 2009 2:34 PM | Report abuse

While the Fed Reserve slept? I think the article should add a few more Federal Agencies. While money was flowing into the system the FBI, SEC, US Attorney, etc allowed massive fraud to go unchecked. I laugh every time I read about the small mortgage bankers or loan brokers getting arrested. Both the US Attorney, SEC and FBI look like foolish pawns being used to go after crimes that happened 5-7 years ago for obvious political reasons. Why is there no accountability for these individuals in the Fed Gov't?

Posted by: rs8581 | September 30, 2009 3:55 AM | Report abuse

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