What if the Fed sleeps again?
Of late, Ben Bernanke has been arguing that the crisis was caused by a poor regulatory structure, and that the answer is a souped-up Federal Reserve with more power to bring banks to heel. This is revisionist history, at best. My question on financial regulation has long been 'does it work if the Federal Reserve does not want to enforce it,' and for good reason: That's exactly the situation we saw in the run-up to the financial crisis. I'll tag in David Leonhardt for this bit:
In 2004, Alan Greenspan, then the chairman, said the rise in home values was “not enough in our judgment to raise major concerns.” In 2005, Mr. Bernanke — then a Bush administration official — said a housing bubble was “a pretty unlikely possibility.” As late as May 2007, he said that Fed officials “do not expect significant spillovers from the subprime market to the rest of the economy.”
The fact that Mr. Bernanke and other regulators still have not explained why they failed to recognize the last bubble is the weakest link in the Fed’s push for more power. It raises the question: Why should Congress, or anyone else, have faith that future Fed officials will recognize the next bubble?
On some level, it's intrinsic to the very definition of a bubble that the empowered regulators don't perceive a problem. If they did perceive a problem, the bubble would get popped. Alan Greenspan might not have had all the powers he would like, but had he been walking around saying that housing prices are unsustainable and probably a bad investment, and had he raised interest rates to cool the economy, the situation today would be very different. That, again, is why I'm interested in automatic stabilizers like limits on leverage and an FDIC-style package of insurance, examination, and regulation in the so-called shadow banking market (the market where banks and professional investors lend and loan to each other).
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