I understand how they printed the money (asset bubbles, cheap credit, etc.). But how were the Fed supposed to prevent that (if it had been doing its job)? It could have raised interest rates. But is that really the only weapon at its disposal?
Which interest rates can it change at all, by the way? The way I heard the story the central banks can only change the rate they charge from the banks - but if the banks can make money for themselves without the central bank, then what kind of fulcrum does the CB have?
Or does the CB control the ratio of "funnymoney" that banks can print to "real money" that they must have in stock to do so?
And what is "real" money anyway? Does "funnymoney" become "real money" once it's been loaned out and then re-deposited by the guy who took out the loan?
We seem to keep running into this relationship between central banks and the rest of the world. Maybe someone should write a Central Banking For Dummies diary and stick it somewhere we can find it. (Fortunately I'm not knowledgeable enough about the subject to do so myself :-P)
- Jake If you only spend 20 minutes of the rest of your life on economics, go spend them here.
But the current crisis has little to do with margin requirements. It is really directly about skirting the banking regulation and the monetary policy limits of the Fed. The banks have done an end-run around banking and credit regulation with securitization and off-balance-sheet "special investment vehicles". I am not sure monetary policy tools like interest rates would have been effective at all. Tightening reserve requirements wouldn't have helped either because essentially what banks have done is outsource the credit risk from money creation by loans, which is what reserve requirements protect banks against, to institutions with no reserve requirements.
I have been called wrong a couple of times on my interpretation of just how regulation was skirted in the subprime case, so I can't say I know how this could have been prevented. However, it does appear that Greenspan was warned about both the lending practices going on in the subprime sector, as well as the financial risks, and chose to do nothing. The blame probably lies squarely with the Fed as bank regulator, not as monetary authority. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. — John M. Keynes
For complex phenomena there is usually more than one way to influence them. Interest rates would have been one in this case. Mortgage lending regulation another, higher reserve requirements yet another, and there are probably even more. Using more than one measure to reach a goal is usually a good idea. Der Amerikaner ist die Orchidee unter den MenschenVolker Pispers
But houses are no stocks. After all people were living in those houses and I doubt that many people are willing to take negative armotisation mortgages. Even if the house price goes on upwards for some more time, you still have the debt and you can't sell your house without some form of replacement. When your house price goes up so much, then probably your replacement would be expensive, too. So you would always end up in trouble. So people look on the loan and what they can pay back and decide.
But still as the banks had to figure in some risk, higher interest would have led to lower leverage? Der Amerikaner ist die Orchidee unter den MenschenVolker Pispers
