FED big mistakes
The consensus is that US policymakers erred when:
· the decision was made to eschew principles-based regulation and allow the shadow banking sector to grow with respect to its leverage and its compensation schemes, in the belief that the government’s guarantee of the commercial banking system was enough to keep us out of trouble;
· the Fed and the Treasury decided, once we were in trouble, to nationalize AIG and pay its bills rather than to support its counterparties, which allowed financiers to pretend that their strategies were fundamentally sound;
· the Fed and the Treasury decided to let Lehman Brothers go into uncontrolled bankruptcy in order to try to teach financiers that having an ill-capitalized counterparty was not without risk, and that people should not expect the government to come to their rescue automatically.
There is, however, a lively debate about whether there was a fourth big mistake: Alan Greenspan’s decision in 2001-2004 to push and keep nominal interest rates on US Treasury securities very low in order to try to keep the economy near full employment. In oter words, should Greenspan have kept interest rates higher and triggered a recession in order to avert the growth of a housing bubble?
by J. Bradford DeLong