We have been saying for a while now that the U.S. Federal Reserve needs a better pair of glasses. Its ability to see even the obvious seems to have been severely challenged, beginning with Alan Greenspan’s era and carrying on with his successor, Ben S. Bernanke. Over a period of several years, the Fed failed to understand the destructive dimensions of the subprime trend or the need to regulate these faulty investment instruments. The New York Times details some of the background to this troubling performance in a major piece today. It paints an unsettling picture during a time of growing economic uncertainty and one that should prompt many observers to ask what else might the Fed be missing.
Here is an excerpt from the piece.
An examination of regulatory decisions shows that the Federal Reserve and other agencies waited until it was too late before trying to tame the industry’s excesses. Both the Fed and the Bush administration placed a higher priority on promoting “financial innovation” and what President Bush has called the “ownership society.”
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Fed officials noticed the drop in standards as well. The Fed’s survey of bank lenders showed a steep plunge in standards that began in 2004 and continued until the housing boom fizzled in 2006.
But the regulators found themselves hopelessly behind the fast-changing practices of lenders. In a bid to set new standards for exotic mortgages, the agencies waited until December 2005 to propose a “guidance” to banks and thrifts. They did not agree on the final standard until September 2006.
Standards for Lenders
But the real shock to consumer groups — and even to some of the regulators — was that the new underwriting standards did not apply to subprime loans. Instead, they applied to only a fairly narrow array of exotic mortgages like “option ARMs.”