Comment on a Martin Wolf Column
Letter to the Editor

Martin Wolf is certainly right in suggesting that a principal lesson of today's financial market debacle is that central banks must target more than just inflation. He is also correct in suggest that central banks need to be keenly alert to the formation of excessive asset price bubbles. However, by focusing exclusively on the Fed's overly accommodative interest rate policy between 2000 and 2006, he seems to underplay the perhaps even greater role that was played in the US housing market bubble by the Federal Reserve's egregious regulatory failure over that period. It would seem that even had the Federal Reserve followed a Taylor rule in setting interest rate policy, we would still have had a damaging housing market bubble due to a massive loosening of mortgage lending standards as a result of the very poor regulation of that lending.

A key lesson that should be drawn from the fall out of the US housing market bubble is that the Federal Reserve can ill-afford to be derelict in the exercise of its regulatory responsibilities. More specifically, there can be no excuse for the Federal Reserve's having tolerated the very poor lending practices of the non-bank mortgage originators, which relied heavily on an originate-to-distribute model and which accounted for around half of all mortgage originations between 2004 and 2006. Nor should the Federal Reserve be absolved of responsibility for having allowed more than US$2 trillion in sub-prime and Alt-A mortgages to have been extended at loan to value ratios often approaching 100 percent and to borrowers who by all accounts were patently not creditworthy.

It would seem that, over the period 2000 to 2006, the Federal Reserve was equipped with both an interest rate instrument and a regulatory instrument that should have allowed it to better attain the two objectives of containing price inflation and of preventing the formation of destructive asset price bubbles. Sadly, the Federal Reserve was far too accommodative in its interest rate policy and highly irresponsible in the exercise of its regulatory authority.

Desmond Lachman is a resident fellow at AEI.

Also Visit
AEIdeas Blog The American Magazine
About the Author

 

Desmond
Lachman

What's new on AEI

Rebuilding American defense: A speech by Governor Bobby Jindal
image Smelling liberal, thinking conservative
image Stopping Ebola before it turns into a pandemic
image All too many reasons for pessimism about Europe
AEI on Facebook
Events Calendar
  • 20
    MON
  • 21
    TUE
  • 22
    WED
  • 23
    THU
  • 24
    FRI
Monday, October 20, 2014 | 2:00 p.m. – 3:30 p.m.
Warfare beneath the waves: The undersea domain in Asia

We welcome you to join us for a panel discussion of the undersea military competition occurring in Asia and what it means for the United States and its allies.

Event Registration is Closed
Tuesday, October 21, 2014 | 8:30 a.m. – 10:00 a.m.
AEI Election Watch 2014: What will happen and why it matters

AEI’s Election Watch is back! Please join us for two sessions of the longest-running election program in Washington, DC. 

Event Registration is Closed
Wednesday, October 22, 2014 | 1:00 p.m. – 2:30 p.m.
What now for the Common Core?

We welcome you to join us at AEI for a discussion of what’s next for the Common Core.

Thursday, October 23, 2014 | 10:00 a.m. – 11:00 a.m.
Brazil’s presidential election: Real challenges, real choices

Please join AEI for a discussion examining each candidate’s platform and prospects for victory and the impact that a possible shift toward free-market policies in Brazil might have on South America as a whole.

No events scheduled this day.
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.