How the financial crises could have been avoided by the federal reserve

[OSR stands with Israel]

When demand and inflation is high(home prices in 2005 and 2006 were high and inflated) doesn't the Federal Reserve raise interest rates to lower demand and lower prices. Why didnt they do that in 2005 when House prices were high sky then. I mean if they increased home interest rates to 10-15% people would stop taking the risky loans which would lower home prices and the banks wouldnt be able to make so much risky loans which would stop the economy from collapsing in 2008.

[Ebsy]

The Fed had very little understanding of what was going on in the subprime mortgage markets in 2005- 2008. It didn't regulate them, and really, for all practical purposes, no one was regulating them. Even as late as 2008, Ben Bernanke was saying that the imploding subprime market was only going to have a limited impact on the rest of the economy, even though I suspect he may have only been saying this to calm down skittish markets. It's easy to criticize the Fed for not seeing the housing bubble coming, but that is what always happens when there is a speculative frenzy. Between 2006 and 2008, there were multiple occasions when the financial system should have blown up, but the mass delusion infecting all the investment banks, government regulators, and investors kept things rolling along, stretching the bubble larger and larger.

Also, in the case against raising interest rates, employment and wages were rather weak in the mid-late 2000s, so the Fed was afraid to raise interests rates because when you do, you run the risk of sending millions into the unemployment lines. The Fed was paralyzed by the fear that by acting in the chaotic and unregulated markets, they would create a crisis instead of preventing one, and thus bear the blame.

[OSR stands with Israel]

The Fed had very little understanding of what was going on in the subprime mortgage markets in 2005- 2008. It didn't regulate them, and really, for all practical purposes, no one was regulating them. Even as late as 2008, Ben Bernanke was saying that the imploding subprime market was only going to have a limited impact on the rest of the economy, even though I suspect he may have only been saying this to calm down skittish markets. It's easy to criticize the Fed for not seeing the housing bubble coming, but that is what always happens when there is a speculative frenzy. Between 2006 and 2008, there were multiple occasions when the financial system should have blown up, but the mass delusion infecting all the investment banks, government regulators, and investors kept things rolling along, stretching the bubble larger and larger.

Also, in the case against raising interest rates, employment and wages were rather weak in the mid-late 2000s, so the Fed was afraid to raise interests rates because when you do, you run the risk of sending millions into the unemployment lines. The Fed was paralyzed by the fear that by acting in the chaotic and unregulated markets, they would create a crisis instead of preventing one, and thus bear the blame.

Volker raised intrest rates in a worse economy then the mid 2000s and the US then due to that stagflation ended and the US went on one an economic boom from 1982-2007 with mild interruptions in 1991 and 2002

[Ebsy]

Volcker was castigated at the time for the havoc high interest rates wreaked on the farming and construction sectors(which are highly, highly dependent on loans). He was replaced by none other than Alan Greenspan, who deserves as much blame as anyone else for the crisis, as he was the one that kept interest rates ridiculously low for most of his tenure. Greenspan, in his day, was seen as the greatest financial mind in history, even though his championing of deregulation during his decades at the Fed created the climate for the Great Recession. It's only now, after the crash, that Volcker's image has been rehabilitated and Greenspan's legacy has been questioned. So yes, you're right, raising interest rates might have been the right course of action, but it would have still caused a lot of pain, though considerably less than the Great Recession.

[sg0508]

Volcker had to force a recession to kill stagflation.  From '81-'82, inflation nose-dived by 50%, but yes, unemployment soared due to the recession. 

[136or142]

Housing prices, at least in Canada but I believe also in the United States aren't counted as part of the inflation statistics.  Rent is though. So, since the Federal Reserve uses the official inflation statistics to determine interest rate policy (they try to keep inflation at either 1-2% or 1-3% per annum), the housing bubble would not have officially concerned them.

There are other measures to address housing bubbles that don't impact on the short term interest rate the Federal Reserve controls (or at least influences) that have been done in Canada but would have been the job of Congress to have done and not the Fed.  They could have raised the amount of money a person buying a home has to put down, they could have reduced the legal limit on the length of time of the borrowing (I believe the 30 year mortgages were the primary driver of the bubble).  Those are the two best measures.

This is a paper from the Canadian CD Howe Institute that looks into house prices and the inflation rate:
https://www.cdhowe.org/pdf/Commentary_362.pdf

[AggregateDemand]

What is this thread about? The Fed did notice the housing bubble, and they responded. Unfortunately, it was too little too late, and when $140 oil arrived, the US economy collapsed.

[Ebsy]

What is this thread about? The Fed did notice the housing bubble, and they responded. Unfortunately, it was too little too late, and when $140 oil arrived, the US economy collapsed.

Exactly. If you look back to Volcker's time, he had to raise rates up near 20% to combat inflation. Raising them gradually up to 6%, where they typically are, barely did anything. However, the oil link between oil and the economy collapsing is a bit less tenuous than you are suggesting.

[AggregateDemand]

Exactly. If you look back to Volcker's time, he had to raise rates up near 20% to combat inflation. Raising them gradually up to 6%, where they typically are, barely did anything. However, the oil link between oil and the economy collapsing is a bit less tenuous than you are suggesting.

y = c + i + g + nx

If net exports plummet because oil imports (dollar value) are soaring and domestic production is declining, the economy is going to falter. I'm not sure oil prices necessarily catalyzed the credit implosion, but the US economy was under immense pressure.

Consumptive imports for 2008 were $327B. Consumptive imports for 2014 were $178B. We're on pace for roughly $115B this year. Free GDP growth at 1.5% plus higher domestic production. Oil is a big part of our recovery, and you can see why Democrats don't really oppose fracking and Republicans don't really oppose CAFE (or the concept of fuel efficiency).

[Ebsy]

Exactly. If you look back to Volcker's time, he had to raise rates up near 20% to combat inflation. Raising them gradually up to 6%, where they typically are, barely did anything. However, the oil link between oil and the economy collapsing is a bit less tenuous than you are suggesting.

y = c + i + g + nx

If net exports plummet because oil imports (dollar value) are soaring and domestic production is declining, the economy is going to falter. I'm not sure oil prices necessarily catalyzed the credit implosion, but the US economy was under immense pressure.

Consumptive imports for 2008 were $327B. Consumptive imports for 2014 were $178B. We're on pace for roughly $115B this year. Free GDP growth at 1.5% plus higher domestic production. Oil is a big part of our recovery, and you can see why Democrats don't really oppose fracking and Republicans don't really oppose CAFE (or the concept of fuel efficiency).

I will agree with that, though one argument for the rise in oil prices is that during any crisis, when doubt enters marketplace, investors flee for commodities like gold and oil, as those things will retain value much more Goldman Sachs stock or "Triple A" CDOs. Regardless of economic conditions, people still buy gas to drive to work. Still, the market implosion had little to do with oil, even if ridiculously high gas prices were one of the outcomes.

[Southern Senator North Carolina Yankee]

Oil is a key factor in why the US economy was so sluggish and reliant on housing to begin with to pull it out. It also would have restrained manufacturing since energy costs are a big factor in that sector. Compare to the 1990's where you had multiple sectors surging and all of it undergirded by the low price of oil.