In today’s Washington Post, Binyam Applebaum and David Cho took a long look at the Federal Reserve’s complete failure to take note of the subprime housing bubble. “The Fed’s failure to foresee the crisis or to require adequate safeguards happened in part because it did not understand the risks that banks were taking,” they wrote. “[R]ather than looking for warning signs, the Fed had joined — and at times defined — the mainstream consensus among policymakers that financial innovations had made banking safer.”
Of course, much of the focus — and the blame — falls to current Federal Reserve Chairman Ben Bernanke, and Applebaum and Cho rightly remind readers of Bernanke’s 2007 declaration that “we see no serious broad spillover to banks or thrift institutions from the problems in the subprime market.”
And it’s not like there was a shortage of warnings given directly to the Fed regarding the housing market’s problems. In one of many such instances, National City bank’s chief economist told the Fed in January 2005 that “an increasingly overvalued housing market posed a threat to the broader economy.” But “the message wasn’t well received” :
One board member expressed particular skepticism — Ben Bernanke. “Where do you think it will be the worst?” Bernanke asked, according to people who attended the meeting, one in a series of sessions the Fed holds with economists. “I would have to say California,” said the economist, Richard Dekaser. “They have been saying that about California since I bought my first house in 1979,” Bernanke replied.
As it turns out, nine of the top 10 subprime lenders were based in California, “including all of the top five — Countrywide Financial Corp., Ameriquest Mortgage Co., New Century Financial Corp., First Franklin Corp., and Long Beach Mortgage Co.”
This cuts right to the heart of whether the Fed should continue to retain its responsibilities over consumer protection. After all, there were plenty of people out there — both in and out of the government — who saw what was going on.
In 2001, then Treasury official and current FDIC Chair Sheila Bair tried, without success, to get subprime lenders to adopt a code of best practices and allow outside monitors to verify compliance. In 2002, Freddie Mac stopped purchasing some varieties of subprime loans, in an effort to discourage predatory lending.
In 2004, the Greenlining Institute (from California, incidentally) told the Fed that “unscrupulous” lending practices were spreading. Finally, in 2005, Federal Reserve Board governor Edward Gramlich tried to warned his colleagues “of the decline of lending standards and the dangers that this posed.”
All of which signals that the Fed is an institution biased toward the banks that it regulates and unwilling to take action against those banks, even when the financial safety of consumers is at stake. It was by no means the Fed alone that dropped this ball, but it certainly bears a good portion of the burden, which should be remembered as the Senate heads toward a vote regarding whether or not to confirm Bernanke for a second term.
Cross-posted on The Wonk Room.