And ... it's a hat trick

A short time ago, a link came in for this Project Syndicate article by Jeffrey D. Sachs, Professor of Economics and Director of the Earth Institute at Columbia University in New York.

He is also a Special Adviser to United Nations Secretary-General on the Millennium Development Goals and will soon be added to the list of TMTGM-approved economists which, while growing, can still be counted on two hands.

The Roots of America’s Financial Crisis
by Jeffrey D. Sachs

CAMBRIDGE – The US Federal Reserve’s desperate attempts to keep America’s economy from sinking are remarkable for at least two reasons. First, until just a few months ago, the conventional wisdom was that the US would avoid recession. Now recession looks certain. Second, the Fed’s actions do not seem to be effective. Although interest rates have been slashed and the Fed has lavished liquidity on cash-strapped banks, the crisis is deepening.

To a large extent, the US crisis was actually made by the Fed, helped by the wishful thinking of the Bush administration. One main culprit was none other than Alan Greenspan, who left the current Fed Chairman, Ben Bernanke, with a terrible situation. But Bernanke was a Fed governor in the Greenspan years, and he, too, failed to diagnose correctly the growing problems with its policies.

Today’s financial crisis has its immediate roots in 2001, amid the end of the Internet boom and the shock of the September 11 terrorist attacks. It was at that point that the Fed turned on the monetary spigots to try to combat an economic slowdown.
...
What was distinctive this time was that the new borrowing was concentrated in housing. It is generally true that lower interest rates spur home buying, but this time, as is now well known, commercial and investment banks created new financial mechanisms to expand housing credit to borrowers with little creditworthiness. The Fed declined to regulate these dubious practices. Virtually anyone could borrow to buy a house, with little or even no down payment, and with interest charges pushed years into the future.
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What was stunning was how the Fed, under Greenspan’s leadership, stood by as the credit boom gathered steam, barreling toward a subsequent crash. There were a few naysayers, but not many in the financial sector itself. Banks were too busy collecting fees on new loans, and paying their managers outlandish bonuses.

The story is worth reading in its entirety. Unfortunately, no easy solutions are offered.

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Also see:

- Sunday, April 6 at 11:49 AM: Greenspan recession probability update alert!
- Monday, April 7 at 9:11 AM: Greenspan: Don't blame me for the housing bubble