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Does the Fed Really Control Money Supply?



October 11, 2009 – Comments (23)

And if not, then who?

The Fed does not lend money to me, or probably most of you. It does not buy material goods and pump the economy as the "stimulus" does.

The Fed lends to member banks. Gatekeepers who control what gets out to the rest of us. If they do not lend, the Fed has delivered no new money out here in the real world regardless of where it sets interest rates. It is upon the Gatekeepers judgement and the judgement of those who influence them that we depend.

Additionally power to create money was surrendered to investment banks by the SEC. By not regulating the CDO and CDS markets and allowing increased leverage to investment banks, trillions of dollars were loaned into the "real" economy that previously would have taken thirty years of mortgage payments to be steadily repaid and steadily lent again. Trillions of dollars were created (taken from the future?) this way and used to buy house after house, cars, countertops, sinks, atv's, gold, equitys, etc.

So the question is in the last ten years has money supply been inflated and deflated more by the actions and advice of a select few investment advisors than the Fed?

See you in few hours.



23 Comments – Post Your Own

#1) On October 11, 2009 at 4:57 PM, lquadland10 (< 20) wrote:

poof. My dear it does not matter because it is all thin air.

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#2) On October 11, 2009 at 5:35 PM, leohaas (30.15) wrote:

Count on banks lending money again pretty soon. It is how banks make money. And because of the fractional reserve banking system we have, they can create way more money than the FED pumped into the system.

You are making an excellent point about securitization. That is what should be regulated. Require anyone issuing a mortgage to keep it on their books for five years, for instance, would return banks to do their due dilligence for every loan they write, and get mortgage brokers out of the business.  The result would be a return to the 20% down guideline, giving home owners skin in the game. Skin in the game is what regulation should be about.

The flipside is that loans will be more difficult to get, interest rates would go up, and the housing market would return to its former low performance. But I am not so sure that is a flipside, because it would also prevent future housing bubbles...

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#3) On October 11, 2009 at 6:05 PM, whereaminow (< 20) wrote:

It's already regulated.... by the Fed.  Every financial instrument created is regulated by the Fed or the SEC.

The best regulator in the world would still be second best to bankruptcy - the ultimate regulation.

The Fed targets interest rates.  These rates influence how much money is borrowed.  If the Fed's rate manipulation had no effect, why would it even bother?  Why would it even exist?  How silly is the line of reasoning being engaged here?  Why not just be honest like Naomi Wolf, who simply admitted that liberals have no idea how the Fed operates.  The fractional reserve banks multiply money through lending.  But what factor is the single most significant in increasing demand among borrowers?  The interest rate.  So arguing that the Fed doesn't have any effect is like arguing that clouds don't have any effect on rainfall. 

I've posted this before, but for some reason it needs repeating:

Among the Fed's functions are the regulation of

Bank holding companies
State-chartered banks
Foreign branches of member banks
Edge and agreement corporations
US state-licensed branches, agencies, and representative offices of foreign banks
Nonbanking activities of foreign banks
National banks (with the Comptroller of the Currency) Savings banks (with the Office of Thrift Supervision)
Nonbank subsidiaries of bank holding companies
Thrift holding companies
Financial reporting
Accounting policies of banks
Business "continuity" in case of an economic emergency Consumer-protection laws
Securities dealings of banks
Information technology used by banks
Foreign investments of banks
Foreign lending by banks
Branch banking
Bank mergers and acquisitions
Who may own a bank
Capital "adequacy standards"
Extensions of credit for the purchase of securities
Equal-opportunity lending
Mortgage disclosure information
Reserve requirements
Electronic-funds transfers
Interbank liabilities
Community Reinvestment Act subprime lending requirements
All international banking operations
Consumer leasing
Privacy of consumer financial information
Payments on demand deposits
"Fair credit" reporting
Transactions between member banks and their affiliates
Truth in lending
Truth in savings

And the SEC Rules and Regulations is over 4,000 pages long.

Former Fed Chairman Alan Greenspan praised CDS's in 2002.  Remember, liberals loved Greenspan when his inflationary policies were making the Clinton economy look good.  Didn't Time magazine call him the Maestro or something?  I'll have to look that up.

There is only one regulation needed.  Let them go bankrupt.  The rest is intellectual poppycock.  I will now go back to football.

David in Qatar

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#4) On October 11, 2009 at 6:44 PM, devoish (71.86) wrote:

Former Fed Chairman Alan Greenspan praised CDS's in 2002

He was your guy, small gov, Ayn Rand, all that. Don't go all Judas on him now.

 liberals loved Greenspan when his inflationary policies were making the Clinton economy look good

At 11% - 6%?

Didn't Time magazine call him the Maestro or something?

Who cares what that Conservative rag called him?

Nobody regulated CDO's or CDS's. That was a completely unregulated market. Without regulations threatening legal punishment lies and misrepresentations ran rampant because without regulations there is no crime.

Whether it fits your dreams or not.

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#5) On October 11, 2009 at 7:52 PM, devoish (71.86) wrote:

Lest we forget what a free marketeer sounds like when selling free markets;

Some other concerns about the transfer of credit risk outside the banking system seem to be based on questionable assumptions. Some observers believe that credit risks will be managed more effectively by banks because they generally are more heavily regulated than the entities to which they are transferring credit risk. But those unregulated and less heavily regulated entities generally are subject to more-effective market discipline than banks. Market participants usually have strong incentives to monitor and control the risks they assume in choosing to deal with particular counterparties.- Alan Greenspan, 2005. 


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#6) On October 11, 2009 at 8:30 PM, whereaminow (< 20) wrote:

I write this for any sane person reading this, as you are incapable of exercising reason. 

Greenspan split with Ayn Rand a long time ago before he became the Fed Chairman.  This is well known even by those who claim that he's a Rand guy.  Let me share a story with you.  Back in the 60's a young Greenspan wrote a paper called Gold and Economic Freedom.  In that paper he explained that the existence of the Federal Reserve made the protection of individual savings impossible.  All the Fed had to do was lower rates and poof!  Savings were systematically destroyed.  Google the paper.  It's free on the web.

In the 70's and 80's Greenspan went off to work with the bankers.  He worked for... guess who?  Google it.  After that, as a promising up and coming statist, he was handpicked to work as Chairman of the Fed.  In that time, he centrally planned the supply of money - a socialist function of a socialist system. 

In the 90's, Ron Paul, a longtime critic of Greenspan (check the YouTube videos where Paul hammers him consistently) approached Greenspan and showed him a copy of Gold and Economic Freedom.  He sarcastically asked Greenspan to autograph it and Greenspan refused and excused himself.

Now, this information is all out there.  If you care, you could check it out.  Greenspan was a typical statist, promising free markets while manipulatng those markets.  Google "the Greenspan put" or Long Term Capital Management. 

Or you can sit here and say really stupid things on your blogs all day and make an arse out of yourself. Your choice.

And yes, Time magazine is so conservative that it put Obama on 14 covers already.  That will really appeal to that conservative readership.

Some people need psychological help.

David in Qatar

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#7) On October 11, 2009 at 8:39 PM, weg915 (< 20) wrote:


Just thought you would like to know, my kid is studying Ancient History in 6th grade - Greece, Romans etc...  I am using some of your posts to talk through different ideas with her and relate history to today.


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#8) On October 11, 2009 at 8:57 PM, whereaminow (< 20) wrote:

weg915 ,

That's great!  Thanks for the kind words.

I'm always a bit embarrasd when someone likes my posts. Is that weird? Probably.">David in Qatar

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#9) On October 11, 2009 at 10:22 PM, devoish (71.86) wrote:


You and Greenspan sound just the same to me. I am happy for you that you wish to be perceived as different. I have told you before I am not buying it. The history left out of your posts is more telling than what you include.

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#10) On October 11, 2009 at 10:23 PM, Chromantix (90.16) wrote:

I'm rec'ing this just for the beatdown in the comment section.

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#11) On October 11, 2009 at 10:24 PM, devoish (71.86) wrote:

NEW YORK (Reuters) - Private equity company Blackstone Group LP (BX.N) CEO Stephen Schwarzman said on Tuesday that up to 45 percent of the world's wealth has been destroyed by the global credit crisis.

"Between 40 and 45 percent of the world's wealth has been destroyed in little less than a year and a half," Schwarzman told an audience at the Japan Society. "This is absolutely unprecedented in our lifetime."

But the U.S. government is committed to the preservation of financial institutions, he said, and will do whatever it takes to restart the economy.

" Who can destroy a thing, controls a thing" - Frank Herbert, from Dune.

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#12) On October 11, 2009 at 10:36 PM, devoish (71.86) wrote:

And I almost forgot to point out CDO's and CDS's were not subject to regulation and they were tools specifically and successfully used to duck bank regulators. A lack of regulation which it appears free marketeer Alan Greenspan used his position and belief in free market ideology to help make happen.

All of which is clearly stated in the Greenspan speech I linked to.

Nice to have you reading again.

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#13) On October 11, 2009 at 10:37 PM, starbucks4ever (91.97) wrote:

The whole regulation debate is misguided. The question is, who does the regulation, in whose interests, and whether it's a good kind of regulation, a bad kind, or something in between. 

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#14) On October 12, 2009 at 2:06 AM, ajm101 (< 20) wrote:

Nice post Devoish.  We're all paying for the banks that created and sold the securitized products for fees and then bet against them with swaps.  The idea that the Fed is the only entity creating liquidity is ignorant and seems mostly propogated by people with an agenda to gloss over the failings of the free market in the credit crisis.

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#15) On October 12, 2009 at 4:16 AM, AbstractMotion (< 20) wrote:

Actually the Fed does have a fairly large influence on the money supply in a variety of ways.  Contrary to what you seem to believe devoish the Fed does maintain a balance sheet of real world assets which has expanded greatly over the course of this crisis.  A lot of this was initially lending to banks, but the more disturbing trend has been a shifting of bank based lending towards the purchasing of various government debt products and agency bonds.  In doing so it is in fact injecting money into the economy and exerting extra influence on certain interest rates, which will likely increase the net amount of banks themselves end up lending out.  On top of this the Fed sets the Fed Funds rate which as historically demonstrated, greatly contributes to how much they're likely to lend out into the economy.  So yes the Fed itself both directly and indirectly influences the money supply.

Links: 1 2 3

As you can see the Fed has increased it's balance sheet by about 1.4 trillion dollars out of thin air.  It's likely to keep fund rates near 0 for months to come and it intends to buy trillions of dollars worth of GSE and treasury debt.  I guess the most positive thing to note is that they're actually behind on their projected spending at this point.  However it's pretty clear that in the 2008-2009 period that the Fed has rapidly expanded it's own balance sheet and in effect injected a large sum of money into the economy.

I'd have to argue against 40-50% of wealth being destroyed too, what's been destroyed is the perception of wealth and changes in various valuations.  That wealth was never there to begin with, all that's changed is the realization of that fact.


While CDS and CDO's contributed greatly to this crisis the Fed played a large part in helping to create it through it's manipulation of interest rates and decision to overlook various red flags along the way.  Keep in mind the Fed itself is a regulator of sorts, to even hint that Fed played a very minor role in all this is flat out ridiculous.  Per your MBS chart as well, it's also clear that the bulk of money loaned into existence did in fact come from GSEs, which are under the direct oversight of the government itself as well.  So while a lack of regulation allowed private banks to get into this mess, a total lack of oversight from the government itself was a huge factor in this crisis.

There needs to be proper regulation of the CDS market without a doubt, but it was far from the only significant player in this mess.  Likewise it's very very clear where a lot of this created "wealth" is coming from.


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#16) On October 12, 2009 at 10:17 AM, devoish (71.86) wrote:

Abstract, thanks for the excellent reply and the time it took to make it.

I'd have to argue against 40-50% of wealth being destroyed too, what's been destroyed is the perception of wealth and changes in various valuations.  That wealth was never there to begin with, all that's changed is the realization of that fact.

This is the role played by my "investment advisors", creating the perception of wealth among lenders who then brought real wealth forward by lending to build unaffordable/unneeded commercial and residential stuctures using real natural resources to do it.

In doing so it is in fact injecting money into the economy and exerting extra influence on certain interest rates, which will likely increase the net amount of banks themselves end up lending out

These are my "gatekeepers" and they decide the amount they distribute to the "real" economy. The Fed has influence but not control.

I actually concur with most of your post. It is clear that since 2008 the Fed is trying to reduce the imagined losses on the imagined gains. If the Fed or someone did not make the attempt the question of who would suffer comes up. The investors who bought these MBS's having been misled to the quality and misled into believing that they were insured by a solvent insurer, or those who committed the fraud and who have already left with their paychecks and bonuses and remain unpunished (this is a seperate issue for a seperate post though).

Below AJM makes the point I was trying to make although a little differently. I would emphasize the word "only" and change "ignorant" to "wrong". The second part of his sentence I would describe as "propogated by people seeking to discredit the Federal gov".

The idea that the Fed is the only entity creating liquidity is ignorant and seems mostly propogated by people with an agenda to gloss over the failings of the free market in the credit crisis.

Back to the subject of who was printing money;

My disagreement with your reply is only to the degree of responsibility held by each party. I absolutely agree that the low interest rates had a big influence, but not nearly the big influence they had prior to the mid 90's, the history which financial modeling of MBS risk was done against. Although this one sentence I take almost complete exception to.

Per your MBS chart as well, it's also clear that the bulk of money loaned into existence did in fact come from GSEs, which are under the direct oversight of the government itself as well

From 2003 forward through 2007 the GSE's had run low on customers who qualified for their loans. Even as the price of houses skyrocketed the GSE's share of the total outstanding MBS market fell from 55% in 2003 to 44% in 2006, even as privates went hog wild financed by CDS's 

The bulk of the money loaned into existence after 2003 came from the private CDO/CDS markets.

During 2000 to 2003 price run-up the bulk of "new" money came from the private CDO/CDS markets as their money creation quadrupled as the GSE's doubled ("only" doubled, relatively speaking).

Please remember my point is not that the Fed did not have a role in creating money, just a drastically reduced role for the last decade as private money creation grew.


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#17) On October 12, 2009 at 1:21 PM, AbstractMotion (< 20) wrote:

My point is that as of now the Fed is directly injecting money into the economy, and GSE's from 2000 onward played one of the largest roles in lending new money into existence.  Per your example the number of MBS originated from them increased almost 5x from 2000 to 2003.  Which is a very similar run up to what you're talking about in the CDS market.  


While the CDS market has expanded dramatically, it does not on it's own create money.  Much like Fed rates it simply influences a lender to lend more due to the risk exposure it defers.  CDO's on their own are also generally a repacking of other types of debt or mortgages, the actual lending of that money is where the creation happens.  On their own neither of these instruments actually "creates" money, much like the Fed's rates, they simply influence with willingness of institutions to extend credit due to their ability to defer risk or immediately realize 30 years of projected income.

Just for perspective, the size of the derivatives market in the US is absolutely massive and has dramatically expanded over the last decade.  If all of this was direct money creation in the economy it would be impossible to actually hide and we'd see an incredible amount of inflation.



A lot of these derivatives have proven themselves to be very dangerous, and I agree that they need stronger regulation.  But their actual creation doesn't magically pull money out of a hat in the same fashion reckless lending or the expansion of the Fed's balance sheet does.  The real risk of these products is that they have the potential to be kind of wealth destroyers you spoke of in your previous post.  Noting once again the bad ones likely won't contain any tangible wealth, but that ultimately there will be a loser who trades real wealth for it.




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#18) On October 12, 2009 at 1:52 PM, ajm101 (< 20) wrote:

AbstractMotion - the instruments do create money supply in a real sense.  Banks wouldn't have had the capital to loan against if it weren't for the bogus risks assumed valuing the CDOs that they held or the imaginary valuations they placed on CDSs that were only backed by the full faith and credit of AIG FP.

Here's how

 1. Co A loans $100 to 100 different deadbeats.  Each loan is on 25% likely to be repaid, so the value of the loans is $2500.   If they held these on their balance sheet, they'd only be able to make loans for $25,000 if they required a capital ratio of .10.

 2. Co B buys all those bad loans, divides them up in a novel way and declares they're now much more likely to be repaied.  They sell the securities back to Co. A for .75 on the dollar and a modest fee.

 3. Co A now has securities would $7,500 on their balance sheet, and can create loans worth 3 times as much as before while maintaining their capital ratio.

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#19) On October 12, 2009 at 2:19 PM, AbstractMotion (< 20) wrote:

The key to what you're talking about is in the words "can now create", which what's being debated here.  The creation of the CDO in itself does not create any new money, it simply allows for the creation of more money later on.  The lending to the deadbeats is what actually creates money in the system.  I'm not disputing the point that it encourages money creation here, simply that the act of underwriting a CDO or CDS in effect creates money.


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#20) On October 12, 2009 at 6:55 PM, devoish (71.86) wrote:

#18 and 19,

A) I think we are in agreement that the creation of the CDO/S creates money in the "financial" economy if we include its affect upon the banks balance sheet as part of that creation.

B) I think we are in agreement that the money does not reach the "real" economy until someone lends it to a "deadbeat".

 I think that extraordinary amounts of new money were added to the system by the combination of A and B.New money that was not accounted for during step A, as it was beyond the purview of any regulatory agency, and was inflationary during/after step B.

I think I showed that the CDO/S market added more money to the system from 2000 until 2008 than any other source including the GSE's and the Fed.

I agree with you that changed dramatically in 2008 and first the Fed and then the Market recovery dominates new money creation for now. Unless there is some other currently unknown and unaccounted for source of new money we haven't heard of yet, like CDO's in 2002.

Abstract, Ajm, Leohas, Zloj, Thanks for the good quality discussion. If htere is more I'll be back.


Thanks? Or should David say thanks? Either way, thanks for reading.

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#21) On October 12, 2009 at 11:01 PM, AbstractMotion (< 20) wrote:

I think I showed that the CDO/S market added more money to the system from 2000 until 2008 than any other source including the GSE's and the Fed.

Don't necessarily agree with this point, but I've covered why.  Even in the financial markets these don't actually create money as a transaction takes place in the process to buy these products using existing money or perhaps bank side leverage.  In general there are a lot of factors here that are harder to measure.  For example, the CDO and MBS market would not have had as many buyers had the Fed kept higher rates and safer, better understood investments had proper yields.  CDO issuance really started to take off around 2000/2001 when Greenspan floored the rates.  Immediately there after GSEs more then double their issuance of MSBs yoy and continue being the primary player up until around 2005.  From 2005 to 2006 the CDO issuance sky rockets then drops dramatically in 2007 when the problem is realized.  In effect the actual creation of the housing bubble was created by the Fed and inflated by GSE's for around 5 years.  The most profound increase of housing prices also happens to coincide with peak of GSEs backed MSB issuances in 2003-2004 (link).  Oddly enough it's after the fact that the GSEs started actually buying up additional sub prime securities from the private market.


 The Fed and GSEs have played a central role throughout this crisis.  I'm not pointing this out because I'm a big fan of the banks or the securitization processes that helped to mask a lot of these problems.  I'm saying it because we're dead set on repeating the same mistakes and the two groups that are in my view most responsible in this mess now control 73% of the mortgage market, have a mission statement to stem the correction in housing prices at all cost and congressional oversight which is dying to "get back into housing" (Barney Frank).  On top of this fact very little in what the President is proposing as a regulation overhaul actually addresses some of the issues in private banking which helped fuel this mess.  Half of it is in fact just creating new venues for bankers to talk to politicians.  It's easy to point at the CDS market and say "wow that's a big number, clearly the banks did it all", but there's literally a mountain of other evidence out there that you seem to be ignoring here.


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#22) On October 14, 2009 at 7:49 AM, devoish (71.86) wrote:

I think we can give Fannie and Freddie their due share of responsibility for the mess we're in, while acknowledging that they were nowhere near the biggest culprits in the recent credit bubble. They may finance most of the home loans in America, but most of the home loans in America aren't the problem; the problem is that very substantial slice of home loans that went outside the Fannie and Freddie box.

- Tanta, from Calculated Risk

Back to the subject of "Money Creation".

The GSE's ability to "create money" was limited by their lending standards keeping them out of the subprime market.

 Countrywide had no such outside control, and the GSE's could not capitalize them. The private CDS market capitalized them and its explosive growth created the new source of money that drove the housing market. A source outside the GSE's and the Fed control because this was not a way to lend new Fed money, but a way to lend the same Fed money repeatedly, effectively putting into circulation twice as much money as the GSE's as their share of the mortgage market shrank below 50%.

All of your points are valid, please do not think I am ignoring them, but the private CDS market fueling growth in subprime lending, was the game changer, IMHO.

As far as being dead set upon repeating the same mistakes, it seems so. The Gov should Nationalize the GSE's again, restore Gov't control to their lending standards, and draw a stronger line between Corporate and State than there is between Church and State.


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#23) On October 14, 2009 at 9:58 PM, AbstractMotion (< 20) wrote:

You're starting to branch off into the risk aspect of this, which I have not been debating.  My point is that GSEs were an integral part in the expansion and formation of this bubble, even with high loan standards.  The Fed lowering rates and GSEs gaining a large share of the mortgage market helped both qualify a large new group of buyers for homes and provide the liquidity necessary for banks to issue them in a very short period of time.  The CDO and CDS market didn't really take off and start contributing to the problem until the GSEs depleted their base of qualified borrowers and a new way to meet the high demand in the MBS market was needed.  Like with any other bubble the quality of the assets being issued grew progressively worse as demand outpaced available supply, most of this did happen in the private market.  However, that was not the primary topic being discussed here.  The run up in house prices and money supply happen chiefly in the period of GSEs being the primary player in the market.


My problem with dismissing this as a minor issue because the lending met the standards at the time is that ignore the facts that we've seen housing become largely politicized and the executive branch gain an enormous amount of influence by being in a participating in the market itself.  By all accounts Bush did in fact encourage the build up of the housing market by pushing his agenda for an "ownership society".  Likewise Clinton loosened regulation on the finance industry in exchange for promises to lend borrowers with less then stellar credit (To be fair the conditions of such loaning through GSEs still required a fixed rate mortgage, not some of the "time bomb" types that were originated privately later on).  


What I'm primarily taking up issue with is Presidents essentially having a push button solution to propping up the economy artificially through the housing market.  There's a plethora of data that suggests a lack of growth in the actual economy from 2000 onward was being masked by borrowing against home equity.  I simply do not believe this is a tool that should be in the hands of any single large player in our system.  The risk of having the housing market explode every time congress or the President's approval rating starts to slip is not something I'd like to deal with for the next 50 years.  There will also be additional pressure to inflate a housing bubble every time a mild cyclic recession occurs, which was largely what drove this particular bubble imho.  


I don't mind if the GSEs are taken out their quasi private status, but I'm of the opinion that a definite wind down in their scale is needed.  However, we're seeing the exact opposite happen currently as their share has jumped to something like 74% of all mortgages and as we've previously discussed the Fed is doing literally everything in it's power to hold mortgage rates down artificially (going above and beyond what Greenspan did in creating this mess).  


Accountability needs to be held in the right places here.  I don't like how reckless the banks were either, but the fact of the matter is that they do not really have a responsibility to the people in the way the government does.  As long as we readily accept the corruptibility and recklessness of our politicians these problems are going to occur.  We had functioning regulation on the books before this whole mess, but it was largely repealed in order to facilitate higher rates of lending which were viewed to be a national priority.  That in itself is not responsible public policy.  The government needs to have a hands on approach to protecting the consumer, but a hands off approach when it comes to driving supply and demand.  As long GSEs operate at their current scale and the Fed continues to placate the desires of the federal government we're going to have the potential for another housing disaster.


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