The Fed’s Crisis Failure – Too Much Wall Street….

For 5 years now I’ve stated that the Great Recession was a CONSUMER credit crisis. It was not a banking crisis. It was not about “too big to fail”. It was not about Wall Street and non-banks. It was not about corporate America. The origins of the crisis were in the US consumer and the unhealthy accumulation of debt that led to an instability in the credit based monetary system.

Diagnosing the exact cause of the disease was crucial.  After all, if we misdiagnose a symptom as the cause, then we inevitably fail to cure the disease.  And the banking crisis was an extension of the household crisis.  The Fed diagnosed this as a banking crisis and they fixed the banks.  That’s why, in large part, 5 years into a recovery, we see banks with record earnings and a stagnant economy.   So, I like this piece by Matt Yglesias highlighting this point.

On the other hand, we have to understand the institutional structure of the Fed.  The Fed is just a big clearinghouse designed to support the banking system.  And when the Fed wants to implement policy that positively influences the economy it does so through the banking system.  If the banking system doesn’t work then the Fed’s policies don’t work.  So the Fed automatically thinks to save the banks first.  As I’ve discussed before, it’s helpful to think of the Fed as having a triple mandate:

1. Maintain a stable banking system.
2. Price stability.
3. Maximum employment.

But when we look back at the crisis we also shouldn’t assume that the Fed could have fixed everything on its own.  It simply didn’t have the tools to do so.  So yes, while the Fed should have focused more on the real economy we also should recognize that the Fed isn’t some omnipotent entity that can make everything all better all the time.  So maybe we’d all be better off if we stopped putting so much pressure on them to achieve things they simply don’t have the tools to achieve….