There’s a good article at Vox by Barry Eichengreen about the financial crisis:
The other key element in the crisis was the set of policies giving rise to global imbalances. The Bush Administration cut taxes, causing government dissaving. The Federal Reserve cut interest rates in response to the 2001 recession. All the while the financial innovations described above worked to make credit even cheaper and more widely available to households. This of course is just the story, in another guise, of the subprime, negative-amortization and NINJA mortgages pushed by subsidiaries of the like of Lehman Brothers. The result was increased U.S. consumer spending and the decline of measured household savings into negative territory.
Of equal importance were the rise of China and the decline of investment in much of Asia following the 1997-8 crisis. With China saving nearly 50 per cent of its GNP, all that money had to go somewhere. Much of it went into U.S. Treasuries and the obligations of Fannie Mae and Freddie Mac. This propped up the dollar. It reduced the cost of borrowing for U.S. households by, on some estimates, 100 basis points, encouraging them to live beyond their means. It created a more buoyant market for Freddie and Fannie and other financial institutions creating close substitutes for their agency securities, feeding the originate-and-distribute machine.
Again, these were not outright policy mistakes. The emergence of China is a good thing. Lifting a billion Chinese out of poverty is arguably the single most important event in our lifetimes. The fact that the Fed responded quickly to the collapse of the high-tech bubble prevented the 2001 recession from becoming worse. But there were unintended consequences. Those adverse consequences were aggravated by the failure of U.S. regulators to tighten capital and lending standards when abundant capital inflows combined with loose Fed policies to ignite a ferocious credit boom. They were aggravated by the failure of China to move more quickly to encourage higher domestic spending commensurate with its higher incomes.
Mr. Eichengreen blames the crisis on the lack of regulatory changes in response to events. That ignores the real source of the problem. He lauds the Fed for cutting rates and avoiding a deep recession in 2001 and says the problem was caused by not changing capital requirements and lending standards. Wouldn’t be better to address the real cause of the problem? If the Fed had not cut interest rates so low, there would have been no reason to change the regulations. Why not just stop the Fed from printing money in response to every “crisis”?