Dean Baker: The Financial Meltdown Continues

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Published on Friday, September 19, 2008 by CommonDreams.org
The Financial Meltdown Continues

by Dean Baker

Virtually the only certainty in the current financial situation is that there will be more problems ahead. Those who controlled the levers of economic and financial policy neglected their greatest responsibility, which was to ensure an orderly financial market and prevent exactly the sort of collapse that we are now seeing. This was a policy failure of massive proportions, not a natural disaster.

The central problem remains the collapsing housing market. The Case-Shiller 20-City Index shows a nominal price decline of almost 20 percent over the last two years, an event that few in the financial sector apparently considered to be a serious possibility. This price decline has led to an unprecedented rate of defaults on mortgages and derivative instruments.

These defaults, in turn, have raised questions about the solvency of a large number of financial institutions. This has led to an increase in the price of risk more generally and the crisis of confidence that is currently shaking financial markets world-wide.

While there is no simple path out of this crisis, it was a crisis that could have been easily avoided. If the Federal Reserve Board had acted to stem the growth of the housing bubble before it grew to such dangerous proportions, the country would not currently be facing a recession and the prospect of a financial collapse.

Alan Greenspan had the tools necessary to rein in the bubble had he been so inclined. First, he could have imposed tighter restrictions on mortgages, as the Fed has recently done. This would have prevented many of the worst mortgages that led to the subprime crisis and helped inflate housing prices.

More importantly, he could have used his platform as Fed chairman to explicitly warn of the dangers of the housing bubble. In his congressional testimonies and other public appearances, he could have carefully explained how house prices had diverged from a 100-year long trend in the mid-90s. ..........(more)

The complete piece is at: http://www.commondreams.org/view/2008/09/19-1