Many commentators will argue that the Fed under Greenspan was "asleep at the wheel" while players in the financial industry relentlessly leveraged their businesses and blatantly ignored sound credit practices, all in the name of higher profit growth and "optimal" balance sheets, i.e. creating off-balance sheet structures or otherwise known as Special Investment Vehicles (SIVs).
David Blake, an executive of an asset management firm, argued recently in a FT column that low interest rates, as seen in the aftermath of the dotcom bubble and 9/11, and often cited as the root cause of the ensuing credit bubble are not too blame, but rather the lack of sufficient action taken when it became clear some asset price bubbles were forming. First, in 1996 Mr Greenspan already conceded about an equity bubble in his "irrational exuberance" speech. He suggested that a tightening of the margin requirement - which investors hold against financial derivative positions - would be effective in stopping the creation of an equity bubble. Second, in 1998 a commission expressed concern about the massive increase in over-the-counter (OTC) derivatives, which of course today is at the heart of the credit crisis.
In both instances the Fed did nothing about it and we have seen two major bubbles, directly related. The equity bubble at the end of the millennium was fuelled by the ease of lending by brokers to buy more shares. When the bubble finally burst another wave of investors interest started in the housing market. We have had a tremendous rally in housing prices and mortgage lenders securitized and packaged mortgages; thereby "spreading their credit risk". Greenspan himself said housing was a safe investment, while the mortgage-backed securitisation market was seen as very effective in spreading credit risk amongst market players.
Even subprime lending - the root cause of the current financial crisis - was regarded as innovative since many marginal applicants could now have qualified to buy their own homes. Apparently, mortgage lenders could afford such high-risk lending because innovative credit models ensured the spreading of risk.
Well, today it seems that nothing can survive the longevity of good old-fashioned credit practices. The innovative, mortgage-backed securitisation market and derivatives did not stood the test of time; it was a miraculous failure to say the least and the stability of the whole financial system is at great risk.