sharply after 2001 and kept them historically low in order to boost aggregate demand and prevent another recession. Then in 2004, Greenspan addressed the Credit Union Association and said, “American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed rate mortgage.” And as if following the Fed chairman’s advice, adjustable rate mortgages (ARMs) became the loan of choice for subprime borrowers who have poor or less than ideal credit scores. Mailboxes were stuffed with offers to borrow 100 percent or more of a home’s value with zero down. Payments and “Teaser” interest rates were held artificially low for the first few years of the loan and then they would jump sharply upward. Forget worrying about not affording the home, your income would not be checked following a “no document” lending practice. Thus, using risky ARMs, banks lent billions of dollars to home buyers who could not pay the bank when the payments and interest rates rose.

Faced with accumulating portfolios of risky debt, banks and mortgage companies sold these risky mortgages to New York investment firms such as Bear Stearns (acquired by J. P. Morgan Chase with financial backing from the Fed) and Merrill Lynch who pooled them with other securities. These packages, often called collateralized debt obligations or CDOs, were sold to customers around the world–all with the blessing of ratings agencies such as Standard & Poor’s. With each of these transactions, large fees were collected, and in short, consummation of the deal was the criterion and not validity of the assessment of risk.

Expansion of the housing market bubble was based on an assumption by all the players that real estate prices would always go up. However, beginning in the summer of 2005, subprime foreclosures rose and home prices dropped as people’s payments rose under their ARMs. Also, once the value of homes fell below the loan value, people could not refinance loans to get lower payments. When people walked away from their mortgages, Wall Street and foreign investors were stuck with bad loans in their CDOs to write off, CEOs were fired, and many real estate executives were indicted for mortgage fraud. As a result, lenders greatly tightened their lending standards to avoid further risky loans, and home financing became difficult to obtain.

In 2008, the Fed announced that it would allow Wall Street investment firms to receive emergency loans and exchange risky investments for Treasury securities. Also, the Housing and Economic Recovery Act of 2008 was passed that allows some borrowers to refinance their mortgages with new fixed-rate loans backed by a federal guarantee, and it provides grants for state and local governments in the hardest-hit communities to buy foreclosed property. It also includes a tax credit for first-time home buyers who buy housing that is unoccupied. And the Treasury Department was given authority to bail out or take over Fannie Mae and Freddie Mac, the troubled government-created firms that fund the vast majority of mortgage loans in the United States.

In addition, a massive $700 billion bailout plan was enacted in 2008 that gave the Treasury the authority to buy and resale bad mortgage debt from financial institutions. Also, the federal government decided to take partial ownership in private U.S. banks until they regain stability and increase lending. Participating banks must curtail executive bonuses and other perks. Moreover, lenders in Congress have promised the biggest changes in regulation of financial companies since the 1930s. Meanwhile, the final price tag to the taxpayers for this financial crisis is unknowable.

In support of the Fed’s monetary policy prior to the deflation of the home prices bubble, one can argue that the reality is that increasing the money supply and lowinterest rates were required to sustain expansion. Based on the Monetarist school of thought, criticize the Fed’s policy.