Here is a pretty good account of who is actually the villain in the recent subprime plot. It is written by
Alvaro Vargas Llosa for
The New Republic. I like this part most:
"All in all, financial instability has been far greater since the creation of the Federal Reserve. What did the Great Depression teach us? Essentially that even with the best of intentions, it is impossible for the authorities to manage the supply of money in accordance with the exact needs of the economy. A country's economy is the sum of millions of people making decisions that no single individual is in a position to anticipate. As economist Murray Rothbard showed in his book America's Great Depression, in the 1920s the Federal Reserve pumped up the money supply, expanding credit by more than 60 percent. Because the economy was very productive, this monetary expansion did not show up in the regular inflation figures. But, as is always the case with inflation, many resources went to the wrong kind of investments--until the crisis hit."
And he concludes:
"The current housing market and debt market crises are in good part the children of the Federal Reserve. By cutting rates 13 times between 2001 and 2003, and then keeping them very low for years, monetary policy contributed to the housing bubble. That is not to say other factors--including financial instruments that made it difficult to see that the underlying foundation was not as solid as it seemed--did not play a part too. But, once again, the Fed has turned out to be a factor of financial instability."
I would add that without credit expansion stimulated by the FED we would have no problem with financial innovations. The problem arises if innovations are not checked by real constraints, that is, if their (opportunity) costs are hidden.
