Richard Green's Three principles for avoiding future subprime messes

Changes in policy should accomplish three things:

(1) It should make sure that all parties in the lending chain have “skin in the game.” While reputational risk mitigates against bad behavior, there is no substitute for financial incentives.

(2) It should make sure that all parties in the lending chain are subject to federal supervision. This will reduce regulatory arbitrage.

(3) It should do what it can to improve disclosures throughout the lending chain. Borrowers must be better informed as to the consequences of their lending choices (although this will be difficult); ratings must be consistent, and securities must be more transparent.

Milton Friedman on Bubbles and Busts.

You can read another version of this on the Hoover Digest 2006 No. 4.

How Might The Fed's Lowereing Its Interest Rate Target Be "Bad News?"

The Fed pushes down the Federal funds rate by buying securities with high powered money which increases bank reserves. Increasing bank reserves allow banks to compete for more deposits that will fund more loans.

More loans mean more business, more economic activity, more demand for goods and services, and potentially more rapidly rising prices (i.e., inflation.)

More inflation penalizes saving and investment, encourages unproductive activities, and capriciously reallocates wealth.

Eventually the Fed will have to rein in the money supply to reduce inflation which will mean real pain.

The bond market voted with its feet yesterday: long term bond yields rose in response to the rate cut and bond prices fell. Bond investors were expecting more inflation.