E LIBOR Destroyed Subprime. But The Fed Deepened The Great Recession

It is clear now that the Federal Reserve Bank deepened the recession in 2008. I have written that a motive for this dampening of the American economy was sticky wage creep, that had pushed American wages up. The need to make America more competitive could have been a major goal behind the decision to let the recession deepen. Stopping the housing bubble, that the Fed caused by mispricing risk, was clearly another motive for Fed inaction. Ben Bernanke practically said so himself:

"My mentor, Dale Jorgenson [of Harvard], used to say — and Larry Summers used to say this, too — that, ‘If you never miss a plane, you’re spending too much time in airports.’ If you absolutely rule out any possibility of any kind of financial crisis, then probably you’re reducing risk too much, in terms of the growth and innovation in the economy.”

Since the risk was mispriced, thanks to the Fed (Basel2) adopting suspect copulas, there was something not moral happening on both ends of the housing bubble.

Because the subprime paper market froze up, as explained below, any financial engineering or inaction on the part of the Fed, that tightened the money supply, also had unforeseen consequences that weakened the banks more than planned. I had written that interbank lending was affected by the LIBOR rate explosion as well as subprime lending. However, as chart 3 below will show, that there was a delay in interbank lending decline, as it did not significantly decline until the Lehman failure and again with the advent of interest on reserves for the big banks.  

There is a timeline offered here that may add to a reasonable explanation of the unfolding of the Great Recession. There are three charts below, making a timeline of sorts that shows a possible deliberate deepening of recession. I explain the charts in detail below. The Fed ignored data, or actively tightened for two whole years, including implementation of interest on reserves (IOR).
Chart 1

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Disclosure: I am not an investment counselor nor am I an attorney so my views are not to be considered investment advice.

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Joe Economy 5 years ago Member's comment

Its questionable whether the Fed's raising rates by 0.25% has had such a drastic effect on the economy. Other major factors combine together to make a recession. The overly strong dollar which hurts exports, the decline of oil, and the fall of China's economy and the knock on effect globally are likely more likely to blame. You never know, if things get bad, maybe Yellen will decide to reverse her decision and lower rates again. Stranger things have been known to happen!

Gary Anderson 5 years ago Author's comment

Rising rates would not be a problem if the Fed did other things to loosen.

Joe Economy 5 years ago Member's comment

Do you foresee the US following Japan and going negative on rates?

Gary Anderson 5 years ago Author's comment

It doesn't seem to concern the Fed if that happens. I will have a new article, hopefully, out on that today, Joe.