If we want to talk about one player that certainly had the power to put a stop to the excesses, we have to look at the Federal Reserve, which sets interest rates and therefore heavily influences the amount of lending that takes place in the economy.
The chief charge against the Fed is that former chairman Alan Greenspan kept interest rates at very low levels far longer than necessary, which in turn sparked the bubble in housing prices and mortgage lending. Looking back, the Fed's behavior does seem bizarre. It kept the key Federal funds rate at 2 percent or lower from November 2001 right through to the end of 2004.
Those rate decisions showed that Greenspan had chosen to use the housing market as his main instrument to prop up the economy after the 9/11 attacks. Using monetary policy to encourage a rise in home prices would be a highly unorthodox move for a central bank. But evidence suggests that Greenspan was overly keen to use housing for exactly that.
In 2002 he called mortgage markets a "powerful stabilizing force" because they allowed people to extract equity from their homes, and in 2004 he said that homeowners should consider using adjustable-rate mortgages to save on interest and prepayment costs. In 2005, when a record $625 billion in subprime mortgages were made, Greenspan gave a speech that blessed the creation of new loan products, including subprime home loans.
As a result, Greenspan has lost a lot of favor in Washington. In March, Senator Christopher Dodd, chairman of the Senate Banking Committee, laid much of the blame for the current crisis at the feet of Greenspan's Fed, saying that it "seemed to encourage the development and use of adjustable-rate mortgages that today are defaulting and going into foreclosure at record rates."
Are we being fair? Is the Fed really this culpable? On the subprime issue, a person close to the Fed at the time responds, "It was only when we got to early 2006 that the Fed had any real data on what was going on in subprime. The first time we saw the data, we thought it must have been a mistake because the amount of subprime origination was so high. We then thought about the implications." But why didn't the Fed work harder to find the data?
And was monetary policy too lax for too long? The person adds, "There is a glaring fact, which people who make that criticism do not consider. And that is that interest rates - long-term interest rates - have been going down for 15 years. And it's a worldwide phenomenon."
So is the Fed off the hook? "That's nonsense," says Paul Kasriel, economist at Northern Trust. "The fact is, the Fed should have tightened earlier. That way they probably wouldn't have had this dilemma." So the Fed has to accept a large slab of blame for the current crunch. Perhaps it even deserves the lion's share.