Monday, October 27, 2008

Government Failure: Orphanides Criticizes GSEs

In a lucid analysis reported by the WSJ, Orphanides criticizes mortgage government sponsored enterprises (GSEs) for their role in the financial crisis and reminds us that the Senate didn't heed Fed's warnings put forward by Greenspan on the mounting mortgage problems created by government policies:

Mr Greenspan foresaw the problems in Senate testimony as early as April 2005, says Mr Orphanides, highlighting the then-Fed chairman’s warning that: “We at the Federal Reserve remain concerned about the growth and magnitude of the mortgage portfolios of the GSEs, which concentrate interest rate risk and prepayment risk at these two institutions and makes our financial system dependent on their ability to manage these risks. … To fend off possible future systemic difficulties, which we assess as likely if GSE expansion continues unabated, preventive actions are required sooner rather than later.”

But, Mr. Orphanides says, “warnings of the problem were not heeded, and the systemic failure that had been a source of concern at the Federal Reserve materialized.”

In his analysis, Orphanides cites this paper by Calomiris.

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