[quote=SK in CV]
Let’s work through exactly what the Fed did and did not do prior to the financial crisis in 2008.
It does set the federal funds rate, which is the rate that member banks pay and receive for over-night borrowing/lending. The quantity of member bank borrowing is limited by capital requirements set by the Fed. Member banks do NOT have unlimited access to funds.
It does buy and sell US government securities to keep the prices of those securities stable, but it does not, per se, set the rates on US govt securities at auction. This is an open market function.
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SK, that was a pretty good tutorial on how Fed works. Thanks for taking time to write it.
The way I understand this is: By buying US government securities, the Fed actions ended up lowering the yields on them (as a stated policy). This low yield forced banks (and others) to look for higher yield elsewhere, i.e. mortgages etc.
Assuming the above to be correct, you are right that the Fed was not a party to mispricing the risk, but their actions definitely contributed to it.
It is not like they did not see this happening; question is what motivated them to keep the yields so low with their actions?
