Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

Could the Fed have contained the bubble through tougher interest rate policy? Greenspan’s cuts of the early 2000s had triggered the lending surge. Indeed, it had clearly been Greenspan’s intention to unleash a refinancing boom to help the recovery from the dot-com bust and the shock of 9/11. But what the Fed did not appreciate was the structural change in the mortgage machine the refinancing boom would trigger. Certainly by 2004 it was clear that it was time to raise rates. In seventeen tiny steps the Fed inched rates from 1 percent in June 2004 to 5.25 percent in June 2006. It was fine-tuning, not shock and awe. The mortgage boom continued undeterred, as did global demand for American safe assets and the expansion of the shadow banking sector. By the spring of 2006, to the alarm of many commentators, the result was that the yield curve was inverted. Long-term rates were below the short-term interest rates set by the Fed. This was usually a signal for trouble. It meant that the normal bank-funding model of borrowing short to lend long no longer made any sense.