Even if monetary policy was not a principal cause of the housing bubble, some have argued that the Fed could have stopped the bubble at an earlier stage by more-aggressive interest rate increases. For several reasons, this was not a practical policy option. First, in 2003 or so, when the policy rate was at its lowest level, there was little agreement about whether the increase in housing prices was a bubble or not (or, a popular hypothesis, that there was a bubble but that it was restricted to certain parts of the country). Second, and more important, monetary policy is a blunt tool; raising the general level o f interest rates to manage a single asset price would undoubtedly have had large side effects on other assets and sectors of the economy. In this case, to significantly affect monthly payments and other measures of housing affordability, the FOMC likely would have had to increase interest rates quite sharply, at a time when the recovery was viewed as “jobless” and deflation was perceived as a threat.

That gives me occasion to publish this astonishing chart of the housing bubble posted by Kevin Drum, showing prices remaining stable until about 2003 before heading skyward. (The Federal Reserve started hiking interest rates before housing prices peaked, in June, 2004.)

An interesting paper flagged by Felix Salmon argues that the primary cause of the housing bubble was an over-investment in mortgage-finance products, priced too low because of a misunderstanding of their risk: “The rise of private-label [mortgage-backed securities] exacerbated informational asymmetries between the financial institutions that intermediate mortgage finance and MBS investors. The result was overinvestment in MBS that boosted the financial intermediaries’ profits and enabled borrowers to bid up housing prices.”

Bullard says that the Fed might start selling off mortgage-backed securities — it owns around $1.2 trillion of them, most purchased from Fannie Mae and Freddie Mac — later this year, using a “reverse taper.” The Fed would start selling nominal amounts, and gradually increase the volume to figure out what the market can bear.

Mr. Bullard acknowledged that longer-term rates could rise “a little bit” but said the outcome would depend on how much is sold and over what period. He suggested starting with $100 billion in sales to assess the market impact. “It would still be very accommodative,” he said, but would allow the Fed to start normalizing its balance sheet.

“I would start slow and then move based on the economy,” Mr. Bullard said. “I would want to ensure markets that you would do it slowly over a longer period of time.”

As Lehman Brothers careened toward bankruptcy in 2008, the New York Federal Reserve Bank came to its rescue, sopping up junk loans that the investment bank couldn’t sell in the market, according to a report from court-appointed examiner Anton R. Valukas.The New York Fed, under the direction of now-Treasury Secretary Tim Geithner, knowingly allowed itself to be used as a “warehouse” for junk loans, the report says, even though Fed guidelines say it can only accept investment grade bonds.

In other words, while Geithner was head of the New York Fed, despite rules that the Fed can’t buy financial instruments that companies can’t sell in the marketplace, it was doing just that in an effort to keep Lehman Brothers solvent. Those bonds, which likely remain less than investment-grade, might well still be on the books.

Grim additionally notes that Geithner, in his position as Treasury Secretary, officially opposes a public audit of the Fed which would, not coincidentally, make public any and all worthless assets the Fed current owns or controls and what it does with its money.

Although the Fed told The New York Times earlier this month that a third party verified the market value of the bonds Lehman used as collateral for loans from the Fed, they did not specify who the third party was. Of course, Lehman’s auditors at Ernst & Young are already implicated in helping Lehman cook their books and fake the value of their derivatives, so the Fed may well have allowed a third party to determine the valuation but, as with the Goldman-AIG valuation debacle, not done a particularly good job at making sure that third party was at all independent.

According to Grim, Lehman’s own internal documents reflected the fact that, third-party valuations or not, the securities they signed over as collateral to the Fed were far from investment-grade.

In other words, the baskets of assets were created for the specific purpose of selling to the Fed for far more than they were worth.Lehman knew it too: “No intention to market” was scrawled on one of the internal presentations about the assets. A separate bank, Citigroup, later characterized the assets as “bottom of the barrel” and “junk” when Lehman tried to push them their way, according to the report.

So at least one third party thought the investments were junk.

Part of the proposed financial reform regulation would require investors to trade derivatives of the kind Lehman sold to the Fed on the open market in order to allow all investors, including the Fed, to have more information and assign them a real market-based value. It is, of course, one of the many provisions that financial companies are fighting tooth and nail, to allow them to continue marketing financial products and services they know full well are junk.

However, for what one assumes are less than coincidental reasons, several banks who also received publicly disclosed TARP funds joined the Fed in its quixotic quest to keep quiet about who took the Fed’s money too. That group includes ABN Amro Bank, Bank of America Corp., The Bank of New York Mellon Corp., Citigroup Inc., Deutsche Bank, HSBC, JPMorgan Chase, US Bancorp and Wells Fargo. If it seems to the average layperson that these banks have already basically disclosed that they are among the beneficiaries of the Fed’s largess and haven’t suffered any ill effect, that might underscore Bloomberg’s reasoning that the Fed simply doesn’t want to be subject to any oversight rather than that there are major business concerns with the disclosure.

In particular, the appeals court ruled today that the Fed and the banks who mysteriously don’t want the Fed to disclose the banks that accepted their loans during the financial crisis failed to meet the standard set forth by the FOIA for keeping such information secret.

In its opinion today, the appeals court said that the exception applies only if the agency can satisfy a three-part test. The information must be a trade secret or commercial or financial in character; must be obtained from a person; and must be privileged or confidential, according to the opinion.The court said that the information sought by Bloomberg was not “obtained from” the borrowing banks. It rejected an alternative argument the individual Federal Reserve Banks are “persons,” for purposes of the law because they would not suffer the kind of harm required under the “privileged and confidential” requirement of the exemption.

In other words, the Fed argued that the individual Federal Reserve Banks which comprise the Fed are people, not banks, and thus covered by the law. Unlike the Supreme Court in Citizens United v. FEC, the appeals court rejected the idea that the banks are people or that they would be harmed by disclosing to whom they lent money.

1. The SEC had no actual authority to directly police Lehman because of Gramm?Leach?Bliley.
If that sounds crazy, it should. In fact, Gramm-Leach-Bliley created a situation in which no agency was explicitly given the power to regulate large investment bank holding companies, so no one did. The SEC had “voluntary” authority, which means it could suggest to Lehman that it ought to do things, but it had no authority to require Lehman to do anything or impose penalties.

2. The SEC’s only way into regulating Lehman was because a Lehman collapse might hurt SEC-regulated enterprises.
In fact, the only authority the SEC had over Lehman was to force it to remain a viable enterprise (something at which the SEC obviously failed) in order to keep SEC-regulated financial firms, like banks and broker-dealers. According to Smith:

While the SEC can supervise the holding company and unregulated entities, its scope of action is limited to preserving the health of regulated entities only.

That means that Lehman could only be indirectly regulated: It couldn’t cause harm to entities that the SEC could regulate — but how could the SEC determine if Lehman was in a position to harm other players in the financial system if the SEC couldn’t provide any direct oversight of Lehman, let alone enforce any actions it took?

3. The SEC weakened its requirements to get companies to submit to its voluntary authority.
Since the SEC had no direct authority, it had to induce investment banks like Lehman to cooperate with regulation and oversight — never an enviable or smart position for a regulatory agency to be in. The way that the SEC accomplished this in the case of Lehman was to lower its capital requirements — in effect, it allowed Lehman to bet more heavily on the market than other banks in order to be allowed a peek at the books. Smith says:

In keeping, to induce the US LIBHCs to participate in an toothless regulatory scheme, the SEC weakened net capital requirements, an action that many experts see as having played a direct role in the crisis (as it is allowed investment banks to attain higher levels of leverage).

So, what little direct authority the SEC might have had — over how much money Lehman had to have around in case the market went south — it conceded in order to look at Lehman’s books to try to indirectly regulate Lehman’s potential negative effects on the market.

4. Congress specifically prevented the SEC from providing further oversight.
As if the SEC’s hands weren’t tied enough when it came to overseeing and regulating investment banks like Lehman, Congress — during the tenure of Clinton SEC chair Arthur Levitt (1993-2001) — repeatedly scaled back the SEC’s enforcement ability through statutory actions and budget threats. According to Smith:

Congress has repeatedly limited SEC enforcement capabilities, starting with Arthur Levitt’s tenure as SEC chief. The SEC is the only major financial regulator which does not keep the fees it collects, but instead turns them over to the government and in turn gets an allowance, um, budget, that is considerably lower. But more important, when Levitt wanted to step up enforcement on the retail front (much less controversial and resource intensive than on the institutional investor side) he was not merely blocked by Congress, but actively threatened with budget cuts.

It appears that the financial sector’s lobby was nearly as influential then as it is now.

5. The Fed and the SEC failed to share information in their ongoing turf war.
One of the main criticisms of the current financial oversight system is that regulatory functions are split between too many agencies to be effective. In the case of Lehman’s collapse, both the Fed and the SEC were involved, but neither was talking to the other and, like a kid working between two fighting parents, Lehman made the most of that. Lehman required the cooperation of commercial banks to clear their transactions and stay in business but the commercial banks — more concerned than the government that Lehman would fail — required Lehman to put up more than the usual amount of collateral to continue doing business with them. In the mean time, the SEC was pressuring Lehman — though not requiring, because it had no statutory authority to do that — to keep more capital free to cover losses. So Lehman didn’t tell the SEC about the collateral requirements and left the money on its balance sheets; but it told the Fed, which didn’t know about the SEC’s liquidity demands. Smith says:

Oh, and by the way, the Fed was aware of at least some of these collateral tie-ups (p. 1514), yet didn’t inform the SEC even though the two bodies had a memorandum of understanding in place (the report makes clear both sides were not sharing all information with each other).

This exact problem is the one consolidating authority is expected to ameliorate, and the consolidation of authority is what financial services companies would like to stop.

Of course, it goes without saying that that the board of Lehman assumed that they, like other banks, would be deemed “too big to fail” and thus be bailed out — in other words, they acted with moral hazard, assuming that there was no real risk of failure because the government was so involved in the rescue process. Whoops.

“It is a striking irony to me that the outcome of the public anger directed toward Washington and Wall Street may lead to the further empowerment of both Washington and Wall Street in regulating financial institutions,” Hoenig said in the letter, written in response to lawmakers’ questions.

It’s an curious premise: If Americans are upset at Washington for not regulating banks stringently enough to prevent a financial crisis, they’ll be upset when Congress asserts its authority and regulates banks more stringently? St. Louis Federal Reserve Bank President James Bullard added his own criticisms of the plan on Feb. 25.

St. Louis Federal Reserve Bank President James Bullard told a business group that a plan for a multi-member financial system watchdog is unlikely to prevent a future crisis because it was unlikely to act decisively.

One of the major criticisms of the bailout is that the Fed and the Treasury Department acted too quickly to throw money at banks without proper oversight or control mechanisms, leading to a situation today in which many banks continue to make money hand over fist while refusing to extend credit or loans to struggling businesses. Hoenig followed up on his letter to the Senate on Feb. 26, when he claimed that the Fed needed to retain its full regulatory powers to keep up with the lives of regular Americans.

“I think that is a tragic mistake; it takes the eyes away from the Federal Reserve in knowing what’s going on in America.”

It’s amusing to think that the Fed needs to maintain its significant regulatory authority to keep up with what is going on in America, when its lack of involvement in what was going on in America helped lead to the subprime mortgage crisis. Today, the president of the Federal Reserve Bank of Richmond, Jeffrey Lacker, added to the calls to keep his authority intact in a speech in Washington

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“As long as the Federal Reserve is responsible for discount-window lending, it makes no sense to diminish the Fed’s robust role in the supervision of a range of banking institutions, from large to small,” Lacker said today in remarks to the annual conference of the Institute of International Bankers in Washington.

In other words, because the Fed loans money to banks and sets interest rates, it should be in charge or regulating banks because those two missions, somehow, inherently go together. To critics who find fault in the Fed’s protection of consumers, Lacker had an answer.

I think we do a really good job of consumer protection, if you look at our record, especially since 2007,” Lacker said. “We acted very rapidly to emerging information about risks to consumers in mortgage lending,” Lacker said. “Plus, putting it with somebody who’s doing safety and soundness regulation makes sense to me.”

Yes, because eventually the Fed realized that the banks over which it had regulatory authority were outright deceiving their customers, putting them in mortgages for which they were unqualified and doing it all for the purpose of securitizing the loans and earning money off of insurance against mortgage defaults, they should be the agency in charge of protecting consumers. All of the Fed presidents’ opinions square neatly with Fed Chairman Ben Bernanke’s statements that the Fed should keep, and even expand, its regulatory authority. Bernanke is even now promising to investigate the currency derivatives set up by Goldman Sachs to help Greece hide the true extent of its debt. Of course, Goldman started its relationship with Greece in 2001, and Greece is now in the midst of a financial meltdown, partly as a result of the swaps which allowed Greece to hide its debt. It only took the Fed nearly a decade and the collapse of an entire country’s economy to get it to think about investigating derivatives. They’re obviously ready to provide consumers with assurances about financial companies and the products they offer.

Congressional oversight committee chairwoman Elizabeth Warren told reporters today that the government’s hands are tied without the consumer protection agency for which Sen. Chris Dodd (D-Conn.) has sought a Republican backer, to no avail.

“[The Credit Card Accountability, Responsibility, and Disclosure Act] is a good first step but it isn’t enough alone,” said Warren on a conference call with reporters hosted by the U.S. Public Interest Research Group. “The credit card industry and the entire consumer credit industry is broken. We need an agency, a cop on the beat that is flexible and responsive.”

Unfortunately, too many senators seemingly disagree with her.

Ed Mierzwinski of the U.S. Public Interest Research Group does not. He thinks the fact that the Fed refused to take tough action against credit card companies’ regulatory evasions last year indicates they don’t have consumers’ best interests at heart and never will.

“The Fed could have had a broader anti-evasion provisions as well, which we all asked for in our comments and didn’t get,” said Mierzwinski. “The Fed gave us obvious protections against a couple of provisions but they should have given us a big hammer and they didn’t.”

But with the folks at the Fed seemingly set to cede some authority to the Treasury Department over banks as part of the larger financial oversight council, don’t bet on them agreeing to give authority to a new agency just because some people think consumers deserve protection. That’s not their job, and they prefer that it not be anyone else’s, either.

“Although at present the U.S. economy continues to require the support of highly accommodative monetary policies, at some point the Federal Reserve will need to tighten financial conditions by raising short-term interest rates and reducing the quantity of bank reserves outstanding,” he wrote.

Markets reacted as though the news that interest rates won’t stay at nearly zero forever was shocking — and as though “at some point” might come tomorrow. The Dow dropped 40 points in the 90 minutes after Bernanke’s 10-page statement was released. The best explanation of why everyone freaked out came from someone who himself swore he wasn’t freaking out.

“Saying it will raise rates ‘before long,’ obviously there’s no specifics but it does put potential rate increases back on investors’ minds,” said Alan Lancz, president of Alan B. Lancz & Associates. “Before, it was considered not in the foreseeable future.”

In other words, the people to whom Americans with 401k’s, Roth IRAs and other retirement accounts are entrusting their non-foreseeable futures were unable to conceive of a point in the near term at which the Fed would return interest rates to something approaching historical norms, and have been investing your money as though the crisis would last forever.

No wonder Chase CEO Jamie Dimon expects a financial crisis every five to seven years.

But unless you’re well-versed in the modern minutiae of the financial market, it probably didn’t help explain anything about why Treasury Secretary Tim Geithner is facing an investigation into his role in the affair.To recap Morgenson and Story:

• The people at Goldman Sachs invested in mortgage-backed securities they expected to decline in value in order to make money off the insurance claims.
• Due to a long-standing relationship, they went to AIG for a kind of insurance — credit default swaps — which were not regulated.
• They then used other companies, including Société Générale, to purchase more of the unregulated insurance that AIG might not have otherwise underwritten in order to manage its own risk.
• When Goldman’s investments declined, they submitted insurance claims for the losses, but insisted on determining the amount of their damages on their own, without any input from AIG, any auditor or the market.
• After Goldman got as much money out of AIG as they thought they could, their stock analysts issued a report about how AIG was bleeding cash and their creditors wouldn’t negotiate, without mentioning that AIG was bleeding cash because of them and that Goldman was the creditor that wouldn’t negotiate. AIG’s stock tanked.
• The government stepped in, took an 80 percent share in AIG and then paid Goldman and the other creditors all the money they’d asked AIG for at the start of the negotiations in 2007, without using their power to force AIG’s creditors to negotiate.

When the federal government, including then-Treasury Secretary Hank Paulson (who once served as chairman and CEO of Goldman Sachs), directed AIG to pay Goldman exactly what it wanted, it overrode significant and long-standing misgivings by AIG’s lawyers and accountants that Goldman’s estimates of its losses were correct. Morgenson and Story note that the prices on the very securities for which Goldman demanded insurance payments have since rebounded — but under the terms of the deal struck by the federal government, Goldman doesn’t have to pay a cent of its insurance settlement back to either AIG or the taxpayers. That’s quite the sweetheart deal for Goldman Sachs, if not taxpayers.

Now-Treasury Secretary Tim Geithner’s role in the November payouts is under investigation; his spokesperson said last month that then-New York Fed Chair Geithner officially recused himself from participating in the AIG bailout after Nov. 24, 2008 — the date of his nomination to Treasury — and had begun to insulate himself from such decisions “weeks earlier in anticipation of his nomination.” The Presidential election was held Nov. 4, 2008, and the plan to give Goldman everything it wanted was made official 6 days later, on Nov. 10. Either Geithner was insulating himself from his own job weeks before the election, or he was as involved in the negotiations as his detractors have charged.

Documents have recently emerged showing that the N.Y. Fed, starting as early as Geithner’s Treasury nomination announcement, worked with AIG to prevent full disclosure of how the bailout money it received in November went straight to companies like Goldman Sachs, Société Générale and Deutsche Bank, among others. The order to AIG from the government not to negotiate with its creditors may have cost U.S. taxpayers $13 billion; it was only under pressure from the SEC that AIG made public in March 2009 (after Geithner’s confirmation) the banks to which it had transferred its bailout funds.

As the N.Y. Fed staffers — who, despite his recusal, still worked for Geithner — were pressuring AIG to refrain from disclosing the government’s demands on behalf of Goldman and the secondhand amount Goldman received from the bailout, Geithner was amending his tax returns and paying back taxes in order to survive his confirmation process. Revelations that he’d also used his position at the N.Y. Fed to preserve the financial interests of Goldman Sachs over taxpayers or the company in which the government had taken a majority stake might have scuttled his nomination entirely. These days, many Democrats seemingly think that perhaps it should have.

CNBC: You still believe it was the right thing to pay counterparties 100 cents for the dollar?

Geithner: Oh, absolutely. Again, the way–this is a tragic failure in the system, and we had no effective legal means to step in and prevent default without doing what you said, helping this firm meet all its legal obligations. That’s why at a centerpiece of the president’s reform proposals is to give the government the tools to unwind, dismember, break up, sell these institutions without the taxpayer being put in the position of having to absorb their losses. That’s the basic–one of the most important reasons why we have to get reform in place.

We had no choice at the time other than to do this. And I’m, personally, very confident it was the right thing to do, and we did it in the best way possible for the American people.

Geithner will testify Jan. 27 before a House oversight panel on his role in those decisions.