policies of the 180's were quite successful, they achieved their objective bringing inflation under control. however, nothing is free and one of the effects of these however, nothing is free and one of the effects of these policies was to raise interest rates quite sharply. i do remember vaguely, i just got out of graduate school 1981, 1982 and i do remember looking at the possibility of buying a home and being informed the mortgage rate for 30-year mortgage was 18.5%. so interest rates were quite high, and as you might expect, activity and affected inflation as well. see this is the unemployment rate.

sharp recession. and in fact the unemployment rate in 182 was almost 11%. even higher than we saw in the most recent recession. so there was definitely a very negative side effect from paul volcker's activities. political pressure, you can imagine, on the fed and chairman volcker was intense. during this period, it was common practice to mail to the fed bits of two-by-fours and on the two-by-fours they would say stop killing construction or save the farm or whatever it might be because the high interest rates were having very negative effects on the economy and i have a few of these on my desk just to remind me, you know, that inflation is a concern and that we always have stability.

but this is also an example ofif paul volcker had been re- elected, perhaps he wouldn't have been able to sustain this policy, but instead he maintained an independent monetary policy. he received at least sufficient support from president reagan and from the congress and he was able to carry through the policy which again succeeded in bringing inflation down. now, during the 1970's, obviously output and inflation were very volatile. we saw how much inflation moved around and i didn't mention but there was a pretty sharp inflation, also, from 1973-1975 after the opec embargo, and then of course there was more volatility in the early 1980's as volcker brought down inflation and as the economy went into recession. now, paul volcker left the

chairmanship in 1987 and he was replaced by alan greenspan who, almost 19 years from 1987. as the quote suggests, one of the important accomplishments of greenspan through most of his tenure was achieving greater economic stability. as he says, greater economic stability has been key to of living in the united states. improvement in the stability of the economy that the period has been -- come to be known as the great moderation. as opposed to the great stag nation of -- stagflation or inflation. this was a striking phenomenon, the great moderation. the first picture here shows you the variability of real g.d.p. growth. so the graph covers the period from 1950 all the way up essentially to the present.

the line just shows you quarterly growth rates in g.d.p. so a sharp line, a sharp peak shows an increase in g.d.p. growth, a negative decline shows a fall in g.d.p. growth. these are quarterly numbers so you can see the bounciness, periods of growth followed by periods of slower growth. the yellow bar is a one standard deviation band, a measure of the average volatility of g.d.p. growth quarter to quarter between the period of 1950 and 1986 -- or 1985, i guess. and you can see that g.d.p. growth was pretty variable throughout the period. there's a lot of volatility in recessions including the severe about 1986, look at what happens to g.d.p. variability

between 1986 and 2007 or so. the variety is much less and it 's shows a standard deviation band for this latter period and is very striking how much more stable the economy was over this 20 or so year period. this was true not only for real g.d.p. growth but also true for inflation. so, again, the same picture basically, the line, the vertical line in the middle of the graph splits the time period from pre-1986 and post- 1986. the graph shows inflation quarter by quarter as measured by the consumer price index. again, the tan bar shows one standard deviation average

volatility of inflation in the pre-1986 period. you see the huge spikes in inflation in the 1970's. and then in the post-1986, you see much more stable, much lower volatility. so both growth and inflation were much more stable, and really quite remarkable extent and something economists commented on quite frequently. that was so-called great moderation. now, why was the economy so much more stable between the mid 1980's and the mid 2000's? well, there's lots of research on it, lots of issues, lots of papers. i think there's a good bit of evidence that monetary policy played a role in creating better stability, in particular volcker's contribution was even though his short term efforts to bring down inflation in the

early 1980's led to a high recession, led to a lot of pain, there was a payoff and that payoff was an economy which was much more stable with low, stable inflation, more stable monetary policy, more confidence on the part of business people and households, and that contributed very importantly toso you remember that the -- and friedman pointed out there was no long-term tradeoff between inflation and unemployment by keeping inflation a little higher, you couldn't permanently lower unemployment. but in a different sense -- which is true. but in a different sense, low and stable inflation over a long economy more stable and supports healthy growth and productivity in economic activity. very good thing to have. and the reduction in inflation

that occurred in the 1980's was really a global phenomenon. a lot of countries had inflation of problems in the 1980's but all around the world, even developing countries brought down their inflation rates quite considerably and that has been a positive for economic growth and stability since the mid 1980's. now, not all of the great moderation was caused by monetary policy, there are other factors no doubt playing a role. i mentioned just general structural change in the economy. an example would be that over time, firms have learned how to manage their inventories much more effectively. the practice of so-called just in time inventory management is a practice where by instead of having large stocks of inventory onhand, firms only acquire

inputs when they need them to produce. and without large stocks of inventories onhand it reduces an in the economy because if demand inventory, then you don't do any more production for quite a while until you run down that inventory but improves management of inventories. it's just an example and many others could be cited of better business practices and factors in the economy that made things more stable. it may also just be the case that there was better luck that we had fewer oil price shocks and other things happening, and that, too, may have contributed to the great moderation. but as those previous pictures showed, i hope it's clear that it was quite a striking change in the way the economy operated after the mid 1980's. ok. now, this takes us up, then, who wrote into the mid 200's. so now finally we can begin to

talk about financial stress and recent developments. just a final word about the great moderation. one of the other aspects of that period is that there weren't any big damaging financial crisis in the united states. there was a stock market crash in 1987 but it didn't do much damage. a more significant event was the boom and bust in the dot- com stocks in the late 1990's, and that touched off a mild recession in 2001, but in one of the inferences that people took away from the great moderation was not only was the economy more stable but the financial system seemed more stable as well. and as a result, financial stability policies got deemphasized to some extent during this period. prelude to the financial crisis. and what i'll do today is just

talk about some of the initiating triggering events, particularly the housing bubble. again, as i said, we'll get next week into more details about what happened during the crisis and the federal reserve's response. one of the key events that led ultimately to the recent crisis prices. so the graph on the right shows prices of existing single family homes where january 2000 is indexed to be 100. from the late 1990's until the early 2006, house prices across the country increased by about 130%. you see that line going straight up, a very sharp increase in home prices. and at the same time that was happening, or perhaps a little

later in the process, the lending standards for new mortgages to buy homes were deteriorating. now, clearly, a big part of what was happening to create the housing bubble or the increase in housing prices was psychology. after all, the late 1990's, was a period, you know, of a lot of optimism about tech stocks and stock market more generally, and some of that optimism, some of that psychology no doubt fed over into the housing market. so there was an increasing sense that house prices would keep rising and that housing was a can't lose investment. i lived in california for a while and earlier than this but it was a period during which house prices were rising and all everybody ever talked about at cocktail parties was what's your house price now and how

much money are you making on your home and kind of made working unnecessary because all you had to do was just keep checking the real estate listings. so there was a lot of excitement and enthusiasm about the fact housing prices were going up and making everybody rich. at the same time that this was happening, the standards for underwriting new mortgages were getting worse and worse which in turn was bringing more and more people into the housing market and pushing up prices even further. so let's talk a bit about the mortgage quality and what happened. prior to the early 200's, home buyers were typically asked to make a significant down payment, 10%, 15%, maybe 20% of the home price, and of course they had to document their finances, their income, their assets and so on in great detail to persuade the bank to make them a loan which in many cases

might be, you know, four or five times their annual salary. unfortunately, as house prices rose, many lenders began to offer mortgages to less qualified borrowers, so-called nonprime mortgages, and these mortgages often required little or no down payment and little or no documents. i say prime rather than subprime and they were the lowest quality mortgages in terms of credit of the borrowers but were other mortgages that were called a-a and other mortgages that were also not up to the traditional standards of credit underwriting, so i say nonprime, what was happening again was that essentially that lenders, mortgage lenders were moving further down the credit spectrum, lending to more and more people whose credit was less stellar. you can see this in a number of different ways.

on the left side of this picture is the share, the percentage of mortgage originations, that is new mortgages created that were nonprime, that is either subprime or alt-a or some other lower quality mortgage and you can see the very sharp increase particularly in the middle 200's, in 2006, almost 1/3 of all mortgages that were originated were nonprime. another indicator of the duration of mortgage quality and the right figure is the percent of nonprime loans with low or no documentation. if you think about this, this is kind of perverse. loanu're going to make a to somebody whose credit is shaky, who doesn't have a down

payment and maybe their fica score is low and so on, you'd think you would want to ask them even more questions about their income and prospects but in fact it went the other way. and you can see by 2007, 60% of nonprime loans had little or no documentation to describe the creditworthiness of the borrower. so there clearly was an ongoing deterioration of mortgage quality. go, this situation couldn't on forever. this picture shows the house -- sorry. this picture shows the debt service ratio as house prices went up and up and up. the amount of income or the share of income being spent on your monthly mortgage payment went up, and as you can see, eventually the mortgage payments became quite large share of personal disposable income, finally reaching the point that the cost of homeownership was high enough that it began

finally to dampen the demand for new houses. and as we see, that service ratio collapsed going after that basically because interest rates came down. but the main point here is that high interest rates -- sorry, high payments on mortgages final will -- finally meant there were no longer new home borers and new home purchases and the bubble burst. here's a picture of home prices. you can see again the sharp increase from the late 1990's up until about 2006, but from 2006 until today, house prices have fallen more than 30%. so there's been a very sharp decline in home prices across

the country. now, one comment about this picture, if you look at this picture, you might say to yourself, oh, my gosh, we have a long way to go because you see, house prices today are still a good bit above where they were 15 years ago. but remember, these prices are in dollar or nominal terms. there's no adjustment for inflation. so even if there was 2% of inflation a year, over a period of 15 years, that would raise prices by 30% to 40%. so if you adjust this for inflation, you get that house prices now are coming much closer to where they were before the beginning of the bubble. now, the house price collapse had some significant consequences. one consequence is that many people who had felt rich because their home had gone up and they had a lot of equity, suddenly found themselves under

water which means that their mortgage, the amount of money they owed was greater than the value of their home. so this is a negative equity. so this is an upside down situation where the borrower is in fact has negative wealth or negative equity in the home. and you can see that starting in 2007, the number of mortgages that were in negative equity grew very sharply. currently there are about 12 million to 13 million mortgages out of a total of about 55 million or so in the united states, so roughly 20% to 25% of all mortgages are now currently under water. that's a very big change from the situation we saw before. at the same time, given the decline in house prices. given that a lot of people borrowed more than they could afford, the decline in house prices led to a big increase to mortgage delinquencies and people not paying on time and

ultimately the bank taking over the property and that's called a foreclosure and then reselling the property to somebody else. so this is mortgage delinquencies. you see in 2009 there were more than five million mortgages in delinquency, which is about, again, almost 10% of all mortgages it. so a very, very high rate of delinquencies. now, of course what we just looked at was the effects of the house price bust on the borrowers and homeowners and those are quite serious. anotherourse there's

side to this which is the lenders, the people who made the loans. and obviously with something close to 10% of mortgages in delinquencies, banks and other holders of mortgage related securities suffered sizable losses and that proved to be an important trigger of the crisis. now, there's an interesting question here, in 1999, 2000, 2001, we had a big increase in stock prices, including but not only dot-com or tech bubble prices, and that -- those prices fell very sharply in 2000-2001, and a lot of paper wealth was destroyed by that. and in fact, the amount of paper wealth destroyed by the decline in dot-com and other stock prices was not radically different than the amount of wealth destroyed by the housing movement bust. and yet, as you know, the dot- com bust led only to a mild recession. the 2001 recession went from march to november, only its

months of recession. unemployment rose but was not anything nearly so dramatic as in the 1980's or more recently. so here we had a big boom and bust in asset price but without too much real serious or lasting damage to the financial system or the economy. now, in the recent case we had a housing boom and bust, if we were looking back at 2001, we would think well, that's going to cause a slowdown in the economy but probably won't be that serious. and that was one of the views we were discussing in the fed in 2006 as we saw house prices decline, might this not look like -- might this be more like the 2001 episode than something different? and yet of course as we know, the decline in house prices had

a much bigger impact on the financial system and the economy than the decline in stock prices. and i think to understand that, it's important to make the decision -- the distinction between triggers and vulnerabilities. the decline in house prices and the mortgage losses were a trigger. they -- to use another metaphor, it was a match thrown on kindling but there wouldn't have been a him consolation if there weren't a lot of dry kinder around. and the housing bust in some sense was set afire. in other words, there were weaknesses in the financial system that made -- that transformed what might otherwise have been a modest recession into a much more severe crisis. now, what were those

vulnerabilities? what was it about the financial system of the united states and of other countries as well that transformed the housing boom and bust into, again, a much more serious crisis? again, we'll talk about this in much more detail next week but just a preview, there were vulnerabilities in both the private sector of our financial system and also in the public sector. in the private sector, many borrowers and lenders took on too much debt, too much leverage. and one of the reasons they might have done that was because of the moderation. there were about 20 years of calm conditions and people became more confident, more willing to take on more debt. the problem with taking on too much debt is that if you don't have much margin if the value of your asset goes down, like the

value of your house, then pretty soon you find that you have an asset which is worth less than the amount of money you borrowed. a second problem, very important problem, was that throughout this period, financial contracts, financial transactions were becoming more and more complex, in ways which i'll describe, but the ability of banks and other financial institutions to monitor and measure and manage those risks was not keeping up. that is, their i.t. systems, their resources they devoted to risk management were insufficient for them to understand fully what risks they were actually taking and how big the risks were. so if you had asked a bank in 2006, well, suppose house prices fall 20%, they probably would have greatly underestimated the impact of that on their balance sheet because they didn't have the capacity to measure accurately or completely the risks that they were facing. the third problem which i'll come back to again. is the funding side.

the financial firms rely heavily on short-term funding when commercial paper which will have a duration as short as one day. or less than 90 days. like the banks in the 19th century that or relying on deposits and making loans, they had essentially the very short- term, liquid form of liability, which we will see it was subject to runs in the same with the deposits were subject to runs in the 19th century. the final private sector -- an example of this was the credit default swap by the ait company. they use this to sell insurance to investors on the complex

financial instruments that the investors held. basically, they've promised that if you lose money on this letter " -- collateral debt obligations, we will make good. as long as the economy was doing well, the financial system was doing well, they were just collecting premiums on the insurance and there was no problem. once they went bad, they were exposed to enormous losses, which had serious consequences. those are some of the problems that occurred in the private sector. we talked a little bit about the public sector. there are also serious problems there, as well. first, a financial regulatory structure had been changed a number of times. basically, it was the same structure that had been created in 1930's over the -- after the

depression. this did not keep up with all kinds of structures in the financial system. there were many important financial firms that did not really have any serious, comprehensive supervision by any financial regulator. an example of this was aig. the insurance regulators looked at the insurance products they sold. the office of thrift supervision look at the thrift, the small banks they own. nobody was really looking carefully at ups cds problem c -- problemds problem that i was describing. also, you had the lehman brothers and bear stearns and merrill lynch. there was no statutory oversight of those firms. they had a voluntary agreement with the sec for oversight but there was not comprehensive

oversight of those firms. as i will talk about, another one was the fannie mae and freddie mac which did have regulators. for reasons i will explain, that was inadequate. the regulatory structure have lots of holes in it. there were important firms that proved important that did not have good oversight. there are also, it even though the laws provided for regulation and supervision, it often was that done as well as it should have been. while this was true across a whole range of agencies and parts of the government, let me talk about the said. the fed made mistakes in supervision and regulation. i want to mention that one would be in our supervision of banks and bank holding companies. we did not press hard enough on

this issue of measuring your risks. i mentioned before that it bought a bank did not have the best ability to lenders -- the capacity to understand the risks they were taking. the supervisor should have pressed them harder to develop the capacity and if they did that, they should have restricted their ability to take these risky positions. i think the fed and other bank supervisors did not press hard enough on this. it better to be obviously a serious problem. another area where the fed perform poorly was in consumer protection. the fed had some authority to provide protections to mortgage borrowers that would have a gun is used, effectively, would have reduced at least some of the bad landing that occurred during the latter part of the housing bubble. but, for a variety of reasons, that was not done nearly to the

extent it should have been. in 2007, when i became chairman, we undertook some of these protections, but that was too late to avoid the crisis. where there were authorities and powers, they were not always effectively used. that obviously lead to some weaknesses. then a final, perhaps more subtle while this was true across the the way our regulatory system is set up -- individual agencies like the fed or the occ had a specific set of firms. the office of thrift supervision is only responsible for thrifts and similar institutions. unfortunately, the problems that arose during the crisis were much broader-based than that.

they transcended any single for more small group of firms. it descended the whole system -- they transcended the whole system. what was missing was enough attention being paid to things that could affect the system as a whole. as opposed to just individual firms. nobody was really in charge of looking to see whether there were problems related to the overall financial system or the relationship between different markets in different firms that could create stress or even a crisis. those were some of the vulnerabilities. we will come back to these vulnerabilities and how they played out next week. let me conclude your by talking about a controversial topic, which is a other aspect. this is the role of monetary policy. now, many people have argued

that another contributor to the housing bubble was the fact that the fed kept interest rates low in the early part of the 2000's , following the recession of 2001. when the economy got a very weak and there was slow job growth in 2001 and subsequently and when inflation fell low, the fed cut interest rates ended to doesn't recover the federal funds rate down to 1% there are people who argue that this was one of the reasons that house prices went up as much as they did. it is true that low interest rates, one of the purposes of low interest rates that monetary policy achieves is to increase the demand for housing. we want to understand the crisis because going forward we want to think about what we should take into account only go

into monetary policy. what extent should we be thinking about things like housing bubble when we make monetary policy. we look at this in great detail. there has been a lot of research outside of the fed. i want to warn you there is no consensus on this. you will probably hear different points of view. the evidence that we have done within the fed suggests monetary policy did not play an important role in raising house prices during the upswing. i want to talk a little bit about the evidence on the question. one piece of evidence is the international comparison. people do not appreciate that the united states, the boom and bust in the united states was not unique. many countries around the world had booms and busts in house prices. the booms and busts or not very closely related to the monetary policies of those particular countries. for example, the united kingdom had a house price boom that was

as big or bigger than that of the united states. tighternetary policy was much in the u.k. and the united states. there is a bit of a puzzle for the monetary theory of the house boom. another example, germany and spain both share the euro. they have the same central bank. the have the same monetary policy. germany's house prices remain absolutely flat throughout the entire crisis. spain had an enormous house price increase, considerably larger than that of the united states. the cross national evidence raises at least some concerns. a second issue is the size of the bubble. it is true that changes in interest rates and mortgage rates should affect prices of homes. there is a lot of evidence to

look at that over a long period of time. when you look at how much interest rates change including mortgage rates and how much interest rates move, based on historical relationships and can only explain a very small part of the increase in house prices. in other words, it was way too large to be explained by the relatively small change in interest rates associated with monetary policy in the early part of the 2000's. the final piece of evidence i would raise is the timing of the bubble. any economist who is well known for his work on baubles, including the housing bubble, argued that the housing bubble began in 1998. that was well before the 2009 recession and before the cut in federal reserve interest rates. moreover, house prices rose sharply after the tightening began in 2004. the timing does not line up

particularly well. what the timing does suggest, there might be a couple of other possible explanations. 1998 was right in the middle of the tech bubble, the tech boom. it could be that the same psychological optimism, the same mentality that was feeding stock prices may have been feeding house prices as well. another possibility is -- it has been pointed out by a number of economists is in the late 1990's, there was a serious financial crisis called the asian financial crisis that hit a number of asian countries and other emerging market economies as well. after the crisis was tamed, one response was that many countries -- emerging market countries began to accumulate larger amounts of reserves. there was a big decrease -- there was a big increase in demand for assets including

mortgages that came from abroad as countries decided they need to acquire more dollar assets. i think interestingly, probably the strongest correlation across countries that you can find to house price increases as capital inflows, the amount of money coming in to buy mortgages and other safer, or at least perceived to be safe assets. that timing would fit with the 1998 or so beginning. those are some arguments against the view that monetary policy was a big important source. i emphasize economists continue to debate the issue. it is a very important issue. going forward, we also have to think about the implications of lower interest rates on the economy and on the financial

system. in particular, currently just out of caution, we are doing a lot of financial oversight and a lot of regulatory oversight to make sure the best we can add nothing is getting and balanced in the financial system. here are a few references to take with you if you want to get into this more. the bottom one is a speech i did a couple of years ago that summarizes some of the evidence. my speech is based very heavily on the second paper which is the result of all the internal federal reserve research. there is a paper there that makes the point interest rates did not move enough to move house prices. the also made the point about capital inflows. a recent survey comes to the conclusion that there was no connection. again, i emphasize this is something that continues to be debated. what were the consequences of the crisis?

we will talk more about the crisis next time. the economic consequences were severe. here is a measure of financial stress. you can see what happens in 2008. a sharp increase in the financial markets. stock market plunged. we had been talking about the first decline there. since 2001, that was the very large decline in tech stocks. notice the decline in the stock market, the most recent one was even bigger. home construction. you can see a sharp decline there. home construction fell before the recession because it was a trigger of the crisis.

looking to the right you can see it still has not really begun to recover. finally, unemployment rose very sharply, and pete around 10%. it is currently falling down to about 8.3%. in the next two lectures, we're going to get into the crisis in more detail. we will talk about how the housing boom and bust and the vulnerabilities in the financial system led to the worst financial crisis at least since the great depression and possibly even worse in the depression. how the fed responded to the crisis. in lecture for, we will talk about the recession recovery in the aftermath and the policy responses there. that is what i wanted to cover today. we do have a few minutes. i would be happy to take questions. what do we not take the microphone?

>> in the previous lecture, we discussed how it led to double that. today we are discussing that policy in the 70's -- how do we know when the right time is? >> well, it is challenging. it is one of the reasons we have so many economists and models. everything we can use to try to figure out what the appropriate number is to tighten or east policy. it is not an easy thing. forecasting is not very accurate. we as provisionally to keep making adjustments as we go along. the 1970's was particularly difficult because at that time, inflation expectations were not

all tied down. one thing that happened then was that if gas prices went up, people began to expect higher inflation. then they began to go and demand higher wages to compensate for the higher prices. then higher wages would feed the the higher prices and so on. nobody had any confidence that the fed to keep inflation low and stable. a very different situation now, and this goes a lot to paul volcker and greenspan as well, most people are pretty comfortable that inflation will stay reasonably low despite the fact there are ups and downs. that helps a lot because with inflation staying low, the fed has more leeway. if policy is easy, that will not feed into a spiral that will create a bigger problem of the road.

keeping inflation low was one of the great accomplishments of chairman volcker and greenspan. an important objection of banks around the world. it is a difficult task. the 1970's were difficult because it was so volatile, any kind of pressure from gas prices quickly fed into wage demands and into other prices. it was much more of a difficult situation. >> [unintelligible] with all the different research conducted, in your role as chairman, if you were chairman now -- >> i am chairman now.

>> if you were chairman and 2001, the think it was the correct thing to do? although you do not think it affected the outcome. cox the very first -- the very first speech -- i was a governor at that time. the very first speech i wrote when i became a governor in 2002 was about bubbles and financial regulation. the theme of my speech was, use the right tool for the job. the problem with tying interest-rate policy to asset prices is like using a sledge hammer to kill a mosquito.

the problem is, housing is on the one part of the economy. if interest rates are dedicated to achieving overall economic stability. we estimate that in order to have stop the increase in housing prices, interest rates would have been raised dramatically in a period where the economy was very weak. inflation was falling towards zero. generally speaking, the right way to use monetary policy is to achieve overall macroeconomic stability. that is coming you should ignore financial imbalances. what we could have done -- what the federal reserve could have done is to be more aggressive on the regulatory side to make sure the mortgages being made for better quality and were appropriately monitoring their risk and so on. one of the lessons of spoke about today was to not be too

sure of anything. be humble. for that reason, you should never allow the possibility that if all of our regulatory interventions do not achieve stability in the financial system that we want, at the last result monetary policy might be modified to deal with that. a again, because monetary policy is such a blunt tool that the fax the economy. if you can get a focus laser type of tool, that will be much better for everybody. [unintelligible]

monetary policies to meet its capital formation. to get a better balance init also tends to promote exports. we would like to get overall, over time we would like better consumption investment and exports as well as spending. those are the main components of final demand. with that being said, we are now way below where we were before the crisis. consumer spending is that recovered. it is still quite weak compared to where it was before the crisis. private debt has come down. you mention the global imbalances. we're talking about the current imbalance with the trade deficit the united states has. if anything, it has moved too

far in the short run because we lack a source of the man to keep the economy growing. again, i agree that just as every country needs to have an appropriate balance of consumption capital formation, exports, and government spending, that is an important task for us going forward. consumption, we are still way low relative to the pattern before the crisis. >> the latter part of your lecture was about monetary policy after the dock, bubble and how interest rates were kept low. -- dot com bubble. to look at it from another point of view, what is your take on the argument that the low

interest rates caused a private investors and banks to make riskier trades because of the low interest rates of the time and how that also could have been a trigger to the crisis? what's that is a good question. i think there is some effect of lower interest rates and risk taking. very similar to the previous question, it is about getting generally speaking on most dimensions, investors become very cautious. that is where they have been for much of the recent past. you want to get an appropriate balance between the amount of risk being taken. currentthis is yet again another reason why financial supervision and regulation needs to be played in a row.

appropriately. appropriate for the job. >> the housing bubble shows how clearly one thing led to another, with rising prices and eventually a fall. when you were observing the economy in the 2000's, what did you think would happen to the rising house prices and the house bubble? eventually pleaded to recession? i know there is a book called "the big short" where investors were shorting that. what is your take on that? >> the decline in house prices itself, by itself was not a major threat.

the head of the chair -- i was the chairman for president bush. in 2005 we did a analysis of what happens if house prices came up. financial crisis. have a broad based effect on the system. what i became chairman in 2006, house prices were already declining. two weeks after becoming chairman, i did a testimony thatthat will have negative impacts on the economy and we are not sure of all the consequences. the fact that they've might come down, that was always a possibility. the hard thing to anticipate fully is the fax on the decline of house prices would be so severe compared to the dot.com stocks. soundness of the financial

system and created a panic which in turn led to the instability of the financial system. it was not just decline in house prices, it was the whole chain. >> there was a bipartisan push for home ownership spurred by president clinton and carried down by george bush. to what degree could be argued that that contributed to the erosion of credit standards? >> another controversial question. there was some pressure to increase, ownership. there was the american dream aspect of owning a home and so on. home ownership rose during this

period. to put it all on the government is probably wrong in this case. most of the worst loans were sold through private sector securitization. they did not touch fannie and freddie. it went directly to investors. fannie and freddie did acquire some prime mortgages, but actually that was a little bit later in the process. i think there was some of this going on everywhere. clearly the private sector without any encouragement from the government was a big player in the decline of mortgage underwriting. >> i think one of the hallmarks has been year commitment to transparency. i think that benefits all of us in the room. i am wondering if you think too

much transparency could actually damage credibility of the central bank, if it could get things wrong i guess. >> a little off topic because we did not get to transparency. generally i agree that transparency is very important. it is important for a couple of reasons. i spoke already about the importance of a central bank being independent. if a central bank is independent, making important decisions that affect everybody, obviously it has to be accountable. people have to understand what it is doing, why it is doing it.

what is the basis for the decision. the central bank to be transparent. i testify all the time, i give other meetings like this. i think it is important for me there is an increased monetary policy were better. reserve communicates that its future actions would be x or why and convey the information to markets, the markets may respond to that by building those expectations and to interest rates and may have a more powerful effect on the economy. communication also reduces the uncertainty and helps increase the impact of monetary policy and financial markets. i have time only for one more question. >> my name is jay. my question is in regards to instability and inflation

expectations. you mentioned the importance of long-term economic growth. given the massive amounts of liquidity pumped into the market recently, how has the fed been able to make an impression expectations so low? but we are right to have to come back. let me ask to try to stick on the particular topic. on the last they will talk aboutlet me just answer the following in a brief way. i think we owe something to our predecessors in this respect, chairman volcker in particular and also chairman greenspan. they got inflation down and kept it there. people they used to what they see. in a world in which inflation remains low year after year, people have become more and more confident that the central bank, the fed, or whoever will keep inflation low. it has been very striking that even though we have had movements in oil prices and other shocks to the economy, a deep recession, everything from

most of the period, inflation expectations have been very well tied down to about 2% range the fed is trying to hit. thank you very much. next week will go into the crisis. [applause] >> this has certainly exceeded my expectations. we are grateful that you stayed until 2:00 yet again. as with tuesday, i know there are still questions that students have. why did you not send one or two questions to the blackboard side so we can talk about them not next week but the following week when we have our discussions. halwe will see you next week. [applause] [captions copyright national [captioning performed by national captioning institute]

>> on c-span3, 8 for all of carolina supreme court. that is at the cato institute and that is live at 1045 eastern. in a few moments, the headlines and calls all live on "washington journal." at 10:00 a.m., live coverage of the heritage foundation discussion on the administration's decision not to fund the training program designed to arm airline flight crew members. in 45 minutes, we examine the gop budget proposal with tom cole. then,