By James Saft
(Reuters) – Acknowledging that sometimes banks chisel clients and bank employees chisel banks may sound obvious to you, but for the Federal Reserve this is a pretty big step forward.
Jeremy Stein, a member of the Board of Governors of the Fed, gave a speech last week in which he said that sometimes it may be necessary for the fed to raise interest rates to control overheating in credit markets.
While a lot was made about him being Wall Street’s new bubble cop, I’d argue that actually the big step here was that he specifically and convincingly argued that you can’t understand markets without understanding the way participants game the system to their own advantage.
This is a huge change from the old Greenspan – and Bernanke – assumption, which was that the market was self-policing; that fear of the commercial consequences of bad actions would serve as an effective brake on fraud and abuse.
That naïve view allowed the Fed to assume that markets would behave predictably and rationally. It helped to set the intellectual underpinnings that led to too-easy rates, further easings when things went bad and the rolling series of bubbles and panics we’ve seen over the last decade and a half.