The Alchemists: Three Central Bankers and a World on Fire by Neil Irwin Page B

sharply. But they failed to understand just how deeply intertwined housing had become with the financial system, or how vulnerable the system was to a shock. “In the event of a sharp drop in housing prices, the odds of a spillover to financial institutions seem limited,” said Michael Moskow, the president of the Chicago Fed.
    In the hundreds of pages of transcripts from Fed policy meetings in 2005—not made public until years later—there are occasional glimpses of officials understanding the problems that were emerging. They almost seemed onto something when Mark Olson, a Fed governor, said he had heard that lending was being funded more by the private pools of mortgages being ginned up by Wall Street than by the more traditional mortgages backed by the government-sponsored Fannie Mae and Freddie Mac.
    “ Not in the United States . I don’t know what country or planet,” said Lehnert.
    Olson cut him off.
    “The planet was Earth. The country was the United States,” he retorted. “And the person making the observation was talking about . . . what they see as a growing and undisciplined secondary market.”
    They quickly figured out that Olson was talking about the flow of new debt being issued, while Lehnert was thinking of the total amount outstanding. That miscommunication cleared up, the subject was immediately dropped.
    What the Fed lacked in this and other discussions about risks to the economy wasn’t technical expertise. It had that in spades. It wasn’t attention or discipline either. The discussions were exhaustive, involving a group of very smart people trying earnestly to come to the right answer. What the Fed lacked was creativity, the ability to see how housing and finance could interact with one another and cause greater damage than either could independently—particularly how the rapid increase in housing prices could threaten the financial system worldwide. In eight closed-door meetings over the course of that year—the transcripts take up nearly eleven hundred pages—there wasn’t a single mention of some of the developments in the financial system that could allow the popping of the housing bubble to turn into a global crisis: the excessive use of borrowed money by investment banks, for example, and the deep insinuation of mortgage-related securities of questionable safety into the machinery of modern finance.
    In the Fed’s 2005 meetings, the moment of most brutal clarity about the situation the U.S. economy faced wasn’t in any of the technical discussions of home price indices or the evolution of securitization markets. It was in a wry aside, made by Director of Research David Stockton. Stockton noted that a number of indicators suggested the housing boom could be ending. He continued:
    I offer one more piece of evidence that I think almost surely suggests that the end is near in this sector. While channel surfing the other night, to the annoyance of my otherwise very patient wife, I came across a new television series on the Discovery Channel entitled “Flip That House.” As far as I could tell, the gist of the show was that with some spackling, a few strategically placed azaleas, and access to a bank, you too could tap into the great real estate wealth machine. It was enough to put even the most ardent believer in market efficiency into existential crisis.
    In other words, the underlying causes of the global financial crisis were hiding in plain sight. Plenty of central bankers fretted about a global housing bubble. A smaller number worried about a global debt bubble—not just in mortgages, but also in consumer and corporate debt. A smaller number still saw a vast and rapid expansion of the financial sector as something that could threaten worldwide financial stability. And you had fundamental imbalances in the global economy that were at the root of it all—which central bankers were well aware of but undecided about how to correct. They just didn’t see how all these pieces