how credit got so easy_debtcrisis_sab34

8/18/2019 How Credit Got So Easy_DebtCrisis_SAB34

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How Credit Got So Easy

And Why It's TighteningBy GREG IP and JON E. HISENRATH

August 7, 2007; Page A1

An extraordinary credit boom that created many first-time homeowners and financed awave of corporate takeovers seems to be waning. Home buyers with poor credit arehaving trouble borrowing. Institutional investors from Milwaukee to Dsseldorf to!ydney are reporting losses. "anks are stuck with corporate debt that investors won#t buy.!tocks are on a roller coaster$ with financial powerhouses like "ear !tearns %os. and"lackstone &roup coming under intense pressure.

'he origins of the boom and this unfolding reversal predate last year#s mistakes. 'heytrace to changes in the banking system provoked by the collapse of the savings-and-loanindustry in the ()*+s$ the reaction of governments to the Asian financial crisis of the late())+s$ and the ,ederal eserve#s response to the +++-+( bursting of the tech-stock

bubble.

/hen the ,ed cut interest rates to thelowest level in a generation to avoid asevere downturn$ then-%hairman Alan

&reenspan anticipated that making short-term credit so cheap would have unintendedconse0uences. 1I don#t know what it is$ but we#re doing some damage because this is notthe way credit markets should operate$1 he and a colleague recall him saying at the time.

2ow the conse0uences of moves the ,ed and others made are becoming clearer.

3ow interest rates engineered by central banks and reinforced by a tidal wave of overseassavings fueled home prices and leveraged buyouts. 4ension funds and endowments$unhappy with skimpy returns$ shoved cash at hedge funds and private-e0uity firms$ which borrowed heavily to make big bets. 'he investments of choice were opa0ue financialinstruments that shifted default risk from lenders to global investors. 'he 0uestion now5/hen the dust settles$ will the world be better off6

1'hese adverse periods are very painful$ but they#re inevitable if we choose to maintain asystem in which people are free to take risks$ a necessary condition for maximumsustainable economic growth$1 Mr. &reenspan says today. 'he evolving financialarchitecture is distributing risks away from highly leveraged banks toward investors

better able to handle them$ keeping the banks and economy more stable than in the past$he says. 7conomic growth$ particularly outside the 8.!.$ is strong$ and even in the 8.!.$unemployment remains low. 'he financial system has absorbed the latest shock.

!o far. "ut credit problems once seen as isolated to a few subprime-mortgage lenders are beginning to propagate across markets and borders in unpredicted ways and degrees. Asystem designed to distribute and absorb risk might$ instead$ have bred it$ by making it soeasy for investors to buy complex securities they didn#t fully understand. And the

The Journal's Jon Hilsenrath discusses the origins of the creditboom and some of the lessons to be learned from its demise.


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interconnectedness of markets could mean that a sudden change in sentiment by investorsin all sorts of markets could destabili9e the financial system and hurt economic growth.

Side Effects of Deflation Fight

/hen a technology stock and investment plunge and the !ept. (( terrorist attacks pushedthe economy into recession in ++($ the ,ed slashed interest rates. "ut even by mid-++:$ ;ob creation and business investment were still anemic$ and the inflation rate was slippingtoward (


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long-term rates$ which are important to rates on :+-year conventional mortgages andcorporate bonds. 'his time$ it didn#t. Mr. &reenspan expressed concern that investorswere willing to accept low returns for taking on risk. 1/hat they perceive as newlyabundant li0uidity can readily disappear$1 he said in August ++B$ six months beforeretiring. 1History has not dealt kindly with the aftermath of protracted periods of low risk

premiums.1

3ooking back$ he says today5 1/e tried in ++C to move long-term rates higher in orderto get mortgage interest rates up and take some of the fi99 out of the housing market. "utwe failed.1

!omething besides ,ed policy was at work. "oth Mr. &reenspan and his successor$ "en"ernanke$ point to an unanticipated surge in capital pouring into the 8.!. from overseas.

'Global Saving Glut'

In =une ())*$ 8.!. 'reasury officials made a plea to %hina that they would be remindedof repeatedly in the following years. 'hailand had devalued its currency in ())$touching off a crisis in the region that led other countries to devalue and in some casesdefault on foreign debt. 'he yen was sliding. %hinese officials$ who pegged theircurrency to the 8.!. dollar$ 1let it be known...that if things kept going this way they#dhave no choice but to devalue$1 recalls 'ed 'ruman$ a 'reasury official at the time. 'he8.!.$ fearing such a move would trigger another round of devaluations$ urged the %hineseto hold their peg$ and praised them when they did so.

"ut times changed. As recessions and depressed currencies held down imports andgoosed exports in other Asian countries$ the countries ran trade surpluses that replenished

foreign-exchange reserves. Determined never to be so tied to the onerous conditions ofthe International Monetary ,und$ they have kept those policies in place. 'hai reserves$effectively exhausted in ())$ now stand at : billion.

3ong after the crisis passed$ %hina#s economic fundamentals suggested its currencyshould rise against the dollar. %hina let it rise only slowly$ continuing to ;uice exports and produce trade surpluses that pushed %hina#s foreign-exchange reserves above ( trillion./hen the 8.!. pressed %hina to let its currency float$ %hina reminded the 8.!. of thefixed exchange rate#s stabili9ing role in ())*. %hina put much of its cash -- part of whatMr. "ernanke has called a 1global saving glut1 -- into 8.!. 'reasurys$ helping hold downlong-term 8.!. interest rates. %hinese government entities also recently poured : billion

into 8.!. private-e0uity firm "lackstone.

Mortgages for All

3ou "arnes$ co-owner of a small %olorado mortgage bank called "oulder /est Inc.$ has been in the mortgage business since the late ()+s. ,or most of that time$ a borrower hadto fully document his income. 3enders offered the first no-documentation loans in themid-())+s$ but for no more than +< of the value of the house being purchased. A few


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years back$ he says$ that began to change as /all !treet investment banks andwholesalers demanded ever more mortgages from even the least creditworthy -- or1subprime1 -- customers.

1All of us felt the suction from /all !treet. Ene day you would get an email saying$ #/e

will buy no-doc loans at )B< loan-to-value$# and an old-timer like me had never seenone$1 says Mr. "arnes. 1It wasn#t long before the no-doc emails said (++


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deposit insurance or the ,ed. It filed for bankruptcy protection in April$ wiping outshareholders and triggering market-wide fears about the health of the subprime business.

LBO Boom

Home buyers were not alone. In August ++$ %west Co&&!ni#ations Internationa$ Inc. -- heavily indebted$ beaten down by the telecom bust and under investigation by the!ecurities and 7xchange %ommission -- decided to sell its @ellow 4ages business.4rivate-e0uity firms %arlyle &roup and /elsh$ %arson$ Anderson !towe agreed to buyit for billion$ about B.B billion of it borrowed. 'he business produced steady cashflow that could be used to pay down the debt.

'he buyers were worried they might not be able to borrow as much as they needed. 1/ewere coming out of a pretty bad credit cycle$1 says Daniel 'oscano$ managing director atDeutsche "ank$ which helped to manage the fund-raising. Instead$ they tapped into agusher. /ithin a year$ e( )edia Inc.$ as the business became known$ was back in the

market. It borrowed **) million to pay a dividend to %arlyle and /elsh %arson$ andthen B+ million more to pay another dividend. In ;ust (B months$ the private-e0uity buyers made back most of their investment and still owned the company.

"y ++G$ the volume of such leveraged buyouts was smashing records from the ()*+s.&enerous credit markets enabled private-e0uity firms to do larger deals and paythemselves bigger dividends. 'hey boosted returns -- and attracted more investors$ whichenabled even bigger deals.

As in subprime mortgages$ lenders began to ease borrowing re0uirements. 'hey agreed$for instance$ to 1covenant-lite debt$1 which dropped once-standard performance

re0uirements$ and 14I-toggle1 notes$ which allowed borrowers to toggle interest payments on and off like a faucet.

"ankers began marketing debt deals for companies that$ unlike @ellow 4ages$ didn#t havecomfortable cash flow. 'here was %hrysler$ burning cash rather than producing it. Andthere was ,irst Data %orp.$ whose post-takeover cash flow would barely cover interest payments and capital spending$ according to !tandard 4oor#s 3%D$ a unit of !4which tracks the high-yield market.

3ast month$ investors began to balk. 2ow many banks find themselves having committedto lend about ++ billion that they had intended to turn over to investors$ but can#t.

Let's All Look Like ale

'he subprime and 3"E booms re0uired willing lenders. 'he stock-market collapse andlow interest rates of ++( to ++C nurtured a class of investors and products to fill thatrole. Managers of pension and endowment funds long had divided their assets amongdomestic stocks$ bonds and cash. 'he funds saw their performance suffer when the stockmarket and then bond yields tumbled.


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A few endowments$ most notably at @ale and Harvard$ had for years been spreading theirinvestments more broadly$ going into hedge funds$ real estate$ foreign stocks$ eventimberland. 'he goal was holdings that wouldn#t suffer in sync with stocks in a bearmarket. !ure enough$ in +++ and ++($ even as stocks tumbled$ Harvard Management%o. earned returns of :.< and -.< respectively. @ale#s returns were C(< and ).


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CREDIT AND BLAME

How Rating "ir&s' Ca$$s

"!e$ed S!+,ri&e )essBenign -iew o oans

He$,ed Create Bonds/ed to )ore endingBy AARON *CCHETTI and SERENA NG

August 15, 2007; Page A1

In +++$ !tandard 4oor#s made a decision about an arcane corner ofthe mortgage market. It said a type of mortgage that involves a

1piggyback$1 where borrowers simultaneously take out a second loan for the down payment$ was no more likely to default than a standard mortgage.

/hile its pronouncement went unnoticed outside the mortgage world$ piggybacks soonwere part of a movement that transformed America#s home-loan industry5 a boom in

1subprime1 mortgages taken out by buyers with weak credit.

!ix years later$ !4 reversed its view of loans with piggybacks. It said they actually werefar more likely to default. "y then$ however$ they and other newfangled loans were key parts of a massive (.( trillion subprime-mortgage market.

'oday that market is a mess. As defaults have increased$ investors who bought bonds andother securities based on the mortgages have found their securities losing value$ or insome cases difficult to value at all. !ome hedge funds that feasted on the securitiesimploded$ and investors as far away as &ermany and Australia have suffered. %entral banks have felt obliged to ;ump in to calm turmoil in the credit markets.

It was lenders that made the lenient loans$ it was home buyers who sought out easymortgages$ and it was /all !treet underwriters that turned them into securities. "utcredit-rating firms also played a role in the subprime-mortgage boom that is nowtroubling financial markets. !4$ Moody#s Investors !ervice and ,itch atings gave topratings to many securities built on the 0uestionable loans$ making the securities seem assafe as a 'reasury bond.

Also helping spur the boom was a less-recogni9ed role of the rating companies5 theircollaboration$ behind the scenes$ with the underwriters that were putting those securitiestogether. 8nderwriters don#t ;ust assemble a security out of home loans and ship it off to

the credit raters to see what grade it gets. Instead$ they work with rating companies whiledesigning a mortgage bond or other security$ making sure it gets high-enough ratings to be marketable.

'he result of the rating firms# collaboration and generally benign ratings of securities based on subprime mortgages was that more got marketed. And that meant additionalleeway for lenient lenders making these loans to offer more of them.


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'he credit-rating firms are used to being whipping boys when things go badly in themarkets. 'hey were critici9ed for being late to alert investors to problems at 7nron %orp.and other companies where ma;or accounting misdeeds took place. @et they alsosometimes get chastised when they downgrade a company#s credit.

1

SHAKY CR!"T#

$ %ind com&lete coerage of the troubles in the credit mar(ets.

'he firms say that since first asked to rate securities based on subprime loans more than adecade ago$ they#ve done the best they could with the data they#ve had. 1'he housingmarket has proven to be weaker than a lot of expectations$1 says /arren ornfeld$ co-head of residential mortgage-backed securities at Moody#s. 'his summer$ the firmsdowngraded hundreds of mortgage bonds built on subprime mortgages. 'hey say those bonds represent only a small part of the subprime-mortgage market.

'he subprime market has been lucrative for the credit-rating firms. %ompared with their

traditional business of rating corporate bonds$ the firms get fees about twice as high whenthey rate a security backed by a pool of home loans. 'he task is more complicated.Moreover$ through their collaboration with underwriters$ the rating companies canactually influence how many such securities get created.

Moody#s Investors !ervice took in around : billion from ++ through ++G for ratingsecurities built from loans and other debt pools. 'his 1structured finance1 -- which caninvolve student loans$ credit-card debt and other types of loans in addition to mortgages-- provided CC< of revenue last year for parent Moody#s %orp. 'hat was up from :< in++.

/hen /all !treet first began securiti9ing subprime loans$ rating firms leaned heavily onlenders and underwriters themselves for historical data about how such loans perform.'he underwriters$ in turn$ assiduously tailored securities to meet the concerns of theratings agencies$ say people familiar with the process. 8nderwriters$ these people say$would sometimes take their business to another rating company if they couldn#t get therating they needed.

1It was always about shopping around1 for higher ratings$ says Mark Adelson$ a formerMoody#s managing director$ although he says /all !treet and mortgage firms called the process by other names$ like 1best execution1 or 1maximi9ing value.1

7xecutives at both ratings firms and underwriters say the back-and-forth stopped short of bargaining over how to construct securities or over the criteria used to rate them. 1/edon#t negotiate the criteria. /e do have discussions$1 says 'homas /arrack$ a managingdirector at !4$ which is a unit of Mc&raw-Hill %os. He says the communication1contributes to the transparency1 preferred by the market and regulators.

!ome critics$ such as Ehio Attorney &eneral Marc Dann$ contend the rating firms had somuch to gain by issuing investment-grade ratings that they let their guard down. 'hey had

http://online.wsj.com/debthttp://online.wsj.com/debthttp://online.wsj.com/debt


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a 1symbiotic relationship1 with the banks and mortgage companies that create these products$ says Mr. Dann$ whose office is investigating practices in the mortgage marketsand has been talking to rating firms.

Slicing #t $%

In assembling a security such as a mortgage bond$ an underwriter first pulls togetherthousands of loans that will serve as collateral. "efore marketing the security$ theunderwriter slices it into perhaps (+ 1tranches1 with varying levels of risk and return.

'he riskiest tranche has the highest potential return$ but it ought to$ because the buyer istaking a great risk5 'his tranche will absorb the first defaults that occur in the pool ofmortgages. 'he next-lowest tranche is the second-hardest-hit by any defaults. "ecause ofthis structure$ most of the higher tranches traditionally were considered well-enoughinsulated from defaults to merit investment-grade ratings -- in some cases$ triple-Aratings.

'he process$ in a bad market$ is like prisoners walking the plank on a pirate ship. 'heholders of the riskiest securities are at the front of the line and go overboard first. /hat#shappening in the subprime-mortgage market is that investors further back than manyimagined possible are going overboard as well.

Had the securities initially received the risky ratings that some of them now carry$ many pension and mutual funds would have been barred by their own rules from buying them.Hedge funds and other sophisticated investors might have treated them more cautiously.And some mortgage lenders might have pulled back from making the loans in the first place$ without such a ready secondary market for them.

Many money managers lacked the resources to analy9e different pools of assets andrelied on ratings companies to do so$ says 7dward &rebeck$ chief executive of a debt-strategy firm called 'empus Advisors. 1A lot of institutional investors bought thesesecurities substantially based on their ratings$ in part because this market has become socomplex$1 he says.

"ack in +++$ piggyback mortgages were ;ust one among a handful of new loan varietiesthat credit analysts were having to evaluate. 8ntil that point$ few borrowers used piggyback loans to stretch beyond their means. "ut lenders began proposing thesestructures as a way to make homes affordable as their prices rose.

"ecause buyers putting less than +< down may have less incentive or ability to avoiddefault$ they normally had to buy private mortgage insurance to protect the lender if theyfail to make the payments. "ut as interest rates slid and home prices rose$ plenty oflenders were willing to provide a second$ piggyback mortgage for all or part of the +


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'he big mortgage buyers ,annie Mae and ,reddie Mac wouldn#t purchase these piggyback deals$ which didn#t meet their standards. "ut/all !treet firms would$ because they found they could turn them intohigh-yielding securities. And there were plenty of buyers for suchsecurities5 /ith interest rates low$ many investors were in search of

higher-yielding instruments.

Data provided by lenders showed that loans with piggybacks performedlike standard mortgages. 'he finding was unexpected$ wrote !4 creditanalyst Michael !tock in a +++ research note. He nonethelessconcluded the loans weren#t necessarily very risky.

!4 didn#t let loans with piggybacks completely off the hook. !4 saidin ++( that it wouldn#t penali9e a subprime mortgage pool so long asthe value of loans with piggybacks didn#t exceed +< of the overallvalue. Any more than that$ and it would impose a rating penalty$ !4

said. 'he firm notes that its assumptions 1remained appropriate forseveral years.1

Despite this limit$ !4#s stance was good news for underwriters andlenders. ,or underwriters$ the !4 decision made it easier to createinvestment-grade securities based on pools of subprime loans. Andunderwriters# appetite for the loans$ in turn$ made it easier for lenders tooriginate them.

'rends then converged to create explosive mortgage-market growth. ,alling interest rates-- as the ,ederal eserve sought to prop up the economy after the tech-bubble burst --

made home financing less expensive. 2ew technologies let bankers construct bonds fromthe payments of thousands of different mortgages. 'he fastest-growing segment wassubprime loans. 3enders brought out loans in which borrowers didn#t have to documenttheir income$ or could at first pay only interest and no principal -- or could use a piggyback to$ in effect$ borrow the whole cost of the home.

Loan &ools

At first$ underwriters creating mortgage securities made sure the loan pools they basedthem on didn#t have more than +< with piggybacks. "ut by ++G$ some were willing toaccept a ratings penalty. 'hey created securities like those structured from a pool of

(C$B++ loans from Washington )!t!a$ Inc.#s mortgage arm. About B< of the pool#svalue consisted of loans with piggybacks$ a prospectus showed.

"y ++G$ !4 was making its own study of such loans# performance. It singled outG:)$)*( loans made in ++ to see if its benign assumptions had held up. 'hey hadn#t.3oans with piggybacks were C:< more likely to default than other loans$ !4 found.


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In April ++G$ !4 said it would raise by =uly the amount of collateral underwriters mustinclude in many new mortgage portfolios. ,or instance$ !4 could re0uire that mortgage pools have extra loans in them$ since it now expected a larger number to go bad.

!till$ !4 didn#t lower its ratings on existing securities$ saying it had to further monitor

the performance of loans backing them. It thus helped the market for these loans hold upthrough the end of ++G.

!ome investors$ however$ grew concerned$ as newer mortgage securities appeared thatwere based not ;ust on piggyback loans but on loans with other risky attributes as well.Ene money manager$ =ames ragenbring$ says he had five to (+ conversations with !4and Moody#s in late ++B and ++G$ discussing whether they should be tougher becauseof looser lending standards. 1I#d think there would be more protection to guard againstdefaults$1 Mr. ragenbring$ from Advantus %apital Management$ says he said to therating companies.

He says he was told that for much of ++B and ++G$ subprime loans were performingabout the same as in previous years. Ether analysts recall being told that ratings couldalso be revised if the market deteriorated. !aid an !4 spokesman5 1'he market can gowith its gutK we have to go with the facts.1

In the second half of ++G$ Mr. ornfeld at Moody#s noticed a troubling trend. In anunusually large number of subprime loans$ borrowers weren#t making even their first payments. 'he market#s great strength 1could not continue$1 Mr. ornfeld recalls thinkingat the time. He called staff meetings to discuss his concern$ and in 2ovember Moody#ssaid publicly it saw signs of deterioration.

In March ++$ !4 said it expected home prices to be stagnant this year but grow :< toC< in ++*. "y early =uly$ !4 had lowered this forecast. It said its chief economist pro;ected that home prices would fall *< from the ++G peak to a trough expected in thefirst 0uarter of ++*.

Defaults and delin0uencies rose. Hard-pressed borrowers found it harder to get a newloan to bail them out or to sell their homes and pay off the loan that way. "y =uly$ almosta third of the loans in /ashington Mutual#s subprime pool were delin0uent or inforeclosure. 'his performance$ much worse than what credit-rating firms had expected$forced Moody#s and !4 to slash their ratings on several securities backed by thoseloans. En some$ !4 cut an initial A-minus investment-grade rating by five notches$ to a

below-investment-grade "".

'he downgrading$ begun late last year$ became an avalanche this summer. En =uly (+$Moody#s cut ratings on more than C++ securities that were based on subprime loans. !4 put G( on review$ and downgraded most two days later. 'he moves ;olted financialmarkets and prompted some investors to critici9e the ratings firms for mis;udging themarket.


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'he firms said that the soaring market of ++B-+G had reduced the relevance of theirstatistical models and historical data.

Money mangers unloaded on a =uly ( conference call with Moody#s analysts. 1@ou hadreams upon reams of data$1 said !teve 7isman$ a managing director of hedge fund

,rontpoint 4artners$ which had made bets against the subprime market. 1Despite all thatdata$ your original predictions of the performance of ++G loan pools have proven to becompletely and utterly wrong.1 He asked why the rating firms waited to take ma;or steps.

'Earl (arnings'

'he chief credit officer at Moody#s$ 2icholas /eill$ replied that some of the originalsubprime data provided to rating firms weren#t 1as reliable as expected.1 He also saidMoody#s put out 1early warnings1 of downgrades as far back as 2ovember ++G. Insteadof cutting ratings right away$ he added$ Moody#s needed time to see whether the loanswould start to recover. 1/hat we do is assess information available at the time$1 Mr.

/eill said.

!4$ Moody#s and ,itch atings have reacted by repeatedly toughening their ratingsmethodology for new subprime bonds$ re0uiring significantly bigger cushions. 'hey nowassume more and 0uicker defaults among pools of loans$ especially those with piggybacks.

'he changes have had an effect. About < of loans made in the first 0uarter of this yearhad piggybacks attached$ down from :B< a year earlier$ according to !4 research.Everall$ issuance of subprime-mortgage bonds is down :.B< this year through =une$according to Inside Mortgage ,inance. 'hat is resulting in lower /all !treet profits and

tighter lending standards for consumers.

%ommittees in the 8.!. House and !enate are broadly examining the mortgage market$ asare various state and federal agencies. It#s not clear whether ratings firms will become afocus of the in0uiries.

Write to Aaron 3ucchetti at aaron.lucchettiJws;.com: and !erena 2g atserena.ngJws;.comC

mailto:[email protected]:[email protected]:[email protected]:[email protected]


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"ed Treads )ora$ Ha0ardSte, In and C!t Rates

Or Stand By and Wat#h1

Whither He$i#o,ter Ben2By E.S. BROWNING

August 13, 2007; Page C1

/all !treet has a dream5 that the ,ederal eserve will rescue financial markets with asharp cut in interest rates.

"ehind that dream lurks a problem$ something financial people call moral ha9ard.

Moral ha9ard is an old economic concept with its roots in the insurance business. 'heidea goes like this5 If you protect someone too well against an unwanted outcome$ that person may behave recklessly. !omeone who buys extensive liability insurance for hiscar may drive too fast because he feels financially protected.

'hese days$ investors and economists use the term to refer to the market#s longing for,ederal eserve interest-rate cuts. If investors believe the ,ed will rescue them from their excesses$ people will take greater risks and$ ultimately$ suffer greater conse0uences.!ome grumble that the ,ed created problems this way in ())*$ ())) and ++:.

If the ,ed were to cut rates now$ it certainly could help with the current market crisis. 'hecheaper money would reduce pressure on stock and bond markets by making it easier to buy beaten-down stocks$ bonds and other securities world-wide. /all !treet is a powerfullobby in /ashington$ and its bleating for help can be hard to resist for politicians$ whosecampaigns often depend on financial contributions from /all !treet figures.

"ut if the ,ed were to ride to the rescue$ the skeptics worry$ it would encourage people tospeculate even more$ creating an even bigger bubble later.

1@ou don#t want to see the ,ed bail out these guys who have made a lot of money. 'heyhave made their bed and you want to see them lie in it$1 says a veteran trader at a 2ew@ork brokerage house. 1'hen again$ you don#t want to see the economy go intorecession.1

'hat$ in a nutshell$ is the choice the ,ed#s policy makers face today.

7arlier in his term as ,ed chairman$ "en "ernanke was seen by a lot of investors as possibly too inclined to bail people out. Mr. "ernanke was dubbed 1Helicopter "en1 because of a reference he once made to an economic theory that$ if deflation threatens$the ,ed#s role is to dump money into the economy as if dropping it from a helicopter.

Mr. "ernanke wasn#t advocating such a posture$ and many felt the nickname was unfair. Ithas taken him months of steady insistence that he wasn#t about to cut rates and fuelinflation for the gadflies to stop calling him that.


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2ow$ it is the other side that is upset$ worrying that his refusal to cut rates will hurtgrowth and enable the credit crisis to fester. 3ast week$ ,ed policy makers issued astatement reiterating their determination to fight inflation$ and the worriers grumbled the,ed was being too tough.

"ut Mr. "ernanke#s old critics -- those who formerly called him Helicopter "en --cheered. Articles were written announcing that the 1"ernanke put1 was dead. 'he1"ernanke put1 was another arcane reference$ in this case to an option known as a putoption that permits investors to sell stock at a preset price$ limiting potential losses.%ritics had complained that$ as long as people could count on the ,ed to intervene in caseof trouble$ Mr. "ernanke was putting a floor under the market -- offering a put. In earlieryears$ people called it the 1&reenspan put$1 a reference to then-,ed %hairman Alan&reenspan.

/ith people screaming from both sides$ the ,ed#s response has been to seek out themiddle ground. Instead of cutting rates$ the ,ed has offered additional loans to banks$ to

ensure there is plenty of money in the financial system$ and it has offered to buy bondsfrom banks that feel they are holding too many bonds in the midst of a bond crisis.

7conomists generally feel the proper solution to such problems is to start small and usethe least intervention possible. 'he ,ed seems to be saying that$ if it can right the shipwithout cutting rates$ it will do so$ and it won#t cut rates unless things get worse.

Debates of this sort$ featuring 0uaint expressions such as moral ha9ard$ have gone on fordecades$ and they flare up whenever crises do. !ome of the issues date back to thegovernment#s failed efforts to save the economy from the &reat Depression$ a sub;ect onwhich Mr. "ernanke has written extensively. !ome go back even farther.

!ome still complain that the ,ed$ then led by Mr. &reenspan$ contributed to the stock bubble of the late ())+s. In ())*$ the ,ed cut interest rates to support the bond marketafter it was swamped by a ussian debt default and the near-collapse of a huge hedgefund that speciali9ed in bonds$ 3ong-'erm %apital Management. 'he ,ed alsoencouraged banks to rescue that hedge fund. !tocks$ the riskiest of which were downmore than +< at that point$ 0uickly recovered.


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3ate in ()))$ the ,ed slowed itscampaign of rate increases and usedother means to pump money into thesystem to avoid trouble as bankcomputers switched to +++ from

())). 'hat dose of easy money mayhave helped prolong a stock surgethat didn#t end until early +++.

!tarting in =anuary ++($ the ,edgradually cut its target rate forovernight bank lending to (< in++: from G.B< in +++. 'hat keptthe economy out of a deeprecession$ but some complain thatthe ,ed kept rates too low for too

long$ laying the groundwork fortoday#s troubles$ which were fueled by cheap money. 'he ,ed beganraising rates at the end of =une ++C$

and the target rate today is B.B


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how credit got so easy_debtcrisis_sab34

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