TightWind is written by Kyle Baxter. Stay Hungry. Stay Foolish.

John Taylor:

The low interest rates added fuel to the housing boom, which in turn led to risk taking in housing finance and eventually a sharp increase in delinquencies, foreclosures, and the deterioration of the balance sheets of many financial institutions as toxic assets grew rapidly. To test the connection between the low interest rates and the housing boom I built a simple model relating the federal funds rate to housing construction. My research showed that a higher federal funds rate would have avoided much of the boom and bust.

And:

Others might say that my research ignores mistakes in the private sector. Of course there were market problems of various sorts. Mortgages were originated without sufficient documentation or with overly optimistic underwriting assumptions, and then sold off in complex derivative securities which credit rating agencies rated too highly. Individuals and institutions took highly risky positions either through a lack of diversification or excessive leverage ratios. But such mistakes do not normally become systemic, and in my view, the government actions tended to convert non-systemic mistakes into systemic risks.

The link is to a PDF, but if you have any interest in politics or the economy at all, you should read it. And then read it again.

Placing the Federal Reserve’s awesome power in the hands of men is dangerous no matter how it is managed, but we would be in a much better position if the Fed followed Taylor’s recommendations.