By David Henderson
Two excerpts from my review:
Throughout 2007 and 2008, Fed Chairman Ben Bernanke and others in policy-making positions assumed that the problem was that the financial system lacked liquidity, and virtually all their actions were calculated to inject more liquidity. But Taylor gives evidence, which he garnered with economist John Williams, that liquidity was not a problem. The problem, writes Taylor, was “counterparty risk.” Taylor compares finance to the game of Hearts. In Hearts, you don’t want to get stuck with the queen of spades. The queens of spades in finance, he writes, “were the securities with bad mortgages in them” and “people didn’t know where they were.” Increasing liquidity by increasing the money supply does nothing to solve that problem.
Many proponents of the bailout argued that the government’s failure to bail out Lehman Brothers made the financial crisis worse. But Taylor, drawing on the well-known finding of financial economists that financial markets adjust within hours or minutes to new information, shows that the Libor-OIS spread did not widen much after the Lehman bankruptcy. Instead, the big widening occurred after Bernanke’s and Paulson’s Sept. 23 testimony spooked financial markets with their warnings of grim days ahead if the bailout were not passed. This is some of the key evidence that the bailout actually worsened the problem.
I do criticize, though, Taylor’s criticism of Greenspan’s monetary policy.