Thinking there's not enough credit in the system, the Fed allows the use of low-quality MBSs at the discount window. The real problem is the default rate in the mortgage market.
This solution failed to realize that the real problem is the quality of the credit: low quality mortgages are doomed as short-term interest rates are pushed up by Fed tightening.
At this point in the cycle, private mortgage insurers are going under, as a flood of bad mortgages sweeps over them. See PMI and MGIC stock prices for evidence.
Another Greenspan blunder.
* * * * * J B K * * * * *
San Francisco
The decision in 2007 underscores how Fed officials defined the mortgage-market disruptions that year as partly driven by liquidity constraints. In hindsight, some analysts say that diagnosis turned out to be wrong.
"It was a way to prevent further deleveraging of the financial system, but that happened anyway," said Dino Kos, managing director at Portales Partners LLC and former head of the New York Fed's open market operations. "The underlying problem was solvency. The Fed was slow to recognize that."
http://www.bloomberg.com/apps/news?pid=20601068&sid=azN4JCUxN.8Y
