What Could the Fed Have Done Differently in 2008?
Recall that Gary Gorton provides evidence that many of the CDOs and MBS were not subprime, but when the market panicked a liquidity crisis became a solvency crisis. This is especially true in late 2008. Had the Fed responded to the falling market sentiment in the second half of 2008 the shadow bank run in late 2008 may have never happened and the resulting bankruptcies been fewer. Again, the worst part of the financial crisis took place after this period of passive Fed tightening. This is very similar to the Great Depression when the Fed allowed the aggregate demand to collapse first and then the banking system followed. Unlike the Great Depression, though, the Fed did eventually get aggressive with its QE programs so outcome was better.
Source: http://macromarketmusings.blogspot.com/2014/03/what-could-fed-hav-done-differently-in.html
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