The analysis of Hummel and Henderson is far too generous toward the Fed. It fails to recognize the role of the Fed's expansionary then restrictive monetary policy during 2002-2006. Hummel and Henderson are correct that

interest rates can be a misleading indicator of monetary policy, but the same is true of the monetary aggregates.

Thus, one needs to look at a combination of things to determine whether Fed policy is expansionary or restrictive. The feedback from markets that adjust quickly is particularly important here. By 2004, the foreign exchange value of the dollar had depreciated substantially, the yield curve was quite steep, and commodity prices were rising. All of these factors along with the prolonged historically low short-term interest rates (the Fed funds rate was 2 percent or less throughout 2002-2004) were indicative of monetary policy that was too expansionary.

But these tell-tale signs were ignored by the Fed, including Alan Greenspan. In my judgment, by this time Mr. Greenspan was believing all of the media reports about his almost magical ability to smooth the ups and downs of the economy. He should have known better. After all, he was well aware of the views of Milton Freidman and other monetarists that the lags associated with changes in monetary policy are long and variable, and therefore policy-makers following stop-go policies in an effort to promote stability will in fact promote instability.

This is precisely what happened. The prolonged low short-term interest rates of 2002-2004 re-enforced the disastrous housing regulation policies, which
had destroyed the mortgage lending standards present prior to the
mid-1990s. The Fed policy along with the housing regulations made it possible for borrowers to take out adjustable rate mortgages and purchase more housing than they could afford. This generated both malinvestment in housing and the housing price bubble.

However, as the Fed responded in 2005 to signs that its policy was causing inflation, short-term interest rates increased, the monthly payments on variable rate mortgages rose, the mortgage default rate soared, and eventually highly leveraged investment banks like Henry Paulson's Goldman Sachs were on the financial brink. Of course, none of this would have happened if the housing regulators had not destroyed sound lending practices. But given that they did, the Fed's manipulation of short-term interest rates during 2002-2006 in creating the current disaster should not be overlooked.