Arnold, you make a good point about the importance of capital but I don’t think it conflicts in any way with the comments quoted here by Geithner. Several European countries had spectacular housing bubbles without Fannie or Freddie or CRA.

You’ve emphasized, as does Geithner, overoptimistic house price expectations, which was surely a big part of the surge in mortgage demand. But the story behind credit supply starts with the fact that the Fed lowered financing costs for the carry trade to the point that it sucked in huge amounts of capital, at the same time that the Fed was at best disinterested and at worst enthusiastic about the decline in lending standards (and chose not to use its authority to stop it).

(This is my main objection to your argument that market rates are independent of policy rates, limiting the Fed’s impact on credit markets. As I see it, the Fed’s control over bank financing costs and other short-term rates is a powerful lever, since most credit suppliers are essentially carry traders, either completely or at the margin. When loan rates follow deposit rates lower, the distortions created by the Fed play out in the traditional way. When loan rates don’t fall as much, then the distortions materialize as falling lending standards, which is a rational response by credit suppliers. Wider carry spreads mean that you can take on more default risk before you lose money. Obviously, you won’t hear this from Geithner.)