Bernanke: We Didn’t Do a Good job Regulating, so Let Us Regulate More
UPDATE: CR appears to agree with me, even as he raises another point:
Bernanke used data from other countries to suggest monetary policy was not a huge contributor to the bubble … however, Bernanke didn’t discuss if non-traditional mortgage products contributed to housing bubbles in other countries. This would seem like a key missing part of the speech.
I’m willing to believe that my interpretation of this speech is inaccurate, but here’s the evidence:
Some observers have assigned monetary policy a central role in the crisis. Specifically, they claim that excessively easy monetary policy by the Federal Reserve in the first half of the decade helped cause a bubble in house prices in the United States, a bubble whose inevitable collapse proved a major source of the financial and economic stresses of the past two years. Proponents of this view typically argue for a substantially greater role for monetary policy in preventing and controlling bubbles in the prices of housing and other assets. In contrast, others have taken the position that policy was appropriate for the macroeconomic conditions that prevailed, and that it was neither a principal cause of the housing bubble nor the right tool for controlling the increase in house prices. Obviously, in light of the economic damage inflicted by the collapses of two asset price bubbles over the past decade, a great deal more than historical accuracy rides on the resolution of this debate.
If I have to pick, I’ll take the latter group. Easy money alone doesn’t cause a crisis. So when he says:
Can accommodative monetary policies during this period reasonably account for the magnitude of the increase in house prices that we observed? If not, what does account for it?
The first answer is clearly “No.” And the second answer is important. Eventually, he answers it:
I noted earlier that the most important source of lower initial monthly payments, which allowed more people to enter the housing market and bid for properties, was not the general level of short-term interest rates, but the increasing use of more exotic types of mortgages and the associated decline of underwriting standards. That conclusion suggests that the best response to the housing bubble would have been regulatory, not monetary. Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates. Moreover, regulators, supervisors, and the private sector could have more effectively addressed building risk concentrations and inadequate risk-management practices without necessarily having had to make a judgment about the sustainability of house price increases.
The Federal Reserve and other agencies did make efforts to address poor mortgage underwriting practices. In 2005, we worked with other banking regulators to develop guidance for banks on nontraditional mortgages, notably interest-only and option-ARM products. In March 2007, we issued interagency guidance on subprime lending, which was finalized in June. After a series of hearings that began in June 2006, we used authority granted us under the Truth in Lending Act to issue rules that apply to all high-cost mortgage lenders, not just banks. However, these efforts came too late or were insufficient to stop the decline in underwriting standards and effectively constrain the housing bubble. [emphases mine]
As Albert Brooks once noted, he “buried the lede.” Bernanke notes that the “nontraditional” products constituted around 1/3 of the market by 2003. (As many others have noted, those mortgages were not passed through/to FHA/Fannie/Freddie, either.) Two years later, guidelines were being developed.
An institution that did not attempt to regulate claiming that it should be given more regulatory power is an invitation to disaster. Or am I missing something?
i wish he would just say ‘we f-ked up but we learned from the mistake and this is what we learned’.
then i’d be happier about having him and summers et al in leadership positions going forward.
instead we get these cover your ass statements that make him sound like a lame politician, which is what he is being at the moment.
Ken,
I’m not getting this. I didn’t think most of that kind of lending and bundling was part of the Fed’s portfolio. Isn’t that SEC stuff? Or at least wasn’t it outside of the Fed’s portfolio when the seeds of the crisis were being germinated?
Slugger has a point, and it leads to another one. The Fed did not screw up in isolation. No regualtory agency with authority over lending institutions did anything like a credible job of regulating residential or non-residential mortgage lending during the past decade. Congress did not ask them too, and when some efforts were made to regulate cowboy finance (such as Gensler’s effort to treat CDOs as insurance), congress twarted them.
So what we are left with, in our effort to impose a more realistic level of regulation, is the need to choose between failed agencies or create a new agency. If we are to choose between existing agencies, then the point that the Fed failed doesn’t help us choose. What we need to know is which agency is most prone to regulatory capture, and has a culture least prone to regulating well. I don’t have sufficient evidence on that point to have a view, and I doubt most of the usual suspects here have either.
If we intend to create a new agency, I’d ask why we’d expect it to do a better job. We have created new agencies to replace failed agencies in the past, and have found that the expertise needed at the new agency resides mostly in the brains of those who served in the old one. New agencies tend to spend a lot of their energy in the early days establishing turf internally and externally. That gets in the way of doing the job. Only when turf issues are settled, at least in the initial round, do we even know whether the new agency will try, under its own steam, to do a good job.
Think of all the nonsense about shutting down the IRS. Sounds wonderful, but you have to replace it with some other government agency – or tax farmers – who perform the same function, enforce the same tax laws and impose the same level of scrutiny and sanction as the IRS, unless we impose a new set of incentives on the neo-IRS. If we are going to enforce better agency performance by changing incentifves, why not just change the incentives for the IRS, and the Fed?
The fed has had an “asset inflation is good” bias at least since the 1980s. As long as wages did not go up, it was OK to pump money to asset managers willing to bid asset prices up. We’re politically hooked on asset inflation. And on the flip side, we’re all in on killing wage inflation whenever there is even a hint of wage inflation. The acceptance of China as a trading partner fit with this strategy, providing a more or less infinite sink to allow pumping money to the financial sector while wages were held in check.
Can you imagine the FED sitting by while real wages increased by 4% a year two years in a row, even if there was little evidence of an increase of the CPI?