Federal Reserve chairman Ben BernankeWin McNamee
U.S. Federal Reserve chairman Ben Bernanke is calling on the world's policy makers to use regulation to pierce developing asset bubbles, in a bid to avoid a repeat of the recent economic crisis.
But interest rate hikes could also be used as a "supplementary" tool, he said, marking a significant shift in one of the bedrock policies of the world's most powerful central bank, which prior to the economic crisis, had disregarded asset prices in its deliberations.
In a effort to defend his agency against criticism that its policy of low interest rates were to blame for the housing crisis, Mr. Bernanke pointed his finger at regulators, who failed to stem the tide of sub-prime mortgages. "The best response to the housing bubble would have been regulatory, not monetary," he said.
Mr. Bernanke's remarks come as policy makers grapple with overheated real estate markets in China and Canada, where concern over asset values is growing as the economic recovery takes hold.
He called for regulators to work "better and smarter" to moderate future bubbles, arguing that a stronger approach to addressing lax underwriting practices and poor lender risk management in the U.S. "would have been a more effective and surgical approach" than tightening monetary policy.
When regulation doesn't succeed, Mr. Bernanke said, the Fed could then look at asset prices when setting monetary policy.
His remarks, made to the American Economic Association, continue a move to push the Fed toward a more interventionist regulatory policy, as the ramifications of the past two years forces deep soul-searching among those who played a role in a crisis.
Mr. Bernanke's attempts to downplay the Fed's responsibility for the run-up in housing prices amount to "sloughing off the blame for the housing bubble and the ensuing damage," said Douglas Porter, the deputy chief economist at BMO Capital Markets.
But his remarks also amount to a refutation of the "Greenspan mantra that the Fed can't really do much about bubbles and should just worry about cleaning up after the fact," Mr. Porter said. "This does question that line of thought."
Such questions have already been raised in Canada, where regulators long ago ended the practice of 40-year and no-down-payment mortgages, and have more recently urged caution among consumers tempted by low lending rates to take on increasing amounts of debt.
While Mr. Bernanke acknowledged that "the timing of the [U.S.]housing bubble does not rule out some contribution from monetary policy," he argued that the unchecked availability of sub-prime mortgages played a far greater role in stoking the problem.
Housing prices began their rapid ascent well before the Fed began slashing its rates in 2001. The boom started in the late 1990s, when interest rates were above 5 per cent. The apex in housing price gains came in 2004 and 2005, when annual appreciation topped 15 per cent and Fed rates were in the midst of a quick ascent, from 1 per cent in 2004 to over 5 per cent in 2006.
International experience also showed little relationship between central bank rates and housing prices. In fact, between 2001 and 2006, U.S. housing prices showed more modest increases than many other industrialized nations, including Canada, France, the U.K. and Australia - all of which had comparatively tighter monetary polices during that time.
"The relationship between the stance of monetary policy and house price appreciation across countries is quite weak," Mr. Bernanke said. And while he argued that the Federal Reserve did attempt to tighten mortgage regulation beginning in 2005, he acknowledged that it was too late, and did not do enough.
The past 24 months have taught that central banks must also be nimbler, said Craig Alexander, deputy chief economist with TD Bank Financial Group. "The behaviour of the banking system was changing so rapidly that the regulators were having a difficult time keeping pace," he said.
Yet the difficulty in spotting a bubble before it pops may lead the Federal Reserve to look for - and restrain - untoward growth in proxies like credit. "They'll look first to fast credit growth," said Mark Chandler, the head of Canadian syndicated finance at RBC Capital Markets. "And if it is too fast, then the first line of defence may be increased capital adequacy requirements."