Bernanke says poor regulation, not monetary policy, led to housing bubble

Bloomberg News

Federal Reserve Chairman Ben S. Bernanke said that the central bank’s low interest rates didn’t cause the last decade’s housing bubble and that better regulation would have been more effective in limiting the boom.

“The best response to the housing bubble would have been regulatory, rather than monetary,” Bernanke said Sunday in remarks at the American Economic Assn.’s annual meeting in Atlanta. The Fed’s efforts to constrain the bubble were “too late or were insufficient,” which means that regulatory actions “must be better and smarter,” he said.

Bernanke said the Fed was working to improve its supervision of banks and had strengthened measures to protect consumers of mortgages and other financial products. But he didn’t rule out raising interest rates to stop new speculative investment bubbles from forming.


The Fed chief’s remarks were his most extensive on the subject since the housing market’s tumble led to the gravest financial crisis since World War II -- and perhaps the worst in modern history, in his view.

Critics blame the Fed for feeding that speculative boom in housing by holding interest rates too low for too long after the 2001 recession.

Senate Banking Committee Chairman Christopher Dodd (D-Conn.), who backs Bernanke for a second term, has called the Fed’s oversight of banks leading up to the crisis an “abysmal failure.” Dodd proposes stripping the Fed and other agencies of bank supervision powers and moving those powers to a new regulator.

Scholars such as Allan Meltzer, a historian of the central bank, have criticized the Fed for helping fuel the housing boom by keeping interest rates too low for too long. The bursting of the housing bubble led to the worst recession since the Great Depression and the loss of more than 7 million U.S. jobs.

Meltzer’s argument has been echoed by lawmakers, including Sen. Richard Shelby (R-Ala.). The senior Republican on the Banking Committee said Bernanke doesn’t deserve a second term as Fed chief.

Shelby, at a Dec. 17 vote on Bernanke’s nomination to a second four-year term starting next month, said the former Princeton University professor “missed clear signals” of a financial crisis when he was a Fed governor from 2002 until 2005.


“I strongly disapprove of some of the past deeds of the Federal Reserve while Ben Bernanke was a member and its chairman, and I lack confidence in what little planning for the future he has articulated,” Shelby said.

Bernanke didn’t discuss the outlook for the U.S. economy or Fed monetary policy in Sunday’s speech or an accompanying slide presentation.

Increased use of variable-rate and interest-only mortgages and the “associated decline of underwriting standards” were more responsible for the bubble, Bernanke said.

He left the door open to using interest rates to prevent “dangerous buildups of financial risks” should regulatory changes fail to be made or turn out to be insufficient.

“We must remain open to using monetary policy as a supplementary tool for addressing those risks -- proceeding cautiously and always keeping in mind the inherent difficulties of that approach,” Bernanke said.

Responding to audience questions after the speech, Bernanke said he wasn’t “particularly concerned” about a possible loss of investor confidence in the U.S. financial system.

The dollar is still the “dominant” world reserve currency, and when financial conditions become more “worrisome,” investors see the currency as a haven and U.S. markets as the deepest and most liquid, he said.

Bernanke devoted most of his speech to rebutting criticism that the Fed’s rate policy fueled the housing bubble. Monetary policy after the 2001 recession “appears to have been reasonably appropriate, at least in relation to” a formula based on the so-called Taylor Rule, he said. In addition, Bernanke said Fed research shows the rise in housing prices had little to do with monetary policy or the broader economy.

John Taylor, a Stanford University economist and former Treasury undersecretary, created the Taylor Rule, a shorthand formula that suggests how a central bank should set interest rates if inflation or growth veers from goals.

Associated Press was used in compiling this report.