Bernanke Says Lax Regulation to Blame for Housing Bubble

By:
Peter King | January 04, 2010

A lax economic policy was not the cause of the housing bubble and crash of the past decade, according to Federal Reserve Chair Ben Bernanke, who said stronger financial regulations and oversight are needed to prevent it from happening again.

Speaking before a meeting of economists in Atlanta, Bernanke argued that raising interest rates would have done little to cool the overheated housing market that developed after the turn of the century. Such increases, he said, would have had little effect on the exotic mortgage products and weak underwriting that were likely a key reason for the bubble.
 
“Even as we continue working to stabilize our financial system and reinvigorate our economy, it is essential that we learn the lessons of the crisis so that we can prevent it from happening again, he said, adding “The crisis revealed not only weaknesses in regulators' oversight of financial institutions, but also, more fundamentally, important gaps in the architecture of financial regulation around the world.”
 
Critics have blamed the Federal Reserve for not tightening credit in response to the growing housing bubble. But Bernanke called monetary policy a “blunt tool,” aruging that raising interest rates in 2003 and 2004 to a level sufficient to stem the housing bubble could have weakened the economy just as it was recovering from the 2001 recession.
 

"Exotic" mortgages little affected by interest rates

 
He also noted that higher interest rates would have had little effect on the so-called “exotic” mortgages that blossomed over the past decade and significantly reduced the initial costs of purchasing a home.
 
He said, for example, that a moderate increase in interest rates would have raised the initial payments on traditional adjustable rate mortgages (ARM) by an average of only $75 a month, not enough to seriously discourage buyers. More exotic products, such as interest-only ARMs, pay-option loans and others, would have been affected even less.
 
“Borrowers chose, and were extended, mortgages that they could not be expected to service in the longer term,” he said. “They were provided these loans on the expectation that accumulating home equity would soon allow refinancing into more sustainable mortgages. For a time, rising house prices became a self-fulfilling prophecy, but ultimately, further appreciation could not be sustained and house prices collapsed.”
 

Other nations experienced price increases as well

 
Bernanke also noted that the housing bubble during this period wasn’t strictly confined to the United States, but also occurred in other countries with stricter monetary policies as well.
 
“That conclusion suggests that the best response to the housing bubble would have been regulatory, not monetary,” he said. “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.”
 
He did not rule out using monetary policy as a response to future crisis, however, saying it must remain a secondary option in case new regulations are not made or prove inadequate to prevent a building of dangerous financial risks.
 
Bernanke made his comments before the Annual Meeting of the American Economists Association.

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