By Sean J. Miller - 01/03/10 06:23 PM EST
Calling the recent financial crisis possibly the “worst in modern history,” Federal Reserve Chairman Ben Bernanke said Sunday that tighter regulation and not interest rate hikes could have prevented the sharp downturn.
“Stronger regulation and supervision” of mortgage lenders “would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates,” said Bernanke, according to an advance copy of his speech to the American Economic Association’s annual meeting in Atlanta.
“Monetary policy is also a blunt tool, and interest rate increases in 2003 or 2004 sufficient to constrain the [housing] bubble could have seriously weakened the economy at just the time when the recovery from the previous recession was becoming established,” he said.
He said linkages between the sharp rise in housing prices and monetary policy is “weak.” The Fed’s policymaking during the last decade “does not appear to have been inappropriate, given the state of the economy and policymakers' medium-term objectives,” he said. “House prices began to rise in the late 1990s, and although the most rapid price increases occurred when short-term interest rates were at their lowest levels, the magnitude of house price gains seems too large to be readily explainable by the stance of monetary policy alone.”
Instead he blamed the increased use of “exotic types of mortgages and the associated decline of underwriting standards,” which could have been curtailed with stronger government regulation. “The lesson I take from this experience is not that financial regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter,” he said.
Still, he didn't rule out using interest rate increases to prevent another housing bubble from threatening the economy. "If adequate reforms are not made, or if they are made but prove insufficient to prevent dangerous buildups of financial risks, we must remain open to using monetary policy as a supplementary tool for addressing those risks," he said.