Following his semi-annual testimony to Congress today, Federal Reserve Chairman Ben Bernanke was asked whether holding interest rates near zero through 2014 created the risk of another asset bubble.
"That's something we have to pay close attention to," Bernanke told the House Financial Services Committee. "We have greatly expanded our ability at the Fed to monitor the financial system, broadly to take a so-called macroprudential approach. And you know right now we don't see any obvious bubbles in the economy. But certainly that's something we are going to need to look at and continue to monitor."
Phew. No obvious bubbles. What about the less obvious ones?
I've always been a little shaky on the macroprudential approach to oversight, so I read up on it a bit, starting with Bernanke's speech last May to the Chicago Fed's annual bank structure conference.
After admitting that legislative reforms are usually an attempt to fight the last war, Bernanke went on to explain that a macroprudential approach considers risks to the entire financial system, not just specific institutions. He cited the creation of the Financial Stability Oversight Council to monitor systemic risk as an example.
To be sure, regulators could have done a better job as no-documentation subprime loans proliferated. But they weren't the reason people bought homes they couldn't afford with mortgages they couldn't pay. The Fed held interest rates too low for too long, and the outcome was as predictable as it was in the 1920s and 1990s.
For some reason, neither Bernanke nor his predecessor, Alan Greenspan, has ever been willing to admit that easy money was the cause of both the 1990s tech bubble and the last decade's housing bubble, when the funds rate overstayed its welcome at 1 percent. In mid-2004, a full two-and-a-half years after the recession ended, the real funds rate (adjusted for inflation) was still at -2 percent.
That's a powerful incentive to borrow and spend -- or in this case, lend. How can regulators, of either the micro- or macroprudential variety, determine that the allocation of capital into a particular asset class is excessive? Besides, when asset prices are rising, bank balance sheets look great.
"Of course, the identification of threats to financial stability must be followed by appropriate remedies," Bernanke said in his May 2011 speech.
Would that remedy be something macroprudential? Sure sounds like interest rates to me.
(Caroline Baum is a Bloomberg View columnist. Follow her on Twitter.)
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