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In a speech delivered on Sunday, U.S. Federal Reserve Chairman Ben Bernanke blamed lax financial regulation for the financial crisis and defended the role of the central bank's monetary policy in the run up to the housing bubble.
Bernanke argued that low interest rates in the first few years of the last decade were appropriate for the time and had not directly caused the price bubble in the U.S. housing market. The Fed has come under criticism from some quarters for keeping interest rates too low for too long in the early 2000s. Bernanke suggested that regulatory failure, rather than an overly accommodative monetary policy, was responsible for the housing bubble and the ensuing financial crisis.
"House prices began to rise in the late 1990s, and although the most rapid price increases occured 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," Bernanke told the American Economic Association in Atlanta.
"Moreover, cross-country evidence shows no significant relationship between monetary policies and the pace of house price increases."
Bernanke pointed out that the most important source of lower initial payments that attracted more and more people to enter the housing market was not the general level of short-term interest rates, but the increasing use of more "exotic" types of mortgages and the associated decline of underwriting standards.
"That conclusion suggests that the best response to the housing bubble would have been regulatory, not monetary," stated the central bank chief. "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."
Bernanke also called for stricter financial regulation to prevent a repeat of the financial crisis that he said could turn out to be "the worst in modern history."
"All efforts should be made to strengthen our regulatory system to prevent a recurrence of the crisis, and to cushion the effects if another crisis occurs," he said.
"However, if adequate reforms are not made, or if they are made but prove insufficient to prevent dangerous build-ups of financial risks, 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," he added.
"Maintaining flexibility and an open mind will be essential for successful policymaking as we feel our way forward."
The central bank chief assured that the Federal Reserve was working towards a better supervisory approach to identify and correct the problems in financial institutions, adding: "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."
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