Bernanke Says Low Rates Didn’t Cause Housing Bubble

By Scott Lanman

Jan. 3 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said the central bank’s low interest rates didn’t cause the past 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 today in remarks to the American Economic Association’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 is working to improve its supervision of banks and has strengthened measures to protect consumers of mortgages and other financial products. Senate Banking Committee Chairman Christopher Dodd, 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 them 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 Senator Richard Shelby of Alabama, the senior Republican on the Banking Committee, who says Bernanke doesn’t deserve a second term as Fed chief.

‘Clear Signals’

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 today’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 in a speech at an economics conference.

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

‘Supplementary Tool’

“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 safe haven and U.S. markets as the deepest and most liquid, he said.

Fed Vice Chairman Donald Kohn said in a speech to the same conference that tight bank credit and caution among households and businesses may impede spending amid an improvement in financial markets. “Credit constraints are a key reason why I expect the strengthening in economic activity to be gradual and the drop in the unemployment rate to be slow,” he said.

Most of Speech

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.” 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.

Under former Chairman Alan Greenspan, the Fed lowered its benchmark interest rate to 1.75 percent from 6.5 percent in 2001 and cut the rate to 1 percent in June 2003. The central bank left the federal funds rate, or overnight interbank lending rate, at 1 percent for a year before raising it at a “measured pace” of quarter-point increments over two years, from 2004 to 2006.

Fed Governor

Bernanke, 56, joined the Fed as a governor in 2002 and supported all of the interest-rate decisions under Greenspan before being appointed chairman in 2006. After the financial crisis struck, he cut the federal funds rate almost to zero in December 2008 from 5.25 percent in September 2007.

The standard Taylor Rule would have recommended that the Fed raise the rate to a range of 7 percent to 8 percent through the first three quarters of 2008, “a policy decision that probably would not have garnered much support among monetary specialists,” Bernanke said. A variation of the rule used by the Fed focused on anticipated rates of inflation, not actual rates, he said.

An index of U.S. home prices in October was down 11 percent from its peak in April 2007, the Federal Housing Finance Agency in Washington said last month. The federal tax credit for homebuyers has boosted demand, helping prices increase 0.6 percent in October from September, the first monthly increase since July.

One in four U.S. homeowners owe more on their mortgage than their house is worth, according to a November report by First American CoreLogic, a Santa Ana, California-based real estate research firm.

Foreclosure filings in 2009 probably reached a record for the second consecutive year with 3.9 million notices sent to homeowners in default, RealtyTrac Inc., the Irvine, California- based company, said last month.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net.
Last Updated: January 3, 2010 12:13 EST