–Fin Reg Focus On Systemic Risk Key To Correcting Past Fed Missteps
By Brai Odion-Esene
WASHINGTON (MNI) – The Federal Reserve failed to fully understand
the devastating impact that a collapse in home prices and the broader
housing market would have on the U.S. economy, San Francisco Federal
Reserve President Janet Yellen said Thursday, in a frank critique of the
central bank’s actions leading up to the crisis.
In the question and answer session of the Senate Banking
Committee’s hearing for the latest nominees to the Federal Reserve
Board, Yellen, tapped to succeed retiring Vice Chair Donald Kohn, said
the Fed should have acted sooner to address the decline in underwriting
standards.
Laying out the mistakes by the Fed leading up to the housing crisis
that sparked the Great Recession, Yellen said while the central bank was
monitoring housing prices, “I think we failed completely to understand
the complexity of what the impact of the national decline in housing
prices would be in the financial system.”
“We saw a number of different things and we failed to connect the
dots,” Yellen said bluntly.
“While we thought about the risk coming from a housing price
decline, I think we failed to understand just how seriously mortgage
underwriting standards had declined.”
The same went for the increasing complexity of securitization and
the resulting risks building up in the financial sector, Yellen added.
“We missed critical elements … that caused the crisis to be as severe
as it was.”
Looking back, Yellen said she wished regulators — including the
Fed — had taken more significant steps earlier to appreciate
underwriting risks posed by subprime mortgage securities being sold into
the market.
The focus of regulators should have been on the systemic risk this
caused, “rather than being as focused as we were on safety and soundness
of banks,” she said.
This is why she supports the provision in the financial regulatory
reform bill that requires examiners to consider systemic risk in
regulation large bank holding companies.
Fellow nominee Sarah Bloom Raskin said the ability to analyse
economic situations on a local or regional level and then apply it to
the macro picture will be “critical” to the Fed.
Peter Diamond, the other nominee to the Board, said he hopes to
explore how the regulatory structure will pay more attention to the
interactions between the risk of individual banks, and systemic risk.
“That requires the kind of background in the nature of economic
equilibrium that I bring … as we now know how important it is,” he
said.
With the Senate set to pass the financial regulatory bill later
Thursday, Raskin said one piece that Congress still needs to tackle is
the reform of Fannie Mae and Freddie Mac.
Overhauling the mortgage giants, she said, is something that needs
to be on the forefront of Congress’ agenda.
One senator asked the nominees how the U.S. can trim its public
debt while the same time protecting the fragile economic recovery,
leading Yellen to acknowledge that the recovery is not proceeding at a
pace sufficient to bring down the unemployment rate rapidly.
“As Congress considers the option for further fiscal stimulus now,”
she said, “I would emphasize that it’s very important, and Congress will
have more flexibility to move in the short-run to support the economy,
if simultaneously it can put in place and show credibility on taking the
measures that are necessary to attack the long-term deficit.”
The deficit will require “painful policy action,” Yellen warned the
Committee, but having a plan to address medium- and longer-term deficit
issues would create greater scope in the short-term for policymakers to
“contemplate appropriate actions to address short-term weaknesses in the
economy.”
Asked what challenges the Fed will face in implementing the
provisions in the financial regulatory reform bill once it passes,
Yellen said the key regulatory issue for the central bank will be to
improve its supervision — “particularly of the largest, and most
complex bank holding companies based on what happened in this crisis and
the lessons that we have learned.”
Yellen added that based on the stress tests of the 19 largest U.S.
banks conducted last year, the Fed has learned that taking a “horizontal
approach” to bank supervision — one reliant on simultaneous reviews of
large institutions using multi-disciplinary teams (including economists)
— reveals the true and comparative situation in large banking firms.
“This is a strategy and tool we are employing on a system-wide
basis to ramp up our supervision,” she said.
The work facing the Fed post-regulatory reform cannot be
underestimated, Raskin said, with a lot of internal reorganization to
also take place within the central bank.
On the subject of weak lending by banks, Raskin, who served as
Maryland’s Commissioner for Financial Regulation over the last four
years, agreed with one senator that “bank lending is not where it should
be.”
Even credit-worthy borrowers are being refused loans, she noted, an
issue that must be addressed. This will also have good consequences for
employment.
Yellen added that as a regulator, the Fed must be careful not to
discourage lending that is sound and carefully underwritten.
Earlier, in her prepared testimony, Yellen said, that given the
large numbers of unemployed in the United States, the main focus of
monetary policy right now should be job creation.
“Over the next few years, the Fed must craft policies that ensure
that our economy accelerates its progress along the recovery path it has
begun to trace,” Yellen said.
She emphasized that with unemployment “still painfully high, job
creation must be a high priority of monetary policy.”
** Market News International Washington Bureau: 202-371-2121 **
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