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.
What policy implications should we draw? I noted earlier that the most important source of lower initial monthly payments, which allowed more people to enter the housing market and bid for properties, 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.
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. Moreover, regulators, supervisors, and the private sector could have more effectively addressed building risk concentrations and inadequate risk-management practices without necessarily having had to make a judgment about the sustainability of house price increases.The Federal Reserve and other agencies did make efforts to address poor mortgage underwriting practices. In 2005, we worked with other banking regulators to develop guidance for banks on nontraditional mortgages, notably interest-only and option-ARM products. In March 2007, we issued inter-agency guidance on sub-prime lending, which was finalized in June. After a series of hearings that began in June 2006, we used authority granted us under the Truth in Lending Act to issue rules that apply to all high-cost mortgage lenders, not just banks. However, these efforts came too late or were insufficient to stop the decline in underwriting standards and effectively constrain the housing bubble.
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