Bernanke wingman Frederic Mishkin today, parroting Barney Frank:
I would like to emphasize the importance of regulatory policy. Monetary policy–that is, the setting of overnight interest rates–is already challenged by the task of managing both price stability and maximum sustainable employment. As a result, it falls to regulatory policies and supervisory practices to help strengthen the financial system and reduce its vulnerability to both booms and busts in asset prices.
Of course, some aspects of such policies are simply the usual elements of a well-functioning prudential regulatory and supervisory system. These elements include adequate disclosure and capital requirements, prompt corrective action, careful monitoring of an institution’s risk-management procedures, close supervision of financial institutions to enforce compliance with regulations, and sufficient resources and accountability for supervisors.
More generally, our approach to regulation should favor policies that will help prevent future feedback loops between asset price bubbles and credit supply. A few broad principles are helpful in thinking about what such policies should look like. First, regulations should be designed with an eye toward fixing market failures. Second, regulations should be designed so as not to exacerbate the interaction between asset price bubbles and credit provision. For example, research has shown that the rise in asset values that accompanies a boom results in higher capital buffers at financial institutions, supporting further lending in the context of an unchanging benchmark for capital adequacy; in the bust, the value of this capital can drop precipitously, possibly even necessitating a cut in lending.
Choking tomorrow’s legitimate commerce — or rather, driving it to less profligate nations — to pay for yesterday’s illusory and Fed-stoked boom.