Fed Should Avert Price Bubbles With Regulation, Mishkin Says
Central bankers should strengthen regulation to avert a credit-fueled increase in asset prices and forgo raising interest rates in an attempt to reverse a future price surge, Federal Reserve Governor Frederic Mishkin said.
“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,'' Mishkin said yesterday in remarks at the Wharton School at the University of Pennsylvania in Philadelphia.
“Central banks should recognize that trying to prick asset bubbles using monetary policy is likely to do more harm than good,'' the Fed governor said.
The collapse of the U.S. subprime-mortgage market has led to a decline in global credit and the worst housing slump in 25 years. U.S. foreclosure filings increased 65 percent in April from a year earlier, RealtyTrac Inc., an Irvine, California- based seller of default data, reported this week, while financial institutions have reported writedowns and credit losses exceeding $333 billion since the beginning of 2007.
The central bank has aided financial institutions by creating ways to expand liquidity, including opening up loans to investment banks.
Funds provided to banks through the so-called discount window rose by $2.8 billion to a daily average of $14.4 billion in the week to May 14, the Fed said yesterday. Separately, the central bank's loans to Wall Street bond dealers rose by $75 million to $16.6 billion.
Market Turmoil
When expected market turmoil doesn't “happen, it's really tough to unwind monetary policy,'' said Robert Eisenbeis, chief monetary economist at Cumberland Advisors Inc. and former head of research at the Atlanta Fed.
“We are in a new world now,'' Mishkin said in the question and answer period regarding the use of an emergency power to loan to investment banks. “This is going to be an issue that involves a lot of discussion'' about Fed involvement in markets.
Mishkin, reiterating arguments used by former Fed chairman Alan Greenspan, 82, and current chairman Ben S. Bernanke, said central banks that use increases in the benchmark interest rate to deflate asset prices will hurt economic growth.
“Monetary policy should react to asset price bubbles by looking to the effects of asset prices on employment and inflation,'' said Mishkin, 57.
U.S. central bankers, when faced with asset price bubbles in technology stocks and housing during the past decade, chose not to intervene with the federal fund rate no fax payday loans.
Internet Stocks
As investors began pushing Internet stocks higher in 1996, the Fed held the benchmark lending rate at 5.25 percent and raised it only once, by a quarter point, the following year.
The Nasdaq Composite Index from 1996 until 1999 rose almost fourfold. After hitting a record in March 2000, the index fell for almost two years. The U.S. economy slipped into an eight- month recession in March 2001.
“It has been pretty clear for a long period of time that there was a fear of a Japanese-type slowdown and unwanted deflation'' among policy makers, Eisenbeis said in an interview. “That led them to keep interest rates too low for too long.''
Similarly, low short- and long-term rates early this decade helped fuel the biggest mortgage boom in U.S. history. Mortgage lending between 2004 and 2006 totaled $2.9 trillion, and house prices rose 31 percent, according to an index tracked by the Office of Federal Housing Enterprise Oversight.
Market Collapse
After the collapse of the subprime-mortgage market, house prices fell during the final two quarters of 2007, OFHEO data shows. Home values will increase less than 1 percent during the first six months of this year, according to economists.
The Fed's hands-off approach to soaring asset prices is “a dangerous, reckless and irresponsible way to run the world's largest economy,'' Stephen Roach, chairman of Morgan Stanley Asia, said at the World Economic Forum in Davos in January.
Greenspan, Fed chairman from 1987 until January 2006, has defended the monetary policy that coincided with the surge in technology stocks and home prices, saying an increase in borrowing costs would harm employment and growth.
“The notion that a well-timed incremental tightening could have been calibrated to prevent the late 1990s bubble is almost surely an illusion,'' Greenspan said in an August 2002 speech in Jackson Hole, Wyoming.
Bernanke has long opposed using the federal funds rate to prick asset bubbles, said Mark Gertler, an economics professor at New York University who has researched the issue with the Fed Chairman.
“Our view is the best way to deal with this is through prudent regulatory structure,'' Gertler said in an interview.