Should the Fed have popped the housing bubble?

The FRBSF’s Kevin Lansing wonders, and concludes with a rather noncommittal “further research is needed”; “unsatisfying”, says Mark Thoma. It seems to me that Lansing’s actual views are clear enough, a little earlier in the Letter.

Monetary Policy and Asset Prices, by Kevin Lansing, FRBSF Economic Letter

Beyond the setting of short-term nominal interest rates, a broader view of monetary policy includes regulatory oversight of financial institutions. Throughout history, asset price bubbles have typically coincided with outbreaks of fraud and scandal, followed by calls for more regulation once the bubble has burst (see Gerding 2006). Recent bubble episodes are no different. If a goal of financial regulation is to prevent fraud, and as history attests, asset price bubbles are typically associated with fraud, then one could argue that financial regulators at central banks should strive to prevent bubbles.

According to Mishkin (2008), financial regulators at central banks may have a greater likelihood of identifying a credit-fueled bubble in real time because “they might have information that lenders have weakened their underwriting standards and that credit extension is rising at abnormally high rates.” He argues that “financial developments might then lead policymakers to consider implementing policies to…help reduce the magnitude of the bubble.” During the recent housing bubble, underwriting standards were weakened and credit extension did rise at abnormally high rates, resulting in rapid growth of subprime mortgage lending. In the aftermath of the burst housing bubble, financial regulators are now taking steps to strengthen the integrity of underwriting, appraisal, and credit-rating procedures.

via Mark Thoma

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