Tuesday, September 04, 2007


Fed Blamed for Asset-Price Inaction

Fed, Blamed for Asset-Price Inaction, Is Told `Tide Is Turning'

By Scott Lanman and John Fraher

Sept. 4 (Bloomberg) -- Federal Reserve officials, wrestling with a housing recession that jeopardizes U.S. growth, got an earful from critics at a weekend retreat arguing they should use regulation and interest rates to prevent asset-price bubbles.

Otmar Issing, former chief economist at the European Central Bank, and Stanley Fischer, head of the Bank of Israel, were among guests at the Fed's summer symposium in Jackson Hole, Wyoming, to challenge the hands-off approach. Fed Governor Frederic Mishkin reiterated his view in a paper at the conference: Officials should only respond to the effects of asset prices on the outlook for economic growth and inflation.

``The position that `this isn't an issue for central banks' has lost some support,'' Issing said in an interview at the gathering, which ran from Aug. 30 to Sept. 1. ``The tide is turning.''

The criticism -- one academic paper gave the Fed an `F' for its handling of housing -- may spur policy makers to strengthen regulation of lending practices that helped fuel the three-year mortgage boom that's now unraveling. Chairman Ben S. Bernanke, 53, has promised to draft new rules by year-end.

Controversy on how to handle asset prices has been stoked by two crashes in the past decade. Some economists blame former Fed Chairman Alan Greenspan for not raising rates enough to curb the Internet-stock boom in the late 1990s. That soured in 2000, contributing to a U.S. recession the next year.

Monetary Policy Faulted

By cutting rates to a four-decade low in 2003, the Fed inflated property values, Ed Leamer, head of an economic forecasting group at the University of California at Los Angeles, said at the conference. The ensuing housing slump, the worst since 1991, and the credit-market turmoil that followed, threaten to undo the six-year economic expansion.

``Central banks, probably on more occasions than they would like to admit, should respond to asset-price bubbles,'' said Fischer, who taught economics at the Massachusetts Institute of Technology when Mishkin, 56, and Bernanke worked on doctorates there in the 1970s. Fischer, 63, also served as deputy managing director of the International Monetary Fund.

As the debate under elk-antler chandeliers at the Jackson Lake Lodge turned to how the Fed should use its regulatory powers, officials stayed silent. That prompted Harvard University economist Martin Feldstein, who moderated an audience discussion, to plead for an official to elaborate on their approach.

Rosengren Answers

Finally, Eric Rosengren, president of the Boston Fed, responded that the central bank's oversight of mortgage lending is limited. The Fed doesn't supervise non-banks, such as finance companies.

``I'm not sure bank supervision is going to be equipped to deal with many organizations that are completely outside of depository organizations,'' said Rosengren, 50, who took office in July.

The debate came a day after Bernanke, who became chairman last year, opened the retreat with a speech saying policy makers would do what's needed to keep markets and the economy working.

James Hamilton, an economist and former Fed research adviser, warned that if the central bank doesn't tackle the loose lending standards that contributed to the housing bubble, politicians will, potentially doing more damage. U.S. legislators blame the central bank for insufficient action to stop predatory lending practices.

`Be Clear'

``It would be wise for the Federal Reserve to be clear on exactly what changes in regulatory authority could help prevent a replay of these developments and pre-position itself as the advocate to get these implemented now,'' said Hamilton, a professor at the University of California at San Diego.

Bernanke, appearing before Congress in July, said the Fed would write new lending regulations to strengthen consumer protection. The central bank has historically favored refraining from dictating rules, focusing instead on disclosure and education so borrowers can make their own, informed decisions.

The Fed had its supporters. Allan Meltzer, author of a history of the central bank, said ``regulation induces innovation to offset regulations'' and endorsed the ``market discipline'' approach.

``There's reason to doubt that central banks can in fact identify bubbles accurately,'' added Meltzer, a professor at Carnegie Mellon University in Pittsburgh.

Light Touch

Bernanke first appeared at Jackson Hole in 1999 with a paper arguing that central banks shouldn't target asset prices except when they affect the economy. Mishkin, who has collaborated on research with Bernanke, said much the same in his paper: Policy makers should respond to housing swings ``only to the extent that they have foreseeable effects on inflation and employment.''

Mishkin's argument provoked a challenge from William White, head of the monetary and economics department at the Bank for International Settlements, who said the Fed should indeed ``lean'' against asset prices when they start to climb.

``Rick is basically saying, `We can't lean, but we can clean up,''' White said, referring to Mishkin by name and raising his voice to make his point. ``I think we can make equally strong arguments for `You can lean and you may not be able to clean up.'''

To contact the reporter on this story: Scott Lanman in Jackson Hole, Wyoming, at slanman@bloomberg.net ; John Fraher in Jackson Hole, Wyoming, at jfraher@bloomberg.net .

Last Updated: September 4, 2007 00:13 EDT

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