May 10, 2013 at 1:31 PM ET
Four years after the worst financial collapse in three generations, lawmakers and bank regulators still have a lot of work to do to prevent it from happening again, according to Fed chairman Ben Bernanke.
In a wide ranging speech Friday to bankers and regulators, the head of the U.S. central bank said that a flurry of new regulations passed in 2009 to prevent another global financial meltdown provided a good start.
But “this new regulatory framework is still under construction,” Bernanke told a banking conference sponsored by the Chicago Federal Reserve Bank.
And as the economy and financial markets get back on their feet, the chances increase that banks and other financial institutions could wind up taking on too much risk again, he said.
Ironically, the threat of that happening, said Bernanke, is heightened by the ultra-low interest rates that he and his Fed colleagues have engineered to repair the damage done by the 2008 meltdown.
“In light of the current low interest rate environment, we are watching particularly closely for instances of ‘reaching for yield’ and other forms of excessive risk-taking,” he said.
Didn’t Congress fix the problem after the financial collapse in 2008?
Sort of. The 2,000 page law known as Dodd-Frank provided a road map for new regulations designed to guard against another collapse. But the specific rules are being implemented, and enforced, by the Federal Reserve and other regulators.
Those rules only go so far, and this is a global problem. U.S. laws can’t prevent, say, banks in Spain or Italy from making too many risky loans. That’s why the Fed is still working with regulators in Europe and around the world on a set of international banking rules called Basel III (named for the Swiss city where negotiations over the regulations are held.)
The risk of another meltdown is also much broader than it used to be. For most of its 100-year history, the U.S. central bank dealt almost exclusively with banks, which made the job of managing risk somewhat easier. Today, trillions of dollars’ worth of money and credit flows through the so-called “shadow banking system” of hedge funds, money market funds, payday lenders and other so-called “non-bank” financial institutions.
"While the shadow banking sector is smaller today than before the crisis ... regulators and the private sector need to address remaining vulnerabilities," Bernanke.
Much of the risky speculation in mortgages behind the financial bubble that brought down the system in 2008 happened outside the reaches of traditional bank regulations.
The stock market is on fire these days. Shouldn’t Bernanke be worried that it’s becominganother financial bubble?
Yes, but Fed chairmen are always worried about bubbles. That’s part of their job.
In the case of the stock market, Bernanke has pointed out that the record prices in stocks are not that surprising given that corporate profits have been rising too. That’s a pretty good sign that investors aren’t getting ahead of themselves.
Bernanke said that Fed officials are casting a wider net as they look for signs of another financial bubble.
The real problem, he said, is that it’s very hard to predict where the next bubble will come from.
“I fully willing to admit there will be times when we can't identify a bubble or some other misvaluation,” he said Friday. “Our hope is to make sure that the system itself is sufficiently robust that if there is a problem, it won't be amplified into a major systemic crisis.”
So are we ready?
Not yet. Bernanke said more work is needed, for example, to deal with banks that are “too big to fail.” Though Dodd-Frank describes a process of “winding down” one of these behemoths, if push came to shove that failure might cause so much damage the government would decided step in again to save it.
That perception is a big part of the “too big to fail” conundrum. If bankers believe that no matter what the regulations say the government would have no choice but to bail them out, they’re more likely to make risky bets they may not be able to handle on their own.
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