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Highlights from Bernanke's testimony to financial crisis panel

Here are the highlights from Federal Reserve Chairman Ben Bernanke's testimony on Thursday to the Financial Crisis Inquiry Commission.

On the causes of the crisis:

Before the crisis, the shadow banking system had come to play a major role in global finance; with hindsight, we can see that shadow banking was also the source of some key vulnerabilities. Leading up to the crisis, the shadow banking system, as well as some ofthe largest global banks, had become dependent on various forms of short-term wholesale funding.

The statutory framework of financial regulation that was in place before the crisis contained serious gaps. Critically, shadow banks were, for the most part, not subject to consistent and effective regulatory oversight. Many types of shadow banks lacked meaningful prudential regulation, including various special purpose vehicles (such as CLOs), ABCP vehicles, hedge funds, and many nonbank mortgage-origination companies. No regulatory body restricted the leverage and liquidity policies ofthese entities, and few if any regulatory standards were imposed on the quality oftheir risk management or the prudence oftheir risk-taking

Although subprime mortgage losses were the most prominent trigger of the crisis, they were by no means the only one. Another, less well-known triggering event was a "sudden stop" in June 2007 in syndicated lending to large, relatively risky corporate borrowers.

Unfortunately, the crisis revealed many other significant defects in private-sector risk management and risk controls. Examples included a significant deterioration of mortgage underwriting standards before the crisis, which was not limited to subprime borrowers; a similar weakening of underwriting standards for commercial real estate loans, together with poor management of concentration risk and other risks by commercial real estate lenders; excessive reliance by investors on credit ratings, especially in the case of structured credit products; and insufficient capacity by many large firms to track firmwide risk exposures, including off-balance-sheet exposures.

On too-big-to-fail firms:

Governments provide support to too-big-to-fail firms in a crisis not out of favoritism or particular concern for the management, owners, or creditors ofthe firm, but because they recognize that the consequences for the broader economy ofallowing a disorderly failure greatly outweigh the costs ofavoiding the failure in some way.

On monetary policy and related factors:
Some have argued that monetary policy contributed significantly to the bubble in housing prices, which in tum was a trigger ofthe crisis. The question is a complex one, with ramifications for future policy that are still under debate; I will comment on the issue only briefly.

The Federal Open Market Committee brought short-term interest rates to a very low level during and following the 2001 recession, in response to persistent sluggishness in the labor market and what at the time was perceived as a potential risk of deflation. Those actions were in accord with the FOMC's mandate from the Congress to promote maximum employment and price stability; indeed, the labor market recovered from that episode and price stability was maintained.

Did the low level of short-term interest rates undertaken for the purposes of macroeconomic stabilization inadvertently make a significant contribution to the housing bubble? It is frankly quite difficult to determine the causes ofbooms and busts in asset prices; psychological phenomena are no doubt important, as argued by Robert Shiller, for example

By Ariana Eunjung Cha  |  September 2, 2010; 1:26 PM ET
Categories:  Federal Reserve , Financial Crisis Inquiry Commission  
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Next: Economic agenda: Friday, Sept. 3, 2010


Interesting to see the 'shadow banking' meme spreading through official excuse-making like a virus. Two small problems with this 2007 invention - firstly, the distinction it makes between a supposedly clean, officially-regulated and backstopped banking sector and an unregulated 'shadow banking' system is entirely false, and secondly it omits to mention that on every occasion when the regulators (Bernanke among them) were offered the chance to step in and regulate 'shadow' activities, not only did they refuse to do so but they asserted (a la Greenspan) that to even attempt to do so would cause irreparable damage to the US economy. Hmmm - some mistake there.

'Shadow Banking' needs to be filed for what it is, a pathetic attempt at excuse making, under the 'Whocouldanode?'/Black Swan heading. See Yves Smith's Naked Capitalism blog for further examples of this

Posted by: Jon Cloke | September 6, 2010 4:57 AM | Report abuse

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