Ben S. Bernanke, Chairman of the Board of Governors of the Federal Reserve System, argued in a speech Sunday at the Annual Meeting of the American Economic Association that regulatory failure, not monetary policy, resulted in the housing bubble and subsequent economic crisis during the last decade. Chairman Bernanke initially discussed U.S. monetary policy in the aftermath of the 2001 recession, noting that the aggressive monetary policy response in 2002 and 2003 was motivated by the fact that "the recovery remained quite weak" with real gross domestic product rising at a rate "insufficient to halt continued increases in unemployment" and the FOMC's "concerns about a possible unwelcome decline in inflation."

While critics have suggested that the Federal Reserve’s monetary policy, including low interest rates in response to the 2001 recession contributed to the housing bubble, Chairman Bernanke concluded that the availability of alternative mortgage products "is likely a key explanation of the housing bubble." In particular, both lenders and borrowers "became convinced that house prices would only go up," thereby extending mortgages to borrowers that they "could not be expected to service in the longer term," on the "expectation that accumulating home equity would soon allow refinancing into more sustainable mortgages," essentially a "self-fulfilling prophecy." Secondly, Chairman Bernanke noted that house price appreciation in the United States was "actually less than that in the majority of countries" and that "the relationship between the stance of monetary policy and house price appreciation across countries is quite weak." Specifically, "capital inflows from emerging markets to industrial countries can help to explain asset price appreciation," rather than strict monetary policy. In conclusion, Chairman Bernanke opined that “stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates.” He called for “better and smarter” financial regulation and supervision to preclude future economic crises.

The Senate Banking Committee approved Chairman Bernanke's reconfirmation last month. The full Senate is expected to reconfirm his nomination prior to January 31 of this year.

Separately, Federal Reserve Board Vice-Chairman also gave a speech Sunday at the Brimmer Policy Forum in Atlanta entitled Monetary Policy in the Crisis: Past, Present, and Future. Vice-Chairman Kohn initially summarized several of the actions taken by the Federal Reserve over the past two years to "stabilize the financial markets and foster a rebound in the economy," including expanding liquidity facilities, significantly lowering policy interest rates, buying longer term assets such agency-guaranteed mortgage-backed securities (MBS), agency debt, and Treasury securities, and lending significant funds to stabilize systemically important institutions.

According to Vice-Chairman Kohn, as a result of many of the foregoing monetary, financial, and fiscal policies, "along with the natural resilience of the economy," there has been "marked improvement in financial markets and the beginnings of a recovery in economic activity," as evidenced by reduced "borrowing from the Federal Reserve" and securitization markets "appear to be functioning more normally, partly reflecting the support provided by the Term Asset-Backed Securities Loan Facility". Notwithstanding the economic improvements, Vice-Chairman Kohn noted that cost of credit "remains relatively high and its availability relatively limited for many borrowers," and "through late 2009, banks continued to tighten terms and standards for lending and to raise the rates they charge relative to benchmark rates." As a result of "lingering credit restraints," the strengthening in economic activity "will be gradual," and "the odds are that the pickup in spending will not be very sharp." Looking forward, Vice-Chairman Kohn discussed several general strategic points, noting that the Federal Reserve "will be able to unwind [it's] actions when and as appropriate," the federal deficit "will not stop the Federal Reserve from exiting from current policies when that's needed to keep prices stable and the economy on a path to sustained high employment," and ultimately, the decision on when and how to exit the Federal Reserve's extraordinary measures will "depend on forecasts" of various economic conditions, including "resource utilization, inflation, and inflation expectations."

Finally, Vice-Chairman Kohn expressed a "strong preference" to use regulation and supervision to strengthen the financial system and lean against developing problems, and use monetary policy "only if imbalances were building and regulatory policies were either unavailable or had been shown to be ineffective."