A Fed governor has outlined a raft of measures she says can help prevent asset bubbles like the one that exacerbated the housing crisis.
Capital standards most effectively protect banks from asset bubbles when they are “part of a system of prudential supervision for all financial institutions,” Federal Reserve Governor Sarah Bloom-Raskin said on Wednesday while speaking before The Exchequer Club Luncheon in Washington D.C.
"And, as we experienced in the financial crisis, when a bubble involving a widely-held asset bursts, the consequent plunge in asset prices can seriously impair the balance sheets of households and firms," Bloom-Raskin said.
So how should regulators stave off asset bubbles without excessively intervening in the markets? There is no question that a higher quantity and quality of bank capital will strengthen the banking system, she said. But she pointed to several separate tools – capital regulation, stress testing, liquidity regulation, margins and haircuts as well as appropriate underwriting.
“From the perspective of the hammer, everything looks like a nail. Similarly, from the perspective of the financial regulator, everything might look like a problem of insufficient capital,” Raskin said. “Instead, capital might, in fact, be sufficient but appear insufficient because of circumvention of compliance, or because of absent or delayed enforcement.”
She emphasized that regulators must not rely on formulas as a substitute for prudential supervision.
“If regulators become fixated on the tools at the expense of compliance and enforcement, the tools themselves will be meaningless,” she said.