It’s “too early” to tell if the new powers given to regulators in the wake of the financial crisis are adequate for managing risks and preventing financial instability, Federal Reserve Governor Lael Brainard said Wednesday.
Brainard, a former official in the Obama Treasury Department and a new member of the Fed, gave a mixed overview of the central bank’s ability to head off systemic crises in her first substantive speech Wednesday at the Brookings Institution.
The Fed, Brainard acknowledged, faces “limitations as a financial stability authority.” In particular, it lacks the ability to monitor markets and non-bank financial firms, areas where other regulators have primary responsibility.
In the face of those limits, Brainard said, Fed officials will place “strong emphasis on structural resilience” at the institutions they do have authority over, namely big banks.
The Fed can lean against overheating markets with some of the tools at its disposal, Brainard noted, including by clamping down on the proliferation of risky loans or requiring banks holding large amounts of dangerous assets — such as mortgage-backed securities during a housing bubble — to be better capitalized.
In certain circumstances, the Fed could raise interest rates to prick an inflating financial bubble, Brainard said. She said that using monetary policy for regulatory purposes should be considered a “second line of defense,” noting that it is a “relatively blunt” tool.
Whether and how much the Fed should use interest rate increases to prevent financial markets from raging out of control have been running controversies among Fed officials. For her part, Chairwoman Janet Yellen has said monetary policy could be used for cooling off markets, but only in extreme circumstances.
The 2010 Dodd-Frank financial reform law gave the Fed new and broader powers to regulate banks and the larger financial system. It also created the Financial Stability Oversight Council, a super-group of major regulators that is meant to identify threats from all sectors of the financial system, and which has the authority to regulate non-bank firms as if they were banks.
But Brainard indicated in her speech and in responses to questions afterward that she is still concerned whether those provisions have done enough to ensure that the Fed has the information and authority needed to curb risks.
“It’s too early to say – to make a judgment about the adequacy of that toolkit,” she said.
Asked whether the Fed’s added powers would be enough to prevent another crisis like the one that struck in 2008, Brainard responded that “that’s question I don’t feel has a very clear answer, but there is no question that our system would have been vastly more resilient.” There was “no question” that the system would have been in “a better place” if banks had the capital levels and oversight from the Fed they have now, she also said.
She also added that it is difficult to use the tools they do have.
“We are humble about the state of the art about how you identify the extent of a boom,” she said during questioning.
“There have been many episodes where authorities have been reluctant to take action until too late,” she noted.
