by Calculated Risk on 11/04/2005 01:23:00 AM

From the New York Times article: To Fight Rising Prices, Fed Nominee May Need New Weapons

Mr. Bernanke ... has also asserted, like Mr. Greenspan, that he does not intend to use interest rates prematurely to puncture an asset bubble. But he has signaled a readiness to use a different set of tools to fight the new inflation, and in this he departs from Mr. Greenspan.

What lifts asset prices, Mr. Bernanke and others argue, is the willingness of lenders to offer riskier types of loans, which "juice up the housing market and are not very responsive to interest rates," as Mark Zandi, chief economist at the research firm Economy.com, put it.

Lenders can engage in riskier loans because they have developed techniques in recent years that make it far easier for them to shed their vulnerability to risk, doing so mainly by shifting the risk of default to others. The lenders operate in sophisticated markets that allow thousands of individual investors to purchase a slice of the original loan, and a slice of the risk.

In the past, the danger of default as rates rose tended to discourage lenders from making overly risky loans. The lender, often a bank, kept the loan and bore all the risk. Mr. Bernanke, in response to the risk shifting, has raised the possibility of limiting the dangers through the use of regulations - microregulatory policy, he calls it.

"There are two ways to approach bubbles: one is interest rate policy, the other is microregulatory policy," he said in a little noted interview published last year by the Federal Reserve Bank of Minneapolis. "Microregulatory policy is the much better approach, in my view," Mr. Bernanke said.

Pursuing his point, he added: "Research on historical episodes suggests that large asset price increases are sometimes preceded by credit booms. In many cases, this pattern results from the fact that the country in question deregulated its banking system, giving banks extra powers, but did not enhance the supervisory structure adequately at the same time."

I believe tighter lending requirements would have minimized the housing bubble. Of course its too late this time.