With the economy four years beyond the most intense part of the financial crisis, traces of its aftermath remain.
As a result, the Federal Reserve has made efforts by greatly increasing the resources devoted to monitoring the financial markets as well as taking a more systematic and intensive approach, said Ben Bernanke, chairman of the Federal Reserve, on Friday at the Federal Reserve Bank of Chicago Conference.
Thus, the central bank’s financial stability monitoring extends to the nonfinancial sector, specifically housing.
“The Federal Reserve also now monitors detailed consumer- and business-level data suited for picking up changes in the nature of borrowing and lending, as well as for tracking financial conditions of those most exposed to a cyclical downturn or a reversal of fortunes,” Bernanke explained.
For instance, during the housing boom, the data revealed the outsized pace of home mortgage borrowing, but it could not reveal the pervasive deterioration in underwriting that implied a substantial increase in the underlying credit risk from the activity.
More recently, gains in household net worth have been concentrated among wealthier households, while many homeowners in the middle or lower parts of the distribution have experienced declines in wealth since the crisis.
“Moreover, many homeowners remain ‘underwater,’ with their homes worth less than the principal balances on their mortgages,” Bernanke said.
He added, “Thus, more detailed information clarifies that many households remain more financially fragile than might be inferred from the aggregate statistics alone.”
The vulnerabilities of the nonfinancial sector can potentially be captured by both stock measures, such as wealth and leverage, and flow measures, such as the ratio of debt service to income.
Nonetheless, the Fed chairman admitted during the conference that it’s difficult to identify when asset bubbles, including housing, are forming.
However, Bernanke reassured attendees that the Federal Reserve are moving toward a more systemic approach that pays close attention to such liabilities of the financial system as a whole.
“I think importantly, we’re not relying on our ability to identify such things as our first line of defense, but identifying the differences between triggers and vulnerabilities,” Bernanke said.
Overall, the goal is to make sure that the system remains robust and if there is a problem it can be identified before the issue becomes amplified into a systematic financial crisis.
“Our stepped-up monitoring and analysis is already providing important information for the Board and the Federal Open Market Committee as well as for the broader regulatory community. We will continue to work toward improving our ability to detect and address vulnerabilities in our financial system,” Bernanke concluded.
