The late economist Hyman Minsky often summed up his theory of financial instability with the paradoxical phrase, “Stability creates instability.” Speaking on Thursday, Federal Reserve Chairman Ben Bernanke echoed that sentiment as he called for new initiatives for financial oversight and regulation on Thursday.
“Our supervisors are emphasizing to institutions that maintaining strong risk-management practices is at least as important in good times as in bad,” Bernanke said. “It is precisely during those good times, when risks appear low and the financial horizon seems clear, that financial market participants can become overly optimistic and make costly mistakes.”
The Fed Chairman was speaking via satellite at the Chicago Fed’s Conference on Bank Structure and Competition. He made no comments on the economic outlook, monetary policy, or inflation.
Bernanke said the Federal Reserve is learning from the ongoing crisis and constantly making efforts to increase the effectiveness of supervision, which he labeled “a top priority.”
Earlier this week, the Council on Foreign Relations recommended that there be financial oversight not only for individual institutions, but for the interactions between institutions.
Bernanke calls such an approach a “macroprudential orientation,” and he spoke to its potential benefits on Thursday.
“All systemically important financial firms--and not just those affiliated with a bank--should be subject to a robust framework for consolidated supervision,” Bernanke said.
The most recent example of such oversight is of course the Stress Tests for 19 major financial institutions, the results of which officially come out this afternoon. Bernanke said those tests look at two-thirds of all bank assets across the nation, and the experience has been fruitful in developing further policy.
“The exercise has been comprehensive, rigorous, forward-looking, and highly collaborative among the supervisory agencies,” he said. “Undoubtedly, we can use many aspects of the exercise to improve our supervisory processes in the future.”
Bernanke, who said the Fed’s role to act as a consolidated supervisor is spelled out in the provisions of the Gramm-Leach-Bliley Act in 1999, said increased oversight will help consumers in addition to the financial sector.
“As the past two years have brought home to everyone, the development of a more stable and sound financial system should be of the highest priority,” he concluded.