Federal Reserve Governor Jeremy Stein (Getty Images)"What factors lead to overheating episodes in credit markets?"

This was one of the opening lines of a speech given Thursday at the Federal Reserve Bank of St. Louis by Jeremy Stein, a Federal Reserve Governor brought on board just last year. And his talk may mark a sea change in how the Federal Reserve thinks about, approaches, and responds to asset bubbles.

Live and Let Pop

Not long ago, the Federal Reserve didn't feel it had any business trying to deflate asset bubbles -- those weapons of mass financial destruction that can wipe an economy out almost overnight, like America's real-estate bubble did in 2008. And this was the policy from America's central bank, one of the country's primary financial overseers.

In 2010, Fed Chairman Ben Bernanke himself told the Financial Crisis Inquiry Commission: "Monetary policy is a blunt tool. Raising the general level of interest rates to manage a single asset price would undoubtedly have had large side effects on other assets and sectors of the economy."

What that means in English is, even if the Fed spots, say, a housing bubble, it fears raising interest rates broadly (the only way to do it) because while raising interest rates would almost certainly deflate said bubble, it could also cool down other sectors of the economy that are humming along quite nicely in a safe, non-bubbly manner.

You Have to Start Somewhere

In his speech, Stein gave three factors he feels contribute to the overheating of credit markets, where asset booms are typically born:

1. Financial innovation, like the boom in complex investments such as derivatives and collateralized debt obligations that proved to be such ruinous contributors to the 2008 crash.

2. Changes in regulation, like we also saw in the lead-up to the crash, dating back decades, that allowed banks to take more and more risks until they were leveraged within inches of their financial lives.

3. Changes that alter "the risk-taking incentives of agents making credit decisions." Again, in English, this means if you pay, say, mortgage brokers to write subprime loans, they will do so without any regard for the eventual mayhem that might follow. Again, see the roaring 2000s.

All this still doesn't mean the Fed can or will step in to deflate or gently burst the next asset bubble (and there will be asset bubbles as long as there's capitalism). But you can tell that Stein gets it here. And for this potentially new direction in the Federal Reserve's thinking we can all be grateful. If nothing else, it's an encouraging start to a potentially less bubble-fraught future.

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42 Comments

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Pete Saeger

Great ! The Federal Gov't is fueling the next 2 bubbles to the extrme, excess money printing and excess debt.
When they burst it won't be pretty.

February 12 2013 at 8:09 AM Report abuse rate up rate down Reply
paulb4178

The common theme of these comments seems to be that some folks are petrified their license to steal might be limited.

February 11 2013 at 4:42 PM Report abuse +1 rate up rate down Reply
Beci

"All this still doesn't mean the Fed can or will step in to deflate or gently burst the next asset bubble ..."

Sure it does, if a government employee, appointee or entity CAN intervene, they WILL intervene.

Anything that a government can do to or with an economy ALWAYS acts as a brake.

February 11 2013 at 4:05 PM Report abuse rate up rate down Reply
setanta_1

will the esteemed twerps of aoL
be finished with their session of ""technicaL difficuLties"" ?
let's see.............

February 11 2013 at 2:57 PM Report abuse -3 rate up rate down Reply
1 reply to setanta_1's comment
setanta_1

holyhorse_sPit batman !
line's OPEN.

February 11 2013 at 2:58 PM Report abuse -2 rate up rate down Reply
Big John

Here is what he is really saying that caused the financial meltdown of 2008. Please notice I said 2008.
1. Financial innovation-Thinking of ways to make more and more profit regardless of the outcome on the country.
2. Changes in regulation-Getting a license to steal by the US Congress.
3. Risk taking-Paying people to take risk with no concern of the outcome except a handful get very rich even if it damages the economy and our country.
Now the big question is who wants less regulation and why?

February 11 2013 at 11:38 AM Report abuse +3 rate up rate down Reply
1 reply to Big John's comment
DANIEL

The problem with regulations is who regulates the regulators who regulate the regulators and so on. The powers who run this country just become part of the regulatory process and they don't care about Republicans and Democrats or Conservatives and Liberals. What they fear is an American Public that thinks for themselves. I don't think they have anything to fear.

February 11 2013 at 12:14 PM Report abuse +3 rate up rate down Reply
1 reply to DANIEL's comment
setanta_1

danny ? those in the know,lay low.
you think collectors or specuators are out and about buying ammO etc ?

February 11 2013 at 2:59 PM Report abuse -2 rate up rate down
DANIEL

It is called The Federal Reserve Bank, the last word is Bank! The Federal Reserve Bank is an independent agency that can raise or lower interest rates independently of Congress. When the Federal Reserve Bank does raise the interest rates (it could be today or five years from now) what will happen then? Do some home work.

February 11 2013 at 11:21 AM Report abuse rate up rate down Reply
britishsteel

http://www.youtube.com/watch?feature=player_embedded&v=5hfEBupAeo4

February 11 2013 at 10:46 AM Report abuse rate up rate down Reply
1 reply to britishsteel's comment
Yarns Unraveling

That link is priceless and speaks to the entire truth of the matter, ALL SHOULD SEE IT, all should take their funds over to credit unions as fast as possible to unfund large institutions from using their money to invest in wars/harmful policies....it makes sense at least for the middle class...who if move as a whole can topple the wants of the top.

February 11 2013 at 11:44 AM Report abuse rate up rate down Reply
hsenpfeffer

The bubbles are mostly based on fraud. Prosecute the frauds and end the bubble. The economy will not heal till thousands of banksters are doing hard time in the federal prison system.

February 11 2013 at 10:20 AM Report abuse +5 rate up rate down Reply
1 reply to hsenpfeffer's comment
jdykbpl45

Proscecute Bernake!

February 11 2013 at 2:47 PM Report abuse -1 rate up rate down Reply
1 reply to jdykbpl45's comment
setanta_1

no. AUDIT the bleeeeeeeeeedin feD and let the chips fall where they may.
LOL--be a lotta chips.

February 11 2013 at 3:00 PM Report abuse -1 rate up rate down
jhrooney

Rate will go up the day after Obama leaves office. He can't bear to say something is his fault.

February 11 2013 at 9:34 AM Report abuse -1 rate up rate down Reply
Sean

Are we ever going to raise the rates

February 11 2013 at 7:31 AM Report abuse +1 rate up rate down Reply