Bernanke defends Fed record

NEW YORK (CNNMoney.com) -- Federal Reserve chairman Ben Bernanke said Sunday that low interest rates in the first half of the last decade were "appropriate" at the time and were not the main cause of the ensuing housing bubble.

Speaking in Atlanta to the American Economic Association, the Fed chairman was addressing a key criticism of Fed policy: That it kept rates too low for too long from 2002 to 2006, encouraging a speculative frenzy that drove home prices to unsustainable levels.

The subsequent crash in home prices led to a surge in foreclosures, billions of dollars in losses for banks, and what Bernanke called the worst financial crisis in modern history.

"Monetary policy during that period -- though certainly accommodative -- does not appear to have been inappropriate, given the state of the economy and policymakers' medium-term objectives," the Fed chairman said in prepared remarks.

Bernanke was sworn in as Fed chairman in February 2006, following the long reign of Alan Greenspan.

More than low interest rates, Bernanke said that the increase in home prices was the result of mortgages that artificially reduced monthly payments and a reduction in lending standards. That brought buyers into the market that could afford their homes only if home prices continued to rise, enabling them to refinance.

When the home-price trend reversed, homeowners were caught with unaffordable mortgages and forced to default.

As such, Bernanke said the more effective way to have averted the problem was through smarter regulation.

"That conclusion suggests that the best response to the housing bubble would have been regulatory, not monetary," Bernanke said.

Interest rate policy: The Fed uses its ability to set short-term interest rates to support economic growth. Following the dot-com stock crash of 2000 and the Sept. 11 terrorist attacks, the Fed cut rates aggressively, from 6.5% in late 2000 to 1% in June 2003.

A year later, the Fed began raising rates, ultimately reaching 5.25% in June 2006. In response to the latest crisis, the Fed has cut rates to effectively zero.

Keeping rates too low can raise the risk of inflation, however.

In its most recent policy statement in December, the Fed signaled that economic weakness and the low risk of inflation is likely to "warrant exceptionally low levels of the federal funds rate for an extended period."

Popping asset bubbles: In the Sunday speech, Bernanke addressed a long-running debate about the Fed's ability to address asset bubbles.

In the moment, it is difficult to know whether a speculative bubble exists or whether price rises are justified, Bernanke said. Further, interest rates are a "blunt" tool for popping bubbles, with the risk of creating collateral damage elsewhere in the economy.

"Monetary policy is also a blunt tool, and interest rate increases in 2003 or 2004 sufficient to constrain the bubble could have seriously weakened the economy at just the time when the recovery from the previous recession was becoming established," Bernanke said Sunday.

Some say last year's surge in asset prices -- U.S. stocks and assets in emerging markets -- is a sign that Fed policy is inflating yet another bubble.

Regulation: Bernanke noted that the Fed did make attempts at tighter regulation of nontraditional mortgages, going back to 2005. He acknowledged, however, that the efforts fell short.

"These efforts came too late or were insufficient to stop the decline in underwriting standards and effectively constrain the housing bubble," Bernanke said.

Bernanke's remarks come as the Senate considers his nomination by President Obama for another term as Fed chairman. The Senate Banking Committee last month voted 16-7 in his favor. Bernanke's current term ends on Jan. 31.

While his nomination remains contentious, Bernanke is expected to win confirmation on the Senate floor.

Meanwhile, a months-long push in Congress to rewrite financial regulation is likely to come to a head in the coming weeks or months. The House in December passed a sweeping package that would increase oversight of big firms and complex financial products and create a new agency dedicated to watching out for consumers seeking mortgages and credit cards.

On the other side of the Capitol, key senators from both parties are negotiating their own version of regulatory reform. Both bills include controversial provisions that aim at the Fed: The House bill would allow Congress to order audits of the central bank's actions, while the Senate bill would strip the Fed of much of its authority to supervise banks.