Interpreting statements of Federal Reserve Chairmen has long been considered a high art form. During Alan Greenspan’s time, journalists and financial analysts made huge efforts to understand his cryptic comments on the economy, with the result that a few sentences could spawn literally pages of analysis designed to “explain” the possible contents of Greenspan’s comments. Most of that analysis was incorrect.

Now, journalists and especially headline writers are attempting to apply the same techniques to Ben Bernanke’s comments. The most widely quoted sentence contained in a scholarly paper he delivered on January 3 before the American Economic Association (AEA) was: “Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates.”

The sentence was promptly interpreted by the New York Times under the headline “Lax Oversight Caused Crisis, Bernanke Says”, while the Washington Post’s headline for the entire talk was “Fed chief Bernanke urges better financial regulation to prevent crises.” Meanwhile, Bloomberg said that “Bernanke Says Regulation Came ‘Too Late’ to Curb Housing Bubble” and the Financial Times claimed “Fed chief calls for tougher regulation.”

The press’ attention was certainly warranted since there is a pressing need to modernize financial regulatory agencies so that they better reflect the realities of today’s financial markets. The existing system is mainly a relic of the 1930’s and divides agency responsibilities by product distinctions that vanished long ago. It contains too many confusing regulations and too many confused regulators. Realigning and combining regulatory agencies along with eliminating scores of obsolete and burdensome regulations is long overdue.

The press’ attention was further warranted by a congressional debate that unfortunately has focused on creating still more regulatory agencies and piling new restrictions on top of existing ones under the seeming theory that shear quantity is a good substitute for quality. However, this was not really the subject upon which Bernanke spoke.

What Bernanke Actually Said

The Fed Chairman did not deliver a routine policy speech before the AEA, but a scholarly paper responding to charges by certain academics that the Federal Reserve’s monetary policy decisions were a major cause of the recession. Thus, while certain sentences can be quoted as though they deal with legislation before congress, they should actually be read as part of a paper on monetary policy and whether the Fed’s decisions in that area caused the housing bubble.

The full paragraph where the quoted sentence appears makes this clear:

What policy implications should we draw? I noted earlier that the most important source of lower initial monthly payments, which allowed more people to enter the housing market and bid for properties, was not the general level of short-term interest rates, but the increasing use of more exotic types of mortgages and the associated decline of underwriting standards. That conclusion suggests that the best response to the housing bubble would have been regulatory, not monetary. Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates. Moreover, regulators, supervisors, and the private sector could have more effectively addressed building risk concentrations and inadequate risk-management practices without necessarily having had to make a judgment about the sustainability of house price increases. [Emphasis added.]

In short, this is a discussion about whether monetary policy changes would have prevented the housing bubble, and not about what congress should do about it going forward.

Similarly, when Bernanke said that: “The lesson I take from this experience is not that financial regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter,” he is not necessarily calling for MORE regulation as more effective regulation, a position that conservatives can happily endorse. In fact, just about everyone agrees that current regulatory policies must be improved.

Finally, when the Fed Chairman said that “[a]ll efforts should be made to strengthen our regulatory system to prevent a recurrence of the crisis, and to cushion the effects if another crisis occurs,” he says so in the context of noting that otherwise, the Fed will be forced instead to try to use monetary policy to deal with the next bubble.

In past statements to Congress, Bernanke has endorsed certain elements of the financial regulatory bill, legislation with serious flaws, but his recent lecture to the AEA was not one of those occasions. It was a scholarly talk designed for a technical audience that just happened to fall on a slow news day.