We will have to be careful not to leave monetary accommodation in place longer than it's needed to put upward pressure on inflation, or to conceivably touch off a bubble in some other area of the economy

From press Q&A as reported by Market News International

To a great extent, the bubble in housing was a classic case of the bigger-fool theory and efficient-market theory run amok.

Asked whether she was concerned that the Fed would be keeping rates too low, too long. she said it's "something we really have to consider going forward. With the benefit of hindsight maybe we did contribute" to the housing bubble by keep rates too low."

From Q&A, as reported by Market News International

The financial crisis, I think, is the unwinding of what was an excessive credit boom in the years up through middle of last year.  For a variety of reasons global interest rates were quite low, and that generated strong efforts to reach for yield, as it was said, and so there was a lot of risk taking. There was a lot of financial innovation. And the result I think was some unsustainable investment, some unsustainable asset creation.

We've seen the unwinding of that. That is in some ways positive. But on the other hand, the contraction of credit and the restriction of financing that we've seen associated with that has slowed the economy and has had adverse effects on families, as you indicate.    We are trying to find a financial stability. The Fed is working as best we can to stabilize the economy and to stabilize the financial system.

From the Q&A session

[It is a] very difficult policy to intervene in the workings of markets at a particular chosen time.

It's difficult to identify, it's difficult to choose timing, difficult to be sure that market forces themselves will not have what
turns out at the end to be a positive effect.

From audience Q&A, as reported by Market News International, saying he's not "comfortable" with the Fed pre-emptively targeting asset bubbles.

While I have not yet changed my opinion that asset-price levels should not be an objective of monetary policy, I am reviewing this conclusion in the wake of the fallout from the decline in house prices and from the earlier collapse of prices of technology stocks. To be sure, it is challenging at best to identify when asset prices have reached excessive levels, to build support for action once identification has occurred, and to implement corrective policy successfully. These are all significant obstacles, and thus it may well be that containing damage as and after prices correct is, in the end, the preferable alternative.

However, I think it is important to consider these conclusions in light of recent events, where it has proven to be neither easy nor costless to deal with the aftermath of unsustainably high asset prices.

Those who argue that you can incrementally increase interest rates to defuse bubbles ought to try it some time. I don't know of a single example of when interest rate policy has been successful in suppressing gains in asset prices.

We will never be able to anticipate all discontinuities in financial markets. Discontinuities are, of necessity, a surprise. Anticipated events are arbitraged away. But if, as I strongly suspect, periods of euphoria are very difficult to suppress as they build, they will not collapse until the speculative fever breaks on its own. Paradoxically, to the extent risk management succeeds in identifying such episodes, it can prolong and enlarge the period of euphoria. But risk management can never reach perfection. It will eventually fail and a disturbing reality will be laid bare, prompting an unexpected and sharp discontinuous response.

In the current crisis, as in past crises, we can learn much, and policy in the future will be informed by these lessons. But we cannot hope to anticipate the specifics of future crises with any degree of confidence. Thus it is important, indeed crucial, that any reforms in, and adjustments to, the structure of markets and regulation not inhibit our most reliable and effective safeguards against cumulative economic failure: market flexibility and open competition.

In other words, it is good to have a few people within the institution who--to paraphrase a former Federal Reserve Chairman--know when to take away the punch bowl. Being the party pooper, however, can be very difficult in any organization, and that is why it is crucial for the risk manager to be known as an independent voice who is influential with top management and for top executives, of large or small firms, to set the appropriate "tone at the top" with respect to the importance of independent and unbiased risk evaluation

[T]here is a risk that an extended period of low interest rates may distort long-run investment decisions; lead to a search for yield that results in excessive risk-taking; and contribute to the development of asset price bubbles.

In my view, these limitations are significant, and they lead me to believe that we should look to fiscal policy to play a more important role in responding to the spillover from a financial crisis. In contrast to monetary policy, fiscal policy can work effectively even when the financial system is impaired, and its effects are felt more broadly across the economy. My own view is that monetary policy may be a good first line of defense, but should not be relied upon too heavily for too long. Of course, we would have to rely less on monetary policy to respond to financial crises if we could, instead, take measures that would reduce the likelihood or severity of financial crises.

In any event, my view is that we should regard recent events in the mortgage market as reflecting the normal process of innovation. The lessons have been expensive and painful, and the pain is not yet over. As with the dot-com bust, where many firms went bankrupt but some sound business models survived, we should expect that successful innovations behind the subprime market will also survive. In time, I believe, we will find that the subprime sector of the mortgage market will be as normal as any other part of the mortgage market.

The proliferation of credit risk transfer instruments was driven in part by an assumption of frictionless, uninterrupted liquidity. This left credit and funding markets more vulnerable when liquidity receded. Banks and other financial institutions lent substantial amounts of money on the assumption that they would be able to distribute that risk easily into liquid markets. A sizable fraction of long-term assets—assets with exposure to different forms of credit risk—ended up in vehicles financed with very short-term liabilities and was placed with investors and funds that were also exposed to liquidity risk.

The unwinding of this global financial boom has caused a substantial degree of stress to the financial system. Was this preventable? I don’t believe that asset price and credit booms are preventable. They cannot be effectively diffused preemptively. There is no reliable early warning system for financial shocks.

The literature on asset bubble pricking is related to this discussion of excess risk-taking: Should a policymaker deflate a bubble before it becomes problematic? I am skeptical that we can identify bubbles with enough accuracy and know enough about how to act to say that we wouldn't have more failures than successes. ... [A]s former Chairman Greenspan [2004] noted, in order to make sure you burst a bubble, you have to attack it aggressively, because if your attack fails, it just gets bigger. And there are big risks to the real economy of making such large moves.

If we want to slow the stock market in terms of technology stocks, or slow the housing industry, we don't have tools for doing that. We have tools, a blunt instrument, that impacts economic activity six to eight months out and impacts inflation 18 months to two years out, so targeting it to a specific industry is just very complicated.

From audience Q&A as reported by Market News International