So, you're not going to identify every possible {bubble} for sure, but you can - you can do your best and you can try to make sure the system is strong. And when you identify problems you can use - I think the first line of defense needs to be regulatory and supervisory authorities …

The Federal Reserve was created about 100 years ago now in 1913. It was the - it was the law. Not a new monetary policy, but rather to address financial panics. And that's what we did in 2008 and 2009. And it's a difficult task. But I think going forward the Fed needs to think about financial stability and monetary economic stability as being in some sense the two key pillars of what the central bank tries to do. And so we will obviously be working very hard on our financial stability. We'll be using our regulatory supervisory powers. We'll be trying to strengthen the financial system. And if necessary, we'll adjust monetary policy as well. But I don't think that's the first line of defense.

A long period of unusually low interest rates is changing investors’ behavior and is reshaping the products and the asset mix of financial institutions. Investors of all profiles are driven to reach for yield, which can create financial distortions if risk is masked or imperfectly measured, and can encourage risks to concentrate in unexpected corners of the economy and financial system. Companies and financial institutions, such as insurance companies and pension funds, and individual savers who traditionally invest in long-term safe assets, are facing challenges earning reasonable returns, and so they may reach for yield by taking on more risk and reallocating resources to earn higher returns. The push toward increased risk-taking is the intention of such policy, but the longer-term consequences are not well understood.

Of course, identifying financial imbalances, asset bubbles or looming crises is inherently difficult, as policymakers were painfully reminded during the financial crisis in 2008. Public transcripts of the FOMC’s discussions from as early as 2006 show participants were clearly focused on issues in the housing market and yet did not fully appreciate the risk to the economy from the financial sector’s exposure to risky mortgages.

Accordingly, I approach policy decisions with a healthy dose of humility when considering the long-run effects of monetary policy. We must not ignore the possibility that the low-interest rate policy may be creating incentives that lead to future financial imbalances. Prices of assets such as bonds, agricultural land, and high-yield and leveraged loans are at historically high levels. A sharp correction in asset prices could be destabilizing and cause employment to swing away from its full-employment level and inflation to decline to uncomfortably low levels.

Simply stated, financial stability is an essential component in achieving our longer-run goals for employment and stable growth in the economy and warrants our most serious attention.

“Financial stability should not be an explicit objective of monetary policy...”

“Price stability should be the number one objective of the central bank, and our record” over the central bank’s century of existence “has not been stellar,” Mr. Plosser said.

Instead, the Fed should deal with markets on a separate track, and promote a stable financial system by using “its regulatory and supervisory power,” the official said.

As reported by the Wall Street Journal

But these calculations may underestimate the true magnitude of the problem. A funding ratio of 75 percent equates to an assumption of an 8 percent average annual return on the portfolio of investments. It's fair to ask whether this is a realistic assumption given current forecasts of the economic and financial environment. Arguably not.

Using this optimistic 8 percent return assumption, public state and municipal pension funds have an $800 billion funding gap to fill. Using a lower, more realistic return assumption (such as the longer-term rate on U.S. Treasuries) implies a $3 trillion to $4 trillion funding gap. You might call this "the other debt problem" in the United States.

A real financial stability concern, however, is the potential for malicious disruptions to the payments system in the form of broadly targeted cyberattacks. Just in the last few months, the United States has experienced an escalating incidence of distributed denial of service attacks aimed at our largest banks. The attacks came simultaneously or in rapid succession. They appear to have been executed by sophisticated, well-organized hacking groups who flood bank web servers with junk data, allowing the hackers to target certain web applications and disrupt online services. Nearly all the perpetrators are external to the targeted organizations, and they appear to be operating from all over the globe. Their motives are not always clear. Some are in it for money, while others are in it for what you might call ideological or political reasons.

 At the risk of some oversimplification, one can classify most uses of the financial stability concept in Dodd-Frank into four categories: (1) as a goal for a new regulatory authority, (2) as an instruction for ongoing analysis and monitoring, (3) as a direct legal standard, and (4) as a factor for consideration in decisions on applications for various proposed actions subject to regulatory approval.

“You can reach a size where risk management becomes an exercise,” Fisher said today in response to audience questions following a speech to the Texas Bankers Association meeting in Fort Worth. “At what point do you reach a size you don’t know what is going on beneath you?”

“That is not the American form of capitalism,” Fisher said. “We are calling for significant downsizing of those institutions. We don’t feel the Dodd-Frank Act is the answer to the problem.”

“We pray for the big risk management teams in those big New York banks,” the Dallas Fed chief said.

In prepared remarks, Evans said the financial crisis revealed weaknesses "in our increasingly interconnected, global financial system."

Bullard, asked by the audience to respond to criticism of the Fed as too intrusive in financial markets, said, “I want market solutions to all of our problems.”

“You can’t outmarket me,” he said.

Going forward, for the Federal Reserve as well as other central banks, the promotion of financial stability must be on equal footing with the management of monetary policy as the most critical policy priorities.

The bottom line, in my view, is that the status quo is not acceptable. As I have shown today, a number of money market funds took significant credit risk that ultimately led to them needing sponsor support in the period from 2007 to 2010...

Funds need to be structured so that neither sponsor support nor government support is likely or necessary, even during times of stress.

“The most critical issue in addressing TBTF concerns is having policy makers with the resolve to follow through,” George said a speech today in New York. The U.S. must “correct the misaligned incentives and the improper expansion of federal safety net protections that encouraged and enabled institutions to take excessive risks.”

To achieve those goals, George said that regulators must not “view stress tests, other forms of quantitative analysis and models used by macroprudential supervisors as being a substitute or replacement for examiners and onsite supervision.”

An important feature of shadow banking is the historical and continuing involvement of commercial and clearing banks--that is, more "traditional" banking institutions. For example, commercial banks sponsored securitizations and ABCP conduits, arrangements which, until recently, permitted those banks to increase their leverage by keeping the underlying assets off their balance sheets. Clearing banks stand in the middle of triparty repo agreements, managing the exchange of cash and securities while providing protection and liquidity to both transacting parties…

Because of these and other connections, panics and other stresses in shadow banking can spill over into traditional banking. Indeed, the markets and institutions I mentioned--the repo market, the ABCP market, and money market funds--all suffered panics to some degree during the financial crisis. As a result, many traditional financial institutions lost important funding channels for their assets; in addition, for reputational and contractual reasons, many banks supported their affiliated funds and conduits, compounding their own mounting liquidity pressures.

I’ve heard Europe’s policy described as kicking the can down the road. But the risk is that Europe might be rolling an ever-growing snowball down a hill.

“When I think about risks to our economy, in terms of whether Europe goes into a recession, and some have said they may be there now, I worry more about things like financial contagion that could come across,” George said. “You see a lack of confidence. You see characteristics that we saw back in 2008.”