Thus far, the quality of other consumer loans has remained satisfactory. However, the delinquency rates on credit cards and consumer installment loans at banking organizations increased over the second half of the year. Moreover, although household bankruptcy filings remained below the levels seen before the changes in bankruptcy law implemented in late 2005, the bankruptcy rate rose modestly over the first nine months of 2007 and could be a harbinger of increasing delinquency rates on other consumer loans. In view of this risk, Federal Reserve supervisors are monitoring these consumer loan segments for signs of spillover from residential mortgage problems, particularly in regions showing homeowner distress, and are paying particular attention to the securitization market for credit card loans.

We are very sensitive, both in the credit card rules and also in the mortgage rules, that these markets are important, we don't want to create a chilling effect, we don't want to shut down these markets; we just want them to work better.

 And in particular we think it's important for consumers to have a better understanding of what it is that they're buying when they purchase products in these markets.

My guess is that a great deal of the potential dislocation resulting from corrective reactions to the subprime boom will be resolved by regulatory initiatives rather than by monetary policy...

Any new regulations that might now be crafted to prevent future recurrences must be well thought out, for two reasons. First, financial institutions will quickly adapt to defeat any regulation that is poorly designed, morphing into new, vaccine-resistant strains. Second, heavy-handed regulations are sometimes worse than the disease against which they are meant to protect. I would be wary of any regulatory initiatives that interfere with market discipline and attempts to protect risk takers from the consequences of bad decisions for fear of creating a moral hazard that might endanger the long-term health of our economic and financial system simply to provide momentary relief.  

Clearly, banking supervision on its own can create some distortions or burden, so it is also very important to let market forces work as much as possible, with reliance on market participants--in their role as depositors, counterparties, creditors, and shareholders--to exercise discipline on banks.  Policymakers have to find the right balance between the more visible hand of government supervision and the invisible hand of market forces. 

I agree with you that legitimate subprime lending is beneficial. It gives people access to homeownership and access to credit, and so the real trick for us is to write rules, to write regulations that will screen out the abusive practices and the improper practices while preserving this market. And I think that's a very challenging task.

From Q&A session

The Federal Reserve will do all that it can to prevent fraud and abusive mortgage lending practices.  However, any new rules should be drawn clearly to avoid creating legal or regulatory uncertainty that could have the unintended consequence of restricting consumers' access to responsible subprime credit.  

[T]he actions of private parties to protect themselves--what Chairman Greenspan has called private regulation--are generally quite effective.

Fifth, how much weight should concerns about moral hazard be given when designing mechanisms for governmental regulation of markets? By way of example, we should note that were banks required by the market, or their regulator, to hold 40 percent capital against assets as they did after the Civil War, there would, of course, be far less moral hazard and far fewer instances of fire-sale market disruptions. At the same time, far fewer banks would be profitable, the degree of financial intermediation less, capital would be more costly, and the level of output and standards of living decidely lower. Our current economy, with its wide financial safety net, fiat money, and highly leveraged financial institutions, has been a conscious choice of the American people since the 1930s. We do not have the choice of accepting the benefits of the current system without its costs.