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Overheating in Credit Markets

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Overheating in Credit Markets

Origins, Measurement, and Policy Responses

Federal Reserve Board,

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How can regulators ensure that credit markets don’t boil over?

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Jeremy C. Stein, a member of the US Federal Reserve Board of Governors, discusses the warning signs of overheating in credit markets. Readers will see why The New York Times calls him the Fed’s “bubble cop.” Stein advocates policies that safeguard the integrity of credit markets but acknowledges that the Fed’s corrective action tools are not infallible. getAbstract recommends his incisive analysis to academics, policy makers and financial services professionals who seek insight on how to identify and handle credit market booms.

Summary

What causes bubbles in certain credit instruments? Two alternate, but not mutually exclusive, views explain such overheating: The first, a “primitive preferences and beliefs view,” says investors’ often irrational perceptions play a large role. For example, consider how investor optimism inflated the 1990s dot-com bubble. The second, an “institutions, agency and incentives view,” argues that financial agents within banks, funds and insurance companies affect credit decisions, exploit regulatory weaknesses and find loopholes to boost their profits. According to this view, three elements drive credit-markets overheating...

About the Author

Prior to his 2012 appointment to the Fed’s Board of Governors, Jeremy C. Stein was an economics professor at Harvard and a senior adviser to the Obama administration.

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