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Bernanke: financial innovation needs regulation

Federal Reserve Chairman Ben Bernanke

Federal Reserve Chairman Ben Bernanke

WASHINGTON – Federal Reserve Chairman Ben Bernanke said Friday that financial innovation is good for the economy but must be accompanied by proper regulation.

New financial products, such as subprime mortgages and structured investment vehicles, have become symbols of the economic crisis. The challenge for the government is to come up with regulations that protect consumers without stifling innovation, the Fed chief said.

“As we have seen all too clearly during the past two years, innovation that is inappropriately implemented can be positively harmful,” Bernanke said in a speech to a Fed conference. “It would be unwise to try to stop financial innovation, but we must be more alert to its risks and the need to manage those risks properly.”

The central bank already is moving in that direction with stronger regulations governing credit cards and home mortgage loans, he said, adding that regulators will be doing even more in the wake of the current crisis.

One area regulators need to watch closely is ensuring that complex financial products and services are explained in ways that consumers can understand.

Structured investment vehicles and securities tied to subprime mortgages are among the complex products that contributed to the financial crisis and credit crunch.

SIVs are funds that borrow money by issuing short-term securities at a low interest rate and then lend that money by purchasing long-term securities at higher interest. Investors can profit from the difference, but SIVs began to struggle as demand dried up for short-term bonds during the credit crisis. The value of SIV holdings fell sharply, forcing banks such as Citigroup Inc. that operated the off-balance sheet funds, to provide them with financial support.

High-interest, subprime mortgages made to borrowers with poor credit records exploded in popularity until the housing boom started to burst. The mortgages were packaged into securities snapped up by investors worldwide. Lenders stopped worrying about the creditworthiness of borrowers and offered them ever-riskier mortgages. Many were made by commission-driven mortgage brokers, who had nothing to lose if the loan went bad.

“The challenge faced by regulators is to strike the right balance: to strive for the highest standards of consumer protection without eliminating the beneficial effects of responsible innovation on consumer choice and access to credit,” Bernanke said.

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