Fed: Research on bubbles needed

WASHINGTON — Fed policymakers must better understand speculative buying in financial markets to help prevent another financial crisis, Federal Reserve Chairman Ben Bernanke said Friday.

Frenzied buying fed a housing bubble that burst, plunging the economy into a recession in 2007, the worst downturn since the 1930s. While many lessons were learned from the crisis, Bernanke, in prepared remarks, said additional research is needed to explain when and why bubbles start.

That — along with a better understanding of how bursting bubbles affect consumers, businesses and investors — would help Fed policymakers as they seek to prevent another financial crisis from happening, he added.

Bernanke delivered his remarks to a conference at Princeton University, where he once taught economics. In his speech, Bernanke didn't talk about the state of the economy or about steps the Fed might take to boost the economy.

Earlier in the week, the Fed signaled that it was prepared to take action if the recovery weakens further. One likely next step would be for the Fed to relaunch a program to buy government debt on a large scale. Doing so, would be aimed at lowering rates on mortgages and other loans. The goal behind that is to entice Americans to spend more, which would shore up the economy.

The bulk of Bernanke's mostly academic remarks were about the lessons learned from the 2007-09 financial crisis.

A new law overhauling the nation's financial regulatory system should help prevent another similar debacle from occurring, Bernanke said. The Fed also has been taking steps to strengthen oversight of big financial companies.

Looking ahead, Bernanke not only called for more study into the formation of speculative bubbles, which can develop in assets like homes, stocks, bonds or commodities, but also called for more research into what makes people tick. That's a field called behavioral economics.

Bernanke spoke of the profound uncertainty during the crisis that prompted panicky selling by investors, sharp cuts in payrolls by employers and big savings buildups by households.

Before the crisis, economists had ideas about how they believed people would act when faced with uncertainty. But that was tested sorely by the crisis, Bernanke said.

"During the worst phase of the financial crisis, many economic actors — including investors, employers and consumers — metaphorically threw up their hands and admitted that, given the extreme, and in some ways, unprecedented nature of the crisis, they did not know what they did not know," Bernanke said.

And, economists need to do a better job of connecting the dots between financial developments and their impact on the economy, Bernanke said.

"The great majority of economists did not foresee the near-collapse of the financial system," he said.