An early warning system to detect financial problems before they reach crisis proportions must allow policymakers to better pinpoint areas of excessive risk-taking, according to a new Federal Reserve paper released Monday.
More up-to-date statistics — both at the level of individual companies and products as well as the big-picture, industrywide information — are needed, the staff paper said.
Policymakers' analysis of the information should focus on the "recurring underlying themes associated with financial instability" such as the competitive climate among companies that can lead to excessive risk-taking, the paper said.
Fed Vice Chairman Donald Kohn and two staffers wrote the paper to be presented at a statistics conference this week in Frankfurt, Germany.
A persistent challenge for the Fed and for other regulators will be spotting risky products and practices that could put the entire financial system and the broader economy in danger. Lawmakers in Congress overhauling the nation's regulatory structure would have the Fed and other regulators work together on this front.
The Fed has been blamed by lawmakers and others for failing to spot problems — namely the explosion of exotic mortgages and mortgage securities along with lax lending standards — that led to the worst financial crisis since the 1930s.
Both economic and financial conditions have improved since the depths of the crisis in 2008. Now policymakers are trying to learn from their mistakes as they consider ways to better safeguard against future crises.
Flexibility is crucial, the paper said.
"A key challenge, of course, is that the appropriate tools cannot generally be specified ahead of time but must be designed in response to the particular signals teased" from the data, the paper said.
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