Setting limits

Tuesday, July 27, 2010

Some suggested measures to control systemic risk by limiting credit and asset bubbles:

Force homeowners and investors to make larger down payments on property.

Pro: Protects banks by ensuring that mortgage holders have more equity, and cools property markets by slowing demand.

Con: Prevents some creditworthy buyers from obtaining loans if they cannot save enough for the down payment.

Force banks to set aside more capital during good times.

Pro: Keeps institutions from lending too freely when property markets are overheating, and builds up capital reserves to help banks through downturns.

Con: Like any "counterycyclical" policy, risks limiting otherwise healthy economic growth.

Raise interest rates.

Pro: Slows lending and borrowing by increasing the cost.

Con: Traditionally, central banks have used interest-rate policy to regulate the overall economy. Using it to focus on problems in specific sectors, such as real estate, might undercut those other aims.

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