WASHINGTON — Janet Yellen, the president's pick to be the second-highest ranking official at the Federal Reserve, acknowledged Thursday that regulators were slow to crack down on risky banking practices that stoked the 2008 financial crisis.
Testifying before the Senate Banking Commitee, Yellen, president of the Federal Reserve Bank of San Franciso, whose region was at the heart of the housing boom, described banking oversight at that time as "insufficient" and "weak."
Beefing it up is a key focus for the central bank, she said. A lesson learned, she said, was how hard it was "for all the regulators involved to take away the punchbowl in a timely way."
The Fed and other regulators, Yellen said, "failed to connect the dots" in understanding how the bursting of the housing bubble would hurt the financial system and the entire economy.
Sarah Raskin, a Harvard-educated lawyer who is the Maryland commissioner of financial regulation and is a nominee for a position on the Fed board, agreed.
Raskin suggested that the Fed didn't pay sufficient attention to a booming housing market that eventually went bust, taking the economy down with it. "I think the extent of the housing bubble was not appropriately monitored or taken seriously," she said.
Going forward, she suggested the Fed needs to pay more attention to curbing such speculative excesses.
President Barack Obama's nominations of Yellen, Raskin and Peter Diamond, an economist at the Massachusetts Institute of Technology, come at a crucial time for the economy.
The Fed is trying to steer the fragile economy into a lasting recovery. The nation has suffered the worst recession since the Great Depression, and the economy is vulnerable to shocks.
At the same time, the Fed will play a leading role in implementing Congress' overhaul of financial regulations, which is moving closer to becoming law.
As vice chairwoman, Yellen's duties would include helping build support for policy positions staked out by Fed Chairman Ben Bernanke, who began a second term in February.
"Over the next few years, the Fed must craft policies that ensure that our economy accelerates its progress along the recovery path it has begun to trace," Yellen testified. "With unemployment still painfully high, job creation must be a high priority of monetary policy," she said.
The unemployment rate is 9.5 percent. The Fed has said it will take five or six years to bring the economy and the employment closer to normal health.
If Congress takes steps for further economic aid, Yellen said it should be coupled with credible measures to whittle down the government's record high budget deficits over the long term. The fiscal situation, she said, is "unsustainable."
Yellen is considered a dove on monetary policy. That means she would be expected to be concerned more about high unemployment than about rising inflation.
Still, she told lawmakers that once the recovery is fully entrenched, the Fed must be prepared to start boosting record low interest rates "in a careful and deliberate fashion" to avoid any inflation threats.
And, Yellen said the Fed must do its best to avoid another financial crisis like the devastating one in 2008. "We have learned a harsh lesson about teh dire consequences a financial crisis has for ordinary Americans in the form of lost jobs, lost homes, lost wealth and lost businesses," she said. "Those of us charged with overseeing the financial system should always keep this human cost in mind," she added
Lawmakers in Congress and others have blamed the Fed for lax regulation, failures to crack down on dubious lending practices and missing signs of risks, which all factored into the crisis.
Sen. Richard Shelby, the highest-ranking Republican on the committee, who's been critical of the Fed's role in bailing out Wall Street firms, sought assurances that the three Fed nominees will work to make the Fed more open – and accountable – to both the public and Congress. "Many believe the Fed's relationship with Congress needs some mending"
The three Fed nominations allow Obama to put a bigger stamp on the central bank.
All three nominations are subject to Senate approval. If the Senate confirms all three nominees to the Fed, Obama will have appointed five of the seven members of the Federal Reserve Board in Washington.
Diamond told lawmakers a central theme of his research has been how the economy deals with risk. If confirmed, Diamond said this background would be helpful as the Fed develops ways to avoid another financial crisis.
Yellen has a long history with the Fed. She has been president of the San Francisco Fed since 2004, and she was a member of the Fed's Board of Governors from 1994 to 1997. She'll replace vice chair Donald Kohn, who plans to step down in September.
Diamond is an authority on Social Security, pensions and taxation. Raskin, who served as counsel to the Senate Banking Committee, would expand the Fed's expertise over financial regulation. That would include consumer issues, which are important to Obama and Congress as the Fed moves to implement the revamp of the nation's financial regulations.
"Even though the worst of the crisis is over, it remains a precarious time for far too many of our families and businesses," Raskin said. "The Fed must do its part to restore the underlying strength and vibrancy of the American economy."