Put The Blame On Me

At least since the global financial crisis of 2008, Federal Reserve officials have, by and large, denied or downplayed the idea that their zero-interest-rate policies and mammoth bond purchases have artificially inflated financial assets even as the Fed is buying trillions – with a capital T – of U.S. Treasury and mortgage-backed securities markets and more recently corporate bonds. Now the presidents of a few of the Fed’s regional banks are suggesting that the Fed study whether its monetary policies are encouraging overly risky investor behavior.

Loretta Mester, the president of the Cleveland Fed, conceded that prolonged periods of low rates could incite “higher levels of borrowing and financial leverage, increased valuation pressures, and search-for-yield behavior.”

“While monetary policy that leads to a stable macroeconomy encourages financial stability, it is also possible that in an environment with low neutral rates, a persistently accommodative monetary policy could, in some cases, increase the vulnerabilities of the financial system,” she said.

Boston Fed President Eric Rosengren went even further, suggesting that the Fed “rethink” financial regulation – but apparently not monetary policy – to rein in speculative behavior.

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“If you want to follow a monetary policy . . . that applies low-interest rates for a long time, you want robust financial supervisory authority in order to be able to restrict the amount of excessive risk-taking occurring at the same time,” he told the Financial Times said. “[Otherwise] you’re much more likely to get into a situation where the interest rates can be low for long but be counterproductive.” The Fed, he said, currently lacks sufficient tools to “stop firms and households” from taking on “excessive leverage.”

If I read him correctly, he’s saying that investors need to be restrained from doing what the Fed is basically forcing them to do. By design, the Fed’s purchases of government bonds and MBS have driven yields so low that investors have had little alternative than to buy stocks and other riskier assets if they want to earn more than what government bonds are paying, which is next to nothing. Now Rosengren and his colleagues are suddenly worried that these “firms and households” are taking on “excessive leverage” and creating asset bubbles, and that the Fed may need to intervene.

Neel Kashkari, the president of the Minneapolis Fed, agreed with Rosengren, although he stopped short of calling for tougher regulation.

“I don’t know what the best policy solution is, but I know we can’t just keep doing what we’ve been doing,” Kashkari said. “As soon as there’s a risk that hits, everybody flees, and the Federal Reserve has to step in and bail out that market, and that’s crazy. And we need to take a hard look at that.”

But at least one other regional Fed president said there’s really not a whole lot the Fed can do in trying, on the one hand, to carry out zero-interest monetary policies and massive asset purchases, while on the other trying to prevent investors from taking the logical and self-interested steps in reaction to those policies, namely reaching for yield and buying more risky assets.

“We should always watch for excess risk-taking, we should always watch for excess leverage,” Mary Daly, the president of the San Francisco Fed, said. “But we shouldn’t regulate off the fear that could happen, and at the expense of so many millions of Americans who need the employment and the income and the access to the economy.”

In other words, the Fed really has no alternative but to do what it’s doing, so it can’t very well complain if some people need to take on risks that they might not normally take absent Fed policy – indeed, because of Fed policy.

Actually, the Fed and the other federal financial regulators should take some credit for tightening up and enforcing stricter capital requirements and taking other measures to better ensure the safety and soundness of the nation’s banks after the 2008 crisis, monetary policies that have prevented a similar debacle during the pandemic. While second-quarter earnings at the nation’s biggest banks were reduced by large provisions for expected loan losses, neither did they report negative income – not even close. The third quarter was even better, as most banks sharply reduced their loan loss provisions and earnings in some cases were better than the pre-pandemic period of 2019. They’re still making plenty of money.

So it’s a little hard to understand why we need more “robust financial supervisory authority” when we already have it, and the banks seem to be doing just fine, both from a safety and a profitability standpoint.

If the Fed is serious about wanting to curb “excessive leverage,” then it should roll back its asset purchases and start raising interest rates, which of course it won’t do. Asset inflation brought on by speculation is a genuine concern. But if Fed officials want to look for the cause, they should look in the mirror.

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George Yacik
INO.com Contributor - Fed & Interest Rates

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.