adminWashington. – Federal Reserve Chair Janet Yellen said concerns about financial stability shouldn’t prompt a change in current monetary policy while flagging “pockets of increased risk-taking” in the financial system.
Yellen delivered a comprehensive salvo in the global debate among central bankers over whether interest rates should be a first-order tool to curb financial excess, saying supervision should be “the main line of defence” against turmoil.
“Monetary policy faces significant limitations as a tool to promote financial stability,” Yellen said yesterday at the International Monetary Fund in Washington. “Its effects on financial vulnerabilities, such as excessive leverage and maturity transformation, are not well understood and are less direct than a regulatory or supervisory approach.”
Yellen said the “primary role” should fall to a macroprudential approach, a combination of multiagency oversight, attention to bank capital and liquidity, and regulatory pressure to create buffers against failure.
“She’s reflecting and also moving toward the leading edge of what’s going on in central bank management of bubbles and the view of bubbles,” said Diane Swonk, chief economist at Mesirow Financial Inc. in Chicago.
Economists said Yellen’s comments seemed to lean against the view of former Fed Governor Jeremy Stein, who left the central bank in May to return to Harvard University.
Stein in a 2013 speech favoured keeping “an open mind” on using monetary policy to control asset-price bubbles. Shifting interest rates “gets in all of the cracks” of the financial system while the Fed’s regulatory reach only extends to banks, he said.
Yellen is “pushing back on what he said,” said Dana Saporta, a US economist at Credit Suisse Group AG in New York. “She clearly believes macroprudential policy should be the primary tool.”
US stocks were little changed, with the Standard & Poor’s 500 Index closing at 1,974.62 in New York. The yield on the benchmark 10-year Treasury note rose 0,06 percentage point to 2,62 percent. Yellen and her Fed colleagues are debating when to raise the benchmark lending rate for the first policy tightening since 2006. The long period of low interest rates may have increased risk in the financial system as investors seek higher returns.
“A powerful and pervasive search for yield has gathered pace,” the Basel, Switzerland-based Bank for International Settlements said in its annual report dated June 29. The Fed has kept the benchmark lending rate near zero since December 2008 and is buying longer-term Treasury debt and mortgage-backed securities, holding down yields on the safest debt. Policy rates in Japan, the euro area, and the UK are all below 1 percent.
In the US, bank regulators have tried to limit risk, issuing guidance on high-yield, high-risk leveraged loans in March 2013.
The directive, which is less stringent than a rule, was unusually prescriptive, saying that debt levels exceeding six times a measure of earnings “raises concerns for most industries”.
Still, US leveraged loans sold to institutional investors have topped $329 billion so far this year, the third biggest first half on record, following last year’s record $414 billion in the first six months.
About half were covenant-light, meaning they lack standard protections for lenders such as limits on debt relative to earnings, according to data compiled by Bloomberg.
Yellen said so far the Fed doesn’t see a “systemic threat” from the high-yield loan market since broad measures of credit growth don’t suggest excessive debt, and improved capital and liquidity positions at banks “should ensure resilience” against losses.
Bank regulators overlooked the risk of securitisation prior to the previous crisis. One feature of the current leveraged-loan boom is that high-risk loans are bundled into structured financial instruments and distributed around the world.
“What is the contagion risk, and how do banks spread it is a critical question,” said Karen Shaw Petrou, managing partner at Federal Financial Analytics in Washington.
When we draw regulatory boundaries and supervise inside them “there is the prospect that activities will move outside those boundaries and we won’t be able to detect them, and if we can we won’t have adequate regulatory tools,” Yellen said in a question and answer period with IMF Managing Director Christine Lagarde. – Bloomberg.
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