Central bank also has concerns about money market funds
By Steve Goldstein, MarketWatch
WASHINGTON (MarketWatch) — Federal Reserve Chairman Ben Bernanke on Friday said the U.S. central bank is closely monitoring the risks from excessive risk-taking with interest rates so low.
In a speech devoted to the vulnerabilities in the financial system that the U.S. central bank is monitoring, Bernanke on Friday identified “reaching for yield” as well as the threat of a run in money-market funds and the possibility that short-term wholesale markets could dry up in a crisis.
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“In light of the current low interest-rate environment, we are watching particularly closely for instances of ‘reaching for yield’ and other forms of excessive risk-taking, which may affect asset prices and their relationships with fundamentals,” Bernanke said at a Chicago banking conference.
His comments come as stocks across the globe have hit multi-year peaks, but it’s more likely that the Fed is concerned with debt rather than stock markets.
So-called covenant-lite high-yield bonds and mortgage real-estate investment trusts are among the areas that some Fed policy makers have drawn attention to, including in a key speech in February by Fed Gov. Jeremy Stein.
By contrast, a New York Fed research piece released this week showed several models point to strong stock-market gains over the next five years.
In the speech Friday, Bernanke did not pick out which, if any, asset class concerns him.
But he did say that what concerns the Fed is the possibility of a sharp move as well as the leverage and degree of maturity mismatch being used by the holders of the asset, the liquidity of the asset, and the sensitivity of the asset’s value to changes in broad financial conditions. That’s why the stock-market drop in 2000 and 2001 didn’t have the systemic consequences that the collapse in house prices and mortgage credit had in the last recession — in the latter, losses were concentrated and through leverage amplified.
Bernanke again drew attention to money-market funds, noting the Treasury no longer has the legal authority to guarantee investors’ holdings in funds, as it did after the 2008 panic, when the Reserve Primary Fund “broke the buck”. This issue is largely in the hands of the Securities and Exchange Commission, though the Financial Stability Oversight Council, of which Bernanke is a member, has called for action in this area.
Bernanke also repeated concerns about short-term wholesale markets, which have the potential to dry up in another Lehman Brothers-like situation. While Bernanke did not draw the link in the speech, the potential for these markets to dry up is a reason regulators are concerned with mortgage REITs.
The central-bank boss said the legacy from the financial crisis of four years ago remains, with the economy still not regaining lost jobs and with the financial system struggling to deal with the economic, legal and reputational consequences. See charts on how tough it is to get a loan or a job.
Steve Goldstein is MarketWatch's Washington bureau chief. Follow him on Twitter @MKTWgoldstein.
