Senior Federal Reserve officials are calling for tighter financial regulation to prevent the US central bank’s low interest rate policies from leading to excessive risk-taking and asset bubbles in the markets.
The surge reflects concerns that the Fed’s ultra-loose monetary policy for struggling families and businesses risks becoming a double-edged sword, encouraging behavior detrimental to the economic recovery and creating pressure for further bailouts.
It also highlights the Fed’s fears that the financial system remains vulnerable to further shocks, despite massive central bank intervention this year to stabilize markets and the economy during the pandemic.
Eric Rosengren, chairman of the Federal Reserve Bank of Boston, told the Financial Times that the Fed lacks sufficient tools to “prevent businesses and households” from taking on “excessive debt” and called for “rethinking” the issues of “financial stability” in the United States.
“If you want to follow monetary policy. . . that charges low interest rates for a long time, you want a strong financial supervisor so that you can limit the level of excessive risk-taking that occurs at the same time, ”he said. “[Otherwise] you are much more likely to find yourself in a situation where interest rates can be low for a long time but be counterproductive. ”
Neel Kashkari, chairman of the Minneapolis Fed and US Treasury official during the global financial crisis, told the FT that stricter regulation was needed to avoid repeated central bank interventions in the market – like those of the last decade and again this year. .
“I don’t know what the best political solution is, but I know that we cannot continue doing what we have been doing,” he said. “As soon as there is a risk that hits, everyone flees and the Federal Reserve has to step in and bail out this market, and it’s crazy. And we have to think about it carefully. “
One of the fears of some Fed officials is that the US central bank may be forced to raise interest rates sooner than it would like if financial sector risks are out of control and dangerous bubbles of emerging assets.
Lael Brainard, a Fed governor, said in a speech last month that protracted low interest rate expectations were “conducive to increased risk appetite, yield behavior and incentives. the leverage effect ”, thus reinforcing the“ imbalances ”of the American financial system.
She said it was “vital to use macroprudential tools” – that is, rules designed to reduce risk – “as well as standard prudential tools as the first line of defense in order to allow policy monetary policy to remain focused on achieving maximum employment and an average of 2% inflation. “
Mr Kashkari, who called for higher capital requirements at big banks, said the financial system needed to be “fundamentally more resilient, both [in] the banking and non-banking sectors ”during a period of turbulence like the present one.
“For me, monetary policy is a very bad tool to deal with financial stability risks,” he said.
While no major regulatory changes are expected in the near term, the debate over tighter financial regulation could accelerate if Democrat Joe Biden wins the White House in November, making the political environment more conducive to action.
Michael Barr, the dean of public policy at the University of Michigan School of Business and a former US Treasury official under Barack Obama, said, “You want to make sure you’re using all the tools you have when it comes to financial stability, so you don’t put the Fed in a position to cut growth. “
So far, senior Fed officials including President Jay Powell and Randy Quarles, the vice president responsible for financial supervision, have indicated that they are comfortable with the central bank’s regulatory stance. leading to the Covid crisis, believing that the banks were in good health. enough to survive the shock of the pandemic and support the US economy.
The Fed looked at the turbulence that unfolded in the US Treasury and short-term funding markets in March, leading to a massive central bank bailout, to see what corrections might be warranted.
The central bank also capped dividend payments and banned share buybacks at the biggest banks until the end of the year, though Ms Brainard – a possible Treasury secretary in a Biden administration – argued that it did not go far enough and that a total dividend ban was guaranteed.
Other Fed officials say, however, that the stricter financial regulations envisaged by the central bank could limit the ability of banks to extend vital credit and reduce market turbulence in times of crisis.
Mary Daly, chairman of the Federal Reserve Bank of San Francisco, told reporters this week that she didn’t see much of a connection between loose monetary policy and financial risks. During the 2019 Fed rate cuts, which were sparked by trade tensions, financial stability concerns were raised but never materialized, she said.
“We always have to watch for excessive risk taking, we should always watch for excess leverage,” she said. “But we must not regulate the fear that may arise, and to the detriment of so many millions of Americans who need jobs, income and access to the economy.