Investors hailed Fed chairman Jerome Powell’s speech in Jackson Hole on Friday, with markets interpreting this to mean that the central bank would not be too quick to end its support to the economy. But not all speakers at the annual meeting gave cause for optimism.
Don Kohn, the former Fed vice chairman for financial supervision, instead warned of impending risks to the stability of the global financial system and urged regulators and lawmakers to address these concerns quickly.
“Dealing with financial stability risks is imperative,” he said during a speech at the Federal Reserve Bank of Kansas City’s annual Jackson Hole Economic Policy Symposium. “The current situation is full of … unusually large risks of the unexpected which, if they occur, could cause the financial system to intensify shocks and put the economy at risk.”
Kohn pointed to the minutes of the recent Federal Reserve meeting, which indicated that members of the bank’s rate fixing committee saw “notable” weaknesses in the financial system, as assets rose to historic highs and public and private debt fell in proportion for the size of the economy almost record values.
Despite these excesses, investors don’t seem concerned, as evidenced by the low interest rates on a wide range of TMUBMUSD10Y, 1.283% government and corporate bonds, “although private indebtedness has increased disproportionately to lower-rated corporate borrowers,” he said.
Furthermore, Kohn said, the government appears to be in a bad position to respond to an economic downturn that could result from an asset bubble burst or a debt crisis, as the Federal Reserve is already putting in aggressive monetary stimulus while the federal government holds in historically high budget deficit maintained.
Kohn’s distrust of the state of the economy and financial markets is shared by many high profile investors, with GMO co-founder Jeremy Grantham being one of the most high-profile advocates of this view. In June he argued that the Fed should “deflate all asset prices as carefully as possible”. [it can]Knowing that an earlier decline, painful as it may be, would be smaller and safer than waiting. ”
Unlike bubble watchers like Grantham, however, Kohn does not blame Fed policies for high debt and asset prices. Rather, he argues that the central bank must now prepare for a possible bubble burst through prudential regulation.
One strategy to protect the U.S. economy from an asset bubble bursting would be to require the big XLF – 1.17% banks to finance themselves with less debt and more equity in the form of retained earnings or shareholder funds.
The Fed’s so-called countercyclical capital buffer allows the regulator to change the absorption capacity of banks and lower the level in good times when banks can afford it.
“By increasing capital needs during boom times, it could halt skyrocketing asset prices,” Jeremy Kress, a former lawyer on the Federal Reserve’s Banking Regulatory and Policy Group and professor at Michigan’s Ross School of Business, told MarketWatch in June . “In contrast to other countries, the Federal Reserve has never activated this discretionary buffer. Maybe now is a good time to activate it, ”said Kress.
Kohn urged the Fed to increase the countercyclical capital buffer, something Randal Quarles, the current Fed vice chairman of financial supervision, has opposed to lending to its customers Biden urged him to appoint either a Fed chair or vice chair who is more receptive to stricter bank lending rules.
Kohn also targeted two creations of the Dodd-Frank Financial Reform Act introduced in the wake of the last financial crisis: the Financial Stability Oversight Council, which includes the heads of all major financial regulators, and the Office of Financial Research, which had subpoena powers, to allow regulators to request information necessary to maintain financial stability.
“I think most would agree that the performance of these two new entities was patchy,” said Kohn, arguing that the FSOC has proven incapable of acting quickly while the OFR is using its subpoena for fear of rioting the industry , never used it. He argued that the FSOC should be reorganized to give the Finance Minister more powers to act unilaterally and that the OFR should be given a new, clear mandate to regularly collect information that policy makers need.
Kohn also called on Congress to issue a new mandate for all federal financial regulators to make financial stability a priority.
“Right now, they don’t have to consider systemic risk when completing their missions,” he said. “They should be asked to broaden their perspective to take into account the systemic effects of their actions and the activities and companies they oversee, and should be held accountable for doing so.”