Bernanke on the Risk of Managers who “reach for yield”
All in all, today’s testimony was pretty mundane, but I did find this portion of the commentary interesting:
“Another potential cost that the Committee takes very seriously is the possibility that very low interest rates, if maintained for a considerable time, could impair financial stability. For example, portfolio managers dissatisfied with low returns may “reach for yield” by taking on more credit risk, duration risk, or leverage. On the other hand, some risk-taking–such as when an entrepreneur takes out a loan to start a new business or an existing firm expands capacity–is a necessary element of a healthy economic recovery. Moreover, although accommodative monetary policies may increase certain types of risk-taking, in the present circumstances they also serve in some ways to reduce risk in the system, most importantly by strengthening the overall economy, but also by encouraging firms to rely more on longer-term funding, and by reducing debt service costs for households and businesses. In any case, the Federal Reserve is responding actively to financial stability concerns through substantially expanded monitoring of emerging risks in the financial system, an approach to the supervision of financial firms that takes a more systemic perspective, and the ongoing implementation of reforms to make the financial system more transparent and resilient. Although a long period of low rates could encourage excessive risk-taking, and continued close attention to such developments is certainly warranted, to this point we do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more-rapid job creation.“
That’s like the portfolio manager who sees lots of risks in what he’s doing, but doesn’t actually do anything to hedge out that risk or prepare for the potential that his optimistic views could be right….Oh well. At least they acknowledge potential risks.
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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I was quite amused by that part – anybody remember the “housing is fine..” -> “housing isn’t fine but inventory will be cleared out quickly and won’t effect the economy anyway” -> “nothing more than a slight recession” -> “MAYDAY, MAYDAY – ICEBERRG” routine of 2007/8?/9?
Also thought Elizabeth Warren’s TBTF questions which drew Bernanke’s typical instinctive, defensive reaction to come to the aid of banks, was also quite interesting.
Warren didn’t seem to understand the gist of the Bloomberg article, She acted like the treasury actually handed over $80b to the big banks.
Disagree completely with that. Warren knows the issue very well, and was pointing to lower spreads than smaller institutions with similar risk profiles. The FDIC agrees with Warren’s argument. Her point was essentially that we should get rid of TBTF by putting in charges to offset this implicit govt subsidy.
I kind of agree with him that if Fed policies do promote a stronger economic recovery and job growth that it doesn’t matter if some managers blow themelves up reaching for risk — except if some managers blow themselves up we’ll have to foot the bill again, because we seem to have trouble liquidating failed positions.
You DON’T HAVE TO to pay the bill. This kind of solution has been deliberately preferred to the other one, like managed default and nationalisation. The dutch government tried to bail out SNS banks the first time, but later opted for nationalisation. Shareholders and junior bond holders payed the bill. This is going to happen again, avoid bank stocks and bonds.
I’d like to believe you, but the bankers run the government.
Look at our incoming Treasury Secretary — Jack Lew spent a couple of years at Citigroup participating in the leveraged mortgage crisis that caused the financial crisis. He got a big paycheck and was sent on his way back into government.
I find it amazing the bankers can install people like this in plain view, even for a president you would think would be hostile to their views.
“[...] the Federal Reserve is responding actively to financial stability concerns through substantially expanded monitoring of emerging risks [...]”
This is supposed to be a joke, I hope? An ‘active response’ consisting of ‘expanded monitoring’, what?
Hmmm, what exactly could Ben do to hedge those risks?
Scratching my head…..
The sorts of risks Bernanke is talking about is portfolio blow ups on leveraged trades. If the blow up is big enough, the Fed has to get a firehose and squirt it out and that means money. Whats the alternative? Should the NY Fed start a derivative trading operation to allay their risk? I can’t wait for the reaction from the blogosphere.
In the end, the Fed is the final strong hand. Even if the Fed were to hedge itself using private sector counterparties these can fail. How useful would that have been to puy derivitaves from AIG, Bear, Lehman, Goldman, and GE when these companies either failed or got bailed.
The reality is their Fed is the final backstop. That’s why there must be good policies up front. Their blowups can at anytime become the liability of the US taxpayer.