Earlier this month, Federal Reserve Chair Janet Yellen opined that regulation is the preferred way of combating excessive financial risk-taking, not interest rate policy.
However, it remains to be seen whether regulation is up to the task. From Bloomberg:
One of the Federal Reserve’s first post-crisis tests of its ability to quash excessive risk-taking using regulatory tools is so far looking like a failure.
The Fed’s Board of Governors told Congress last week that it’s engaged in “strong supervisory follow-up” to guidance given to banks in 2013 to improve their underwriting standards for high-yield loans. Despite those efforts, Chair Janet Yellen said she’s still seeing a “marked deterioration” in quality.
For the first time, more than half of the junk-rated loans arranged in the U.S. this year lack typical lender protections like limits on the amount of debt borrowers can amass relative to earnings. Yellen’s own easy-money policies are boosting demand for such high-yielding products at the same time that she tests her doctrine that financial bubbles should be constrained by supervisory actions, not a general rise in interest rates.
The full risks to financial stability are unlikely to become obvious until the US economy weakens significantly. And that has apparently not happened yet.
The Chicago Federal Reserve reported on Monday that its national activity index dipped to +0.12 in June from +0.16 in May. The three-month moving average fell to +0.13 from +0.28.
According to the Chicago Fed, the three-month reading shows that economic growth was somewhat above its historical trend.
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