Former Federal Reserve officials, including one ex-Vice Chair and two financial stability experts, say the current iteration of the U.S. central bank is creating a new crisis environment by easing banking regulations at the same time it’s cutting interest rates.
Former Vice Chair Alan Blinder and stability experts Daniel Tarullo and Nellie Liang said loose credit and lax rules will encourage banks and investors to take too many risks. And while that’s great for economic growth, it could blow up in everyone’s faces and cause another recession.
“When you lower rates and put incentives in place to increase borrowing, it should not be surprising that risks will increase,” said Liang, the former Director of the Federal Reserve Office of Financial Stability and current Brookings Institution senior fellow and economist. “That means this is not the right time to be also significantly loosening financial regulations.”
Liang was nominated for the current Fed board by President Donald Trump but withdrew after several months passed without a hearing in the Republican-led Senate.
Stocks of course have been red-hot, setting record after record the past month or so on the hopes of a new trade deal with China. We officially have a phase one deal that has been agreed upon by both sides.
The Fed lowered interest rates three times in 2019, the first three rate cuts in more than a decade, before pausing on Dec. 11 and indicating rates will remain steady through 2020.
Of course, Trump and other Republican lawmakers have argued the Fed hasn’t gone far enough with lowering rates, which makes sense considering lower rates leads to bigger numbers on the major stock indexes. With the 2020 election coming up, Trump is banking on record stock numbers boosting his reelection chances.
Democrats, meanwhile, say the Fed has gone too far with easing rules and cutting rates while the economy is strong.
Liang said she is worried about growing corporate credit, according to Bloomberg.
“I worry that defaults and investor losses will be higher than expected in the next downturn, and will make the next recession more severe,” she said.
The Fed even admitted during its latest meeting that prolonged periods of low rates could spur banks to take more risks.
Current Fed leadership denies weakening the financial system, and says the country has a “stable, healthy and resilient banking sector,” according to Vice Chair for Supervision Randal Quarles.
“One of our principles has been to ensure that we do not reduce in any material way the loss absorbing cushion of the institutions,” Quarles said. “I think we have succeeded in doing that.”
Tarullo is a former Fed governor who was a key player in the central bank’s regulatory drive after the 2008 financial crisis, and he disagrees.
“I suspect quite strongly that the effective amount of capital the banks have to have for a given portfolio is lower because they have so much more information about the stress tests,” he said.
