The Federal Reserve should be reluctant to intervene in markets to stop specific asset markets from overheating, Fed Governor Jerome Powell said Wednesday.
Speaking about financial regulation at New York University, Powell said in prepared text that “unless there is a plausible threat to the core of the system or potential for damaging fire sales, I would set a high bar” for regulators to step in and prevent banks and other financial firms from bidding up prices in a risky market for loans.
Powell specifically addressed leveraging lending, or loans made to businesses with poor credit or high debt, in some cases used to finance mergers or buyouts.
The Fed in recent years has issued stern warnings about excess risk-taking in leveraged loans. With other banking regulatory agencies, it sent out a special guidance to banks intended to prevent them from making overly risky or poorly underwritten leveraged loans in spring 2013. It reiterated criticisms of leveraged lending in the fall.
But the regulators’ warnings have not served to stifle the market, with $800 billion of leveraged loans now outstanding, according to Powell.
Leveraged loans were “clearly in bubble territory” prior to the 2008 financial crisis, he said, and some aspects of the market now “evoke the pre-crisis bubble period and thus raise red flags” again.
Nevertheless, he said, “financial stability need not seek to eliminate all risks. We need to learn, but not overlearn, the lessons of the crisis.”
The megabanks at the center of the financial system that failed in 2008 are much better capitalized and prepared to withstand a crisis now, he noted.
Powell added that “the Fed and other prudential and market regulators should resist interfering with the role of markets in allocating capital to issuers and risk to investors unless the case for doing so is strong” and it has the right tools to do so.
Powell, a former official in the George H.W. Bush Treasury now in his second term on the Fed’s Board of Governors, did not address monetary policy in his speech.
Nor did he talk about the “Fed audit” legislation championed by Sen. Rand Paul, R-Ky., that has drawn attention in the past few weeks. Powell spoke out last week against the legislation, meant to increase congressional oversight of the Fed by subjecting it to a comprehensive Government Accountability Office audit that would include monetary policy decisions.
