US Federal Reserve Chairman Ben Bernanke on Friday said the central bank is stepping up its monitoring of “too big to fail” companies and other risks to financial stability.
Bernanke said the Fed was moving into a more systemic mode of financial monitoring after failing to spot the seeds of the 2008 Wall Street meltdown more than four years ago.
“The step-up in our monitoring is motivated importantly by a shift in financial regulation and supervision toward a more macroprudential, or systemic, approach,” Bernanke told a Chicago Fed conference, according to the prepared text.
That approach supplements the central bank’s traditional focus on the health of individual institutions and markets, he said.
“Our economy has not yet fully regained the jobs lost in the recession that accompanied the financial near-collapse,” he said.
“And our financial system — despite significant healing over the past four years — continues to struggle with the economic, legal and reputational consequences of the events of 2007 to 2009,” he said.
In addition to the lessons learned from the financial crisis, the more intensive monitoring was needed “because financial activities tend to migrate from more-regulated to less-regulated sectors,” Bernanke said.
“The second motivation for more intensive monitoring is the apparent tendency for financial market participants to take greater risks when macro conditions are relatively stable,” he added.
Bernanke sounded a note of caution about the recent record-setting rise in the US stock market as the Fed holds its near-zero key interest rate and pumps US$85 billion a month into bond purchases to support a weak economic recovery.
“In light of the current low interest rate environment, we are watching particularly closely for instances of ‘reaching for yield’ and other forms of excessive risk-taking, which may affect asset prices and their relationships with fundamentals,” he said.
“For the purpose of safeguarding financial stability, we are less concerned about whether a given asset price is justified in some average sense than in the possibility of a sharp move,” he said.
On Wednesday, the Dow Jones Industrial Average and the Standard & Poor’s 500-stock indices closed at record highs, with the broader S&P hitting an all-time record for five straight days.
Bernanke said that the implementation of the Dodd-Frank financial reforms was still being developed, including the treatment of the so-called “too-big-to-fail” companies deemed crucial to the health of the financial system.
Under the Dodd-Frank Act, the largest bank holding companies are treated as systemically important financial institutions (SIFIs) and have been subjected to Fed stress testing since 2009.
Bernanke said the US Financial Stability Oversight Council, created by the act, was in the process of naming nonbank financial companies as systemically important.
He said the central bank was developing market-based measures of systemic vulnerabilities and systemic risk, as well as network analysis, to better monitor the interconnectedness of financial institutions and markets.
Bernanke warned that shadow banking had “remaining vulnerabilities” that need to be addressed by regulators and the private sector.
There could be a run on money market funds if a fund should “break the buck,” or report a net asset value below US$0.995, as the Reserve Primary Fund did in 2008, he said.
“The risk is increased by the fact that the Treasury no longer has the power to guarantee investors’ holdings in money funds, an authority that was critical for stopping the 2008 run,” he said.