Yellen Warns Of “Algo Presence” In Markets, Fears “Risks Of Excessive Optimism”
While we will not see her speech or Q&A, the much anticipated speech on financial stability from Janet Yellen has just dropped. While expectations were for a ‘snoozefest’ speech, market volatility heading in suggested more than a little anxiety. While the core of her speech pushed back against easing financial reforms, she fears “risks of excessive optimism returning sooner or later” in financial markets and warns of the “larger presence of algorithmic traders in markets.”
Fed’s Janet Yellen said more resilient, post-crisis U.S. financial system “is better prepared to absorb, rather than amplify, adverse shocks,” yet “there is more work to do” and “we can never be sure that new crises will not occur.”
Policy makers, investors should continue to monitor indicators of financial-system resilience, Yellen said Friday in text of speech at Kansas City Fed’s annual symposium in Jackson Hole, Wyoming.
“All-too-familiar risks of excessive optimism, leverage, and maturity transformation” will re-emerge “sooner or later” in new ways that require policy responses, given technology, regulation and evolution of financial system
Market-based measures may not reflect true risks; supervisory metrics “are not perfect, either”
Evidence shows that post-crisis reforms have made the financial system “substantially safer”
Credit default swaps for large banks suggest market participants are assigning low odds to distress of a large U.S. bank
Market-based assessments of the loss-absorbing capacity of big U.S. banks have moved up, and measures of equity now in range of book estimates
Market liquidity for corporate bonds remains “robust overall”
Healthy condition of the market is apparent in low bid-ask spreads, large volume of corporate-bond issuance
Even so, “liquidity conditions are clearly evolving”; some regulations “may be affecting market liquidity somewhat”; may be benefits to simplifying parts of Volcker rule
New regulatory framework has made dealers more resilient to shocks; any adjustments to framework should be “modest”
Broader set of changes may deserve consideration, such as simplifying regulatory changes for small/medium-sized banks
“Not altogether surprising” to see conflicting research results on effects of capital regulation on credit availability
Credit may be less available to some borrowers, even if it’s “not readily apparent” that there are material adverse effects of regulation on broad lending measures
Credit appears broadly available to small businesses with solid histories
Which is odd as she said in June there would be no more financial crises in her lifetime?
June: “I don’t expect another financial crisis in our lifetime.”
August: “We can never be sure that new crisis will not occur.”
Below are some of her most interesting comments, verbatim:
“I expect that the evolution of the financial system in response to global economic forces, technology, and, yes, regulation will result sooner or later in the all-too-familiar risks of excessive optimism, leverage, and maturity transformation reemerging in new ways that require policy responses.”
“We relearned this lesson through the pain inflicted by the crisis.”
“We can never be sure that new crises will not occur, but if we keep this lesson fresh in our memories–along with the painful cost that was exacted by the recent crisis–and act accordingly, we have reason to hope that the financial system and economy will experience fewer crises and recover from any future crisis more quickly, sparing households and businesses some of the pain they endured during the crisis that struck a decade ago.”
“…algorithmic traders and institutional investors are a larger presence in various markets than previously, and the willingness of these institutions to support liquidity in stressful conditions is uncertain.”
“There may be benefits to simplifying aspects of the Volcker rule, which limits proprietary trading by banking firms, and to reviewing the interaction of the enhanced supplementary leverage ratio with risk-based capital requirements.”
Additionally, as The FT notes, the regulatory reforms pushed through after the great financial crisis have made the system “substantially safer” and are not weighing on growth or lending, Janet Yellen said as she warned against forgetting the devastation wrought by the meltdown of 2007-09. The Federal Reserve chair said in a speech at Jackson Hole, Wyoming, that there were ways of adjusting regulations to ensure they did not overburden institutions such as smaller banks, but she warned that memories of the last crisis “may be fading” and did not call for radical changes. Her remarks come in the face of mounting calls for a loosening of financial regulation from Republicans concerned that the regime is stifling growth.
Photo: “Janet Yellen, Chair of the U.S. Federal Reserve System” by University of Michigan’s Ford School is licensed under CC BY-ND
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