Fed boss: No rate rise to boost stability

Christine Lagarde (left), managing director of the International Monetary Fund and Janet Yellen, chairman of the U.S. Federal Reserve, listen Wednesday as Michel Camdessus, former managing director of the IMF, speaks during an event at the IMF in Washington, D.C.
Christine Lagarde (left), managing director of the International Monetary Fund and Janet Yellen, chairman of the U.S. Federal Reserve, listen Wednesday as Michel Camdessus, former managing director of the IMF, speaks during an event at the IMF in Washington, D.C.

WASHINGTON -- Federal Reserve Chairman Janet Yellen said Wednesday that there is no need to change current monetary policy to address financial stability concerns although she sees "pockets of increased risk-taking" in the financial system.

Addressing the worldwide debate among central bankers over whether interest rates are a first-order tool to rein in financial excess, Yellen came down against that idea and in favor of regulatory tools.

"Monetary policy faces significant limitations as a tool to promote financial stability," Yellen said at the International Monetary Fund in Washington. "Its effects on financial vulnerabilities, such as excessive leverage and maturity transformation, are not well understood and are less direct than a regulatory or supervisory approach."

She said the macroprudential approach, a term that describes a combination of multiagency oversight, attention to bank capital and liquidity, and regulatory pressure to create buffers against failure, "needs to play the primary role."

Yellen's comments are significant because economists worry that central banks may now be causing a worldwide reach for yield as interest rates are suppressed by monetary policy.

"A powerful and pervasive search for yield has gathered pace," the Basel, Switzerland-based Bank for International Settlements said in its annual report dated Sunday.

The Fed has kept the benchmark lending rate near zero since December 2008 and is buying longer-term Treasury debt and mortgage-backed securities, holding down yields on the safest debt.

Bank regulators have tried to limit risk, issuing guidance on high-yield, high-risk leveraged loans in March 2013.

The directive, which is less stringent than a rule, was unusually prescriptive, saying that debt levels exceeding six times a measure of earnings "raises concerns for most industries."

Still, U.S. leveraged loans sold to institutional investors have topped $329 billion so far this year, the third-biggest first half on record, following last year's record $414 billion in the first six months.

About half were covenant-light, meaning they lack standard protections for lenders such as limits on debt relative to earnings, Bloomberg data show.

Yellen said so far the Fed doesn't see a "systemic threat" from the high-yield loan market since broad measures of credit growth don't suggest excessive debt, and improved capital and liquidity positions at banks "should ensure resilience" against losses.

Yellen said the financial crisis wouldn't have been prevented or mitigated by "substantially tighter monetary policy" in the mid-2000s.

Higher interest rates would have increased unemployment and wouldn't have closed regulatory gaps that allowed large banks to "escape comprehensive supervision," nor would they have brought transparency to derivatives markets or improved bank risk management practices, she said.

"Tighter monetary policy would have been a very blunt tool," Yellen said. "Substantially mitigating the emerging financial vulnerabilities through higher interest rates would have had sizable adverse effects in terms of higher unemployment."

Halting the U.S. housing bubble also would have required "a very significant tightening" because of the momentum of real estate prices during the period, Yellen said. Job losses and higher interest payments "would have directly weakened households' ability to repay previous debts," she said.

Business on 07/03/2014

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