Minutes released Wednesday from the Fed's January policy meeting show officials concerned that the current easy-money policies could lead to excessive risk-taking and instability in financial markets. The Fed is buying $85 billion in mortgage and U.S. Treasury securities a month to drive down long-term rates and has promised to keep short-term rates near zero until unemployment improves.
The program hasn't fueled inflation, as many feared, and many officials are inclined to stay the course. But some said the Fed might have to taper its controversial bond buying before the job market fully recovers, according to the January minutes. The Fed has previously allowed bond buying programs to end in this recovery and then restarted them. It will review the programs at its next meeting, March 19-20, setting the stage for another high-stakes debate.
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Of late, the view in financial markets has been unsettling: Banks and investors are holding riskier debt. Companies are issuing record amounts of junk bonds. And exotic corners of mortgage securities and corporate loan markets are growing.
Fed officials aren't convinced these recent signs point to any immediate danger to the U.S. financial system. But they are debating whether Fed programs could lead to future financial turbulences and whether the programs will be more difficult to unwind later, as they grow.
The Fed has said that short-term rates would stay low until unemployment falls to 6.5%, from its current level of 7.9%, as long as inflation remains low, and that the bond-buying programs would continue until substantial job market improvements. But officials have always hedged these forecasts, saying they could change with any emerging threats to the financial system.
The same low interest rates intended to trigger spending, investment, growth and hiring are also spurring a race by investors to find higher returns that, by nature, carry higher risks.
"We have a hyper-robust bond market right now," Dallas Fed President Richard Fisher, a former investment manager, said in an interview. These robust markets are part of the Fed's policy intent, he said, but the credit market jump has put him on guard for a new destabilizing credit boom. "You don't sit on a hot stove twice."
Jeremy Stein, a Federal Reserve governor, likened the Fed's challenge to that of a ship's crew, which must distinguish chunks of ice from dangerous, deep-rooted icebergs. A lot happens in markets beneath the surface, beyond the notice of regulators, he said in a recent speech: "We should be humble about our ability to see the whole picture, and should interpret those clues that we do see accordingly."
Identifying financial threats is harder than spotting such problems as inflation or unemployment, which have uniform measures. Until recently, the long-running complaint among economists critical of the Fed's low-rate policy was the danger of high inflation, which has settled below the Fed's 2% target.
Mr. Stein, a finance specialist on leave from Harvard University's economics department, expressed worry over the growth in junk bonds and corporate loan markets this month and acknowledged the Fed's conundrum: Its low-interest-rate policies to help the U.S. economy might also contribute to destabilizing booms.
The danger is that low rates prompt some individuals and institutions to take on too much debt or too many risky assets. In worst-case scenarios, such market behaviors can topple banks and financial institutions that are heavily exposed.
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Fed officials are watching several potential dangers, including junk bonds. Last year, companies issued $274 billion worth of junk bonds, up 55% from a year earlier and more than double the levels seen before the financial crisis, according to Dealogic. Yields on low-rated junk bonds have fallen to under 6% as investors push up their prices. One risk is for borrowers who take on too much debt; another is for investors should the value of junk bonds collapse.
In another market, corporate borrowers are facing looser restrictions from lenders on new loans. Covenant-lite corporate loans—borrower-friendly business loans that don't require firms to meet traditional performance standards—are up. In 2012, banks underwrote $58 billion worth of such loans, according to Dealogic. That compares with $36.5 billion in 2011 and $8.5 billion in 2010.
Credit ratings firms are taking notice. When Netflix Inc., NFLX -4.75% the video rental firm, issued $400 million worth of new debt late last month, Standard & Poor's lowered its outlook for the debt, noting the firm's increased debt. Moody's Investors Service downgraded JG Wentworth, a financial services firm, after it took out a $425 million covenant-lite loan in February and used most of the proceeds to pay shareholders a special dividend. Moody's noted the firm's debt would triple.
David Miller, the chief executive of JG Wentworth, said the added debt was manageable because the firm generates lots of cash and interest rates are low. He added S&P didn't downgrade the firm's debt. A Netflix spokesperson declined to comment.
Mortgage real-estate investment trusts are growing briskly, too, and that has caught the attention of regulators. These largely unregulated financial firms use short-term loans to buy mortgage-backed securities. One worry among regulators is that their short-term funding could dry up quickly if the firms face challenges, forcing the sale of assets at a loss. Other regulators, including the Financial Stability Oversight Council, a group of regulators run by the U.S. Treasury, have been looking at the business model of these firms, according to several people familiar with the matter.
The industry has bigger capital cushions than most banks and is disciplined because it doesn't rely on a government safety net, said Wellington Denahan, the chief executive of Annaly Capital Management Inc., the sector's largest company by assets.
Fed officials have also taken notice that some banks are taking more risks, as they venture away from such safe but low-yield investments as Treasurys in the search for higher returns.
Gerald Lipkin, chief executive of Valley National BancorpVLY -0.98% of Wayne, N.J., which has $16 billion in assets, sees problems looming for banks. His customers want to lock in low-rate, long-term loans, and he worries that too many low-rate loans will squeeze profits if interest rates go up.
"I think this could be a major problem for financial institutions that do it," he said. He said he was resisting that temptation, but added, "it's getting very, very difficult not to do it," because of the Fed's low-rate policies.
The Fed uses core inflation to measure its effectiveness. Core inflation as put out the the US government measures the cost of maintaining a declining standard of living minus the cost of two of life's essentials: food and energy. If you look at the chart bedow, the blue line represents a good approximation of the cost of maintaining a set standard of living:
ZitatOf late, the view in financial markets has been unsettling: Banks and investors are holding riskier debt. Companies are issuing record amounts of junk bonds. And exotic corners of mortgage securities and corporate loan markets are growing.
So the Regime and their lackeys are setting up the conditions that lead to the collapse and they railed against previously. Swell.
RIGHT'S RIGHT 
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Thu Feb 21, 2013 5:28 am
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