Risk Management

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Fed Vigilante Tom Hoenig Blasts ZIRP, Warns Market "To Cease Its Reliance On Fed Risk Management"

"There is no question that low interest rates stimulate the interest-sensitive sectors of the economy and can, if held there too long, distort the allocation of resources in the economy. Artificially low interest rates tend to promote consumer spending over saving and, over time, systematically affect investment decisions and the relative cost and allocation of capital within the economy... We now find ourselves with a Federal Reserve system balance sheet that is more than twice its size of two years ago. The federal funds rate is near zero and the expectation, as signaled by the FOMC, is that rats will remain so for an extended period. And the market appears to interpret the extended period as at least six months. Such actions, moreover, have the effect of encouraging investors to place bets that rely on the continuance of exceptionally easy monetary policy. I have no doubt that many on Wall Street are looking at this as a rare opportunity... The unintended negative consequences of such actions are real and severe and if the monetary authority goes too long in creating such conditions. Low rates over time systematically contribute to the buildup of financial imbalances by leading banks and investors to search for yield... The search for yield involves investing less-liquid assets and using short-term sources of funds to invest in long-term assets, which are necessarily riskier. Together, these forces lead banks and investors to take on additional risk, increase leverage, and in time bring in growing imbalances, perhaps a bubble and a financial collapse... While we may not know where the bubble will emerge, these conditions left unchanged will invite a credit boom and, inevitably, a bust. I am convinced that the time is right to put the market on notice that it must again manage its risk, be accountable for its actions, and cease its reliance on assurances that the Federal Reserve, not they, will manage the risks they must deal with in a market economy." - Kansas Fed President Thomas Hoenig

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