Fed: Risks To US Financial System Ease As Economy Recovers

NEW YORK: The risks to the U.S. financial system have eased significantly compared to a year earlier, the Federal Reserve said Monday.

The central bank noted that as the economy recovers from the pandemic-driven recession, the balance sheets of individual Americans and businesses continue to strengthen.

However, the Fed did cite the significant rise in asset prices most notably home and stock prices as well as the rise of volatile trading of so-called meme stocks as potential risks to the financial system.

The observations came in the Fed’s semiannual Financial Stability Report on trends going on in both trading, investing as well as economic issues. The report is not an economic forecast, nor does it try to predict the next risk to the financial system. But it does attempt to highlight areas of concern to central bankers.

Overall the financial system is in better shape than it was a year ago and even six months ago, the Fed said. Borrowing by individual Americans and businesses continues to trend back to pre-pandemic levels. Low interest rates have made handling higher levels of debt easier. Banks are reporting record profits and their balance sheets are nearly back to where they were before the pandemic.

The Fed did note the rise in asset prices from a year earlier, and how prices for assets ranging from stocks to homes are at levels above historic norms. The central bank said in its report that it has not seen a decrease in credit quality for mortgages, however, which was the cause of financial crisis of 2008 and Great Recession.

If investors were to decrease their appetite for risk, or if interest rates were to rise significantly, these high asset prices could fall noticeably, which would be a risk to the financial system, the Fed said.

One notable element of the report is the Fed’s attention to meme stocks such as GameStop, AMC Entertainment and others. These companies have seen extremely volatile trading this year largely due to a tug-of-war between Wall Street hedge fund managers and a mostly online group of retail investors who collectively strategize over social media.

The Fed noted that the combination of companies charging extremely low or zero dollar commissions to buy or sell stock, plus social media, has made it easier for individual investors to heavily influence one particular company’s stock price. Retail investors are now using advanced forms of trading such as options or leverage, which could pressure a stock one way or another.

While the Fed said in its report that it does not believe GameStop or AMC individually would have caused any issues for the economy or the financial system, it notes that it would not be hard for another company to become a target like GameStop if the conditions were right.

There are also concerns that these retail investors who are generally much younger may not be able to financially handle a significant drop in stock prices.

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