Janet Yellen fears financial system risk among non-banks

“Life insurers continued to invest heavily in corporate bonds, secured loan obligations (CLOs) and CREs [commercial real estate] debt, making their capital positions vulnerable to sudden declines in the value of these risky assets,” Fed officials wrote.

“Gradually rising interest rates improve the profitability outlook for life insurers because their liabilities generally have longer effective durations than their assets, and higher interest rates may reduce the incentives for life insurers to invest in riskier assets,” officials added. “However, a large and unexpected increase in interest rates could induce policyholders to surrender their contracts at a higher rate than expected. If the increase in surrenders is large enough, it could put downward pressure on performance. of life insurers.”

Officials also noted the increased use by life insurers of non-traditional liabilities, such as securities backed by financing agreements, advances from the Federal Home Loan Bank and cash received under agreements. repurchase and securities lending transactions.

“These liabilities, which are generally more vulnerable to rapid withdrawals than most policyholder liabilities, have been steadily increasing in recent years,” officials said.

Warren’s concerns

Senator Warren – who has been active in efforts to develop the Dodd-Frank Act approach to financial services regulation – noted during the hearing that in 2019 Yellen joined the former Fed Chairman, Ben Bernanke, and two former Treasury secretaries, Tim Geithner and Jack. Lew, to write a letter opposing the 2019 limits on the FSOC’s ability to designate non-banks as SIFIs.

In the letter, Yellen and his colleagues said the new limits would make it impossible to prevent the build-up of risk at some non-bank financial institutions.

Warren said she believes one of the most powerful tools Congress has given the FSOC is the ability to designate non-banks as SIFIs, and that hedge funds, private equity funds and other non-bank asset managers now oversee billions of dollars of assets “from the shadows of the financial system.”

“These companies control huge chunks of the US and global economy, which means their mismanagement or failure could threaten the entire economic system,” Warren said.

Warren asked Yellen if she still agreed with the 2019 letter.

“Yeah, I do,” Yellen told Warren.

Yellen on the activity-based approach

But Yellen added that the FSOC continues to have the ability to regulate activities involving non-banks, such as the administration of money market funds, which appear to involve concerns about financial stability risks.

“Sometimes designation is clearly the right tool when there is an institution whose failure could threaten financial stability,” Yellen said.

But Yellen said certain activities, such as the offering of money market funds, occur throughout the financial system, and activity-based oversight is appropriate to manage those activities.

The FSOC closely monitors money market funds, run-on-the-mutual-fund risk and other activities, Yellen said.

Yellen said regulators need to have both institution-based and activity-based tools, and regulators should carefully consider SIFI naming rules.

The Federal Reserve Building in Washington (Photo: Shutterstock)

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Don F. Davis