The BIS annual report released Sunday focuses on yield chasing, but provides few solutions to it beyond an important suggestion that monetary policy normalize as quickly as possible. Consistent with its longstanding focus on macroprudential tools, the BIS also suggests some of these could be deployed to prevent what it characterizes as a potentially procyclical “market boom” as dangerous as the last financial one. In her last two client notes, Karen Petrou has highlighted yield-chasing as an emerging systemic risk warranting rapid policy response. Our views are summarized below:
Microprudential solutions to yield chasing are of limited value because much of this behavior – at least within reasonable bounds – is prudent when undertaken by individual banking organizations. The problem here is not microprudential risk-taking, but rather a collective action one.
However, there are few macroprudential tools regulators can in fact deploy to effect in the U.S. because the banks to which these tools can be applied play only one important role in a diverse financial market that is increasingly reliant on non-bank financial institutions. Nevertheless, the agencies will throw what they can at yield chasing, starting first with tough enforcement actions on leveraged lending and another effort at consistent FRB/OCC policy on these loans. Mortgage LTV limits – long a focus of Fed attention – are also possible, but we do not expect them in the near term. Asset-managing designations on either a firm or activity-specific basis are in the works, but will take time and thus are an inadequate response to growing market risk.
Monetary-policy normalization may accelerate in the U.S. in the face of the BIS request, but we doubt it. Instead, the real fix for yield-chasing lies in fiscal policy, especially changes to the tax code that restore a balance between debt and equity. Government fiscal incentives – notably partial guarantees for private investment – can also spur markets without the central-bank balance-sheet risk of profoundly accommodative policy. However, the Congressional impasse in the U.S. means no new fiscal-policy initiatives are possible, forcing creativity by the Administration under current law. This was done late last week with regard to affordable-housing lending related to multi-family properties. Additional initiatives in this area are possible, but in their absence pressure will grow on bank regulators to chasten their charges regardless of the limited impact micro- or even macro-prudential tools will have.
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