Last week, the Washington Post ran an astonishing article, easily overlooked in the personal-finance section. In it, the writer advised the many consumers she said were besieging her with fearful questions about how best to ensure their money is safe in the bank – and, if they’re still worried, where to buy a nice safe. That same day, a friend asked me if his short-term Treasury bills are safe. These are, of course, anecdotal reports, but such worries are rarely tracked as the leading indicators they are. It’s obvious in crisis after crisis that, when retail depositors and investors are frightened, we should all be very worried.
How much uncertainty does it take to create a financial or macroeconomic crisis? None of the Fed’s financial-stability reports deigns to consider consumers, nor does the Fed tell us when to worry because it fears we will if the Fed cracks its stone face. However, a brand-new Fed study provides a very useful – if frightening – analytical context in which to consider anecdotal data.
The Fed staff paper examines different types of uncertainty and their impact on economic activity and financial conditions. While it doesn’t directly extend the analysis to financial stability, the results are important given the strong correlation between economic and financial volatility and very, very bad financial-market events.
The paper assesses six key drivers of uncertainty: real economic conditions, inflation, economic policy, trade policy, geopolitical risk, and financial uncertainty as reflected in the VIX. These uncertainty drivers exploded by four to sixteen standard deviations based on the indicators from 2019 to 2024. Notably, economic and financial uncertainties had the biggest macro impact and God knows how many standard deviations we are now from the already-worrisome end-2024 indicators.
And, even these aren’t as bad as they might be – none of these standard-deviation measures captures nonlinear or “extreme uncertainty” events. Of late, trade-and-economic policies, geopolitical risk, and market volatility look pretty “extreme” to me.
What might FSOC or national leaders do in the face of all this uncertainty and other, heightened consumer financial fears not captured in these indices?
First, don’t rely on banks as market bedrock. Banks are more resilient than other financial entities because they are better capitalized, but stress testing and the buffers reflecting results are not only flawed in more traditional risk scenarios but also founded on linear relationships between defined scenarios, not early warning signs such as heightened uncertainty calling for more liquidity as a critical first line of defense.
What about the rest of the financial system? Secretary Bessent last week pointed to lots of risks outside the U.S. regulatory perimeter and national borders. What might happen to NBFIs under stress such as a retail-investor dash for cash or to foreign GSIBs and NBFIs if Trump policies accelerate trade uncertainty or if geopolitical risk again transmits through fragile commodity markets? And, what of China, a nation uncannily able to exacerbate geopolitical uncertainty? What about a particularly infelicitous Signal chat from The Secretary of Defense? Or …?
Actually, maybe retail depositors and investors aren‘t foolishly frightened. Maybe they’re canaries who, when they stop singing, tell us to turn around.