Can We Talk?

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 is the gift that keeps on giving. One of its little known presents is the Office of Financial Research (OFR), which promotes financial stability by looking across the financial system to measure and analyze risks, perform essential research, and collect and standardize financial data. The ORF’s primary duty is to support the Financial Stability Oversight Council (another child of Dodd-Frank), the Congress, the Council’s member organizations (including the Fed), and the public.

Twice a year the OFR releases its assessment of risks in the financial system in the U.S., and when reviewing the release it is fun to imagine what these researchers whisper into the ears of the financial policy power elites. Last week it released a report that included the unsurprising observation that “overall risks remain in the medium range but have been pushed higher by the United Kingdom vote to exit the European Union.”  Mildly surprising is the thought that seven years after the financial crisis we should be no better off than in the medium range. However, this tepid assessment is consistent with the Fed’s cautious approach to raising rates and its desire to continue pushing forward with financial re-regulation. It is easy to see that regulation will grow tighter in the years to come, in our view.

More surprising is the OFC’s view that the biggest risks for the financial system stem from long-term U.S. interest rates that have declined to ultra-low levels and can motivate excessive risk-taking and borrowing. Considering the Fed has kept the Fed funds rate essentially at zero since 2009, we wonder how it dances around this issue? We can picture the OFR going into Janet’s office and saying, “Can we talk?”

Obviously, the Fed should know its policy of low interest rates and quantitative easing contributes to financial instability, yet the lack of very loose monetary policy could lead to something worse. So it stays the course. Rates will be lower for longer, and the Fed will try to balance the risk of lower rates with tougher financial regulation. We hope this works.

Sources: Office of Financial Research (OFR), Bloomberg, Wall Street Journal