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Tags: Treasury | Asset | Sales | Risk-Taking

Treasury Sees Threats in Asset Fire Sales, Risk-Taking

Tuesday, 02 December 2014 05:16 PM EST

Fire sales of assets, the Russia-Ukraine crisis and excessive risk-taking driven by low interest rates all pose potential threats to financial stability, the Treasury Department said.

The Treasury’s Office of Financial Research, in its annual report released Tuesday, pointed to “vulnerabilities associated with declining market liquidity, and the migration of financial activities toward opaque and less-resilient corners of the financial system.” The OFR also cited excesses in the use of leveraged loans and the need to fill “data gaps” in the office’s monitoring of financial markets.

The annual report, the OFR’s third, reflects the concerns of a unit set up under the 2010 Dodd-Frank law to identify and monitor risks. The office, run by former Morgan Stanley chief U.S. economist Richard Berner, works closely with the Financial Stability Oversight Council, a group of regulators led by Treasury Secretary Jacob J. Lew that was created to help prevent another financial crisis.

“We see material evidence of excessive risk-taking during the extended period of low interest rates and low volatility,” the OFR said in its 164-page report. Low rates can encourage “reaching-for-yield and herding behavior following a long period of low volatility.”

Federal Reserve Vice Chairman Stanley Fischer Tuesday signaled that policy makers are closer to dropping their vow to keep interest rates low for a “considerable time” and will stress economic data to guide the first increase since 2006.

Shook Markets

The OFR also said volatility that shook markets in October could occur again.

“Although the dislocation that peaked in mid-October was fleeting, we believe there is a risk of a repeat occurrence, given the increased prevalence of algorithmic trading, a shift in risk preferences by broker-dealers, and the persistent incentives for risk-taking,” the OFR said. On Oct. 15, the U.S. Treasury market had its biggest yield fluctuations in a quarter century.

On Russia, the OFR said the effects of an escalation of tension with Ukraine could spread to U.S. and European financial markets.

Direct Exposure

Foreign bank claims represented about $209 billion of the $700 billion in Russian external debt as of the first quarter of this year, according to the OFR. Direct exposure of U.S. institutions is a “manageable” $27 billion, or 0.8 percent of bank claims. That rises to 3.4 percent “if other claims such as derivatives, guarantees and trade credit are included,” the OFR report said, and “some European banks are heavily exposed.”

Russia-related risks include exposure of investment funds to outflows from the country, and volatility in the energy sector, according to the OFR. Russia accounts for 8 percent of global crude oil imports and the European Union imports 25 percent to 30 percent of its crude oil and gas from Russia, according to the OFR report.

Berner’s office also raised concerns about activities moving to “less tightly regulated parts of the financial system,” sometimes known as the shadow-banking system. The report cited the captive-reinsurance industry, mortgage servicing and single-family rental securitization as shifting in that direction.

Liquidity ‘Fragmented’

The researchers raised concerns about financial-market liquidity, saying it has become “more fragmented” since the 2008 financial crisis. Inventories at large broker-dealers have shrunk, the OFR said.

The OFR came under criticism from the financial industry and lawmakers after it released a report in September 2013 saying asset managers could pose threats when reaching for higher returns, herding into popular asset classes or amplifying price movements with leverage.

In Tuesday’s report, the research office said it wants to fill “data gaps” to help it understand “risks in asset- management activities and short-term wholesale funding markets.”

The OFR last year set up a “Financial Stability Monitor” to track the evolution of various threats. This year’s analysis showed interest-rate risk at the highest level and an increase in vulnerabilities including volatility and corporate credit.

Cyber Threats

Among the monitor’s limitations are a lack of good data on threats from cyber-related attacks, the OFR said. Though the Securities and Exchange Commission requires publicly traded companies to disclose cyber-attacks, “there remains a significant data gap, because firms are reluctant to provide details about the size or impact of cybersecurity breaches due to concerns over potential damage to the confidence of clients and business partners.”

On leveraged lending, the OFR said that “despite stronger supervisory guidance and other actions, excesses in this market show little evidence of easing.”

The office also cited a need to improve data collection in the repurchase agreement and securities lending markets. The OFR, the Fed and the Federal Reserve Bank of New York are planning a data collection pilot program “to improve our understanding of bilateral repo activities,” according to the report.

© Copyright 2023 Bloomberg News. All rights reserved.

Fire sales of assets, the Russia-Ukraine crisis and excessive risk-taking driven by low interest rates all pose potential threats to financial stability, the Treasury Department said Tuesday.
Treasury, Asset, Sales, Risk-Taking
Tuesday, 02 December 2014 05:16 PM
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