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Former Fed chair warns of ‘gigantic holes in the system’ & new financial meltdown risk

Former Fed chair warns of ‘gigantic holes in the system’ & new financial meltdown risk
Janet Yellen, former US Federal Reserve chair, has warned that another financial crisis could be in the country’s future, due to ballooning corporate debt and regulatory impotence.

I think things have improved, but then I think there are gigantic holes in the system,” Yellen told economist Paul Krugman at the City University of New York. Winning the award for understatement of the century, she added that “The tools that are available to deal with emerging problems are not great in the United States.”

High levels of corporate debt are especially worrisome, said Yellen, who compared the “collateralized loan obligations” (CLOs), created by bundling corporate debt for investment purposes, with the collateralized debt obligations – made of high-risk subprime mortgages – that inflated the housing bubble, ultimately causing the 2008 collapse. Like those mortgages, the corporate debt that comprises these instruments is rated very low – one step above junk, in many cases. However, she said, holders of CLOs are in a better position to absorb any potential losses, making a repeat of 2008 unlikely.

Still, corporate debt now stands at $9.1 trillion, almost twice what it was in 2007. If there’s a downturn, she said, such “high levels of corporate leverage could prolong the downturn and lead to lots of bankruptcies in the non-financial corporate sector.”

Yellen lamented the unfinished post-2008 regulatory agenda, highlighting areas that desperately needed addressing and mentioning “regulatory pushback” against finishing the job. As the Fed’s powers currently stand, she said, regulators cannot address systemic issues, only individual banks. While some regulatory powers were expanded after the crisis, others were limited.

She mostly steered clear of discussing the current economic situation, limiting herself to vague generalities: “Interest rates are low. I believe they’re likely to remain lower than they’ve been in past decades.” Her successor, Jerome Powell, has raised interest rates three times since taking over in February and is expected to increase rates again before the end of the year.

Her remarks represent a shift from the sunny (if unrealistic) optimism she displayed a year ago after leaving office, when she told a London audience she did not believe there would be another financial crisis in her lifetime because of “financial reforms.”

President Trump has been harshly critical of the Fed, calling it the “biggest threat” to his presidency and blaming it for several market downturns in recent months. While appointing Powell was his idea, he has wondered out loud if he made a mistake and has urged the new chairman to focus on “what’s good for the country” instead of raising rates.

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