FRB Cleveland / OFR Financial Stability Conference Remarks

Thank you, Dasol, for your kind introduction.

Good afternoon, and thank you also to President Mester for co-hosting another fantastic stability conference. My only disappointment is having to miss your city’s terrific Italian fare this year.

As Dasol noted, my name is Dino Falaschetti and I have the privilege of leading our Treasury Department’s Office of Financial Research. This morning, I am excited to share with you an overview of our Office’s recently published Annual Report to Congress.

When we last convened in Cleveland, our Office of Financial Research was about to publish its annual assessment of financial stability. Like many other assessments published at the end of 2019, our Office saw risks to financial stability in the medium range.

Unbeknownst to us and most anyone, a global pandemic would unfold only a few months later – triggering uncertainty, considerable market turbulence, and a sharp spike in unemployment to almost 15 percent – higher than any time since the 1930s. Massive central bank and fiscal interventions were delivered.

Fast forward one year. Our Office’s financial stability assessment sent to Congress earlier this week is much different than our 2019 study. I raise this not to be critical but to highlight that vulnerabilities to financial systems can be fundamentally difficult to anticipate. Despite lessons learned from past crises, and despite ready access to informative data, sound research, and insightful analysis, COVID’s health, economic, and financial crisis surprised market participants, central banks, and regulators alike.

This year’s global pandemic dominated headlines, with far reaching implications in most financial categories. Our Annual Report finds the pandemic and related economic, financial, and government policy reactions impacting all risk categories that we monitor, and triggered disruptions far worse than the most severe stress tests had projected.

Against this backdrop, risks to financial stability appear elevated. To be sure, at the same time that new vaccines appear promising, they may soon have to contend with a strong “second wave” of increased cases. Macroeconomic risk could thus remain elevated as long as the pandemic continues. And to the extent that banks respond by tightening lending standards, a reduction in loan availability could also temper economic recovery.

Unlike previous annual reports from our Office, this year’s publication was written in the wake of a material and unexpected threat to financial stability.

Moreover, despite lessons learned from past crises, and despite ready access to informative data, sound research, and insightful analysis, Covid’s health crisis surprised market participants and experts alike. Our annual report this year thus explores the potential for information markets to complement more traditional stability monitors.

To be sure, economic indicators on the eve of a global pandemic showed little if any concern about a slowdown, let alone a sharp but short economic contraction. For example, our unemployment rate for February dropped to a 50-year low of 3.5 percent. Just two months later, it spiked to almost 15 percent.

The Great Financial Crisis of 2008 revealed vulnerabilities in commercial real estate. Those vulnerabilities also appear as a source of financial fragility in this year’s COVID crisis. To the extent that employees continue to work remotely post-COVID, those fragilities could be even more concerning.

State and local governments have seen sharp drops in revenue at the same time that demand for resources to cope with the pandemic have increased. As a result, credit risk has risen for some municipal bonds, and especially so for those backed by revenue from projects such as transit systems and convention centers.

Other vulnerabilities include natural disasters, Britain’s exit from the European Union, and the transition from LIBOR to alternative reference rates for financial instruments.

Perhaps the most important revelation from the pandemic - from an analytical perspective - is the limits to how researchers typically evaluate threats to financial stability. The pandemic made clear that conventional monitoring tools can be prone to material blind spots.

The 2020 global pandemic illustrates the difficulty these market assessments had in predicting economic stress events. Invariably, any such process of identification is prone to finding vulnerabilities that turn out to be immaterial or nonexistent, as well as missing vulnerabilities that are fundamentally difficult to anticipate.

To this point, in 2019, about 30 central banks, multilateral organizations, and government agencies around the world issued official financial stability reports, including the OFR. Yet, not one discussed the potential for a pandemic to threaten financial stability.

During the turbulent months since the pandemic, our Office’s mission has never been more clear or important. As COVID-related disruptions evolve, OFR’s data and research products will continue to provide timely indicators of stress for the Financial Stability Oversight Council (FSOC) and its members.

Following my confirmation, our Office executed on an all staff strategy to dutifully fulfill our Dodd-Frank responsibilities - that is, to further financial stability through informative analysis of financial data, and advance data standards and products, principally in support of FSOC and its members. Following this strategy throughout the turbulent months that began in February of this year, the value that our Office has provided to FSOC and its members has increased and deepened considerably.

Contributions to our annual report have come from every part of our Office. I am proud of this good work and whole team effort, and even more so during the challenging fallout from a global pandemic.

I am grateful for the integrity that our staff-members bring to our office each and every day. Without it, we cannot do our best work. With it, we will continually strengthen our Office’s support of FSOC and its members by building on our organizational excellence, and furthering our culture of accountability and professionalism at every level.

Finally, let’s always remember why we engage this mission – because when and where financial stability is compromised, economic opportunities go missing throughout our society. And that impact can be especially acute for low- and moderate-income households that may have trouble weathering emergencies, lack opportunities for economic mobility, or face high hurdles to improve life chances for children. As our recovery develops further, OFR will continue to fulfill its mission to strengthen financial stability, and ultimately economic opportunity.