FRB Cleveland/OFR Financial Stability Conference Remarks
Published: November 18, 2021
Thank you, Dasol, for your kind introduction.
Good afternoon and thank you also to President Mester for co-hosting another fantastic stability conference.
As Dasol noted, my name is Dino Falaschetti, and I have had the privilege of leading our Treasury Department’s Office of Financial Research since 2019. This morning, I am excited to share an overview of our recently published Annual Report to Congress.
Unlike last year’s report, which was written in the wake of a material threat to financial stability, this year’s report was written during a remarkable economic recovery. Our 2021 Annual Report to Congress documents the COVID-19 global pandemic, which continues to grab headlines as it stretches into its twentieth month. However, while many economic sectors have begun to recover, we cannot become complacent. The recovery in the first half of 2021 was robust, but its momentum has slowed in the second half as a result of both existing and new vulnerabilities, including the future of the COVID-19 pandemic, rising inflation, and tighter monetary policy.
To be sure, macroeconomic uncertainty will test the staying power of our economic rebound, and risks that have not traditionally been examined in terms of threats to financial stability may begin to take shape.
Our 2021 Annual Report to Congress saw that overall risks to U.S. financial stability remained in a medium range. Our Office reached this assessment after carefully weighing the resilience of the nation’s financial system against its vulnerabilities. While some vulnerabilities have played a role in past crises, others have not. That said, early recognition of any vulnerabilities provides regulators and policy makers more room to react in a timely manner.
As I mentioned earlier, COVID-19 variants may continue to emerge, potentially threatening a fuller-scale economic recovery. Unfortunately, no amount of financial monitoring can fully predict these outcomes.
Last week, the U.S. Department of Labor reported that the consumer price index rose 0.9% in October, with an annual rate that is now above 6% - a high not seen since 1990. While inflation is still nowhere near the heights it was in the 1970s companies across the nation continue to deal with supply chain bottlenecks and labor shortages, which include millions of workers who were lost during the pandemic, willingly or not.
Rising inflation could increase the risk of an economic slowdown, though currently, financial conditions appear stable.
Credit risk is susceptible to high debt burdens and vulnerabilities in some sectors that could worsen. Nonfinancial corporate debt levels, already elevated before the pandemic, saw new record highs after the virus’ outbreak, aided by extraordinary monetary and fiscal stimulus and fueled by investor demand for higher yields.
In the Treasury cash market, actions in 2020 by the Federal Reserve improved liquidity and reduced volatility, but structural vulnerabilities could still exist. Likewise, near-term market risks appear contained by the supportive nature of fiscal and monetary policies, solid corporate earnings, and risk-free rates at historic lows.
Lastly, our Annual Report highlights specific sectors of our economy that might play a role in impacting U.S. financial stability.
Short-term impacts to the commercial real estate market have been mitigated due to strong liquidity injections. Long-term impacts remain uncertain, as multiyear leases expire and companies reevaluate their needs.
Residential real estate market-risk is low due to strong home prices and the forbearance relief and eviction bans put in place as the pandemic took hold. It is important to note that, as expiring consumer assistance programs wane, some amount of burden could return for certain homeowners and renters. Turning to hedge funds, we have seen stronger-than-expected performance throughout 2021. However, the default by Archegos earlier this year could raise questions about the financial stability of the hedge fund sector—something the OFR will continue to monitor closely.
As I noted earlier, this year’s report contains two emerging risks that have traditionally not been examined more completely in terms of vulnerabilities to financial stability.
The OFR first identified cybersecurity as a potential risk to financial stability in 2016, a concern that has only increased since the onset of the COVID-19 crisis. By almost every measure, the cost of cyberattacks has surged in recent years both in terms of direct losses and the expenses tied to prevention. In 2021 alone, the U.S. led the world in the average cost of data breaches at just over $9 million, up 5% from the previous year. That figure more than doubled the average global cost, which stands at $4.2 million. This year’s report examines how a cyberattack on critical systems or infrastructure could disrupt services and threaten stability of the financial system.
Relative to other vulnerabilities discussed in this report, climate risk is not as easily defined. Major weather events, the impacts of which the OFR has highlighted in previous reports, have yet to trigger a financial crisis on a systemic level. To be sure, climate change is a growing risk to monitor, and our Office stands ready to support the FSOC with the research and data necessary to complete that research.
As I enter my fourth year as Director, I am incredibly proud of my colleagues who continued to meet our statutory mandate as Congress intended it. During these turbulent times, our Office dutifully supported the FSOC and its members by producing timely research and analysis, as well as providing relevant financial data. This year’s report saw contributions from every part of our Office, a truly, whole team effort.
The OFR remains committed to financial stability, because in its absence, households and businesses cannot reliably advance real economic opportunities. This is the seriousness with which we pursue the important mission of our OFR.