Fed Issues Warning About High Debt and Overvalued Asset Prices

While the markets were giddy about the prospects of a coronavirus vaccine, the Federal Reserve was warning of more economic chaos on the horizon.

The Fed released its biannual Financial Stability Report Monday. The report warned we could see a wave of defaults and “significant declines” in asset prices in the near future.

The biggest concern outlined by the Fed is the surging levels of debt in the economy. “As many households continue to struggle, loan defaults may rise, leading to material losses,” the Fed report warned.

It also expressed concern about the rising levels of business debt.

Debt owed by businesses, which was already historically high relative to gross domestic product (GDP) before the pandemic, has risen sharply as businesses increased borrowing to weather the period of weak earnings. The general decline in revenues associated with the severe reduction in economic activity has weakened the ability of businesses to service these obligations.”

According to the report, small businesses “credit quality … has worsened notably since the COVID-19 outbreak and has not yet stabilized, with many small businesses closing or scaling back operations significantly during the crisis.”

Despite the problems, the Fed said the worst possible outcomes resulting from the pandemic have been largely avoided – so far.

So far, strains in the business and household sectors have been mitigated by significant government lending and relief programs and by low interest rates.”

The Federal Reserve report also expressed concern about overvalued asset prices, particularly the stock market.

Given the high level of uncertainty associated with the pandemic, assessing valuation pressures is particularly challenging, and asset prices remain vulnerable to significant declines should investor risk sentiment fall or the economic recovery weaken.”

In simple terms, the Fed’s monetary policy has blown up a big stock market bubble, along with bubbles in other asset prices including housing. It wouldn’t take a very long pin to pop those bubbles and send the stock market crashing through the basement.

Speaking of the housing market, the Fed noted that it is showing signs of stress.

The strength in the housing sector reflects robust demand from households and is being supported by the low level of interest rates. However, downside risk remains, given the unusually large number of mortgage loans in forbearance programs and the uncertainty around their ultimate repayment.”

About 7% of mortgage holders are behind on payments. That up about 2% since the beginning of the pandemic.

Overall, the Fed report warned that we still have high levels of risk in the US economy.

In the near term, risks associated with the course of COVID-19 and its effects on the US and global economies remain high.”

Ironically, the Federal Reserve created this high-debt environment and blew up the suddenly problematic asset bubbles – on purpose – through the very programs it claims have saved us from harm. Artificially low interest rates and borrowing programs funded by money printing allowed businesses to run up the massive levels of debt the Fed is now concerned about. They also fueled the big run-up in the stock market even as the economy collapsed under the pressure of government lockdowns.

This is precisely why we have said there is no exit strategy from this extraordinary monetary policy even if scientists come up with an effective coronavirus vaccine. As Peter Schiff noted in a recent podcast, “The problem is not really the fact that we have a disease, but that we’re addicted to the cure, which was cheap money and all this debt. And so now, it’s the addiction to the cure that’s the real problem.”

The Fed can’t take away the cure without causing an even bigger problem than the initial disease that the cure was meant to cure because now the problem isn’t the disease. Who cares about that? The problem is the cure that was so addicting. And now we’ve got an even bigger problem than the one we started with. And that problem’s not going away. There is no antidote or vaccine that’s going to work for that. We are stuck with that.”