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The BIS says attempts by the US Federal Reserve and the Bank of England to choke off risky behavior by raising interest rates have failed so far.
The BIS says attempts by the US Federal Reserve and the Bank of England to choke off risky behavior by raising interest rates have failed so far.

BIS Warns Investors of Bubbles in Financial Markets

Investors are at risk of the market experiencing a repeat of the dotcom crash of the early 2000s

BIS Warns Investors of Bubbles in Financial Markets

The body responsible for overseeing the world's central banks has warned that investors are ignoring signs of overheating in financial markets and consumer debt levels rising to unsustainable levels.

The Bank for International Settlements likened current market conditions to the pre-2008 crash era when investors, chasing high returns, leveraged up in order to invest in risky assets, despite moves by central banks to restrict access to credit, InvestmentWeek reported.

The BIS, known as the central bankers’ bank, said attempts by the US Federal Reserve and the Bank of England to choke off risky behavior by raising interest rates had failed so far and unstable financial bubbles were continuing to grow.

Claudio Borio, the head of BIS, said central banks might need to reconsider changing the way they communicated base interest rate rises or the speed at which they were increasing rates to jolt investors into recognizing the need to calm asset markets.

“The vulnerabilities that have built around the globe during the long period of unusually low interest rates have not gone away. High debt levels, in both domestic and foreign currency, are still there. And so are frothy valuations.

“What’s more, the longer the risk-taking continues, the higher the underlying balance sheet exposures may become. Short-run calm comes at the expense of possible long-run turbulence,” he said.

Stock Markets in Danger

The warning came as Neil Woodford, one of the UK’s most high-profile fund managers, said stock markets were in danger of crashing, resulting in huge losses for millions of people.

The founder of Woodford Investment Management, which manages £15 billion ($20.27 billion) worth of assets, told the Financial Times that investors were at risk of the market experiencing a repeat of the dotcom crash of the early 2000s.

Woodford said he was concerned that historically low levels of interest rates in most developed nations over the last decade were pushing asset prices to unsustainable levels.

“Ten years on from the global financial crisis, we are witnessing the product of the biggest monetary policy experiment in history,” he said. “Investors have forgotten about risk and this is playing out in inflated asset prices and inflated valuations. There are so many lights flashing red that I am losing count.”

The BIS said the benign global economy, which is predicted by the International Monetary Fund to see growth accelerate next year to 3.7% from 3.6% this year, was encouraging investors to dismiss concerns about high debt levels and growing asset bubbles.

Economists have become concerned that high-risk investments such as European junk bonds yield similar returns to relatively safe investments such as US government bonds. There are also concerns that some of the most popular investment vehicles such as exchange-traded funds are backed with vast sums of borrowed money.

Woodford also noted that measures of volatility in financial markets had stayed low for an unprecedentedly long period, indicating that investors were betting that the current economic benign period would continue and asset prices would increase for several more years.

Pre-Warning Ignored

The BIS was one of the few organizations to warn during 2006 and 2007 about the unstable levels of bank lending on risky assets such as the US subprime mortgages that eventually led to the Lehman Brothers crash and the financial crisis.

The organization’s chief economist at the time, William White, who now chairs the OECD’s review committee, warned last year that global debt levels had escalated to unstable levels largely in response to almost zero interest rates to create a situation that was “worse than 2007”.

Borio was more circumspect, but said the current attempts to tighten credit with gradual interest rate rises had failed to deter risky behavior. “Can a tightening be considered effective if financial conditions … ease?,” he said.

“Even as the Fed has proceeded with its tightening, overall financial conditions have eased. If financial conditions are the main transmission channel for tighter policy, has policy, in effect, been tightened at all?”

The Bank of England has repeatedly expressed concern about mounting consumer debt in the UK. The BIS has ranked the UK among the most vulnerable countries in terms of households’ debt service burdens, especially if interest rates were to be raised rapidly.

Last week the UK’s central bank reported that consumer debt in October had grown by 9.6%, more than four times the average for wage increases of 2.2%.

 

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