Quote of the Day: Monetary policy is contributing to risk taking...is unsustainable and will collapse on itself

I think monetary policy is contributing to risk taking. The whole point of zero interest rates is to force borrowers and lenders out on the risk curve. So, if you are a bank and you can't make your cost of capital if you are holding a lot of government securities or highly-rated corporate debt, you go out on the risk curve to get a higher rate of return and that is what we are seeing now.

So, we're seeing banks that traditionally held large quantities of high quality debt dramatically reduce those holdings. They are holding less liquid, riskier assets, which in and of itself creates problems. One is because they have more risk – the risk of credit losses is greater. The other is that the market may need liquidity if we have a lot of volatility in the fixed income markets as the Fed moves to raise interest rates. The traditional providers of liquidity are not there anymore and that creates instability in the system.

And, then, unfortunately, you are seeing households taking on more debt now, too. They are borrowing more. Their rising debt levels are outstripping their meager income gains. That always raises a red flag: when income gains are insufficient to support repayment of that debt, that’s when you start having instability build in the system. That’s what we saw prior to the crisis: when real wages were flat, mortgage debt was increasing dramatically. That is unsustainable. At some point it collapses on itself. I think we are still some ways away from that happening, but nonetheless you see that trend is again at play.

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This excerpt is from an interview of Sheila Blair—Senior Advisor, Pew Charitable Trusts and Chairman, Systemic Risk Council; former Chairman, Federal Deposit Insurance Corporation; former Assistant Secretary of the Treasury for Financial Institutions; former Commissioner of the Commodity Futures Trading Corporation; and former Counsel, Senate Majority Leader Robert Dole—at Professors Stephen Cecchetti and Kermit Schoenholtz’s Money and Banking