Sen. Elizabeth Warren has sent a letter to Treasury Secretary and Chair of the Financial Stability Oversight Council (FSOC) Janet Yelle [1]n seeking information on how the FSOC is responding to three potential risks to the banking system caused by the Federal Reserve’s increase in interest rates over the past year-and-a-half:
- The decline in value of banks’ bond portfolio
- Losses in commercial real estate
- Losses in the leveraged lending market
“The collapse of Silicon Valley, Signature, and First Republic Banks in March 2023 further demonstrated the risks that the Federal Reserve’s (Fed) rate hikes posed to banks’ balance sheets, and banks’ failures to adequately manage that risk,” wrote Sen. Warren [1]. “In light of these developments, I seek information about the steps FSOC is taking to respond to three potential threats to the financial system.”
Beginning in March of last year, the Fed announced interest rate increases to fight inflation [2]. After a brief pause in hikes in June 2023 [3] to hold rates steady, another increase in July raised the rates to their highest levels in 22 years. These historic interest rate hikes have “led to rapidly tightening financial conditions and bond fund outflows straining fixed income markets,” according to the Office of Financial Research (OFR).
In the letter [1], Sen. Warren asked Treasury Secretary Yellen, in her capacity as FSOC Chair, to take strong action to address the alarming fallout from these rate hikes and protect the safety of our financial system. Sen. Warren identified the following three potential risks to the banking system caused by these recent rate hikes:
- Risks to banks from unrealized losses on bonds: As the Fed raised interest rates, bond prices fell, leaving banks with assets that have significantly declined in value. The prevalence of this risk across the banking system threatens to spell more deposit runs and bank failures that could catalyze another crisis.
- Risks to the commercial real estate sector: The streak of interest rate hikes and the largescale shift to remote work after the COVID-19 pandemic have slashed commercial real estate values. Pension funds, real estate investment trusts, and especially regional banks that have heavily invested in commercial real estate are finding themselves with loans and securities with much less value.
- Risks emerging from the leveraged lending market: Rising interest rates have put pressure on the $1.4 trillion leveraged lending market. While banks, insurance companies, pension funds, hedge funds, and other private investments funds that originate leveraged loans may hold them directly, the vast majority of leveraged loans are sold off to investors, allowing exposure to these loans to spread throughout the economy. If leveraged loan borrowers are unable to repay their loans, these companies and the loans could fail, spreading risk to all the entities that are exposed to them.
“I am concerned that financial institutions may not be adequately managing these risks particularly in light of reports that banks are planning huge shareholder payouts,” added Sen. Warren [1]. “I urge FSOC to carefully assess these risks and work swiftly to mitigate them.”
In July 2021, Sen. Warren sent a letter to U.S. Treasury Secretary Yellen [4] urging the FSOC to use its existing authority to address risks posed by the highly volatile cryptocurrency market and lead the financial regulatory agencies in developing a comprehensive and coordinated approach to regulating cryptocurrencies.
In March 202, Sen. Warren sent a letter to Treasury Secretary Steven Mnuchin [5], who also serves as Chair of the FSOC, requesting information about the leveraged lending market and the risks these loans pose to the financial system as global financial and economic conditions deteriorate amid the spread of COVID-19.
In October 2019, Sen. Warren sent a letter to Treasury Secretary Mnuchin [6], who also serves as Chair of the FSOC, requesting information about recent turmoil in the overnight market for repurchase agreements (repo market) and the Federal Reserve Bank of New York (New York Fed)'s response to this volatility.
In November 2018, Sen. Warren sent a letter [7] to Treasury Secretary Mnuchin, Federal Reserve Chairman Jerome Powell, Comptroller of the Currency Joseph Otting, Federal Deposit Insurance Corporation Chairman Jelena McWilliams, and Securities and Exchange Commission Chairman Jay Clayton, expressing concern about the rapid growth of leveraged corporate lending and the inadequate response from the FSOC and federal regulators.