Surging corporate debt and spiking equity and corporate valuations have combined to put the US economy at more peril now that even at the beginning of the covid-19 crisis, the US Department of Treasury’s risk council says.
“These valuation pressures make these markets vulnerable to a major repricing of risk, increased volatility and weakening balance sheets of financial and nonfinancial businesses,” the Financial Stability Oversight Council said in its annual report. “Sharp reductions in the valuations of different assets could heighten debt rollover risk.”
The warnings in the 200-page report canvass everything from climate change to inflation to cryptocurrencies. They’re used to urge the SEC, CFTC and other regulators on in their reform plans. SEC chairman Gary Gensler and CFTC acting chair Rostin Benham both sit on the council and voted to approve its report on 17 December.
Financial services firms are reluctant stars of the new report:
- When the pandemic hit the US, it “highlighted the potential for liquidation pressures to be amplified by prime money market funds… and open-end mutual funds because of the liquidity risk in their business models, and by hedge funds because of their use of leverage”.
- Broker-dealers and asset managers, meanwhile, have helped drive up securities on loan to $646 billion.
- The collapse of family office Archegos Capital Management “highlighted the importance of counterparty credit risk management practices and relatively limited visibility into the activities of highly levered private investment vehicles”.
- The January raid on GameStop, AMC and other “stonks” has forced regulators to think about how rapidly changing technology has widened the pool of retail investors – and the risks they face.
- As banks have throttled back their lending, private equity firms have throttled up. Between 2015 and 2020, private debt “roughly doubled” to more than $1 trillion. “In addition to supporting the private credit business of their private equity firm owners such arrangements may also generate investment management fee income,” the report states. “This intersection may increase interconnectivity among nonbank lenders, insurers and the broader financial sector while exposing a growing investor base to lending activities that may be subject to less regulatory scrutiny.”
This article first appeared in affiliate publication Regulatory Compliance Watch