Federal Reserve Chairman Jerome Powell on Monday evening made the case that business borrowing doesn’t represent the threat to the U.S. economy that subprime mortgages did a decade ago.
Acknowledging that there’s a category of debt that is growing faster than the income of the borrowers even as lenders loosen underwriting standards, and that much of the borrowing is financed outside the banking system, Powell argued at an Atlanta Fed banking conference that the parallels stop there.
“The financial system today appears strong enough to handle potential business-sector losses, which was manifestly not the case a decade ago with subprime mortgages,” he said.
“And there are other differences: Increases in business borrowing are not outsized for such a long expansion, in contrast to the mortgage boom; business credit is not fueled by a dramatic asset price bubble, as mortgage debt was; and CLO structures are much sounder than the structures that were in use during the mortgage credit bubble.”
Related: Fed’s Quarles says leveraged loan buildup isn’t a replay of subprime crisis
Powell pointed out the risks from business lending. “Some businesses may come under severe financial strain if the economy deteriorates. A highly leveraged business sector could amplify any economic downturn as companies are forced to lay off workers and cut back on investments,” he said.
Sen. Elizabeth Warren, the Massachusetts Democrat, and former Fed chief Janet Yellen are among those warning about the risks of such lending. Powell’s colleague on the Fed’s board of governors, Lael Brainard, also has sounded increasing concerns about the market segment.
Powell did acknowledge that regulators are, in his words, “working to stitch these parts together so we can collectively see that larger picture and the risks it holds.” The Securities and Exchange Commission is looking at the potential for liquidity strains at mutual funds, and the Commodity Futures Trading Commission is working to understand the use of derivatives to hedge risks associated with leveraged loans.
Since most of the CLOs are not held by U.S. banks, the Fed is working with the Financial Stability Board in determining the size of the global leveraged loan market and the holders of the loans, Powell said.