Fed warns high asset prices could make investors vulnerable

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FILE - In this June 14, 2018, file photo Federal Reserve Board Governor Lael Brainard participates in an open meeting in Washington. The Federal Reserve on Thursday, May 6, 2021, is warning that the U.S. financial system remains vulnerable to threats stemming from the global pandemic. Fed board member Brainard, who chairs the central bank's financial stability committee, said in a statement that the failure of Archegos highlights the potential for nonbank financial institutions such as hedge funds and other leveraged investors to generate large losses in the financial system. (AP Photo/Cliff Owen, File)

WASHINGTON – The Federal Reserve is warning that prices of stocks and other financial assets are rising to levels that could set investors up for big losses from sudden declines.

A Fed report released Thursday noted that stocks and other risky assets have risen in value since last November, in some cases to record highs, as the outlook for the post-pandemic U.S. economy has improved with increases in vaccinations and business re-openings.

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“Asset prices may be vulnerable to significant declines should risk appetite fall,” the Fed report warned.

The warning was included in the Fed’s twice-a-year “Financial Stability Report.” The central bank has been publishing the report since 2018 in an effort to highlight and address potential threats to the U.S. financial system. Its aim is to prevent a repeat of the 2008 financial crisis that pushed the U.S. and global economies into steep recessions.

“With investors ebullient on expectations for a strong rebound, it is important to closely monitor risks to the system and ensure the financial system is resilient,” Fed board member Lael Brainard, who chairs the central bank’s financial stability committee, said in a statement.

The report also cited vulnerabilities to U.S. institutions from a possible sharp rise in global interest rates that could strain developing countries.

A worsening of the coronavirus pandemic could also stress the financial systems in emerging markets and some European countries, the Fed said.

The risk of instability in those markets could interact with existing vulnerabilities at U.S financial institutions and “pose additional risks to the U.S. financial system," the Fed said.

Recent developments explored in the report include the March collapse of Archegos Capital Management, which generated more than $10 billion in losses at top global banks.

Brainard said the failure of Archegos “highlights the potential for nonbank financial institutions such as hedge funds and other leveraged investors to generate large losses in the financial system.”

She said the incident demonstrated the “limited visibility” regulators have into hedge-fund operations.

“The potential for material distress at hedge funds to affect broader financial conditions underscores the importance of more granular, higher-frequency disclosures,” Brainard said.

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