Federal Reserve Economic Overview: Things Look Pretty Good

NEW YORK (AP) – The risks to the U.S. financial system have eased significantly compared to a year earlier, the Federal Reserve said Monday. The central bank noted that as the economy recovers from the pandemic-driven recession, the balance sheets of individual Americans and businesses continue to strengthen.

However, the Fed did cite the significant rise in asset prices – most notably home and stock prices – as well as the rise of volatile trading of so-called “meme” stocks as potential risks to the financial system.

There is also the risk that the coronavirus pandemic could worsen again, which would in turn impact stock prices and exacerbate the supply-chain problems rippling throughout the global economy, the Fed said.

“Despite recent improvements, an increase in uncertainty over the course of the pandemic might pose risks to asset markets, financial institutions, and borrowers in the United States and globally,” the Fed said.

The observations came in the Fed’s semiannual Financial Stability Report on trends going on in both trading and investing, as well as broad economic issues. The report is not an economic forecast, nor does it try to predict the next risk to the financial system. But it does attempt to highlight areas of concern to central bankers.

Overall the financial system is in better shape than it was a year ago and even six months ago, the Fed said. Borrowing by individual Americans and businesses continues to trend back to pre-pandemic levels. Low-interest rates have made handling higher levels of debt easier. Banks are reporting record profits and their balance sheets are nearly back to where they were before the pandemic.

The Fed did note the rise in asset prices from a year earlier, and how prices for assets ranging from stocks to homes are at levels above historic norms. The central bank said in its report that it has not seen a decrease in credit quality for mortgages, however, which was the cause of the financial crisis of 2008 and the Great Recession.

If investors were to decrease their appetite for risk, or if interest rates were to rise significantly, these high asset prices could fall noticeably, which would be a risk to the financial system, the Fed said.

One notable element of the report is the Fed’s attention to “meme” stocks such as GameStop, AMC Entertainment and others. These companies have seen extremely volatile trading this year largely due to a tug-of-war between Wall Street hedge fund managers and a mostly online group of retail investors who collectively strategize over social media.

The Fed noted that the combination of companies charging extremely low or zero dollar commissions to buy or sell stock, plus social media, has made it easier for individual investors to heavily influence one particular company’s stock price. Retail investors are now using advanced forms of trading such as options or leverage, which could further pressure a stock one way or another.

The Fed also seemed to express concern about the way these online trading platforms make stock trading appear like a video game.

While the Fed said in its report that it does not believe GameStop or AMC individually would have caused any issues for the economy or the financial system, it notes that it would not be hard for another company to become a target like GameStop if the conditions were right.

“Social media can contribute to an ‘echo chamber’ in which retail investors find themselves communicating most frequently with others with similar interests and views, thereby reinforcing their views, even if these views are speculative or biased,” the Fed said.

There are also concerns that these retail investors – who are generally much younger – may not be able to financially handle a significant drop in stock prices.