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The Federal Reserve Board | Concerns with Risk

  • Writer: Doug Lagerstrom
    Doug Lagerstrom
  • Oct 4, 2022
  • 2 min read

Although the Federal Reserve Board (FRB) is charged with a dual mandate of price stability and full employment, another element they pay attention to is risk taking. In the words of former FRB Chairman Alan Greenspan, “… we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.”*



The purpose of capital markets is to allocate money efficiently. By allowing investors to decide where to allocate their money, the thinking follows, they will seek to maximize their risk adjusted return. They won’t be foolish with their own money.


History shows us mixed results on that front. In his seminal classic “Extraordinary Popular Delusions and the Madness of Crowds” Charles McKay details several financial bubbles including the Mississippi Scheme, the South Sea Bubble and Tulipmania. His book, first published in 1841, has since been revised to include other financial bubbles.


In his “irrational exuberance” speech December 5, 1996, chairman Greenspan shared his concerns about the financial market’s valuation. “But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”* I remember that night. The S&P 500 futures were down limit, meaning stock prices declined substantially and trading was halted until the next morning. After a few anxious days, the NASDAQ bull market continued and ultimately peaked in March 2020.


What does that have to do with today?


In 2021, interest rates were zero, the economy was in lock down, stock trading was free, sports were cancelled so the only gambling game left in town was the stock market. The money seemed to flow to the riskiest assets. GameStop, Robinhood, AMC, NFT’s, and Crypto currencies all had stellar returns that year. There is, however, a difference between prudent risk taking and foolish behavior. Because the later can have an undesirable effect on the economy, the Fed needs to be concerned with it, as former Chairman Greenspan noted.


In addition to fighting inflation, higher interest rates hurt the value of the riskiest assets the most. By taking some “irrational exuberance” out of the financial markets, the FRB is hoping to return to disciplined investing. At PWS, we commit to doing our part, as always.


Doug Lagerstrom


*“The Challenge of Central Banking in a Democratic Society” December 5, 1996


 
 
 

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Doug Lagerstrom and Allen Minassian are registered with and offer securities through Kovack Securities, Inc. Member FINRA/SIPC. 6451 North Federal Hwy, Suite 1201 Ft. Lauderdale, FL 33308 (954)782-4771. Investment Advisory services offered through Private Wealth Solutions, a registered investment advisor. Private Wealth Solutions is not affiliated with Kovack Securities, Inc. or Kovack Advisors, Inc. The Investment Adviser Representative of Private Wealth Solutions offers investment advice with residents of a SEC/jurisdiction for which they are properly registered or where excluded from registration requirements. Linked sites are strictly provided as a courtesy. Kovack Securities, Inc. does not guarantee, approve nor endorse the information or products available at the sites, nor do links indicate any association with or endorsement of the linked sites by Kovack Securities, Inc. nor Kovack Advisors, Inc.

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