Visitors take photographs near the U.S. Capitol in Washington, D.C., on January 2, 2020. Photographer: Andrew Harrer/Bloomberg.
The U.S. government’s debt load is now seen as the biggest risk to financial stability, outweighing persistent inflation in a Federal Reserve survey. “Concerns surrounding U.S. fiscal debt sustainability were atop the list in this survey, followed by escalating tensions in the Middle East and policy uncertainty,” the Fed said in its semi-annual financial stability report.
The report includes a survey of the Fed’s financial-market contacts conducted from late August to late October, conducted by New York Fed staff members. It also includes the central bank’s assessment of developing risks in four main areas: asset valuations, borrowing by businesses and households, leverage in the financial sector, and funding risks.
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More than half of the respondents—54 percent—cited fiscal debt sustainability as a salient risk, up from 40 percent just six months ago. Respondents worry that more debt issuance by the Treasury could start to crowd out private investment or limit policy responses if there’s an economic slump, the survey found.
By contrast, respondents believe the banking sector remains “sound and resilient overall,” with capital ratios hovering around record levels and liquidity high, the Fed said. But in financial markets, the Fed found valuations remain elevated, liquidity is “generally low,” and leverage across hedge funds is at or near the highest level observed since data became available in 2013. The central bank also singled out life insurers for a steady decline in the liquidity of their assets amid greater use of alternative investments.
Taking a look at households, the Fed said credit card and auto loan delinquencies are above average, especially among those with lower credit scores. Overall, the report judges vulnerabilities related to household and business debt as moderate. “These borrowers hold a relatively small share of aggregate debt, and their high delinquency rates reportedly reflect, in part, more borrowing by some households during and after the pandemic, rather than an abrupt broad-based weakening in households’ ability to repay,” the report said.
The central bank said funding risks have eased but remain “notable.” With an eye on last year’s bank failures, the Fed said that most lenders are relying less on uninsured deposits. Those tend to attract customers who might quickly yank their money away if there’s a hint of trouble at a lender, a vulnerability that contributed to bank failures in the weeks surrounding the March 2023 turmoil. Some lenders have now increased deposits collected through brokers and from other short-term sources of cash, according to the report. “The stability of this type of funding during periods of stress may be lower than that of traditional core insured deposits,” the Fed said.
Finally, the report addressed stablecoin assets, which have grown “substantially” since the prior report, with a total market capitalization of more than $170 billion by the beginning of November—a notch below a record high seen in April 2022. “These digital assets are structurally vulnerable to runs and lack a comprehensive federal prudential regulatory framework,” the Fed said.
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