Fed’s Rosengren: Distress Ahead for the Heavily Leveraged

Boston Federal Reserve Bank President Eric Rosengren opposed the pre-crisis rate cuts and now he is being proven right, the pandemic’s effects will be worse than otherwise because the Fed had less ammunition while some individuals and firms accumulated too much low-interest debt, he said Wednesday.

“If this continues for some time and there’s some persistence to how long it is that we have to be sheltered at home then you are going to see more and more distress in those riskier types of deals and those may not come down very quickly,” Rosengren said, answering a question in a teleconference organised by the Boston Chamber of Commerce.

He and Cleveland Fed President Loretta Mester had dissented from three of last year’s rate cuts, saying the economy at that time didn’t need additional easing. “When interest rates are very low for a long period of time individuals and firms take more risks,” he said.

“What is really a public health crisis is likely to become a more severe problem for the financial side of the economy,” Rosengren continued. “Some individuals and many leveraged firms are in a position where they’re not going to be able to go without revenue over a period of months.”

He went on, “If the public health side means that we have to be sheltered in place for a longer time than currently anticipated firms and individuals that took on a lot of debt are not going to be well positioned to whether this storm through this. That is something I wanted to avoid.”

He added he was concerned about the financial stability threat from “encouraging too many people and firms to take on too much risk,” and added, “I think over the next several months we’re probably going to start seeing evidence that those that became very levered experience very significant losses and that will make the downturn much more severe than it otherwise would have been.”

He described the Fed’s massive buying programmes as very much a work in progress, with positive results in some markets showing up only “a couple of days ago” and in some cases still not sufficient. Asset-backed commercial paper, which tracks the fed funds rate, saw rates up “dramatically” until couple of days ago, only now starting to “stabilise a little bit.” Highly-rated corporate debt was seeing significant changes in prices along with difficulties in issuance and even now, spreads are still elevated and only “somewhat improved.”

Rosengren said he expects at least two quarters of “negative growth,” and unemployment up “substantially.” He said the Fed’s projection is for an unemployment rate heading above 10%.

In commercial real estate the pandemic “is going to be a challenge, I think, in the near term for both homes and for apartments as well as office properties” that amounts to “significant softening over time.”

Large landlords are not specifically helped in the Phase 3 CARES Act and may be among those, including states and municipalities with broken budgets, who may need Phase 4 support from Congress, he said.

There may be longer term effects even after the pandemic fades, for housing markets to office properties. “I think it’s going to change some of the ways people are thinking about doing things in the long term,” with more telework leading to less need for office space, he said.

What is “particularly troubling about this pandemic and one of the primary concerns” is how is has “disproportionately affected hourly workers. The low- and moderate- income workers are probably going to bear more of the brunt of this” because of their reliance on mass transit, where now social distancing has crippled. The overall economy’s recovery, in fact, may have to await the restoration of mass transit, he said, adding, “So a lot of attention has been focused on the business community and I think the business community obviously is critically important. But we probably need more attention to the non-profit side which tends to provide a lot more of the services to low-income individuals.

“We can’t be forgetting the food pantries, we can’t be forgetting the homeless shelters, we can’t be forgetting the various other services that are provided to low-income individuals.”

Colin Lambert

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