(Updates with Yellen in ninth paragraph, closing markets in fifth.)
Nov. 11 (Bloomberg) -- Federal Reserve Bank of San Francisco President John C. Williams said he sees a “significant risk” of a new asset bubble forming that would leave the financial system and economy vulnerable.
Williams, in remarks delivered in Washington, also said he sees a “risk of runs in financial markets.”
The Fed will be limited by the Dodd-Frank financial overhaul legislation in providing liquidity to individual institutions and non-banks, and it’s unclear whether regulators will be able to complete orderly resolutions of systemically important entities, the policy maker said. Requiring banks and other large, interconnected institutions to hold more capital and strengthen their liquidity positions also may not be enough to offset the next crisis, Williams said.
“Despite serious reforms to strengthen our financial system, significant risk remains that another asset bubble could develop,” Williams said without specifying where the trend of rising prices would develop. “Moreover, the financial system and the economy are still vulnerable to such an event.”
U.S. stocks rallied, preventing a second straight weekly decline for the Standard & Poor’s 500 Index, as consumer confidence topped estimates and Europe took steps to address its debt crisis. The S&P 500 jumped 2 percent to 1,263.85 at the close in New York, pushing the index up 0.9 percent for the week and 0.5 percent in 2011.
Williams, appearing on a panel to discuss challenges and solutions to monetary and macroprudential policies, said he sees signs suggesting that “the risk of runs in financial markets remains a very real concern for financial and macroeconomic stability.”
In addition, “it remains untested whether supervisors can successfully complete an orderly resolution of complex, systemically important international financial institutions during a period of heightened uncertainty,” Williams said in the remarks at the International Monetary Fund headquarters.
Fed officials refrained from taking any new steps to ease policy this month, while saying “significant downside risks” remain to the outlook. The Federal Open Market Committee kept policy unchanged, by reiterating it would lengthen the maturity of the Fed’s bond portfolio and hold the benchmark interest rate near zero through at least mid-2013 if unemployment remains high and the inflation outlook is “subdued.”
Fed Vice Chairman Janet Yellen, appearing in Chicago today, said that “very low levels of interest rates can potentially touch off a buildup of leverage and risk in the financial system.”
“While I don’t believe monetary policy should be the main tool for addressing financial instability or the buildup of systemic risks, I would look to macroprudential and supervisory, microprudential tools to do that,” she said in response to audience questions. “It’s tremendously important for a group of monetary policy makers to be keeping a very close eye on the financial system and monitoring that buildup of risk.”
In response to audience questions after the panel discussion in Washington, Williams said the Fed shouldn’t use policy in a way that’s perceived as pushing stock-market prices to a “different valuation” when they seem to be overvalued.
Williams, who became head of the San Francisco Fed in March, was a senior economist for the Council of Economic Advisers during the Clinton administration. The Sacramento native succeeded Yellen and becomes a voting member of the rate- setting FOMC next year.
--Editors: Kevin Costelloe, Gail DeGeorge
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