Fed Challenged Over View That Leveraged Loans Won't Cause Crisis

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A top Democratic lawmaker questioned whether Federal Reserve Vice Chairman Randal Quarles can be trusted when he says leveraged lending isn’t a current threat to the financial system, pointing to his failure to foresee similar dangers before the credit crisis a decade earlier.

Senator Sherrod Brown of Ohio, at a Banking Committee hearing on Wednesday, quoted a series of recent remarks by Quarles alongside similar assurances he’d expressed as a senior Treasury Department official in 2006 before the subprime mortgage meltdown.

“How should I know whether the economy is safe, or you’re just bad at making economic predictions?” Brown, the committee’s ranking Democrat, asked Quarles, who is the Fed’s supervision chief.

The leveraged lending market -- a subset of almost $1.2 trillion in borrowing that often funds mergers and acquisitions involving heavily indebted companies -- grew 20% last year. The Fed, in a report issued last week, pointed to decreasing protections for lenders, with the risk typically passed on to investors in the form of collateralized loan obligations.

“We are concerned -- and appropriately so -- about what is the right regulatory response to developments in the underwriting of leveraged loans that could affect a business downturn in the future,” Quarles said at the Wednesday hearing. Despite the view of the Fed and other regulators that the market isn’t likely to endanger the financial system, he said it could still amplify a downturn.

Global regulators are trying to learn more about who is buying CLOs that could suffer in a downturn, Quarles said, but he reiterated that U.S. banks aren’t very exposed. At the same time, he and others have noted that bank regulators have limited say in the riskiest end of the market, pointing to nonbanks as the lenders making the most hazardous deals.

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