MNI POLICY: Fed's Rosengren Warns on Financial Stability Risks

By Jean Yung

     WASHINGTON (MNI) - Federal Reserve Bank of Boston President Eric Rosengren

warned Friday that very low interest rates can encourage unhealthy risk-taking

and contribute to factors causing a downturn, pointing to co-working spaces as

an example of a new source of vulnerability in the commercial real estate

market.

     "The current situation involves pushing rates lower when asset prices, and

in particular some risky asset prices, already seem inflated," Rosengren, who

voted against this week's move by the Fed to lower rates to a range of 1.75% to

2%, said in remarks prepared for the Stern School of Business in New York.

Markets are expecting several more rate cuts over the next year.

     A decade of very low interest rates has led highly-leveraged firms to

increase debt multiples to very high levels, he noted. That does not of itself

cause recessions but can make downturns more severe.

     More worrisome is how evolving business models and low interest rates are

creating "a new type of potential financial stability risk" in the form of

co-working spaces, he said, in remarks which came just days after WeWork's

parent company postponed its $3 billion initial public offering over doubts

about its high valuation.

     The co-working company, which enters into long-term leases with property

owners but re-leases to small businesses on short-term bases, would be exposed

to the loss of tenant income in a downturn, putting itself and the property

owner at risk. What's more, a legal arrangement utilizing special purpose

entities for leases may actually allow the company to walk away from

unprofitable lease arrangements in a downturn, hurting the property owner, he

said.

     Capitalization rates are arguably very low, which can indicate "an overly

optimistic valuation of real estate assets" that makes these investments

vulnerable in a downturn, he said.

     "I am concerned that commercial real estate losses will be larger in the

next downturn because of this growing feature of the real estate market, which

could ultimately make runs and vacancies more likely due to this new leasing

model," Rosengren said.

     --ECONOMY FAIRLY ROBUST

     The U.S. economy appears to have weathered the impact of trade disruptions

and slowing foreign growth so far, Rosengren said. Growth is slightly above

trend, the unemployment rate is quite low, and underlying inflation appears to

have picked up over the summer.

     "I would argue that having such an accommodative stance of monetary policy

is unusual in what appears to be a fairly robust economy," he said.

     It is appropriate for policymakers to respond to risks in the outlook, but

economic forecasts expect continued growth near a sustainable 2%, he said.

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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