The Federal Reserve warned about financial stability risks emanating from frothy stocks and debt-laden hedge fund bets in its twice-annual report on potential vulnerabilities in the system, pointing to the rise of so-called meme stocks as one sign that risk-taking could be getting out of hand.
The central bank’s Financial Stability Report, released Thursday, followed an unusual six months for markets. Over that period, stocks climbed steadily as the U.S. economic outlook rebounded, and stories of excess began to crop up.
Internet discussion boards helped fuel interest in stocks such as GameStop, a cryptocurrency created as a joke has run up in value, and a little-known hedge fund melted down, stories that have captured headlines and caused many — including, evidently, some at the Fed — to ask whether the financial system was headed for problems.
“Vulnerabilities associated with elevated risk appetite are rising,” Lael Brainard, a Fed governor, said in a statement accompanying the Fed’s release. Stock prices are high compared with earnings, and “the appetite for risk has increased broadly, as the ‘meme stock’ episode demonstrated.”
Archegos Capital Management, spilled back to hurt banks. The fund had amassed big, leveraged stock bets that went bad and ended up costing banks it had done business with.
“While broader market spillovers appeared limited, the episode highlights the potential for material distress” at financial companies that aren’t banks “to affect the broader financial system,” the Fed said in its report. It said hedge fund opacity had also raised questions during the meme stock episode: Some funds that were betting against the stocks in question took losses as chat board vigilantes poured into them.