Former Treasury Secretary Geithner warns of calm before market storm

Turn to page 510. That’s where Timothy F. Geithner’s memoir reminds investors what happened the last time financial markets were this calm.

“I got to see how much power the belief in the ‘Great Moderation’ had over smart people, and to witness its expression in the credit boom,” writes Mr. Geithner of his time running the Federal Reserve Bank of New York prior to the 2008 financial crisis.

The result was a sweep of what Mr. Geithner calls “financial fires” he struggled to fight. Yet just six years on and with zero-interest rates still in place, there’s talk of a Great Moderation 2.0, a rebooting of the label given to the 1990s and early 2000s, when the mass of investors bet markets only went one way.

Bank of America Corp.’s Market Risk Index — a measure of shifts in equities, currencies, commodities and bonds — last week reached its lowest since the eve of the turmoil in 2007.

As Mr. Geithner continues his book tour, today’s policy makers are starting to echo his warnings against complacency. The lull “makes me a little nervous,” says William Dudley, Geithner’s successor as head of the New York Fed. Bank of England Deputy Governor Charlie Bean says trading is “eerily reminiscent” of the pre-crisis years.

It’s a trap of the central bankers’ own making following their effort to save the world from a financial crisis and recession. They’re only now beginning to search for the exit.

‘CLASSIC TRADE-OFF’

Richard Barwell, senior European economist at the Royal Bank of Scotland Group Plc, calls it a “classic trade-off.”

“Tranquil markets and inflated asset prices are good for monetary stability today, but might be a cause of financial instability tomorrow,” said Mr. Barwell, who previously worked at the the Bank of England.

The Federal Reserve is still buying assets on a monthly basis albeit at a slower pace, pushing its holdings of securities further beyond $4 trillion. The European Central Bank is readying fresh rate cuts even with their benchmark already at 0.25 percent and the Bank of Japan may also pursue new stimulus. The Fed and Bank of England say when they do raise rates, most likely next year, they will do so slowly.

So the cup of easy cash runneth over. Policy makers have to bet they have the regulatory tools to head off a messy end when they do pull back.

‘RATE RAGE’

A taste of how investors respond was evident last year when speculation the Fed would soon slow its asset-buying roiled emerging markets. Dario Perkins, an economist at Lombard Street Research Ltd., this week warned clients of potential “rate rage” when central banks do finally raise borrowing costs in 2015.

William White, the former head of the Bank for International Settlements’ monetary and economic department, has been here before. He began spotting potential bubbles in 2003 and is again concerned monetary policy will be kept too loose.

“When you look at financial markets to me a lot of it looks like 2007 all over again,” Mr. White, who now advises the Organization for Economic Cooperation and Development, said in a recent interview. “There are more of the same policies which brought you the problem in the first place.”

(Bloomberg News)