U.S. still faces possible default wave, asset declines due to pandemic: Fed

WASHINGTON (Reuters) - The United States may still face a wave of debt defaults and “significant declines” in asset prices because of the coronavirus pandemic and recession, the Federal Reserve warned on Monday, in a stark reminder the economy is far from out of the woods.

FILE PHOTO: The Federal Reserve building is set against a blue sky, amid the coronavirus disease (COVID-19) outbreak, in Washington, U.S., May 1, 2020. REUTERS/Kevin Lamarque/File Photo

“As many households continue to struggle, loan defaults may rise, leading to material losses” for lenders, the Fed said in its latest biannual Financial Stability Report. Business debt “has risen sharply as businesses increased borrowing to weather the period of weak earnings. The general decline in revenues associated with the severe reduction in economic activity has weakened the ability of businesses to services these obligations.”

Asset prices “remain vulnerable to significant declines should investor risk sentiment fall or the economic recovery weaken.”

The comments were issued on a day when U.S. stock markets surged on news that a coronavirus vaccine may be on the horizon -- a possible boon to businesses and households globally.

In the Fed’s last report on financial stability, in May, the central bank warned of “severe” risks facing the country as economic activity cratered. Over the intervening months the worst outcomes have been avoided, partly due to Fed lending and other actions taken to keep financial markets functioning, and partly due to other government transfer and grant programs that let households and businesses continue paying their bills.

“So far, strains in the business and household sectors have been mitigated by significant government lending and relief programs and by low interest rates,” the Fed said on Monday.

But that could change depending on the course of the pandemic and the course of the recovery.

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Banks bolstered their capital reserves under regulations put in place after the 2007 to 2009 financial crisis and have “remained well capitalized throughout” the pandemic so far, the Fed said.

The risk now is whether that will remain the case if the pandemic worsens, begins to slow the country's nascent rebound, and pushes businesses and households into default. Despite hopeful results from a vaccine announced on Monday by Pfizer PFE.N, a renewed surge in coronavirus cases has again begun overwhelming local hospitals and led some localities to begin imposing new restrictions.

The Fed noted that the real estate market is showing signs of strain as vacancy rates rise and rent growth slows or turns negative. About 7% of home mort age holders are behind on payments, compared to around 5% before the pandemic, though most are in forbearance programs with their lenders.

Among small businesses “credit quality ... has worsened notably since the COVID-19 outbreak and has not yet stabilized, with many small businesses closing or scaling back operations significantly during the crisis,” the report stated

“In the near term, risks associated with the course of COVID-19 and its effects on the U.S. and global economies remain high,” the Fed reported.

Reporting by Howard Schneider, Ann Saphir and Jonnelle Marte; Editing by Chizu Nomiyama and Tom Brown