Fed Vice Chair Randal K. Quarles: “Fundamentally, the U.S. economy is quite solid.”

Fed Vice Chair Randal K. Quarles: “Fundamentally, the U.S. economy is quite solid.”


– Thank you, thanks. Thanks, Ana for that
exceptionally warm introduction. That was, thank you. And thank you to Georgetown and to Ana and to Adam Levitin for the opportunity to speak to you today. I was particularly delighted to be asked to speak at today’s
conference because the topic is law and macroeconomics. Which is a field that my
experience has persuaded me is of the first importance
but ill understood and surprisingly understudied. Now, at first blush that may sound like a beloved former president
venturing into a grocery store. Golly can you believe these scanners! (chuckling) Because the field of law and economics was already sturdily established
when I was in law school back in the Coolidge Administration and is now well over half a century old. It’s been the source of
some of the most innovative and influential legal scholarship over the lifetimes of everyone here. And in many ways the insights of the law and economics movement have become the default frame work that policy makers and practitioners alike use when we think about the law conceptually and often even at the level of granular application. But while we’ve called
that law and economics it would, I think we’d
all agree, be more precise to call that law and microeconomics. Both law and microeconomics
are centrally concerned with incentives. How are they constructed? How do they operate? How do legal or economic
actors respond to them? And the interplay between
these different ways to think about incentives
has been a natural and fruitful focus of
investigation in a broad range of legal studies, tort law, property law, criminal law, contract law, corporate law. But both law and economics
are also centrally concerned with systems. The performance and
relationship of broad aggregates of laws or economic activity. Not merely how do individual actors react to changes in incentives
but how do large scale combination of actors respond
to changes in systems? How are legal or economic
systems constructed? How do they operate? How do those systems constrain
wide areas of human activity? Now the interplay between those two ways of thinking about systems would seem to be as natural and fruitful a focus of investigation as is
law in microeconomics but as Ana and Adam have indicated it’s only just beginning to be thought of as a field in itself. So for a concrete example of at least how I’ve been thinking about this, think about the often observed fact that corporate profit
margins have been increasing steadily over the last few decades. Law is likely to have
been a significant element in this evolution. But not any individual law. Rather, an entire system of laws. Laws relating to corporate governance, corporate combinations,
taxation, litigation, labor, have evolved over
an extended period of time. And under this theory one
outcome of this system, higher corporate profit margins, would likely give firms greater scope to increase wages without
increasing prices. Thus offering a potential explanation for the flattening of the Phillips Curve the traditional macroeconomic relationship between the unemployment
rate and inflation. For a policy maker who
accepted this theory his comfort in maintaining a
very low rate of unemployment could depend significantly
on his understanding of that underlying legal system and his estimation of how its evolution in the legal environment
would proceed in the future. Thus, the formal union
of law and macroeconomics should seek to examine
the interplay between the legal system and
macroeconomic outcomes. Above and beyond the connections
that a particular law may have with it’s impact on
short term human behavior. Scholars and policy
makers have spent our time primarily thinking about
the impact of single laws but it’s appropriate
to focus more broadly, especially since we have
in fact repeatedly sought over the past century to
revamp our system of laws to improve macroeconomic outcomes. Consider the debate in
the half dozen years after the 1929 market crash that
led to the establishment of the foundation of
federal financial regulation in the United States. Laws creating the Federal
Deposit Insurance Corporation and a federal deposit insurance
and receivership framework. Establishing the Securities
and Exchange Commission. Greatly expanding the responsibilities and capabilities of the
Federal Reserve system were very purposefully intended to help restore confidence
in the US financial system as a necessary condition
to foster recovery from the devastation of
the Great Depression. In essence, we designed and implemented a new system of financial regulatory laws to alter macroeconomic outcomes. Not only to effect short
term individual behavior. The debate around those laws in the 1930s was not an academic one because the pain and suffering of that era was evident. At the time Congress was
debating the Banking Act of 1935 which established
the modern framework for federal bank
regulation and supervision. The unemployment rate in the United States was still 20%. So I’ll leave to others, or
at least to another time, the question of whether every detail of the laws passed in this
period was equally effective. Some of you may suspect that
I have some views on that. Whether in the short or the long term in promoting macroeconomic stability. But we should recognize that rules to promote financial stability
and a healthy economy have deep roots in the
American legal tradition. So building upon that
strong tradition I want to focus my remarks
this morning on the role that law and macroeconomics
has since played, played since the financial crisis in promoting a more stable economy. I’m referring of course, to macro prudential financial regulation. So let’s rewind the tape a bit. After many decades of
remarkable financial stability in the United States since the 1930s the focus of financial
oversight had moved away from systemic risks. Prior to the financial crisis the better part of our
regulatory framework was micro prudential in nature. Individual laws geared to mitigating the fallout from
idiosyncratic shocks to firms. This framework was designed
to protect investors and depositors, viewed negative shocks as not originating from
the financial system and did not take into account risks that might be shared by financial firms. It’s not to say that
regulators didn’t understand the consequences of an
interconnected system and the potential of contagion. For example, the US government
under the able leadership of Treasury Secretary
Nicholas Brady recognized and responded to the
financial stability risks of the Latin America
debt crisis of the 1980s. The US had geopolitical
interests in stabilizing allies in Latin America, yes, but a central part of the motivation was to
contain potential risks to the US economy. The events of 2008 and
’09 redefined our mission by more explicitly
connecting macroeconomic and financial stability as in the 1930s. Congress and the executive branch embraced a sweeping response designing a system of laws to reflect the recognition that the cumulative
interconnected behavior of financial institutions
as a system had implications for financial stability
and even the behavior of a single large and complex institution could have implications
for financial stability. This new system was also adopted
at the international level. Starting with the G20
summit in Washington, DC in November of 2008. The global community established the runway for structural change. The subsequent G20 Summit in London led to the establishment of the
Financial Stability Board with a strengthened mandate as a successor to the Financial Stability Forum and subsequently including
at the following summit in Pittsburgh world leaders agreed that the supervision of
individual financial institutions had to account for the
financial system as a whole. And it was recognized that
shocks could originate from within the system and could spread to institutions with common exposures. In other words the supervisory framework had to be macro prudential
focusing on mitigating systemic risk and accounting for macroeconomic consequences. This reorientation was a defining part of the 2010 Dodd-Frank
Act and internationally the Basel III Accord. Section 165 of the
Dodd-Frank Act in particular requires the Federal
Reserve Board to implement heightened capital and
liquidity standards, concentration limits, and stress testing. All to further the
macro prudential purpose of preventing or mitigating
risk to the financial stability of the United States. So as I’ll discuss in a moment,
the boards followed through with rules such as the G-SIB surcharge, the liquidity coverage ratio, single counter party credit
limits just to name a few. And importantly we’ve used
macroeconomic considerations in calibrating a number of these rules. Now, let’s fast forward to the present. Over a decade has passed
since the migration began toward a renewed focus on
macro prudential regulation. Our evolution didn’t stop with the Pittsburgh G20 summit in 2009. Indeed global financial standard setters have continued to adapt and learn as they implemented
and updated regulations in line with the global
consensus that was reflected in Basel III. I’d like to highlight three
important regulatory paradigm shifts that follow from this renewed focus on macro prudential regulation. First, in line with the
pivot away from micro prudential regulation
we have a renewed focus not only on the health of
individual financial firms but on the amount of capital
in the entire banking sector. Now note that the idea of
improving the stability of the financial system by regulating individual bank capital has
been around for decades. Global policy makers began construction of the modern risk based
bank capital framework in the 1980s when the
aforementioned Latin American debt crisis increased concerns that the capital held by
large international banks was deteriorating. And since then regulators
such as the board of governors, the Fed, have continued to have one eye focused
on the capital held at individual firms but now, over a decade after the crisis, exercises
such as stress testing have caused us to have the
other eye focused strabismicly on assessing the amount of capital in the entire banking system. The second paradigm
shift is that regulators have improved their methods of conducting quantitative
analysis of regulations. Such analysis, including
conventional cost-benefit analysis traditionally did not take
macroeconomic variables like gross domestic product growth, or unemployment rate into account. That’s no longer the case. Since regulators are given
the task of maintaining the stability of the system as a whole they must concern themselves
with externalities and spill over effects
to the broader economy. At the Federal Reserve
several regulatory initiatives have exemplified this change
in the character, if you will, of quantitative analysis. At the height of the financial crisis the Federal Reserve created
the first stress test. The Supervisory Capital
Assessment Program, or SCAP. To estimate potential
losses at the largest banks if economic and financial
conditions worsened. Building on SCAP the Federal Reserve moved to the current stress testing assessment the Comprehensive Capital
Analysis and Review, or CCAR. To evaluate whether the largest firms have sufficient capital
to absorb potential losses and continue to lend even
under stressful conditions. In the CCAR process the
Federal Reserve simulates macroeconomic scenarios like a recession in which GDP falls and
the unemployment rate rises significantly. In the 2019 stress test
cycle, for example, we tested banks against a
hypothetical global recession in which the unemployment
rate in the United States rose to 10%. The stressed banks were required to show that they could continue to meet minimum capital requirements in the face of those hypothetical
macroeconomic shocks. Aside from CCAR the Financial
Stability Board compiles an annual list of global systemically important banks, or
G-SIBs, which are subject to stricter capital
requirements in the form of a capital surcharge. These banks must meet this
higher capital standard based on the judgment that
their potential failure would have a larger system
wide impact on the economy. The goal therefore, is to
reduce a G-SIB’s probability of failure so that it’s expected impact on the economy would be the same as that of a non G-SIB. Similarly to reduce risks
of interconnectedness and contagion within the
system the United States and other jurisdictions
have implemented rules that limit the exposure
that one bank may have to a single counter party. And finally, research on
optimal bank capital levels by staff at regulatory
and supervisory bodies around the world have factored in macroeconomic costs and benefits. Specifically these models assume that higher capital
requirements would reduce the probability of a
financial crisis occurring but would increase the
cost of bank lending, thereby lowering GDP growth. Now, not surprisingly these models have produced a wide
range of capital estimates given the wide range of
underlying assumptions but the important factor is
that they all take into account macroeconomic consequences in attempting to calibrate the legal
and regulatory system. The third paradigm shift at the Fed is combating pro-cyclicality. Now to be sure, none of
the regulatory developments that I’ve just been
discussing so far screams macroeconomics quite as
loudly as a time varying discretionary regulatory regime,
the express goal of which is to fight pro-cyclicality. Cyclicality, in this case
fluctuations in the economy based on the business cycle, is a concept that’s near and dear to every
macro economist’s heart. In fact, theoretical
studies of economic cycles go back to the early 1800s
and the National Bureau of Economic Research’s tracker
of the US business cycle dates economic contractions and expansions back to the 1850s. Quite impressive. Although, I suspect
that the quantification as one gets back there
a bit is aspirational. But nonetheless, quite impressive. There’s also more than just a handful of volumes of articles
and book chapters written on the business cycle and
counter cyclical fiscal policy. But in the context of
macro prudential regulation pro cyclicality represents a problem because banks tend to
build up excessive credit during an economic expansion. Limiting pro cyclicality means limiting both the highs and lows of a credit cycle. Along with many other jurisdictions the United States adopted a
counter cyclical capital buffer to address the issue which
we frequently call the CCYB. The US CCYB is a capital
buffer that ranges from 0% to 2.5% of the
covered institutions risk weighted assets. Domestic regulators have the discretion to switch the CCYB on
or off anywhere within that range in order to prevent or mitigate the overheating of credit
markets under their jurisdiction. In setting the buffer
the Federal Reserve takes into account, among other things, leverage in the financial sector, leverage in the non-financial sector, maturity in liquidity
transformation in financial sector, and asset valuation pressures. Notably, the CCYB is not
calibrated bank by bank. It’s not micro prudential regulation. It’s not calibrated asset
class by asset class. Rather, regulators set the buffer based on their perception of the
aggregate domestic credit cycle. Whether it’s too hot,
too cold, or just right. Under the board’s current
policy we would activate the CCYB based on when
systemic vulnerabilities are meaningfully above normal. So based on this policy the
CCYB is currently set at 0% in the United States but has
been turned on in France, Hong Kong, Sweden, the
United Kingdom, and Norway. Now it’s worth noting
that in the United Kingdom the CCYB has been set equal
to a positive level, 1%, in normal times. As opposed to our framework
when we would turn it on when vulnerabilities are
meaningfully above normal. As a result their buffer can
be adjusted upward or downward based on the perceived risks of the time varying credit cycle. And as I’ve said in other contexts, I see real merit in
exploring the UK approach as a tool to promote financial stability. So let me conclude these opening remarks by offering a few thoughts
on three research topics that fall squarely in the intersection of law and macroeconomics. First, while international
agreements such as Basel III demonstrate that the
international regulatory community has agreed on the high
level systemic changes and developed similar
perspectives following the crisis, national governments gave
different regulatory powers in both degree and scope
to their central banks in pursuit of the new
post crisis consensus. In the United States,
Congress did not change the Federal Reserve’s dual mandate. But did provide new responsibilities to promote financial stability. There was no change to the
European Central bank’s monetary policy mandate but
it received direct supervisory authority over some of the
Euro zone’s largest banks through the single supervisory mechanism and also continues to monitor
financial sector risks. The Bank of Japan does not control Japan’s macro prudential toolkit, but it does play an active role in
monitoring systemic risk. The Bank of England, on the other hand, was explicitly given the task of a new financial stability mandate and it directly oversees
macro prudential regulation. In line with the debates over
central bank independence and macroeconomic outcomes
legal scholars who engage in cutting edge research
on institutional design may have thoughts on which model leads to the best outcomes
for financial stability. Second, in addition to giving
varying degrees of power to their central banks,
national governments also created new bodies that
promote financial stability. Such as the Financial Stability
Board Internationally. The Financial Stability
Oversight Council here in the United States, to
monitor systemic risks and to identify systemically
important institutions and activities. For example, the main
issue on the FSB agenda for this year were developments
in financial technology, non bank financial intermediation, the evaluation of our too big to fail reforms internationally. In the same vein the FSOC domestically produces annual reports
that highlights such threats and vulnerabilities, including new ones such as cyber security. Given today’s audience
I’d very much look forward to hearing your thoughts on these issues. Particularly suggestions on ways in which our legal framework can be used to mitigate these risks and the extent to which additional
macroeconomic tools should be developed to monitor
or address evolving risks. Third, and finally, since I’ve spent a good part of this speech
talking about issues that are near and dear to every economist, I feel like it’s only
fair for me to wrap up by discussing an issue of
equal if not greater emotional import to lawyers, which is due process. Specifically, I’d like
to close by talking about the due process considerations associated with the aforementioned
macro prudential policies. There’s nothing improper about mitigating negative externalities through regulation. That’s an important purpose of much post crisis financial effort. However, it’s also well accepted
that due process requires the fair, even handed application of laws so that individuals are not at the mercy of an arbitrary exercise
of government power. As I’ve eluded to throughout my remarks, we’re currently placing a
much greater regulatory burden on a select group of banks. The largest and most complex firms because we believe that their failures could bring the entire financial system. Some might argue that
during the crisis itself we dispensed with due
process considerations while conducting version
1.0 of the stress tests. This is why I’ve strongly
pushed for the recent shift toward greater transparency
around the structure of the stress tests than
the models themselves. It affords greater due process
to the affected participants. In the same vein, I’d welcome
greater legal scholarship on the due process
considerations associated with bank supervision
as a process distinct from bank regulation. By bank supervision I
refer to the processes and activities identified
with examining banks including checking compliance
with laws and regulations, assessing bank capital
and liquidity levels, assigning supervisory ratings to banks, taking formal and informal
enforcement actions. While it’s important for bank supervision to be up to the task of assessing
the world’s largest banks and as we’ve discussed, and
important for it to evolve to taking into account
systemic considerations as well as micro prudential considerations especially in light of the
financial stability risks that I’ve been discussing today. An equally important task is making sure that our supervisors are acting fairly. Although questions of fairness are routine in law and economics there’s ample room to explore these issues as they relate to bank supervision. While transparency and
fairness are pillars of due process, I appreciate that there are other approaches worth considering on this matter and with this growing field of law in macro economics I hope to see and implement many
interdisciplinary solutions on the path forward. Thanks for your time this morning and I’m happy to take some questions. (applause) – [Ana] Okay. So. – Whatever’s good. Do you want me to stay? I’m at your service. I’ve always been at your service. (laughing) – [Ana] Sit, I’ll feel better. – Sit, okay, okay. – [Ana] Thank you so much. So Randy, thank you so much, this is, it’s incredibly generous of you as always. So here is how I would love to do this. If we have any students
here at this early hour by student standards. And if you have questions,
please manifest yourselves. – The professors in the room
are laughing hysterically. (chortle) – That was just, look at
how young they all look. And then if we could take
a couple of questions from folks who are not members
of the warmly welcomed media and then you know, if we have time left and I’m sure we’ll have time left, we would take any
questions from any and all. So, if you have a question
perhaps you could start by stating your affiliation
and then ask the question. Oh, wait, are you a student? No. You look like a student. Students, going once, going twice. All right, in the back, please. – [Student] Hi, thank you
first of all for this. Sir, you spoke about
having responsible leverage in the non financial
sector or sectors of offer. Could you talk a little more on that? – Sure. – That’s a cozy entry. (chortle) – Sure, absolutely. So we look at. So we consider leverage in
the non financial sector which includes both households
and businesses as you know. And everyone in this
room is obviously aware that corporate credit, business
credit has been expanding significantly recently. And that the quality of that credit has probably also been eroding. When you look at the non financial sector as a whole, however, you
look at the households where the credit situation
is actually quite solid. And it’s pretty good relative
to historical levels. And so the two tend to,
when you look at, again, in our taxonomy that we have of leverage in the financial sector, leverage in the non financial sector. Non financial sector
leverage in the aggregate does not currently appear to us to be meaningfully above normal. But it’s worth then looking
a little more granularly at the corporate credit issue. And there we look at that,
even if you were to look at that growing vulnerability and I think that clearly is a growing vulnerability but when you look at it
in the overall context of the system and the other
factors that we consider probably the most important element is leverage in the financial sector. Which is at historic lows. Extremely low given the amounts of capital and liquidity that we now
require for institutions. And so that factor tends
to swamp the other factors as we come to an aggregate assessment of whether aggregate
financial stability risks are meaningfully above normal. And the current assessment of the board is that they aren’t and therefore this corporate credit development is not a financial stability risk. That doesn’t mean that it’s
not a macroeconomic risk in the sense that, you know, a sudden reversion in the pricing
of this class of assets could lead to an amplification
of a business downturn. Not one that we think would have true financial
stability consequences, but nonetheless one that might be worth tapping the brakes on with respect to its further development. The reason that way of
analyzing the problem is important is because it talks about what the potential policy
response ought to be. If we thought we saw financial
stability risks rising as a result of developments
in leverage lending in corporate credit we would
perhaps appropriately respond with a macro prudential
tool such as turning on the counter cyclical capital buffer. If we see this as more of a business cycle exacerbating factor then the proper response is perhaps as a supervisory matter to tap the brakes on the erosion of underwriting practices in the area, which we have done through our shared national credit program. Leveraged lending has been a focus of the last two shared
national credit exams. Looking closely at these
underwriting practices and in the most recent
one we have pushed back against the development of some practices which I assume many people in this room are familiar with. Such as EBITDA adjustments,
aspirational EBITDA adjustments and automatically drawn
incremental facilities that are, you know that
we think could lead to potential increased
losses in this sector and therefore would be appropriate
for us to push back on. – Mr. Sobel do you still
have your question? Oh wait, no we have one more student. You’re next, sorry. (laughing) I promise, you really are. – It’s like boarding an airplane. – Hey, it’s exactly like
boarding an airplane. – [Leland] My name is Leland Smith. I’m a student year three here. One of the three shifts you mentioned from micro to macro was the focus on the amount of capital on the entire banking sector. I was wondering if that specifically, with regard to banking
assets or if there’s also a consideration about non banking such as shadow banks, so called shadow banks, and insurance for example. – So that’s an excellent question. And the answer is that we,
is that the great weight both of focus and of
response in the evolution of the regulatory system post the crisis and the development of
macro prudential regulation has been on the banking system. The regulated banking sector. We obviously have greater information than we used to have,
and put greater focus than we used to do on the evolution of vulnerabilities in the
non bank financial sector. Not that we were ignoring that before. That’s one of the purposes of
the Financial Stability Board in drawing together a
broader range of regulators than simply the banking
regulators that continue to gather in Basel with
the Basel Committee on Banking Supervision. That we should, in thinking
about financial stability, be taking into account a broader range of institutions and activities. But we have much less
ability internationally and domestically to affect
the aggregate capital levels if you will, in the non banking system. And in the way of thinking systemically I think that we have to
take that into account as we think about the entire system as we consider the evolution of regulation for the banking sector. So to take an example. So the Federal Reserve has
done macroeconomic work that would suggest that the proper, and I referred to this a
little bit in my remarks that the right range, the optimal level of capital in the system as a whole is between 12 and 24% and we’re currently in the aggregate at about 14%. Different groups have
had different estimates. The Reserve Bank in Minneapolis believes that we should have at
least twice as much capital. The Bank of England has
slightly lower estimates. I think they run from
maybe between 10 and 20 or a little below 20. That’s heavily dependent
on the assumptions that go into that about what
the cost of a crisis would be. And in particular one key assumption, if you were to keep one in your head as to what’s driving some of
these significant differences. You know, Minneapolis
assumes that the cost of financial crisis in the
future would be 120% of GDP. The Fed paper that we tend to refer to and use as our lodestar assumes the cost of a financial
crisis to be about 40% of GDP. Both of those estimates
are materially above what most estimates are of the actual cost of the last crisis as a percentage of GDP. Therefore the Bank of
England uses a lower estimate of a cost of a future crisis. And that drives considerably
these differences. But, so you know, so we need
to have that sort of view but those are pretty broad ranges, right? For the optimal level of capital. So where should we be between 12 and 24? I think we have to take into account that we can ramp up and be
within an intelligent estimate of the optimal range of capital,
up higher in that continuum but the clear cost is going to be that we will push some activities out into an area of the financial sector that we have much less visibility into and control over that
is less well capitalized and perhaps less well able to respond to a shock that could result from that activity blowing up if we pushed it out of the financial sector. So again, thinking systemically about this precisely because of the
question that you raise, I think that is a
governor on where we ought to put ourselves within the continuum that’s going to result from any estimate of the optimal level of capital. – Thank you, all right
Mr. Sobel you’re on. – [Sobel] Thank you. Great presentation, great
to see you, thank you. – Name, affiliation? – [Sobel] Mark Sobel,
former US Treasury person. Work for several groups now. That question teed up mine perfectly. So you did speak about
macro prudential regulation in the banking system
which is up the Fed alley. But you didn’t really talk so much about market based finance as
it’s called or non banks. And of course if there are problems there that’s gonna reverberate throughout the entire financial system and economy. And that’s really much
more up the FSOC alley. So there have been those that have criticized the
FSOC designation process for non banks, lately. There was a letter written by some of the people in this room
that you’ve probably read. Others have debated whether
activity based regulation is, suffices, whether it should
be entity based regulation. So I just kinda wanted to ask you. How concerned are you or
not for the United States and internationally given your FSB hat that non-bank macro-prudential
oversight may be deficient and how should it evolve? And you just said, well we have to look at capital levels from the standpoint that there could be
gravitation to the non banks but maybe if that’s the case do you need to do something more in the non banks? So if you could offer
us your thoughts on that I’d appreciate it. – Absolutely. So let me start first with
kind of the FSOC process in entity versus activities
based designation which has been controversial. I think controversial in part because of what it might have been as opposed to what I think has actually happened. So I do believe, just
intellectually and conceptually, that thinking about
activities as the potential source of systemic risk and therefore the target of systemic response to systemic regulatory response is the right way to do that. I don’t think that. And that kind of a process,
thinking about activities in the first instance as
opposed to the second instance I think can lead to entity
designation, ultimately and in the process that the FSOC has been describing could lead ultimately to entity designation. But that activities are the first, are the right first port of call. And just to use an example, again that’s currently topical that
we were just talking about. Leveraged lending. So given the structure of
the way leverage lending is operating and what
we think the risks are, those loans are originated
largely in the banking sector and then they are largely sold
outside of the banking sector and they are widely distributed. And you’ve got many different purchasers. You’ve got CLOs, you’ve got mutual funds, you’ve got different
types of holding vehicles and then you’ve got different types of investors in those holding vehicles. So if you were to say today,
is that a systemic issue? The response to it is almost certainly not going to be to designate
any particular entity or even a group of entities as the locus of the systemic response. It would require saying, we think that activity is creating systemic risks and then how do you
respond to that activity. So the FSOC has come up
with, I was very heartened because I didn’t know myself
at the outset of the process whether it was going to be
a Potemkin village process of really we’re changing the character of designation as a way of saying there will be no more designations. But that really has not
been how it’s developed. I think it has been
very clearly looking at what’s the real source of systemic risk, how ought we to respond
if that is the source of systemic risk, if we seen an activity as opposed to an entity that’s there. You know, it’s really quite carefully done and it retains, as a potential end result, we continue to have the
ability to designate an entity if that’s the right way to respond to a particular activity that’s identified sometime in the future. Now with respect to regulating the non bank financial sector generally, so I do think that is something that we need to think about what’s the right way to address the risks of I believe that after many
months of negotiation we have settled on calling it non bank credit intermediation. Months spent deciding
the shape of the table. (laughing) But we need to think about that. I’ve been hopeful that, as you well know, Mark knows better than
anyone in the room, really. It’s very easy for those
sorts of discussions about non bank finance in
the international arena to degenerate simply into the rest of the world beating up
on the United States. And our evil financial structure. And therefore it has instinctively been, it’s been the instinctive response of the United States across
many different administrations and time periods to try to push back on having those issues discussed at all. If it’s just going to
be beating up on the US then we’ll take care of our own problems. We really don’t need other people to simply shout at us in
the international fora. I am hopeful that having the FSB led by a US person at this particular juncture, can create sort of more
comfort in the discussion. That we can grapple with these issues on a dispassionate intellectual basis without allowing them,
again, simply to degenerating into the French beating
up on the Americans. – Nothing against the Frenchmen. So this is, I think we’re in
free for all at the moment. So whoever you are,
you may ask a question. There’s a roving microphone. While the microphone gets
to the gentleman named Mr. Truman in the front row, I just want to ask a very brief one. Feel free to answer it briefly. It’s something we’ve been
struggling with mightily. You mentioned fairness
in the due process sense and there are related concepts of equity, and of course the whole
debate about inequality. And the extent to which
and the way in which research in this field could address that. And in particular the
role of central banks. I mean, one way to look at the mandate is, you know unemployment certainly
goes in that direction but how would you think about
central banks and inequality? – So I think central banks, so our tools for directly
addressing inequality are limited. But they are not negligible, right. I think probably, you know I think this is probably fair to say. If you look over the
course of the last decade, maybe the single most
effective policy decision that was made, that has sort affected, reduced inequality if
you will, in the society, was the decision that
the Federal Reserve made under Janet Yellen’s leadership. I mean it was her insight that you could have unemployment rates
that were much lower than traditional, you
could run a softer policy than I sitting outside the
Federal Reserve at the time believed with could
without igniting inflation. And she led the Federal Reserve to do that and if you look at the
distributional consequences of the current strong
labor market that we have those have been significant, right? So there are still gaps
but those gaps are smaller than they were beforehand. And so I have frequently said and I have said it to Janet before and happy to say it here as well. She was right and I was wrong. And that. (laughing) Yeah, we’ll see what you
say this afternoon, but. – Just keep that thought. – But that has had important
distributional consequences and it’s increasingly
in the minds of the Fed. Not that distributional consequences are an express target of what we do but we have a much better understanding of what they’re going to be,
of decisions that we take. And I think that’s appropriate. – Thank you very much. So what we’re gonna do
in the free for all stage is collect three questions at a time. Is that okay with you? – Sure. – Mr. Truman? – [Ted] Ted Truman from
the Peterson Institute. Is this on? Peterson Institute for
International Economics. So I thank you also for a very thoughtful and thought provoking
speech, set of remarks. I wanted to pick you up a little bit on your first topic for examination where you emphasized that the responses of different authorities,
national authorities to the new regime, if you
want to put it that way. The post crisis regime have differed. Do you imagine the fact that
there are those differences could lead to conflicts or
difficulties going forward? And do you see the FSB structure as a way to at least
discuss these differences and maybe learn from ’em, either way? I mean, so in some sense it’s a policy coordination
question that I’m asking and the role that FSB might be in thinking about these differences. – Thank you. So two more questions. All right, you know what, we
have three more questions. Let’s just collect them
all and that way you can. – Okay. – Answer them all. One, two, three. All right, okay. – [Dick] Hi, Dick Warden. I wanted to ask a little bit more about the due process thing that
you mentioned earlier. So it strikes me that if the Fed wants to penalize a bank with a monetary fine it has to publish that information. But if the Fed take sort
of injunctive action against a bank ranging from
a matter acquiring attention to an order not to grow, that
doesn’t need to be published as far as I understand. And I guess I wondered if you thought that was the sort of appropriate
level of transparency for these sorts of
injunctive kinds of remedies? – [Victoria] Hi, Victoria
Guida from Politico. I just wanted to ask about
regulatory reform broadly. You know you’ve been in this
role for almost two years now and I know there’s still a
couple of tailoring things you need to finalize here soon and the stress capital buffer
you’re still working on. But how much work left do you think that you still have to do on that front? – And then, one more there. And then we’ll take one
more round and that’s it. Great, so will answer, that one. Right here, oh. Is that okay, do you have another five? – [William] Hi, my name’s William Edwards, from Bloomberg News. What’s your outlook on the economy and do you see the need to provide more support to inflation? – I’m sorry, I didn’t
catch the last part of it. – [William] Do you see the need to provide more support to inflation? – Okay, so that was the first wave? Okay. – There are only gonna be two folks. – Okay, okay. – Raise it high. – I feel like, I feel like Johnny Carson, The Amazing Kreskin. But so, different national implementation on supervisory practices,
that’s the question. I actually think that
will be an important role of the FSB going forward. I was just, the commit, there’s the FSB has a ridiculously complex structure. But the first level of
its complex structure are three standing committees. The main one of which is
a committee on supervision of regulation that has
just received a new chair. A Japanese official named Ryozo Himino. I was meeting with Ryozo
yesterday talking about what his views and expectations were for the role of that
committee going forward. And one of the things
that he has suggested is exactly that, looking
at how it could be that differences in
supervisory practices around the world could have effects
on financial stability that we might not appreciate. So again, so without running
too much into the weeds but I do think it’s important. So you look at the disruptions
in the repo markets that happened over the
course of the last week. One thing that, there
are many causes of that and I guess the first thing I should say is that when you look at those causes they are either transitory
or eminently addressable. Right, the transitory
large demand for cash and certain factors that, you know, there are a variety of
measures we can take. We haven’t decided which we will take but there are many measures we could take that ought to address that. One factor, however, that has been cited as potentially contributing
is that in our supervision of liquidity requirements,
not in the structure of the liquidity requirements themselves, but in our supervision
of liquidity requirements we have been, in the
United States, putting a thumb on the side of the scale that banks should satisfy
them with reserves rather than with treasury securities. Now for some time I have been saying I don’t think that we should do that as much as we have. That we have a regulation that says that you need to have
high quality liquid assets and you can satisfy
those with bank reserves or you can satisfy those
with treasury securities. And that if we sort of push on one side of that scale rather than
another it could lead to distortionary effects. That may have been part of what happened over the course of the last week. Now the reason that’s
relevant to your question is that, so we have some
supervisory practices here that I think we can
modify in order to reduce potentially that result. But I realized during
the course of that period which is, I actually don’t
know how they supervise this in the United Kingdom, in
Europe, in Japan, right? We have similar regulations,
virtually identical regulations but are they
doing the same thing? Are they doing it more? Are they doing it less? Is there a risk that something like this could happen in their money markets? Could that feedback into us? We, at the moment, I don’t know. I don’t actually think that anyone knows and the use of the
Financial Stability Board and this standing committee on supervision and regulation which
has mostly been focused on regulation up to now, to also take the supervisory part into account, I think can be very useful. Due process, injunctions
don’t need to be publicized. Is that right? So, I don’t have the answer
to that specific question yet. What I do know is that over the course of the next couple of
years I want it to be an important focus of the
regulatory process generally and certainly what we do
at the Federal Reserve to think about exactly
those sorts of questions. What do we do through supervision? What do we do through regulation? Where have we drawn that
line over the decades? This is not just a post crisis issue, this is something that has
been developing over decades what that bank supervision which once was Mr. Carter going into the
Bailey Building and Loan and ensuring that there was
enough cash in the vault in “It’s a Wonderful Life” has become a vast panoply of actions
that the supervisors and regulators take and what falls on the regulation side of the line which requires publication
and due process, and comment, and input,
and cost benefit analysis, and what falls on the
supervision side of the line which requires none of that, has happened largely accidentally as opposed to intentionally. I think we need to
intentionally think about that distinction, draw a fair line, and you can imagine
due process constraints around supervision that don’t rise to the level of administrative
procedure act process but nonetheless provide some warning, notice, opportunity
for input appropriately while nonetheless maintaining a firm and dynamic supervisory system. That’s a hard question. I don’t think that’s an easy question but it’s an important question and one we’ll be thinking about over the next couple of years. Regulatory reform, you
know, aren’t you done? Can’t you go back to Utah now? The, so I do think we focused very heavily on a program of regulatory reform that we could accomplish in
the first couple of years. For a variety of reasons. I think that was the,
you know, A, there were some clear things that needed to be done. We could think that through,
we could get that done. But inevitably there are
some additional thoughts about regulation that will be worked out through the next couple of years but this focus on
supervision and due process will be extremely important. In fact, it may be that when I look back on my tenure in doing this, everyone thought that
I was sort of supposed to come in with a flame thrower and set fire to Dodd-Frank, but that the most important thing that the Fed does during this period is to think intentionally again about what are we doing through supervision? What can we do through supervision? How do we make that
effective but also fair? Outlook on the economy. Need for more support for inflation. Fundamentally the economy is, fundamentally the US
economy is quite solid. It is, every time I
talk with bankers across the country, when we talk with
our reserve bank presidents and the input that they receive from all of the different economic
actors, sectors of the country, it’s really quite positive with respect to actual activity, generally
with respect to sentiment. There are issues about uncertainty around the global situation for firms that are particularly effected by that. There’s uncertainty around trade policy for firms that are
particularly effected by that. The trade policy issue in particular seems to have been weighing
on business investment. And that concerns me because ultimately business investment is where we get the future productive
capacity of the economy. Which I had been quite confident about but business investment has
kind of fallen off a cliff. I think that’s a concern but not one that effects the fundamental soundness of the current position of the economy. However, there are different views among the members of
the FOMC as to whether the current level of
inflation should be one of the drivers of how
we think about policy. I am, you know, I’m on the side of the argument that we don’t need to be overly concerned
about the current level of inflation that we are a few tenths of a point short of meeting
our 2% inflation target, if you will. You know, our measures of inflation are not terribly precise. The policy measures that we can take in order to try to affect
it act with very long lags and their understanding
of the relationship there is changing. I mentioned the Phillips
Curve issue in my remarks which changes how one thinks about it. You know, I do think that there’s a possibility that one of
the things we’re seeing is that inflation is where it is because we have anchored
expectations so firmly that everyone believes
that the Federal Reserve will take care of this,
they’ve got this under control and that if we undertake
the heroic measures that would be necessary to move inflation a few points higher in
what seem to be the way the current, the macro economy
is currently performing that what we might succeed in doing is convincing people that
geez, they don’t seem to care about this. They aren’t going to do what’s necessary to control inflation and that the result would not be edging inflation
up a couple of points but actually unanchoring
it and where it goes, then we don’t know. So that’s my take on is the current level of inflation a reason
that we should be trying to get that higher and
setting policy to do that. But that is, there are a range of views on the committee about
that question on inflation. That is not speaking for how the process is going to evolve necessarily. – So my job here is to be a total jerk and not let this take over the entire day although I actually. It’s an interesting question. We’re going to, if you don’t mind, taking one more round because I am trading this off against lunch I think this is a worthwhile trade off. So we’ll take three more questions. Yes? Tops, one, two. Two is great. Oh, three, great okay. That’s it. Thank you so much. – [Peter] Peter Conti-Brown
from the Wharton School. I want to ask again about this due process and I like the idea that in concept, it’s a founding concept
for our great republic. But I’m curious about how you recognize and quantify your sense of balance. Because supervision of course requires a distance, it requires
having a supervisory store that’s not exposed to
the supervised parties and in particular the mono model problem that is a mouthful to say, but the idea that if stress
tests are to be effective they work in parallel and can’t be exposed to Fed’s models in their entirety. You might agree with that but
where do you strike the line and how do you know that the line already struck, is struck poorly? – So all great questions. So with respect to transparency maybe it has to do with having grown up as a lawyer, although that does seem like a long time ago now that
I practiced law, but. I kind of begin from that default view is the government should be
transparent about everything that it does, right. Whatever it is that’s
happening should be disclosed. That’s the default and that you need some argument, and it’s
a reasonably high bar, for lack of disclosure. Now, we all know, I mean there are things that we universally would
agree should not be disclosed. The intelligence that we
gather from covert operations is useful to us as a democracy and we should not put
on the website where all of our intelligence agents
around the world are. You know the plans for
tomorrow’s attack in the midst of a war should not be
publicized in a democracy. I think that there are
reasonable constraints that all of us would
agree should be applied to perfect transparency on
the part of the government. But I think that same
principle then applies to what we do with respect
to bank supervision. What we do with respect
to the stress tests. Now, I have. You know, I do believe
that the mono model problem is a serious one, and for
those who don’t follow this deeply here, that’s the concern that if the Federal Reserve disclosed all of the elements and
models of our stress tests that the banks would simply do what we say as opposed to think independently
about their own risks and because these models are complex and inevitably judgemental there will be idiosyncrasies and
judgements and errors in what we do as there are
in the banks’ own thinking. So if we disclosed all of ours the risks in the system will in
fact coalesce around our idiosyncrasies and it will
create a more fragile system rather than a less fragile system. I’m persuaded that’s true. So I don’t think that we
should completely open our kimono with respect
to the stress tests. But I think that we were not preceding from that default position
of, we should disclose as much as possible without running, while limiting that
mono model problem risk. So I think, we proposed some things that I think have been,
I think have generally been perceived to strike that line. Not in the only ineluctable
way that it could have been struck but in a reasonable way to provide additional
transparency without, which also is additional opportunity for everyone in this room. That’s not just transparency
to the industry, for everyone in this room to say, really I didn’t know you did
that, why do you do that? Reasonable transparency without
that mono model problem. You know on the question
of how do you know that we have, how do we know
that there’s any problem with the way we have currently drawn the line between
regulation and supervision? That’s why I don’t have a program today as to how we’re going to change it. I think that is a, I think
that’s a hard question. I don’t think that’s an easy question. That’s, I think that is. I happen to think that it’s intellectually a quite interesting question. It has been a terribly
understudied question even among experts in bank
regulation and supervision. Among policy makers. We haven’t really even thought about it. We just do some things through supervision and some things through regulation because that’s the way we
decided to do it this morning. So I think that is a hard call. That’s a hard question. – So two questions together and then you can help me
with a rotten vegetable. – [Gregg] Gregg Gelzinis,
Center for American Progress. So you brought up FSOC’s
interpretive guidance and I was wondering if you could answer, why is it appropriate to
consider a firm’s likelihood of distress in the designation process when Dodd-Frank’s first
determination standard calls for the FSOC to assume
material distress at the firm? – [Eric] Eric Gurgen,
University of Colorado. In looking at the repo
markets I’m wondering if you’re also looking
at the regulatory angle of whether banks are too
dependent on short term funding? – Super. So with respect to the first,
likelihood of distress. So I, myself, don’t
believe that likelihood of distress should be
a significant factor. I don’t think that it is intended to be a significant gating
factor in the determination of the, of an activity. It is mentioned now. You know, and in fairness I remember when I was a very young lawyer, again this was back in the Taft administration. And preparing my very
first bank loan document and I was quite proud of
having thought about everything and the partner looked at it and up against some of the risks that I had provided
provisions for said, yes Randy that could happen and a pig could fly in backwards through the
window in a helicopter but we don’t need to provide for it in the contract because it
will be excessive burden and people will think we’re idiots. So I think, I have viewed the reference to some consideration of
likelihood of distress as opposed to being a material
gating factor in the process to being some taking into account of exactly that factor. If you run into something
that could be an issue but is as likely as a
pig flying in backwards through the window in a helicopter, you know is there some way of taking that into account. But I agree with you that should not be a material gating factor. On, you know. Do the recent incidents of the repo market suggest the banks are too
reliant on short term funding? I don’t think so. My, our assessment really, again is that the factors that led to that
we understand pretty well. And those that are not transitory that temporary demand for cash are eminently addressable
without materially reforming our regulatory structure. I don’t think that they’re being driven significantly by regulatory structure. It may have been added to by some of our supervisory practices which is something that we
can change quite easily. – So please join me in
thanking the vice chair for incredible work.

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