C. Peter McColough Series on International Economics with Randal Quarles
Vice Chairman Randal Quarles discusses the outlook for the U.S. economy, inflation, and monetary policy.
The C. Peter McColough Series on International Economics brings the world's foremost economic policymakers and scholars to address members on current topics in international economics and U.S. monetary policy. This meeting series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies.
BLINDER: Good morning, everybody. I’m going to begin the proceedings by shutting off my cellphone, which is mean to be an example to everybody. (Laughter.) First I have to figure out how to shut it off. There we go.
Welcome, everybody. Good morning. This, as you probably know, is part of the C. Peter McColough Series discussions of various sorts on international economics, and I will introduce our guest of honor in a second. I’m Alan Blinder, a professor at Princeton and now-defunct—do we call it defunct or retired member of the board of this organization? (Laughter.) I’m not sure which it is.
We will, the two of us, discuss a number of things for about half the time, and then I will open the floor for questions and answers.
Let me introduce our speaker with great pride and honor. As all of you in this room know, America has a great tradition, almost unique in the world—not quite unique—of talented people jumping in and out of the private sector and the public sector. And nobody really exemplifies that better than Randy Quarles, our guest this morning. Randy was born in San Francisco, raised in Utah—where he still lives, by the way, I just learned. His New York connections are a degree from Columbia—undergraduate degree from Columbia and some years at Davis Polk and Wardwell here in New York. He was a very young man in the Bush I administration when he did his first public service at the United States Treasury, first as a special assistant to the secretary and then deputy assistant secretary for—and the last two words are the important ones—financial institutions, something that has stuck with him for some years. And then he went back to private life, came back in the Bush II administration first as assistant secretary, again, in the Treasury for international affairs, and then undersecretary for domestic finance. You can see this is a—we are building here a good resume to become vice chairman of the Federal Reserve.
He then went back to the private sector while the Democrats were in the White House, and of course has come back now, appointed by President Trump to the Board of Governors of the Federal Reserve, and in particular to the position of vice chairman for supervision—technically, the first holder of that office. A lot of people think Dan Tarullo had that position, but he never actually got the title, though Dan was serving in that position. Randy Quarles is now in that position officially, to the great glee of a lot of bankers and to the consternation of Elizabeth Warren. (Laughter.)
You don’t need to comment on that, nor should you.
BLINDER: So just to start things off, I’d like to ask first, once they taught you the secret handshake, what else surprised you about the Federal Reserve?
QUARLES: So I—in my positions at the Treasury and in the private sector, I’d worked a lot with the Fed, and so I thought I had a really good understanding of it. But there were—I would say it’s an institution with a thick culture that you can’t probably really understand, except from the—except from the inside. So there were things that didn’t surprise me at all: the extreme professionalism of everyone associated with the institution and the enormous reams of data and the focus on the data. Some of the—some of the formalities associated with FOMC meetings and so forth were—I was surprised with. And I think perhaps the complexity of the governance of the institution, which, again, even as well as I thought I understood the Fed, I didn’t really appreciate until joining the board.
BLINDER: Does Jay Powell call you “Randy” or “Mr. Vice Chairman”? (Laughter.)
QUARLES: As you know, the—Jay was the one who brought me to Washington in Bush 41. He had been a young associate at Davis Polk, and while we never really overlapped he needed a special assistant. And while my title was special assistant to the secretary, effectively he canvassed New York for a young special assistant and found one at his old law firm. And so we’ve been very, very good friends for over a quarter of a century. So he tends to call me “Randy” when he calls me something printable. (Laughter.)
BLINDER: That’s good.
I want to go back to the quip I made about the bankers versus Elizabeth Warren indirectly and talk about the board’s easing in some people’s mind, but you may prefer a different gerund, of bank regulations. In particular, as you well know, your colleague Lael Brainard, the only holdover from the previous administration, voted against the board’s decision to ease the capital and liquidity requirements. It was about a month ago. She said, quote, “This raises the risk that taxpayers again will be on the hook.” So why was she wrong?
QUARLES: (Laughs.) So I think—so I do prefer a different gerund than “easing,” and not just for communications purposes. I think—the way I think about it and the way I’ve talked about it is that really what’s required at the moment and what I think that a fair assessment, if you stand back and look at everything that we’ve been doing and the program for going forward, it’s a recalibration without a relaxation. So we—nothing we have proposed—and we’ve said a number of times we wouldn’t intend to weaken it—has weakened the capital standards for the largest firms, the total loss absorbency for the largest firms.
I think—I think it would be—it would be anomalous in the history of the world if the first cut at putting in place the body of post-crisis regulation had been the best that we could do, had been perfectly calibrated to ensure that everything was working together—you didn’t have, you know, provisions that made sense in isolation, but were sort of pushing in different directions; or you hadn’t turned a dial too high in some places. And one of the things I’ve tried to stress is that we have a—we have a great public interest in the safety and soundness of the financial sector, but we have a great public interest in the efficiency of the financial sector as well. And one of the things that the regulatory system needs to keep in mind is that we ought to be promoting the efficiency of the financial sector, as well as its safety and soundness, because all of those are public interests.
So the only responsible thing to do with the relatively recent completion of implementing the body of post-crisis regulation—the last bits of the Basel international agreement that was a response to the crisis was just barely finished—was just barely finished about a month after I arrived at the board a year ago. So, with that being done, the only responsible thing to do is to stand back and say, all right, now how can we achieve these objectives in a more efficient way, which is—which is what we have been trying to do. And part of that efficiency is to ensure that there’s a continuum of risk that different institutions pose to financial stability, potentially, depending on their business models and their size, and our regulation should reflect that continuum of risk to ensure that we’ve calibrated regulation appropriately to the type of institution.
So over the—well, as everyone knows, over the summer the Congress passed a bill that proposed that we should do that tailoring, and that’s what we most recently did. That did adjust—for firms below the very largest, adjust their—principally their liquidity levels, to a small degree their capital.
BLINDER: So how do you answer the criticism that the Fed’s gone well beyond what S.2155—right? I think I got that right.
QUARLES: That’s correct, yes.
BLINDER:—actually called for in the legislation?
QUARLES: So I don’t think that’s—so I don’t think that’s correct. So 2155 had a provision—its basic instruction to the Fed was that we must tailor our regulations to the risk of an institution. Dodd-Frank had always allowed the Frank to—had always allowed the Fed to do that, and there had been a certain amount of so-called tailoring even before 2155 that the Fed had done. But that was discretionary, and 2155 clearly said you must tailor your regulations. Then it went on further to state that for firms in a certain size category—100 (billion dollars) to 250 billion (dollars)—that there were a variety of specific things that we needed to do. So, in the implementing regulation, we did those specific things in what we proposed to implement 2155. We did those specific things, but we also realized that there was the broader instruction that we needed to tailor even beyond that 100 (billion dollars) to 250 (billion dollars). And the proposal that we have is relatively modest in how we do that, but it does do that. That was—that was part of the instruction of the regulation.
BLINDER: What about specifically the stress tests, which I think are widely viewed as having been a big success, a major innovation in the way the Fed does supe and reg, starting with the crisis and continuing? What about loosening the—or easing, or—again, you’ll chose a different verb than I—(laughter)—whatever verb you like, the stress tests.
QUARLES: So what we have proposed on the stress—so, A, I agree with you. I think that conceptually and in practice stress testing as a way of evaluating the capital requirements and the risks posed of individual institutions is—that is a great idea. It is a—it’s a costly idea in terms of resources both on the supervisory side and on the bank side. And in connection with that theme of efficiency what we have tried to do in thinking about stress tests is to find ways to improve the efficiency without in any way undermining the rigor of the test.
We have proposed, for example—and were close to finalizing a proposal shortly after I arrived—we made a proposal to be more transparent about the models that we use in connection with the stress tests. And, you know, some people have said, aren’t you giving the questions to the test away to the class before you give them the test? That’s really not—you know, that’s not a particularly good example because we’re not proposing to, you know, allow them to adjust their portfolios in light of specific questions, which are the scenarios that we propose each year. Being more transparent about the models is a little bit more like giving the class the textbook before you give them the exam.
There are complications about that. I don’t think that at least at this moment we can be fully transparent about the models. I can go into more detail about why I think that if that’s of interest. But more transparency about how it is that we evaluate stress, I think that is—I think that allows banks to run their firms more efficiently. I think that it contributes to improving the rigor and effectiveness of the tests by allowing more comment from a variety of sources—obviously, not just the industry, but from—but from academics and from public interest groups, from the Congress. And more input can only make those tests better, as opposed to weaken them.
BLINDER: I’d like to broaden this a little bit. You just took over—I think you told me yesterday, officially—as the chairman of the Financial Stability Board—
BLINDER:—in Basel. So, as you look over—answer this either way or both as you like. As you look over the financial landscape in the United States or in the world and your worry hat about financial stability is on, what thoughts come through your mind?
QUARLES: So where—obviously, in part because of the—you know, the robustness of the response to the crisis, we have a—you know, we have a much more resilient financial sector than we did a decade ago. So I do think that there are some questions that we need to remain alert to as to the level playing field across the entire financial sector. I’m a little—and that is to say there are parts of the financial sector that are regulated much more vigorously than others, and I think that we need to be sure that we understand what that is doing in a complex system. You would naturally expect that that will lead to, you know, activities to move to different places in a complex system, which is not necessarily a bad thing but it’s—but it could be. And so it’s something that you need to keep an eye on as to how—as to how that’s developing when you’re looking at the financial sector as a whole as opposed to simply banks, for example.
There are, you know, obvious issues that didn’t have much to do with the last crisis, but that are big issues for the financial sector currently: cyber risk on a variety of fronts, both the technological innovation and what that can do to the business models of particular financial institutions currently, and therefore how that can affect financial stability; as well as the, you know, very obvious threat of cyberattack and theft. I think those—my own view is that those are questions that not for any lack of attention or focus or strength of will, but just the complexity of them, I think that both the official and the private sector are probably behind the curve on.
BLINDER: You didn’t mention leveraged lending, which I hear a lot from Fed people and non-Fed people, which I’ve always—I take that phrase as a euphemism for bad lending, but let’s just stick with leveraged lending.
QUARLES: (Laughs.) So that’s—I think that’s an example of, if you think about—if you think about that from the point of view of financial stability, then it leads you in—then it leads you along a particular path of thought. So the first question is, if either the volume of leveraged lending or the underwriting standards of the loans that are being made, the volume is increasing or the underwriting standards are eroding, first is that a prudential risk to the institutions that are writing those loans. Our best assessment is that it isn’t currently because they are not keeping them on their books.
BLINDER: This is for U.S. banks you’re talking about.
QUARLES: This is for U.S. banks—U.S. banks, principally. So they’re not keeping those loans on their books. A far lower percentage of the assets of U.S. domestic institutions are composed of leveraged lending. They’re selling them off to other investors, principally CLOs.
So then the second question is, all right, if those loans are moving elsewhere in the system, are the investors that are ending up with them likely in the—if there were an event that resulted in a lot of those loans creating losses, are the holding structures likely to amplify financial instability? But the CLO structures, you know—unlike, you know, CDOs and CDO-squares and so forth, the CLO structures were not particular contributors to the last crisis; which doesn’t mean that, you know, logically that they can’t be to the next crisis, but they have generally not been runnable, right? So the obligations, the liabilities of the CLOs, are generally of longer term than the—than the maturity of the assets that they’re holding. We need to continue to focus on whether that continues to be the case, right? But at least the best information that we have is that they’re not evolving in a way that that would be a particular problem.
And then we need to focus on, all right, well, then who are the equity holders of the CLOs? Because if that were coming in backdoor to the banks, if the banks were therefore a lot of the holders of the exposure to CLOs, whether it’s debt or otherwise—if the banks are exposed to the CLOs, is it coming back into the banking system that way?
That’s a more complex analysis, and one that we are still in the middle of, we’re still trying to get a handle on, and something that we need to be vigilant about. But the shorthand that particularly in Washington is often used is leveraged lending is growing, this is a problem; underwriting standards are eroding, this is a problem. To my view, that is not necessarily a problem until you finish going through that chain of analysis in determining whether you’re really having an effect on financial stability. And I don’t think that that is a—is by any means a decided question.
BLINDER: Thanks. I’m tempted, but I won’t ask you whether the FSOC is helping or hindering in this. But just skip that.
BLINDER: That’s an air-duct reference. I don’t expect you to answer.
I want to ask you one more question about regulation and then turn to monetary policy a little bit, which is about concentration in the U.S. banking industry. There’s a lot of attention beginning to be paid in economics about rising concentration in general across the industrial landscape, but I only want to ask you about banking. Banking has become more concentrated by conventional measures since the crisis for some obvious reasons. And I remember at the time thinking in 2008, while things were crumbling all over the place, this would be a terrible time to worry about concentration in the banking system. But we’re now like eleven years, ten years later, and do you think it’s time for bank regulators, presumably led by the Fed to worry more about concentration in the industry?
QUARLES: So I think that’s an interesting question. I don’t—so I don’t worry per se about the size of the largest banks currently. What I do think is important is that we shouldn’t have a regulatory system that encourages concentration. So, to the extent that concentration either is increased or lessened as a result of business decisions that private-sector actors make, I don’t know that that’s in and of itself a reason for concern if we are, you know, appropriately regulating the prudential safety and the stability of the overall—of individual firms and the stability of the overall financial system.
But I do think that we shouldn’t be putting a thumb on the scale of trying to encourage that concentration, which is another reason for the emphasis that I have had on the efficiency of regulation. So one of the things that I did, you know, before—between my service in Bush 43 and coming back to the Fed was at Carlyle. I invested in a lot of small banks post-the crisis, participated in the recapitalization of a lot of small banks. And most of my career up to then had been involved with the very largest financial institutions, and now I was dealing with community banks in different sectors of the country. And the—just the cost and the burden—not even the financial cost, although that was significant, but the management burden on these small institutions of complying with post-crisis regulations, that were probably over-calibrated for the risk that these institutions would actually pose to the economy, was a significant headwind to those institutions continuing as sort of separate competitive forces. And a lot of consolidation has happened and will continue to happen as a result of that. So I think that what we certainly should be doing in the official sector is trying to ensure that we aren’t serving as an additional impetus to concentration in that way.
BLINDER: OK, thanks. Let me turn to monetary policy. I did allocate the time that most is about supe and reg, and only a little in your case about monetary policy.
But I want to ask you about this. There has been a huge amount of talk both inside and outside the Federal Reserve System about so-called R-star, the neutral rate of interest, and I’d like to just hear how you think about the utility of that concept. And, of course, if you want to give us the number to two decimal places, that would be fine also. (Laughter.) But I don’t have that in mind so much.
BLINDER: How do you—how do you think about it? How can the Fed figure out where it is and things like that?
QUARLES: So you’re right, R-star has received a lot of attention both outside and inside the Fed. I think it—and I think that it can be, you know, a useful concept in helping guide monetary policy, but it’s not—as you obviously know, as everyone in the room knows, it’s not a terribly precise concept. So I think that its use is probably greatest when there’s a clear direction in which monetary policy ought to go, when there have been large movements in the estimate of R-star. But it’s not as observable variable. It’s not something that we can directly measure. And it’s subject to change over time. It’s subject to—depending on what you think is happening to the productive capacity of the economy in a variety of ways. And as a consequence, it’s not something that you can calculate to the second decimal point.
The members of the FOMC, obviously, we publish every other meeting our estimates, our projections of what we think the neutral rate of interest is, and there’s a range of that currently from, you know, 2 ½ (percent) to 3 ½ percent, which is a pretty big range. And so we’re coming up to the bottom of that range, but even on the FOMC there’s a—you know, a great deal of differing views as to where R-star is currently and as to where it might be moving over time.
And so, from my point of view, I think that in the current moment, as opposed to, you know, R-star being a very good communications tool in explaining why you would have extremely low interest rates relative to historical levels given an historically anomalous event like the financial crisis, as you approach a more normal state of the world the combination of unobservability and variability of R-star means that you should, you know—that it can be—its utility as a—as the central organizing thought around how your—how you’re conducting monetary policy becomes less.
BLINDER: So your—what you said, of course, about the two decimals is exactly right. Your colleague on the FOMC John Williams, along with colleagues, does publish it to two decimals, or maybe one. There’s a decimal place, anyway; it’s not the integers.
QUARLES: Surely it can only be one. (Laughter.)
BLINDER: OK. And I believe the last published number was near the low end of that range that you just correctly referred to. So should I take it from what you said that the concept starts to lose utility as you get into the range? You were talking about it being very useful when you’re far from the range.
QUARLES: Yes. So that’s what I think. I think in the—so in the current environment, again, as opposed to communicating about what we think the expected path of policy is going to be in relation to R-star, because there’s such a wide variety of estimates of it and because we are nearing the time where—you know, where we’re moving back into a normalized monetary policy, that what’s really important is that the Federal Reserve have a clear and clearly communicated strategy about monetary policy, and that we execute on that strategy in a way that’s predictable and transparent. And in the current environment I think that focusing on estimates of R-star, you know, inherently uncertain, actually can cloud communication as opposed to—as opposed to improve it.
BLINDER: So that leads naturally to my last question before opening up to the floor. As you well know, the Federal Reserve has been criticized by a number of people—let’s leave it at that—for raising interest rates too much. It’s not only that one person we’re all thinking about, but other people have criticized the Fed for that. Would you like to take this opportunity to defend the Federal Reserve against that criticism?
QUARLES: (Laughs.) I think that the—we have a mandate that’s been given us from Congress to maintain price stability and maximum employment, and we’re focused on, you know, analyzing data about the economy to ensure that we make decisions that achieve those two mandates. Currently, I think that the performance of the economy over—you know, over a long period would say that the Fed is doing a pretty good job of that. And that is principally what we’re focused on doing, is ensuring that we make decisions that are designed to—you know, to maintain a strong economy, to extend the expansion for as long as is—as is possible, and to maintain maximum employment. I think the data show that we’re doing a pretty good job of that.
BLINDER: For what it’s worth, I agree with you. Thank you. (Laughter.)
The floor is now open. As you get recognized—there are microphones going around, right? Yeah. As you get hold of a microphone and I recognize you, please stand up and identify yourself by name and affiliation. And I just want to remind everyone, especially whoever is shy in this group if there is such a person, this is on the record, and in fact is being videoconferenced to wherever it’s going. Anyway, it’s not one of these things that what’s said in this room stays in the room, which is often the case in Council affairs. This is an open session.
So, yes, ma’am. Right there.
Q: Michelle Caruso-Cabrera, CNBC contributor. Thanks for taking the question. Good to see you.
When Jay Powell spoke at the ECNY, the stock market soared because investors were left with the impression that when it comes to hiking rates you might all be done sooner rather than later, certainly sooner than expected. Was the investor interpretation correct? (Laughter.)
QUARLES: Well, I assume there’s a range of investor interpretation, as there’s a range of views on the FOMC about policy, and those are expressed in that—in that spread of terminal rates that we were talking about of somewhere between 2 ½ (percent) and 3 ½ percent.
So Jay had said, you know, quite accurately that we are approaching the—we are approaching that range. But it is a—it is a range. And where we will end up in that range will depend on the data that we receive and our assessment of the performance of the economy over the course of the next year.
BLINDER: Doug Elliott, over here. I already told your name, but go ahead.
Q: I’ll confirm it. I’m Doug Elliott from—(laughter)—Oliver Wyman.
And, first, congratulations again on becoming chair of the FSB. I think that’s a great thing.
QUARLES: Thank you.
Q: But my question is more domestic. The banking industry that you supervise is changing dramatically: fintech, other tech things, movement of business to the non-banks, et cetera. How does the Fed itself need to transform to deal with that changed system?
QUARLES: Well, so the first and principal thing I think that we need to do is to ensure that we are understanding it. And so I think, you know, that the research capacity of the Fed, as well as information that we gain from our supervisory engagement, we shouldn’t be looking only at, you know, the narrow question of prudential supervision of the banks, but the broader question of what are we learning that tells us how the financial sector’s evolving, because I think—because I completely agree with you that that can have significant consequences for financial stability. And if significant parts of the—of financial activity move to less-regulated or unregulated parts of the system, it can have, you know, important prudential consequences as well, competitive consequences. So I think we need to understand that.
At the moment we are in the early stages. I think that that evolution is in the early stages, so we are in the early stages of coming to a view as to what the implications of that evolution are going to be. We’re principally, therefore, in the study phase, as opposed to the change-the-structure phase, of that process.
BLINDER: Let’s get Seth right there.
Q: Seth Carpenter from UBS.
You had just said about monetary policy it’s best if it’s predictable and transparent. I think you and all of your colleagues have acknowledged that monetary policy works with a lag. So can you articulate what it means to be transparent and predictable if you can’t just look at where the data are now, if you’re doing monetary policy on a forward-looking basis because of the lags? How can you be transparent about that process?
QUARLES: Well, I think you can be transparent by, you know, having a clear strategy and communicating that strategy. I’ve described it to the—you know, to the analogy of a pilot. In the old days of airplanes I happened to be a—when I was a young man learning to fly, the instruments were much less accurate than they currently are. And they would—and the instrument that told you what course you were on, which is a little circle that has a line straight up and down the middle of it, and if you’re on course that line is vertical and in the—in the center of the dial; and if you’re off course it will, you know, move to the left or to the—to the right. But in the old days that dial would move to the left or the right for a whole variety of reasons. It would just wander across the dial. And you needed to set a course and stick with that course as the needle wandered until it became clear that the information that the instrument was receiving was strong enough that you were, in fact, off course, and then you would adjust.
Now, in the days of GPS, they’re much more accurate and you don’t have to do that so much anymore, but monetary policy is still kind of in the old days of radio beacons, as near as I can tell. There’s enough uncertainty about the inputs and the consequences and traditional macroeconomic relationships in this current environment, whether it’s post-the crisis or the evolution of technology, that we should—we should be data-dependent, but not reacting to every wavering of the needle across the dial, but have communicated a policy that we’re clear that we will be following this path until there is a significant—you know, until there is a significant reason to change.
Now, I think that we have described—in all of the communication tools that the Fed has around monetary policy, I think we’ve described a path that’s pretty clear, markets seem to be pretty clear about what it is that we are—that we are intending to do, and that that’s our task. And so, with respect to the question of, well, given that there are long lags, I think the answer to that is we obviously take that into account. There is significant uncertainty about what those lags are going to be and what the effects are going to be as they show up. So we’re taking that into account. We describe a path that we’re going to be following given what we expect the current data show and future results are likely to be. And as they come in, if they—if they suggest significantly that we need to make a change, then we should make a change. But it should not be perceived and we should not be reacting as if we’re sort of at the dashboard, and with every new bit of information that comes in we’ve got our white lab coats on and there’s the Van De Graaff generator beside us and we’re fine tuning our decisions in light of each new piece of data. We’re following a strategy and we’re—and we’re taking account of data, but over time as it comes in and in response to significant changes in direction.
BLINDER: Well, you made me even more happy that I never flew an airplane. (Laughter.) Thank you.
Gentleman right here, then I’m going to move to the back. And then I’ll get you.
Q: Thank you, Governor. Arturo Porzecanski with American University.
It’s reasonable to say, I think, that a lot of risk-taking has been chased out of the large financial institutions, but it has migrated to the shadow banking system. So is the job done? Is there an understanding on your part that financial risk is only natural in the financial industry, and it’s just a question of wheres, hows, and to what extent this—the government has to bail them out? Or is the job not done and we have to chase risk wherever it may hide?
QUARLES: So I think—so I think the job of the official sector is to establish a framework in which risk-taking—risks can be taken prudently and innovation can happen fruitfully, but again, safely. And so the challenge, in light of the phenomenon that you clearly expressed—which is that a lot of activity has moved, in light of the sort of heavy regulatory response to the regulated financial sector from the financial crisis, risk has moved elsewhere. And it’s a challenge for us to be sure that we are—that that is—you know, that that is not allowing unsafe activities to happen that will eventually feed back into the regulated financial sector and to the—and to all of us as consumers of the products of that sector in another crisis without interfering with useful risk-taking and innovation.
Currently, that’s something that we’re watching, but that I’m not—but that I don’t—I don’t view as a—as a first-order problem. I think that we do continue to have—because the non-regulated sector, the non-bank financial intermediation generally does have enough touch points to the sector that we more closely regulate and have more visibility into. Those touch points allow us to see not clearly, but I think adequately how risk is developing across the system as a whole, and we’re comfortable with what we see currently. But that’s something that will always be evolving and that we always have to be—and that we always have to be looking at.
That’s a clear near-term task, I think, of the Financial Stability Board, and something that should be the case because it’s a global system and the phenomenon you describe is a—is a global one. But again, I don’t view it as a problem that requires an immediate solution as opposed to a phenomenon that requires constant monitoring.
BLINDER: I’ll just add as an editorial comment that it’s really crucial how much leverage is on the balance sheet of whatever you’re talking about before this other risk gets piled on. I’m sure you agree with that.
There’s a question right there. The gentleman there.
Q: Thank you very much. Paul Sheard, Harvard Kennedy School.
We’ve been using prudential policy a lot. Usually a distinction is made between microprudential and macroprudential. Micro, I guess, is the reg part much more. But could you talk a little bit about—I mean, is that an important distinction, in your mind? And how you think about the interaction between those two forms of prudential policy, and particularly the link to monetary policy. It seems that macro kind of links the microprudential to the monetary policy. And while it’s pretty clear, although complicated, how the micro bank financial system regulation takes place, less clear—to me, at least—how the macroprudential kind of policy’s developed and the locus of decision-making—at the FOMC, the board of governors, FSOC, FSB, even from the global perspective. Could you say a little bit about sort of how the macroprudential policy fits in, and how it would actually work in practice if it had to be triggered?
QUARLES: So that’s a great question. And certainly this morning, when I’ve tended to say prudential as opposed to financial stability, I’ve been focused on the microprudential, exactly as you say. Now, at the Fed, you know, we have—it was developed before I got there. And while it’s not inelectable, I think it’s perfectly reasonable. We have a framework for thinking about macroprudential financial stability questions. And we look at different—I mean, we just put out our financial stability report, that describes that in some more detail. And essentially there are different categories that we look at that could pose financial stability risks—you know, asset valuations, levels of debt in different parts of the economy, the overall leverage of the financial sector and liquidity resources of the financial sector.
And we both look at them individually and then come up with an overall view, on the basis of that disciplined and methodical approach, as to where we think macroprudential risks are currently to financial stability. And as I said, you could imagine different ways of looking at that, but I think that’s a perfectly good one. And what’s particularly important is that you do have a framework that provides a discipline to how you think about this, as opposing to reacting to headlines in the newspaper or random bits of data that you’re gaining from your microprudential supervisory activity—although, all of that feeds into these—into this overall assessment.
Currently, our assessment is that those overall risks are moderate. But, you know, we’ve been also very clear that part of that framework is, is that as they become more elevated—if financial risks were to become more elevated—that we would respond with tools such as the counter-cyclical capital buffer, which would, again, create additional loss-absorbing capacity in the financial sector as a whole to respond to our sense of increased vulnerability risk in the financial sector as a whole.
Those decisions are made by the Board of Governors, rather than the full FOMC. Although, you know, we’ve discussed them, you know, sort of very thoroughly and collaboratively in the system as a whole, and not just the principles of the system but all the resources of the system as well. So everything goes into that—into that decision. But that macroprudential response is one for the—is one for the board, as opposed to the FOMC or individual actors.
BLINDER: If I could keep you on that for one second more.
BLINDER: The Fed has been gradually tightening monetary policy now since 2015. The counter-cyclical buffer that you just mentioned, if used—which it hasn’t been—would be a little bit of—would be a tightening—a macro tightening. So why has the Fed not—the board, as you quite correctly say—not used that tool?
QUARLES: So this concept of the counter-cyclical capital buffer is one that developed in international discussions. And both the purpose of it, as agreed internationally, and the purpose of it as implemented the framework that I just described, is to be a response to financial instability as opposed to—as opposed to purely macroeconomic concerns. So macroprudential financial stability concerns as opposed to a business cycle tool. Now, different—and in that context, as I’ve said, in principal part because of the significant increase in reserves of capital and liquidity that the financial sector has, our assessment of overall financial stability risks at the current moment is not that they are elevated. Given historical ranges, they’re moderate. And in that framework, if you’re going to be disciplined and methodical about it, you would not turn on the counter-cyclical capital buffer currently.
But the, you know, thinking has evolved in some other jurisdictions of the world—and I’m thinking particularly about Britain here, which has had experience of turning on the counter-cyclical capital buffer, turning it off, turning it on again, driven in part by the volatility of their economy in light of Brexit. And as a result of that experience—I don’t want to speak too much for them—but it seems to me that what I observe is that their thinking about it has evolved to be more a business cycle adjustment tool, as opposed to purely a financial tool. They’ve said publicly that they intend for it to be on all the time, so that—what they have found the principal use of it is in that in the sense of a business cycle downturn, they can reduce it. That is principal benefit less to increase resiliency at a time of increased financial instability risk and more to essentially be a tool to—a business cycle tool to turn it down when there’s a need to turn it down.
So you could imagine it being even higher. And you could—you could imagine a rethinking of our framework. Certainly if the call were to rethink our framework something more along the lines of the British, so that—so that you had a more flexible capital structure that allowed us to turn down portions of the capital structure in the event of a business cycle downturn, that’s not a crazy idea but it’s not one—but those who are currently saying we need to turn on the counter-cyclical capital buffer aren’t really articulating that call in terms of a change of framework. They’re simply saying, why wouldn’t we turn this on? And to that, my response is, you know, we have—we did a lot of work in thinking about what this tool was for. We have a framework for evaluating when we turn it on. And that framework currently says that we should not.
BLINDER: Thank you.
There’s a question right here in the front table.
Q: Thank you. Alan. Barry Zubrow, ITB.
One of the legislative responses, as you know, in Dodd-Frank was a significant cutting back of the Fed’s powers for emergency and exigent lending under 13(3). In the discussions of recalibrating and adjusting some of the legislation, is this an area that the Fed will invest some of its goodwill with Congress to get changed? Or are you willing to accept those constraints, looking forward to emergency situations?
BLINDER: You’re not going to tell us how much goodwill the Fed has to spend, right?
Q: I’ll leave that to you.
QUARLES: So my assessment currently, in the current framework—I mean, as you know, there—you know, there remains in Dodd-Frank, and there is an active legislation discussion over whether this should be further amended. But there remains a discretionary interventionary response in the resolution of institutions that could be helpful in Dodd-Frank. My assessment, as you look at the overall range of our remaining authorities, is that they’re adequate to respond to a future stress. You know, it is obviously something that we have looked at closely. So I, myself, don’t see a need to further change that with Congress. But as the discussions continue about how there might be further changes, we're, obviously, engaged with them to ensure that we retain what it is that we think it is that we need.
BLINDER: Could you say a sentence of two about to what extent you think that change in the law, 13(3), was a serious constraint on the Fed's abilities or not?
QUARLES: So I think it made a difference. It, clearly, made—it, clearly, made a difference into the mechanics of how we would respond and be able to respond in a future crisis. But if you look still at the overall framework of the tools that remain for the Fed under the Federal Reserve Act and Dodd-Frank, I do think that they're adequate to allow us to respond vigorously and appropriately in the event of a future crisis.
BLINDER: Thanks. Looking in the back, way in the back. There.
Q: Tony Zobul (ph) with AIG.
I'd be interested in your—in any thoughts you might have or comments you might have on the nonbank world, recent, you know, removal of the last nonbank SIFI designation and what the future plans might be regarding monitoring and mitigating systemic risk in the nonbank space.
QUARLES: So we have—the FSOC, you know, has made clear its intention to develop a framework for evaluating a designation on the basis of activities as opposed to entities. That's a(n) easy thing to say. I think conceptually it makes—it not only makes sense. I think conceptually that's, clearly, a superior framework for thinking about designating potential risks from the nonbank financial intermediation.
It's a complicated thing to do and the FSOC is in the middle of developing that framework. I would expect that, you know, you will see a result of that. You know, I don't know what the time frame would be but it is something that we have been working on assiduously.
And so some folks have said, well, doesn't this mean that it's the end of designation. I think it really is simply a change in how one thinks about what ought to generate designations and what they ought to cover, and I think it's quite logical to say really what we ought to be concerned about are activities that potentially create risk and that ought to be the trigger of designation as opposed to particular entities. That discussion is being had internationally as well in international standard-setting bodies and at the FSB and in the IAIS, for example. Those are logical—I think those are very logical ways to think about it but conceptually easier to agree than they are to implement. I think that's the task for the FSOC and the FSB over the course of the next year or two.
BLINDER: I'd like to make it clear that despite the amount of assets represented in this room, the Council on Foreign Relations is not a SIFI. (Laughter.)
Over there in the back.
Q: Matthew Hurlock, Gibson Dunn.
The question—in terms of policy, looking forward, how does the Fed—and I grant you, these are early days as a threat—but how do you think about cryptocurrencies as a threat to policy and regulatory ability and also as a challenge to the dollar in terms of extraterritorial influence of the dollar as the default currency?
QUARLES: So notwithstanding, you know, the amount of mind share that they have—that they have taken—and it seems to have become—it seems to have become less over the last few months—I don't think that cryptocurrencies or crypto assets is I think the internationally agreed term now precisely because their volatility and difficulty of use in the payment system really don't make them useful as currencies yet and probably or certainly possibly ever, so I don't think that they pose a significant threat to financial stability. I don't think they pose a threat to the—to the dollar.
They do, obviously, create issues. Their extreme volatility has created issues around investor protection. Their anonymity creates issues around law enforcement—you know, terrorist financing, financial crimes of various sort(s)—that are real issues and that deserve attention and we're giving them attention, particularly the parts of the financial regulatory apparatus that are focused on that, in particular—the SEC with respect to investor protection and the Treasury with respect to financial crime. But with respect to the issues that are of most concern to the Fed, we're watching that closely. But I really don't see them being a threat to the operation of the payment system or the dollar in any way currently.
Q: Jeff Shafer, JRShafer Insight.
The main theme of this discussion has been risk outside the banking system. When Alan mentioned the question of leveraged loans, you said you weren't too concerned about them in part because they're not on banks' balance sheets. You also said they're not runnable. Other people are expressing quite a bit of concern about the extent to which these loans are building up in the assets of mutual funds that in fact are runnable and I'm wondering if you're at all concerned about that.
QUARLES: So, again, I think that they are building up to a higher level than they were and that is something that we're monitoring, and I guess I should say I wouldn’t want—I wouldn’t want to be interpreted as saying that I'm not concerned about it; simply that the—you know, I think that the path of analysis as to the risks that they pose is different than the simple question of looking at the volume of leveraged lending and what is, clearly, the evolution of underwriting standards in leveraged lending.
I think that those things can happen without necessarily posing either micro-prudential or macro-prudential risks and that question is—the question that we need to be looking at is, is that happening. Now, the mutual fund phenomenon that you point to is, I think, in the current environment the one where you would say there is an increase in potential financial instability risk. I don't—while there is an increase, I don't think that it is yet a—you know, a dispositive or overly concerning increase. But it is definitely one that we—that we're looking at.
BLINDER: OK. One last question. Right there. Thank you.
Q: Hi. Joyce Chang from JPMorgan.
Thank you so much for your comments. I was wondering if you could talk about market liquidity and the way that's shifted over the last decade and whether that could become a first-order problem as we've seen the rise of passive investment, algorithms, electronification of the markets.
QUARLES: So I think that it—I, clearly, think that it could. I don't think that there are particular phenomena in that line that cause me to think that there is an immediate financial stability risk. I think that concerns about the evolution of market liquidity have driven our proposal to simplify the operation of the Volcker Rule, for example.
The sort of academic analyses of the liquidity effects of the Volcker Rule have pointed in different directions, but I think it's very clear from market participants that however one might quantify it there's been some effect on liquidity from that and one of our objectives, again, in refining the content of the Volcker Rule has been because we want to stay ahead of that curve and, again, not create—certainly, not create regulatory incentives to the reduction of liquidity.
BLINDER: Well, I remember when I was vice chairman of the Federal Reserve, not for supervision. My instructions, when I went in the hinterland, was whatever they ask you just say blah, blah, blah. (Laughter.) I'm very glad that you've come not with that attitude and have handled a tremendous range of questions very frankly and very well.
And on behalf of everybody, I thank—we all thank you. (Applause.)