(exciting music)
-: Thanks to our panelists today.
Thanks so much.
I was joking with Don Cohen
that back when I was a reporter at Bloomberg,
I basically used to stalk he and the rest of the Fed.
So it's a different environment right here,
at least I hope it is for him.
-: Great.
-: Good to see you. Thank you for being here.
Thank you for bringing your expertise to to our audience.
-: Great to be here, Peter.
With all these very important people
in the news these days.
-: Much in the news.
Not for all the reasons we would've liked,
but it is an important moment for our industry
and an important moment for us,
for the economy as well.
It's Fed Day, we're gonna get to that in just a moment.
And we couldn't ask for a better set of experience
in terms of what Jerome Powell
and the Fed's going through today,
the decisions they have to make.
We'll get to that in just a moment.
But we do wanna start on
what's happened in the banking sector,
the health of the banking sector
and the actions taken by the treasury secretary
and federal regulators in in the last few days.
I first want to get, Don, your take on those actions.
Had you been in their shoes just a few days ago,
would you have been supportive of what they did
and has it made a difference?
And I'll get to Sayee on that as well.
-: So yes, I would've been supportive.
It is clear when I was looking at this from the outside,
say on Friday morning,
I was kind of hoping that Silicon Valley Bank,
I didn't know anything about Signature Bank,
Silicon Valley Bank would be seen as
idiosyncratic, very concentrated risk,
and there wouldn't be spillovers and they could let it fail
and let the uninsured depositors take the consequences.
But it was clear from what we saw over the day Friday
and what the regulators,
supervisors were getting in information over the weekend
that this was threatening to spread out
in a much more systemic way.
And with the information they had
about how the failure could
spark contagion to other banks.
And when it sparked contagion, have a very serious effect
on the availability of credit
to US households and businesses throughout the country.
That kind of information led them to make
the decisions they made to extend
the insurance to the uninsured depositors.
I'm quite confident that with their information,
I would've made that same decision. Yeah.
-: Sayee, we heard from the treasury secretary yesterday.
She said in her view things were stabilizing.
She expressed confidence in the banking system.
Those are words but there's also some data out there
to suggest this is happening.
We're not just talking about share prices.
-: Sure, yeah.
The share prices, we've been tracking share prices,
and as of yesterday we had seen
that most of the bank stocks were sort of
backed in sort of normal territory in terms of
day over day changes.
We also been looking at the core plumbing of the market
where we see signs of stresses,
the depot market, the sofa market and the Fed funds market.
And while there has been volatility for various reasons,
it's not just what's happening
in a microcosm in our industry,
but in a corner of the industry,
but also credit service and so on and so forth.
If you look at it from a totality perspective,
the market is functioning as theory to good product,
which gives us comfort that it's doing it right job.
And so all the signs are towards the market
in terms of pricing.
And when people use the term crisis,
I don't see any crisis in terms of
what the market prices are signaling today.
-: Yeah. Let me ask you, Don, about one aspect
of the response from regulators and that was,
and from the Fed specifically,
the creation of this liquidity facility.
There's been some talk about it here
over the course of the last day or so.
Talk to me about the role that liquidity facility plays.
And if I'm a community banker out there and I'm hesitant
to participate in it for whatever reason,
what would your message be?
-: So I think one reason that Sayee was able
to sit up here and say
that the markets are still functioning reasonably well
and that confidence hasn't disappeared even more
from the banking system and from the markets
is that the Federal Reserve took note
of the fact that some banks in certain circumstances
would be under liquidity pressure
and they gave them a new way
of liquefying their portfolio,
of locking in an interest rate for a year.
And I think that helps.
The fact that that facility is out there
helps confidence and it gives the bankers, you guys,
a chance to meet, if you have deposit outflows,
to meet them with good collateral,
treasury and MBS agency collateral valued at par
so that you have a generous collateral.
You can borrow, you can meet those deposit outflows
without having to sell the securities,
which would put pressure on those markets
and make you realize those losses.
So I think that facility was a good idea.
Tim Geitner, who I worked with during the financial crisis
used to talk about putting foam on the runway.
So I think the plane was coming in and,
the extra discount window was the foam
they were putting down in order to make the landing
as safe as possible.
And I think it was a good idea.
-: We were talking earlier
and Sayee, I asked you about this,
that there's still the stigma concern.
That if you do it, it's a sign of weakness.
And I think the message we've heard in
webinars we've had with the Fed
is that's not how folks should look at this.
Sayee, anything you want to add on that.
-: No, absolutely.
I think it's a facility that's available
and it's prudent risk management requires that,
even if you're not going to use it,
get the plumbing in place, get the paperwork in place.
And just to elaborate a little bit more on the facility,
or that a couple of weeks ago when we were waiting
for the announcement to come,
we were all talking about there might be a facility
that the Fed will put in place.
And if you go back to March of 2020
and there were bigger liquidity concerns
and a bunch of facilities were put in place,
but the market did not use those facilities at all.
But the fact, to Don's point,
the fact that the facility was put in place
was good enough to the market in terms of
that it's sort of a buyer of last resort
or a liquidity provider of last resort.
But you shouldn't take it for granted, right?
So it's there for a reason.
I think it makes sense for people to do it.
On the stigma thing, as an economist, I would say,
don't worry about the stigma
because your job is to protect your bank.
And hopefully, and maybe Don could speak about it
if he's comfortable,
it'll be great for the Fed to take steps
to get the stigma out of the equation, right?
If financial stability and system sort of stability
are so important, then let's get the stigma out
and let's not share that information
in terms of its bankers.
-: So I completely agree with you Sayee.
And it's a point that I've tried to make
since I left and even a little bit before I left,
worrying about the stigma.
The Fed was created in 1913,
importantly to provide discount window credit
to banks so that they wouldn't have to dump there,
have a fire sale of their assets
when they're under liquidity stress.
And to your point, Sayee,
just knowing the thing was there
was supposed to prevent liquidity stress.
I see that today's discount window
and even some of the thirteen three things,
the lending to non-banks,
we did as a natural extension
of why Congress created the Federal Reserve
to prevent or at least limit bank panic.
So I think the Fed, there are steps the Fed can take.
I've wondered why.
Part of this, and you folks know better than I do,
the attitude of your supervisors.
So to what extent are you allowed
to build in access to the discount window
in your recovery and resolution plans,
in your liquidity plans?
And I think the Fed can take steps to normalize that.
It's a lender of last resort.
It's priced above the market to make it that way.
But it ought to be there
and you ought to feel free to do it
and you shouldn't get adverse comments
from your supervisors when you use it.
So I think there are steps the Fed can make.
-: There's an important implication here, right?
If you think about our approach to bank regulation,
especially after the last crisis,
there's been huge focus on capital, right?
Bank should hold more capital and
there's a constant focus on that.
And bank capital is supposed to focus on
the entity, right?
Making sure that the entity remain the entity risk.
But what we are discovering is that, across the board,
banks are holding a lot of capital
and that's really helpful,
but there are other risks
and liquidity risk is a big aspect
of risk factor that we are seeing today.
And the approach to liquidity risk management
from a regulatory perspective and so on and so forth
has to be very different.
And so I think it's time to focus,
move away from bank capital, just capital
and think about other risk factors
and what should be the regulatory framework
to ensure that we are helping banks
and, from a broader system perspective,
manage the risk better.
I think you should see,
I think the good outcome will be
if we spend more time thinking about liquidity risk
and how to manage it.
And look at what aspects
of the current regulatory framework
are getting in the way in terms of,
to Don's point, of banks taking advantage of these fiscal.
-: Yeah, and building on that point, Sayee,
the interest rate risk.
So we've seen pieces from BPI and others
that said they could have passed a liquidity stress test
but they sure couldn't pass an interest rate stress test.
So I think, I hope one of the reforms
or the changes that come out of this incident
is to elevate the interest rate risk
type of stress scenarios
and tie that to the valuation
of the securities on your balance sheet.
So if you can't pass an interest rate
and liquidity stress test combined
without dipping into your hold to maturity assets,
in my view, they should be valued at their market value
not at their hold to maturity value.
So I think there needs to be changes
in the available for sale,
whether the banks,
all the banks and not just the top ones,
need to reflect the market through their capital accounts.
I think there needs to be an examination
of the hold to maturity and the intersection of that
with liquidity and interest rate stress.
-: You mentioned interest rates
and I wanna make sure in our time remaining
we spend some time on interest rates and
where they might be going even later on today.
It's Fed day.
It is the first Fed decision in some time
where there's some drama around it.
Not everyone's sure exactly what they're gonna do.
Could they move 25 basis points as the market suggests?
Some talk of, just a few weeks ago
we were talking about a 50 basis point increase
and there's some people saying in light of what's happened,
Jerome Powell needs to pause.
Don, what do you think they're gonna do later today?
What should they do?
-: I think you're right Peter.
A couple weeks ago there was a lot of talk about
50 basis point increases.
And that reflected the very substantial resilience
of the US economy that continued tightness
in the labor market,
huge gains in hiring that didn't seem sustainable
and very stubborn core inflation.
So headline inflation was coming down
with petroleum prices,
some of the shipping issues and shortages being cured.
But the core inflation particularly,
and Jay Powell has this eye on
core services ex housing
and that was stubbornly high and not coming down.
So disappointingly, after some good news
in the fourth quarter,
I think the news in January and February,
the information becoming available over the last 60, 90 days
has suggested that progress on inflation
isn't as quick as we,
and I'm sure the fed thought it should be,
which argues strongly for raising interest rates.
Now the disruption in the banking markets
and the problems there mean that you folks,
I think very wisely will be really careful
about managing your liquidity
and managing your credit risk
probably a little more than you were before.
So we know from surveys that the Fed was doing that
the banks were tightening the terms and conditions
of bank loans over the second half of last year
already because you were concerned
about where the economy was going
and the credit risk you might be taking
if the economy entered a soft period
as the Fed was fighting inflation.
I think the events of the last two weeks
are going to amplify that tightening
and you'll build your liquidity.
you'll be more careful, that will tighten.
So that will actually move in the direction
that the Fed needs to move in
because it will have a discouraging effect
on household and business borrowing and spending
when they find it harder to get loans
or more expensive to get loans at at your bank.
So that moves.
So while a couple weeks ago people thought 50 basis points,
I think that tightening and bank credit
that's ongoing and will amplify mean they,
certainly don't need to do 50.
I think the argument for a pause I find less convincing
than the argument for 25.
So the argument for a pause is there's
huge uncertainty out there. Totally agree.
We don't know what's gonna happen.
Raising interest rates could cause
the system to crash even more.
But we have, as you mentioned, Peter, wide expectations
that they're going to raise by 25 basis points.
I don't think the system is so unstable
that a expected increase in interest rates
of 25 basis points is going to break it.
So I would, if I were over there
on Constitution Avenue again,
and I'm glad I'm not,
(audience laughs)
I think I would go into the meeting
arguing for 25 basis points
to keep on top of this inflation issue.
Keep going on that.
Make sure everyone understood
that I had a price stability mandate
and I was determined, as Jay Powell has emphasized so often,
to meet that mandate and I had confidence
in the foam we put on the runway
and the other steps that we're taking
to smooth the financial, to make sure that
another tiny little step in interest rates
wasn't gonna break the system.
-: Sayee, an increase in interest rates, as Don said,
in some ways an expression of confidence
in the financial system.
But there's so many crosscurrents out there.
I've been talking to bankers here
but it's still a tight labor market trying to find talent.
Talk to me about some of those crosscurrents,
all the factors that Jay Powell.
-: Absolutely. Completely agree with Don's point.
The Fed has been talking about
wanting to see a tightening of the financial conditions.
And that's happening in front of our eyes.
So some of it is, the outcome is,
they've been traveling towards this outcome
with the catalyst which will cost us to move towards it,
you're never sure about it unfortunately.
So I think if they don't increase by 25 basis point,
and the market is fully expecting it, a surprising turn,
then explaining why they're not doing it
will be very tricky, right?
And that will make the job really, really difficult.
The labor market is very interesting.
So to Don's point,
yes, you're continuing to see inflationary pressures.
The labor market continues to remain tight
and the the only way to fight it
is to keep up on the rate increase.
And if you look at the market,
they're still pricing in rate increases
for the next few, couple of FMC meetings.
It's not gonna be 50 basis point but keep up with it.
And you have other instances,
the ECB raised rates last week,
when they were in the midst of their own banking issues.
And then the Bank of England,
when they had some hiccups in their markets,
they kept to the job in terms of fighting inflation.
So I think that's the right way to go.
And we had the panel of bankers yesterday
who were all comfortable with another rate hike
and said the system is well, to Don's point,
and focus on getting the
fight against inflation underway
and just continue with it.
-: So, I think Sayee's point
about the labor market is very important
and your point, Peter, because
that core inflation,
particularly in the services industry,
is so tightly tied to the labor market.
I mean, labor is a huge input into the provision services.
That's what you guys do.
You know that much better than I do.
And as long as that market is tight,
as long as the wages are going up much more quickly
and consistent with the 2% inflation target,
I think they're gonna focus on the labor market,
taking some of that pressure off the labor market
in order to take pressure off of prices.
We've seen a few
indicators that some of the pressures coming off people.
Be fun to take a poll with the audience.
I know we can't do that, but
Peter: We can try.
-: The people aren't quitting jobs as often,
so they don't see the job market as tight.
There's still a lot of vacancies.
They're like two vacancies for every unemployed person,
which is very high, very tight.
And wages, although wage increases have come off
a little in some areas they haven't come off a lot
and they're still too high.
So that nexus, the connection,
between inflation and labor market quite important.
-: I'm gonna do a little informal,
raise your hand if you're having a hard time
hiring staff right now.
-: Yeah.
-: All right. A good number of hands in the crowd.
I'd say almost a majority, if I'm not blind here
and seeing everything properly.
Let me ask you just about the longer term outlook,
and Sayee touched on it.
There are some out there who say that yes,
the Fed's gonna raise today, but by the end of the year
they're gonna be cutting rates.
Is that a realistic possibility here?
Are we gonna be stopping, starting and dropping?
-: No, I don't.
It's always a possibility.
So I think one important thing for us to acknowledge,
Sayee and me, to acknowledge,
is that there is a huge amount of uncertainty.
It's all, this whole episode of inflation,
of a pandemic that closes down the global economy
and reopens in a very uneven way,
a land war in Europe for the first time.
Unfortunate Russian aggression in Europe
that disrupts food and energy markets,
huge fiscal and monetary stimulus.
There are a lot of really unusual things going on.
And now we're adding to that uncertainty about
what's the tightness of financial conditions
running through the banking system
and spilling over from the banking system
to non-bank markets.
So I think we have to start by acknowledging
no one knows what's gonna happen here.
I think the Fed will go in
with the view that they're gonna,
stick with the view that they're gonna get
to where they want to go,
pause and see what happens.
And I think their going in position would be,
no, we're not counting on lowering rates later this year.
We're not ruling it out
because things could occur that way.
But this inflation picture looks pretty stubborn
and we would have to see real progress on inflation
that we could project forward to getting to close to
our 2% target in 2025, which is what they're projecting.
So we will get projections from the Fed this afternoon.
Well, we should get projections.
I noticed one analyst out there who said
maybe they won't give us projections
because of this uncertainty.
-: No more dot plot?
-: Well that's what she was suggesting.
The uncertainty was so big, you couldn't logically do this.
I think,
I guess what I'm hoping, maybe more than thinking,
is that we'll get projections,
but with acknowledging the uncertainty
and the possibility of widely varying outcomes.
But being, as Jay Powell says, data dependent,
seeing how the information comes in,
but being really,
he will not back away from his focus
on getting inflation down to 2%.
That's the legislated mandate
for the Federal reserve price stability and he'll go there.
So I think it'll be interesting to see whether the Fed,
the Feds dot plot is about rates at the end of the year.
There could be some members of the committee
who take it up higher and then down lower.
We're not quite sure.
Maybe Jay Powell can clarify that in the press conference.
But I think most members of the committees going in
would be, we're gonna get to a place
where we think financial conditions,
including what bankers are doing,
are tight enough to bring inflation down
and we're gonna stay there for a while
to make sure it's coming down.
-: Yeah.
-: Tracking this, forecasting this,
particularly in this environment,
it's getting challenging,
Sayee, later on this week,
the second most important gathering of economists
other than the Federal Reserve meeting,
(Sayee laughs)
will be a gathering of our economic advisory committee,
which includes economists
from some of the largest institutions
and volunteer members of our EAC,
who give us advice on what's gonna happen in the future.
Give all of our members advice.
Talk to me a little bit about the challenges
the EAC's got going forward.
-: Yeah, so the EAC has been,
it's a very humbling time to be an economist,
as Don is alluding to.
There's so much of uncertainty.
The models that people have been working on are,
we need to go and change them.
So the chief economists, they meet every quarter,
coincidentally they're gonna be meeting tomorrow.
They've been great. They were met earlier last week.
But the thing which has been confounding them like crazy
is the labor market.
Everybody has good theories on what's happening,
in terms of pricing, in terms of goods and services.
But when comes with the labor market,
that has been a challenge.
I was at a conference, a monetary policy forum,
where all the main thinkers on monetary policy issues
meet in New York every year.
And the consistent set of questions from the audience
to all these economists on
what's happening in the labor market
and throwing some stats.
And none of the economists were willing to wade in
with any sort of responses.
So the labor market remains a mystery.
But it's also important to understand that
monetary policy works with a lag.
You need to give it time to,
may work its way through the system.
Once in a while we have these episodes
which push us in that direction,
but it just works with a lag.
But there is this other issue which,
and it comes across from bankers a lot,
and it also came up during breakfast yesterday,
which is this two person inflation target.
The two person inflation target,
inflation targeting, was put in place
around 2018, 2019?
Don: 12 actually.
-: 2012. And so then there was,
the framework got updated just before the pandemic.
So there was this question as to
does it make sense anymore, right?
We had this long period of low inflation,
there were a lot of global factors
pushing us in the direction.
And going forward, what price are we going to be paying
through monetary policy to push us down
to the two person inflation target.
Or instead, should we be more cognizant of
the dislocations that have been happening.
Just in time to just in case,
that's what people are talking in terms of supply chains.
And that everything comes at a price, right?
So we need to build in more buffers and
risk mitigants in your supply chains.
And that all adds to the pricing pressures.
So should we tolerate a slightly higher inflation rate
instead of two person, three person?
So I'm sort of curious, Don,
if you have any thoughts on that.
-: So the 2% was widely adopted globally,
started in New Zealand, spread the Canada,
the UK, back to the US, to Europe, et cetera.
And to a certain extent it was inertia.
But it met,
Alan Greenspan's definition of price stability was
inflation was low enough
that people didn't have to pay any attention to it,
as they were making decisions,
as they interacted in the labor market,
as businesses sold goods and services,
they didn't have to think about
what's the inflation rate going to be next year.
It's low enough for that.
And I think that's a good definition
and 2% I think fits that.
Now, whether a higher one would
is a question.
There are a number of academic studies,
to Sayee's point, that say if what you're worried about
is having low interest rates on a steady state basis
and then a negative shock hits the market,
the Fed doesn't have much room to lower interest rates.
It gets stuck back at zero again,
as we did in 2008 and nine,
and going forward and as they did in 2020.
So the debate is, could having a higher inflation target,
say 3%, would that be low enough
to meet the Allen Greenspan definition?
It's hard to tell.
But high enough to add a little more
to nominal interest rates
because inflation does get built into interest rates
to get the Fed some more room.
When the Fed undertook their reexamination
of their framework for monetary policy,
Jay Powell was very clear.
And he said, 2% is our target.
We're gonna stick with 2%.
We believe that's a good definition of price stability.
And the American public doesn't like inflation.
So whether they could raise it to three.
And raising it to three when you're above it
would be hard to do credibly because
you raise it to three when you're above it coming down
and people will say,
"well then they'll just raise it to four
when they have trouble getting down to four
or raise it to five".
So I think raising the target
from this position is really hard.
But I do think to your point, Sayee,
they could have a longer runway into the 2% target.
They could take more years
and that would reduce the dislocations
in the economy and labor markets as they get there,
as long as they were clearly going down there.
So inflation expectations remained anchored.
-: All right. We've got just a couple seconds left.
I want to give you all a final opportunity.
What's the most important thing for Jay Powell?
What does he want to accomplish in his press conference?
What's the headline he wants out of it today?
Quick answer if you don't mind.
-: So I think he wants to underline that,
while there are pockets of problems in the banking system,
the system itself is still safe
and well capitalized and liquid.
And that they haven't given up at all
on their pursuit of price stability.
-: Don't make any waves.
The market doesn't like volatility
coming out of press conferences.
Stick to the message that Don just handed out to him.
-: All right, on that note, Sayee, thank you so much.
Donald Cohen, thank you again.
Appreciate it.
Thank you for your insights
and thanks to all of you for listening.
(crowd applauds)
All right. Thank you.