Michael Barr is a busy man these days. As the Federal Reserve's vice-chair for supervision, he's looking at ways of making the financial system safer through the next-generation of US banking regulation, known as the Basel 'endgame' proposal. In July, he also unveiled the central bank's new real-time payment settlement system for banks, called FedNow, after years of development. Of course, all of this is happening at an interesting time for banking. This year saw the collapse of three banks following deposit runs. There have been big losses on bond portfolios as interest rates rise, a cyberattack that briefly unsettled the US Treasury market, and there's still a lot of general uncertainty over the direction of the US economy. In this episode, which was recorded live onstage at The Clearing House annual conference in New York, we speak to Barr about how he's thinking about the payments space, big changes to bank regulation, and the macro outlook. This transcript has been lightly edited for clarity.
Key insights from the pod
:
What's the status of FedNow? — 1:01
Could real-time payments get fractured between two competing systems? — 3:37
What are the challenges to real-time payment uptake? — 9:17
Why everyone is talking about Basel requirements — 13:03
What is the purpose of the new rules? — 14:24
How does finreg intersect with monetary policy? — 18:16
What is the plan to improve supervision? — 20:21
Where are we in the interest rate cycle? — 26:46
What is the significance of consensus on the new rules? — 33:46
What are the risks outside the banking system? — 37:11
The risk of crypto contagion to banks — 43:18
How best to think about stablecoins? — 46:41
Are rate hikes impairing the supply side of housing? — 52:04
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Tracy Alloway (00:09):
Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.
Joe Weisenthal (00:14):
And I'm Joe Weisenthal.
Tracy (00:15):
So, you are about to listen to a very special episode. This is a live conversation that we recorded with Michael Barr, the Fed's vice-chair for supervision at The Clearing House Annual Conference in New York on November 17th.
Live recording begins:
Tracy: (00:30)
What should we talk about? There's nothing going on. It's not like there's been any development in payments or bank regulation. It's kind of boring.
Michael Barr (00:38):
Yeah, I don't know!
Tracy (00:39):
No, okay. There is a lot to talk about, so I should get started right away. Why don't we start with payments? We are at the Clearing House conference, so that's probably a good place to start. You launched FedNow, the new real-time payments clearing system, a few months ago in the summer. How's that going? What's the take up been like and what have you learned since launching that?
Michael (01:01):
Well, I think it's going well. I think the important thing to remember about take up is that it's going to take a long time. When we've seen any payments innovation in our economy, it takes a long time for people to get used to the idea, to develop it, to figure out how they're going to use it.
But right now what we've done is built the rails and those rails can be used by the banking sector to provide new services to their customers, to households and businesses. Take up really requires banks to decide that their customers really want the service, and then they can innovate on top of it. That's what we're looking forward to over time.
Joe (01:38):
Do you have any way of gauging, setting aside that it's going to take a while, like what constitutes a benchmark that we should watch for? Setting aside maybe decades, but what should we be looking out for? Is this going well?
Michael (01:55):
I, again, I think the right way to think about this is over the very long term. If you look, think about any payments innovation, whether it's the development of bank notes or the rise of checks in the 1700s or really any kind of innovation we've seen in payments, they take a very long time to build a network. Once that network gets built and you have scale, then it really takes off and everybody assumes it's been that way forever. So we're really at the very early stages of this.
Tracy (02:25):
So, speaking of development, I am not a payments expert. I used to know more about the space when I was a banking correspondent, but that was like more than 10 years ago at this point. But I do remember 10 years ago, The Clearing House also developed its own real time payment system. Is it weird that we've ended up with two, basically a publicly-owned one and a sort of privately-owned?
Michael (02:50):
We actually have a very long history in this country of having both public rails and private rails. That's the way most of our payments technology has evolved over time and most of our payment systems today have both public and private aspects. We really think of these things as complimentary. We work really closely together. David [Watson, CEO of The Clearing House] and Mark [Gould, the Federal Reserve System’s chief payments executive] were taking selfies yesterday, these are close collaborations.
Tracy (03:15):
Glad we could be here to facilitate it. But just on this note, I mean, could you get a situation where, for instance, a lot of the higher volume payments from the big banks are traveling along the Clearing House pipes, whereas a lot of the smaller payments from smaller banks are going along the public rails? Basically a fracturing or a fragmentation of the system?
Michael (03:37):
I don't think that if we ended up that way, I don't think that would be a fracturing. We have lots of systems now where larger volume payments travel one route and smaller volume payments travel. That could end up being the efficient way to do it, it would be fine if it ended up that way. It also would be fine if there were a mix of transactions on both kinds of rails, they really are complimentary. I think that if you move forward many years, we would expect that banks would have access to both kinds of rails. They could choose which rail to send an individual payment on. That would be great.
Joe (04:12):
Why are they complementary? Because if they do roughly the same thing, I would intuit that most payment systems essentially benefit from network effects, and the bigger one makes it more valuable to use that one. Why wouldn't we assume that it's just going to be one wins and one loses?
Michael (04:28):
Well if you look at existing payment systems today, we have private rails for ACH, we have public rails for ACH. I don't foresee this being a conflict. I really do think that banks are going to be able to have optionality in the systems that they use, and they might use different rails for different kinds of payments.
Tracy (04:49):
Why did it take so long to develop a real-time payment system? Because again, I mean, I spent a lot of time in the UK. I think the UK had something equivalent in like 2007, and we are here in 2023 just launching it.
Michael (05:02):
It has taken a long time, I would agree with that. Look, the Federal Reserve is a conservative institution, and I think that's appropriate. People expect us to be able to provide trustworthy, reliable services, and we earn that trust by being very, very careful about everything we do and that's true with FedNow as well.
Joe (05:28):
Does the fact that there are these two competing payment systems, or maybe complementary, but ambiguity about which one will gather more volume and for which type of payments, do you think it slows down adoption at all in terms of a bank having to decide which one they're going to invest their time and energy, or turning into a sort of retail facing application of it and thinking about which one is going to win?
Michael (05:52):
My expectation is that banks will end up, again over time, probably adopting both the public rails and the private rails and using them for complementary kinds of services. It's going to take time. I would say, especially for community banks, one of the key issues here is making sure that core service providers get up to speed quickly and offer the service to all the community banks in a fair and equal and accessible way. And so we are very focused on working with those service providers to make sure they're offering that service to community banks.
Tracy (06:27):
Can you give us a sense of the take up and the expansion so far?
Michael (06:31):
What I would say is you should be thinking about this as taking years to do. Take up is always slow at the start. It's going according to what we thought, but that's very slow and we expect it to be slow at the beginning.
Joe (06:45):
Will you come back on our podcast in 10 years to assess?
Michael (06:49):
I would be delighted to. That would be really fun.
Tracy (06:52):
Well, I mean, talking about long timescales, there is a sense of irony in that the Fed was working on this for a long time, and then they release it in the summer of 2023, right after we've seen essentially a bank run on Silicon Valley Bank. And I've seen some commentary about a potential tension here.
You're making real-time payments possible — more instantaneous deposit withdrawals 24/7 — at a time when deposit withdrawals have become problematic. I think Joe Abate over at Barclays was talking about how you're basically allowing banks to kind of slim down their inventory in really efficient ways, but in a way that as we learn from the pandemic, could be problematic if something happens. How are you balancing that tension?
Michael (07:42):
Well, if you look at the situation today, obviously Silicon Valley Bank failed without any new technology. People were able to withdraw very, very quickly. The real issue in Silicon Valley Bank was deep mismanagement of interest rate risk and liquidity risk, and then the highly networked nature of their deposit base. The technology side of that made it possible for them to withdraw, but not in any fancy new technology, but technology that's been around since the 1970s.
So really what we need to do is focus on the fundamentals for banks to make sure that they are appropriately managing their risks. With respect to the new technology, with respect to FedNow, the individual banks can set their own limits on the way in which they use the technology. They can set size limits if they want, they can cap it. So I don't think it'll introduce new significant risks into the system. The risks in the system that are there, we need to make sure we manage appropriately.
Joe (08:43):
Setting aside whether it's FedNow or the private sector Clearing House one, in the US, does the fact that arguably banks make a lot of money from the lack of real time payments, whether it's overdraft fees, late fees, there's a lot of money in the business of people not making timely payments. I also wonder, and maybe it's off the mark, but I wonder we're in a high interest rate environment, so people want to hold on to cash maybe for a few extra days. When we are thinking about timelines, do you think that that affects their trajectory of these timelines, the business of slow payments basically?
Michael (09:17):
I do think we have to look forward to a system in which businesses and households can get their funds right away. We might end up in a situation where we can have a significant effect in reducing overdraft fees, insufficient fund fees, a situation where a small business can get paid right away for the work they've done. That would be a huge benefit for American society.
And so I do think that one of the potential upside benefits of FedNow is the ability to actually deliver for households and businesses the kinds of banking services that they want and that would reduce risk to them. I think that's a wonderful thing for society.
Tracy (10:00):
Just in terms of the payment space, you've finally unveiled this. What's on the agenda now? What other payment improvements could be made for the US?
Michael (10:09):
Well, I think it's a great question. Look, I said before that we're a very conservative institution and we are but we also need to continue to think about innovation. FedNow will continue to be an important part of the way that we innovate. So we're looking to add additional features to FedNow over time and those features will make it easier for banks to use, better for banks to use, better for banks to offer to households and businesses.
I think those kinds of innovations are really important. And then we're also doing very basic research in newer technologies around distributed ledger technology, using encryption techniques to send payments back and forth. That very basic research might help us to continue to innovate in our payment systems.
Joe (10:56):
Since you mentioned digital ledger technologies and people talk about other types of payments, central bank digital currencies, I always have a hard time wrapping my head around I guess the ‘why’ of some of this. I mean, I understand these are interesting technologies maybe, but why, like what do you feel is the impulse when people talk about exploring some of these new, I don't know, paradigms of money or paradigms of payment, what people hope to accomplish with some of this?
Michael (11:26):
It's hard for me to say what lots of other people think, but I'll just say from my perspective, I think the research is important because we might uncover ways to be much more efficient with the payment system. And payment system efficiency can help banks and households and businesses conduct their transactions in a lower cost way. So I'm not super into all the very large claims people make for central bank digital currency. But I do think that the underlying technology, if it can lower costs, improve efficiency, those things are worth researching.
Tracy (12:18):
Joe, you want to talk about bank reg[ulation]?
Joe (12:20):
Let's talk about bank reg.
Tracy (12:21):
So again, I used to be a former banking correspondent, and I remember whenever I pitched a story about bank regulation to my editors, their eyes would just sort of glaze over.
Michael (12:31):
You’re going to fix it now!
Tracy (12:32):
I don't have to, because now, you know, there are adverts about Basel playing during NFL Games.
Joe (12:39):
Our own listeners of the podcast often talk about ‘Oh, I'm learning a lot about Basel Endgame.’
Tracy (12:46):
This is something I never thought I would see in my lifetime. I feel like it's a slippery slope to the point where everyone starts including their position on the Basel Endgame proposals in their, like, Tinder profile or something like that. It's a new talking point. But have you been surprised by the amount of discussion that this is generating?
Michael (13:03):
I have been surprised by it. I mean I do think that some of the advertisements and things you're seeing in the public are extremely unusual for bank regulation. Normally we issue a proposal and then we get very detailed comment letters back, and we take those comment letters into account and we finalize our rule. That's sort of the normal process. So seeing ads at football games, that's kind of unusual.
Joe (13:29):
How does it feed through to you? I'm always actually curious when an industry group does something like this, or even when I see an ad for some sort of B2B software or something. How does it actually filter through to you in your job in terms of the decision and the pressure that maybe builds on you?
Michael (13:50):
You know like in the Peanuts, when adults talk and it goes ‘ wah, wah, wah, wah, wah.’
Joe (13:55):
That's what they're accomplishing? Money well spent.
Tracy (14:00):
I mean, in fairness, this is a big deal for banks and I think there is some discussion around making the cost of capital more expensive or less available for obvious reasons. And one of the criticisms that you hear now is this is going to make mortgages more expensive for Americans. How would you tackle that particular issue, or that particular criticism?
Michael (14:24):
Look, anytime that you change regulation, there are costs and benefits to that regulation. The big benefit of having higher capital is that you make the banking system more resilient. One of the things that we saw in the global financial crisis is that it really crushed the American economy. It caused millions of households to lose their homes to go into foreclosure. That financial crisis shuttered American businesses. It caused massive unemployment, huge harm to the economy. We want to make sure that the banking system doesn't crush households and businesses again.
At the same time, when you have higher capital levels, that increases the private cost to banks. Banks use more equity and a little bit less debt to fund their mortgages or their trading activity. The capital proposal that we've put forward mostly changes the rules for trading and other non-ending activity. A very small portion is actually related to lending.
And when you look at that increased cost to the banks with respect to capital, that translates on average for a typical loan to an increase if all of it is passed through to the borrower, if there's no competition at all and all of it is passed through to the borrower. The average increase would be 0.03%. So it's a very, very small change in the cost of credit and a significant increase in the resiliency of the banking system.
Tracy (15:58):
Just on the point about the different ways that big banks versus smaller banks are treated, I mean, my understanding is the US is one of the only jurisdictions that actually created carve outs from Basel for smaller banks. And I guess going back to the Silicon Valley bank example, I mean, given where trouble in the banking system was this year, is that something we should still be doing?
Michael (16:23):
Well, you, you raised an excellent point. So what we've done in this proposal is say that those stricter capital requirements should not only apply to the top eight banks in the country, but they should also apply to banks that are over a hundred billion. So there are 37 banks in the country that are over a hundred billion, there aren't that many.
We have over 4,000 banks in the banking system, so less than 40 out of 4,000 are covered and it would've covered institutions like Silicon Valley Bank if we had had this in place before. I think one of the lessons from that experience was that it's important for large banks that might have an effect more broadly on the economy to have that real resilience to them. With respect to Silicon Valley Bank, they didn't have to account for the unrealized losses on their balance sheet, reduction in value of securities. And under our proposal, those institutions at that size would need to account for that now.
Joe (17:28):
I don't want to jump ahead too much and, well, this is still a regulatory question, but at the FOMC, at the Fed, do you think much about the interplay of rate policy and financial stability or regulation? Because I feel like we often talk about these two different things. There's the supervisory aspect of the Fed, the regulation of the banks, etc., and then there's monetary policy, and that's economics. But as we saw with SVB, they can interplay and the losses born on long-term debt or other holdings can become financial stability issues. How much do those two conversations oversect in your — is that a word? — oversect in your world where you think about the stability aspects of economic policy choices?
Tracy (18:11):
I think you mean overlap and intersect. It’s a good word though — oversect.
Michael (18:16):
They both overlap and intersect. I think it's a great point. So first of all, I have two jobs. I'm a governor and therefore sit on the Federal Open Markets Committee, and I'm the vice chair for supervision. And so in my own personal responsibilities, those are quite oversecting. But also more broadly for the FOMC and for the board, we care about both, both issues. Obviously we have a clear monetary policy mission. We're going to bring inflation down to 2%, that's our job and we're going to do it.
And we also need to understand that and do understand that as interest rates rise, that changes dynamics in the banking system and the financial system. We're really attentive to those changing dynamics. Obviously, if we don't have a functioning financial system, we don't have a functioning economy. And so we have to care about financial stability risks in the system. We regularly monitor these, we have regular reports from our financial stability staff, not only internally at the board, but also to the FOMC. We have an opportunity for members of the FOMC to comment on financial stability issues as we have our discussions. So these things really do go together.
Tracy (19:35):
Joe brought up the fact that there are supervisory functions, financial stability functions, market functions. Just going back to the example of Silicon Valley Bank, it seems like part of the issue here was supervisory. So even though you could see that there was a capital problem, you could see the mark to market losses coming through on the balance sheet some months before the bank actually went down.
Enforcers didn't raise those concerns and they certainly didn't force a capital raised by SVB. Do you think there's more to be done on the supervisory front, maybe changing the culture of some of those supervisors so that they feel more comfortable, more willing for whatever reason, to actually raise these concerns at the appropriate time?
Michael (20:21):
I think you raise a really important point and we issued a report right after SVB failed, and one of the findings of the report was that supervisors identified the risks at the bank, but they didn't feel empowered to push hard enough to get the bank to take action. And so one of the things that we're making sure of is that supervisors know that they should act with speed and with force and with agility, when risks warrant that kind of action.
It does take a change of culture, it does require us to really make sure that examiners feel supported and empowered to take that step. You want to make sure that they're trained and that they have guidance to act forcefully, and I do think that all these measures are really critical to making sure we have a supervisory system that's effective.
Now of course at the beginning and end of the day bank management and the board of directors of the bank are responsible for running the institution. We're not able to come in and run the bank for bank managers, that's their job to do. In the case of SVB and some other banks, the banks really sorely mismanaged both interest rate risk and liquidity risk. And they did things that in retrospect, you kind of are hedge scratchers, they had for example, some hedges on some of their interest rate risk, and they took those off.
Tracy (21:50):
I saw the internal presentation where they talked about doing that, and it was basically like, ‘Well, we have these hedges, they're expensive. We don't think the Fed's going to raise rates, so why don't we make some more money?’ It was literally that.
Michael (22:03):
It does go to this question of compensation. They were really focused on short-term profits and not looking at long-term risks. And that really is inconsistent with the approach that we require of banks to have compensation aligned, not just with how a bank is doing in the short term in terms of profits, but also thinking long term about risk management.
Joe (22:26):
So just on this point, particularly about the culture of supervision in March, 2024 or March, 2025 down the road, can you talk about what specifically is being done now such that in the future the culture is better?
Michael (22:42):
There's a lot of work going on. One of the things that we're doing is, again, making sure that examiners feel empowered to act on the basis of the information they have in front of them in a timely way, make sure that they have the tools to put in place mitigants. If a firm is getting itself into trouble and we want to make sure that we have a system that escalates appropriately so that if there are significant risks, you don't wait years before action is taken on those.
We're making sure that examiners have the training they need to take action when they need it. In the current environment, we're focused on things like interest rate risk, liquidity risk, credit risk, particularly in the office sector and cybersecurity, which is just a fundamental risk that many banks are exposed to.
Tracy (23:36):
I definitely want to talk a little bit more about some of those individual risks, but just on interest rates, so we talked about Silicon Valley and the fact that they didn't think the Fed was going to raise rates, even though I would argue looking at Fed speeches for most of 2022 and into 2023, there was a lot of discussion about ‘we are raising rates.’ But that said, we have been in this sort of weird environment where the economic outcomes seem almost binary, at least if you read financial commentary.
So going into 2023, it felt like the two options were either soft landing or massive recession. And I think if you're a bank, it's kind of hard to juggle those two things. Is there anything that the Fed can do more on the sort of forward guidance side to minimize interest rate risk? So aside from the Basel endgame proposals in terms of communications, is there more you can do?
Michael (24:36):
First let me just say with respect to interest rate risk, we expect banks to be able to manage interest rate risk, whether rates are rising or falling. That's part of prudent risk management. The Federal Reserve does communicate quite often about the path of interest rates. The FOMC every other meeting puts out a summary of economic projections that are designed to show what each individual member of the FOMC believes about the path going forward for the economy.
It's not a forecast, it's not a collective judgment or a consensus document, but it does let the public know what each individual member of the FOMC is thinking about the future path for monetary policy. I think Chair Powell has made it clear that we're going to need to hold interest rates at their peak level for some time in order to make sure that we're on the right path to get inflation back to 2%.
And so I do think that kind of communication can help the market, can help the economy, can help businesses plan for the future. Of course, we're all taking in information in real time. We do need to be dependent on the data we receive. The data we receive helps us update our forecasts for the future and we are living in an uncertain time. The pandemic caused significant changes to our economy, and those are still working their way through the system.
Joe (26:07):
I think we were going to throw in a couple of macro questions at the end, but just since we're talking about the dots, so in the last few weeks we had a non-farm payrolls report that came in a little bit weaker than expected, continuous jobless claims, highest level of the year, close to highest level in two years, CPI report that came in pretty clearly cooler than expected. As an FOMC member, how is your thinking on the economy right now and the appropriateness of Fed's policy stance where it is right now?
Michael (26:36):
Thank you. Look, we take all this data as it comes in and we're very data dependent, but we're also not dependent on any one single data point.
Joe (26:45):
That's why I said three.
Michael (26:46):
I think it's useful for us to take that information in. Certainly the information that we've had recently suggests that we're moving into better balance on the risk between, over tightening and under tightening. And I think that's quite encouraging. So we're likely at or near the peak of where we need to be in terms of having a sufficiently restrictive stance of monetary policy that we will sustainably bring inflation down to 2%. And I think the recent economic readings reinforce my view that that is probably correct.
Tracy (27:24):
What's your favorite or most compelling indicator right now for the direction of the economy? These are Desert Island Indicators, if you had to pick one, what would you bring with you?
Michael (27:35):
So it's a terrific question that I'm not going to answer.
Tracy (27:39):
Oh okay. Those are always the best questions — the ones that don't get answered.
Michael (27:42):
It really goes back to my point earlier, the pandemic really did significantly disrupt our economy and it disrupted many of the ways that we think about economic relationships in our economy. And so it does require us to really look at a very broad range of indicators as they come in and not just a single data point as evidence that now I know that we're in the right place. I would say I am, and generally as a committee, we are cautious about overinterpreting any one data point.
Joe (28:20):
Not that anyone asked, but mine would be claims because I figure if I'm on a desert island, I don't want to wait a whole month for a data point. I figure once a week, something to keep me entertained.
Going back to the regulation question, you know, you mentioned that in your view lending costs would be pretty minimal with some of these new capital constraints. But I'm curious, you know, when we talk to regulators and most regulator conversations, it's very much centered around de-risking constraints, etc. But I'm wondering if you ever think about the opposite of building out a sort of affirmative capacity for lending at banks.
And the specific reason I ask is, a few weeks ago, Tracy and I interviewed Jigar Shah, who runs the loan program at the Department of Energy, a lot of lending to clean energy companies and so forth who aren't in a position to borrow money from banks and even actually cited Basel rules as a reason that banks were not in a position to do a lot of this lending.
And I'm curious whether you worry about that. Essentially, banks no longer building that in-house knowledge of capacities of specific sectors, of the economy, of different areas, real estate, energy, etc. And it all sort of ended up getting outsourced to private credit, public type banks, etc. and how much of that do you think ideally should be preserved in-house at the lending desks of banks?
Michael (29:41):
We do take all those kinds of issues into account. We're in the phase of our rulemaking where we've issued a proposal, we're taking comments on that proposal. We really are open to all kinds of input on the proposal. We want to make sure we get it right. If there are areas that we can improve, we certainly will.
One of the areas that you mentioned is, with respect to energy, some people have come to us and said ‘We think that the way you're treating in the proposal tax credits, equity tax credits doesn't appropriately take into account the way in which repayment occurs under the tax credit. Because in a normal equity investment, the return to the investor is from the investment itself. And in these tax credit deals, we should think of those as having the return coming from the tax credit. The tax credit is a regular source of payment, so you should think about this tax credit differently from other equity investments.’
And that's the kind of comment that is useful to us. We'll look at that, we'll examine the analysis, the empirics of it, and if that proves out to be true, then we can make an adjustment.
Tracy (30:47):
I mean, it is true more broadly that your counterparts in Europe, some European central banks have made accommodations for green energy loans or investments. It sounds like that's something that you would consider, at least from a tax credit perspective, that sort of change?
Michael (31:03):
We don't consider the non-risk factors, I would say, related to tax credits. But if the risk of those tax credits is lower, then that is exactly something.
Tracy (31:15):
Oh, I see. So it would still be industry neutral.
Michael (31:17):
Correct.
Tracy (31:18):
In terms of other changes that you may or may not be considering, one of the big points of contention with the Basel endgame proposal has to be the change to operational risk and the way that's calculated. And I've seen some numbers floating out there saying that, you know, I've been watching the NFL and I've heard the ads...
Michael (31:38):
Your listeners are willing to talk about operational risk?
Tracy (31:41):
It's surprising, I know. But is that something that is up for debate or some wiggle room, or what sort of conversations are you having right now with the stakeholders about this particular issue?
Michael (31:54):
We also do look at, again, comments on any aspect of the rule. We've heard comments already, and I'm sure I'm going to hear more of them soon, that the operational risk charge is too high for some categories of activity. Again, we're open to comment that is evidence-based, that's analytic that demonstrates that the risk calibration should be different. We want to get the rule right and we're open to those kinds of comments.
Speaker 4 (32:36):
Should we take a couple or throw a couple audience questions?
Tracy (32:38):
Yeah, let's do it.
Joe (32:39):
Here's a question: FedNow, could it ever be the backbone for a simple point of sale system?
Michael (32:45):
Well, that's a great question. One of the cool things about setting up a structure like FedNow is that people can innovate in lots of different ways on it and I do think that that might be one of the ways that people could innovate over time.
Tracy (33:01):
Do you want to do another one or shall I throw one in?
Joe (33:03):
Yeah, throw one in.
Tracy (33:04):
Oh, okay. I'll throw one in. So in some respects, I hope this is one of the easier or more relaxed conversations that you're having this week because you were t alking to lawmakers and politicians earlier and that's always a sort of intense discussion, I find. But one of the questions was ‘Are you aiming for consensus on these new bank rules?’ And so I'm not going to ask that question again, but what does consensus actually look like to you?
Joe (33:34):
Was there a subtext there? There were so many questions on this consensus question. What were they really asking about?
Michael (33:45):
Traditionally, one of the things that is true of the Fed and that I really value about the Fed is that we're very much a collegial body. We spend a lot of time working with each other, talking to each other, working through issues, and to the greatest extent, practical, we try to get most or all of the board members in favor of any particular thing that we're doing.
So, if I look back over the last year and a half, not quite a year and a half, but we've had about 50 substantive either supervisory matters or rulemakings that I've brought to the board for consideration. And almost all of those have been unanimous decisions. It doesn't mean that they are always unanimous. Sometimes we have dissents and I respect the dissents.
So we have board members, one or two board members on a handful of matters that have dissented from the proposals that I've put forward. And I think it makes this a better institution to have that first of all the conversation and to try and teach consensus. And second, if we can't get there to have dissenting voices.
Joe (34:54):
Tracy already asked a question about capital requirements at large and small banks, but one of the audience questions is on the process and just sort of the pure regulatory burden side, setting aside capital requirements, are there concerns that just the higher cost of compliance in any respect hurts smaller banks and will sort of accelerate industry concentration?
Michael (35:17):
So this rule only applies to the largest 37 banks in the country, banks over a hundred billion. So community banks are not affected at all, smaller banks are not affected at all. We do care about compliance burdens, even for the very largest banks. We want to make sure that they're commensurate with the increased resilience of the banking system that results. But this is not affecting small banks anywhere in the country.
Tracy (35:44):
Should I do another one? We’re alternating. Well I feel we've been very bank focused, which maybe in some respects is unfair or makes complete sense given our current venue, but maybe we could talk about non-bank entities for a bit. I have a couple questions on this.
So again, post-2008, when we saw those initial Basel rules come in, a big part of that was making banks safer for obvious reasons. We saw, to your point, the destruction that the financial system had on the global economy at that time. And it seemed like a lot of the risk was pushed into non-bank entities. Again, for obvious reasons, they're less levered, they're more contained potentially, you don't want systemically important banks to be taking all these risks because it comes back to bite you, as we saw in 2008.
But fast forward to 2023, it does feel like the non-bank sector of the economy has grown enormously and Joe and I had a conversation earlier this week about private credit. I was shocked to find out that the private credit market in the US is now as big as the broadly syndicated market for junk-rated bonds. I mean, that is huge and even the junk-rated bond market has been growing exponentially in recent years, up until 2023. So how are you looking at those non-bank risks nowadays?
Michael (37:11):
That's a great point. Look, we need a strong and resilient banking system that's at the core of our financial system. We need to pay attention to the non-bank sector but we can't have a weaker bank system because of concerns about the non-bank sector. We need a strong banking system, and then we also need to pay attention to the non-bank risk.
So we do spend a lot of time at the Fed and at our sister agencies looking at and examining risks in the non-bank sector. I gave a speech yesterday at the Treasury market conference, and one of the things that I noted is that the hedge funds are significant participants in the Treasury market that has lots of benefits in terms of liquidity in that market, in terms of matching activity between the cash part of that market and the futures part of that market, in terms of helping asset managers to get access to futures that they want. But there are also risks because the activity is being conducted with, in many cases no margin at all, which means the trades are extremely highly leveraged.
Tracy (38:16):
Well, we saw what happened in March, 2020.
Michael (38:18):
Exactly. So in March 2020 hedge funds were among the contributors to the disruption in the Treasury market. And so we want to be sure that first of all, that banks, as they're providing credit to their clients, the hedge funds are thinking about those risks. And then we also want to make sure that the Treasury market is resilient to those kinds of potential disruptions. So we look very carefully at that. We're looking very carefully at other aspects of the non-bank sector and all of that I think is important for financial stability reasons.
Joe (38:54):
Looking carefully at other aspects of the non-bank financial sector, I mean obviously entities, funds can lose money, but are there other ways in which you could foresee the risks becoming systemic in a meaningful way? Or is the view that, well, yes, risky investors can lose money, but that doesn't necessarily mean systemic risk?
Michael (39:16):
We aren't really concerned when investors lose money or when they gain money, that's not really any of our business. It's really about are there disruptive events that could cause significant harm to the system. One area that I mentioned very briefly that we're looking at very carefully is the way in which cyber events might cause systemic disruptions.
We had a smaller event over the last couple of weeks where we paid careful attention to working with treasury and other Federal regulators, but we wanted to make sure that banks and other participants in the market are resilient to cyber attack. And that means both that they have good prevention systems in place, and also that they have good systems for recovery in the event that cyber attacks are successful, which given the way the world is, you have to assume that some of those attacks are going to get through. And so we really are quite focused on making sure that that kind of risk is appropriately attended to by regulated entities.
Tracy (40:20):
Just going back to Treasury clearing for a second, I mean, this has been a hotly-debated topic. The degree to which this actually poses a risk to the market, and I did mention that it definitely became an issue in March of 2020, but there is an argument out there that, do we need to tailor our day-to-day policy for an event that happens once every 300 years or something like that?
And I think we asked Darrell Duffie this question in Jackson Hole, and he was adamant, he just said ‘Yes, we absolutely do.’ But I'd be curious to understand how you’re sort of balancing the immediate trade-offs versus like the long-term goal of having a more stable system?
Michael (41:05):
We absolutely have to have a reliable, stable, resilient system for trading of Treasuries. Treasuries are really at the core of our financial system. They're the way that individuals across the globe price other assets. They're the mechanism for the government to raise funds. They're really at the core of the system and so we absolutely have to have a reliable, resilient system, a deep system.
And so we do need to take the measures necessary to make sure that it stays that way. I think that the kinds of steps that we've taken thus far are useful. For example, one of the steps that the Federal Reserve took is to establish a Standing Repo Facility and a facility for foreign official counterparts so that if there's pressure in the system that can be relieved through using repo transactions instead of outright sales that might cause serious dislocations to the economy.
Joe (42:07):
Tracy mentioned our conversation with Darrell Duffie and obviously when we talk about just the sheer amount of debt that's being issued, a lot of people talk about it in terms of macro conditions and the financing costs, but just in terms of infrastructure, is there more, in your view, that needs to be done, whether on sort of private sector, balance sheet side market structure, central clearing, etc., that would make the market have more capacity for all this issuance?
Michael (42:37):
I do think it's a really critical question. We do need a system that can intermediate effectively for Treasury securities. There appears to be strong demand for Treasury securities, so it really is a question of making sure that securities can efficiently get to the right buyer. I think that the SEC's move towards central clearing of Treasury securities might be an additional appropriate next step. We're studying lots of other ways. This is, I would say, ongoing work and will be ongoing work. I was just at the, as I mentioned, at the Treasury conference yesterday, it's an area that we're paying attention to all the time.
Tracy (43:18):
So I realize we've hit a lot of different risks in this discussion. So we've done interest rate risks, operational risks, cyber risk, risks in the Treasury market. One risk we haven't really talked about, maybe because it isn't in the headlines quite as much anymore, is crypto risk.
And we had a big slide in the crypto market over the past year or so. It doesn't seem like that was a huge deal for the banking system except maybe in respect to something like Silvergate, but one aspect of crypto contagion, I guess, or like one little crack that I think hasn't gotten that much attention even though the guy behind it certainly has, has to do with Sam Bankman-Fried, who has been a guest on this podcast a number of times and is now in a lot of legal trouble for reasons I think everyone knows. But he did buy, or FTX appears to have bought, a US bank through a Cayman-based company, which seems like a pretty big channel through which crypto could perhaps come into the US banking system. Is that something that you, in your supervisory role, are looking at or aware of, or how are you thinking about crypto contagion and the risks posed there more broadly?
Michael (44:35):
Well, let me just say that in general, the banking system is not deeply exposed to issues in the crypto space. Most banks have been taking what I would describe as a careful and cautious approach to crypto. But we have been paying attention to these issues very much since I arrived at the board. We've established a novel activity supervisory program to bring experts from around the Federal Reserve System together to help supervisors deal with issues at banks that are engaging in some crypto related activity.
And that novel activity supervisory program should help us wrap our arms around the issues and should provide greater clarity and guardrails to banks that want to be involved in this space. So we want to enable banks to innovate using these new technologies, but to do that in a way that is safe and sound that complies with consumer protection laws that doesn't expose the banking system to threats from illicit finance, terrorist financing, money laundering all those issues really need to be completely buttoned down and this supervisory program will help provide that kind of clarity.
Joe (45:53):
Speaking of crypto, while we're on the subject, one of those things that we've sort of learned to appreciate over the time is that systemic risk seems to come from instruments which are presumed not to be risky, but to be safe — and so whether we're talking about the money market funds back in 2008 or just the par value of deposits at a bank in 2023.
And so then obviously when it comes to crypto, that leads you to the stablecoin conversation. So I kind of want to ask two questions. One is, what further do we need to do to make sure that stablecoins at some point in the future don't become a source of systemic risk, but also in the positive sense, do you feel any optimism at all that privately-issued stable coins could be meaningful and important part of the global payments landscape going forward?
Michael (46:41):
Well, let me just say, first of all, I think that we have to be very careful with stablecoins. Stablecoins are a form of private money and we've seen throughout history that private money, if it's not well regulated, can be extremely explosive. People come to rely on it in the case of a stablecoin linked to the dollar, stablecoins are really borrowing the trust of the Federal Reserve. And if that's the case, we need strong federal oversight of stablecoins. We need oversight of the issuers and the wallets.
We need to make sure that there's strong enforcement, there's strong rules of the road because they can be quite explosive. And so I do think we have to be really careful in the stable coin space. I think that innovation is hard to predict. It's hard to say that a particular technology is the one that's going to be the next technology of the future. I think it's appropriate for us to let that innovation happen, but it's got to happen within really clear guardrails.
Tracy (47:46):
We just have a few minutes left, shall we take some more questions?
Joe (47:48):
Going back to the FedNow question that I asked, is the Fed conflicted as a regulator of debit card costs and an operator of FedNow potentially competing with debit card costs? And I also wonder [about this], it sort of dovetails back to this question that I asked earlier about the degree to which real time payments for various reasons haven't flourished because of the lack of real time payments service.
Tracy (48:13):
People make money off of it!
Joe (48:14):
A lot of money is made on the existing payment system.
Michael (48:18):
Look first of all on the second point, we talked about this briefly before. I do think that there are revenues in the banking system like overdraft fees and insufficient fund fees that some banks have gotten used to. Many banks now are getting out of that business entirely. They've announced that they're not going to do overdrafts anymore. They're not going to charge for them. I think that's positive for our economy and for consumers. Overdraft fees are often really hard for consumers to avoid.
And so if we can get rid of them, because banks are deciding that that's not the business they want to be in, I think that's a net positive for households and alike. With respect to the existing payment system, I don't see a conflict between the work that we're doing on debit cards and the work that we're doing on FedNow.
Congress has assigned us a very particular role with respect to debit cards. Congress has said that we need to determine that debit card interchange fees are reasonable and proportional in relation to certain specified costs. That's our job, we do the job Congress has assigned us. We recently issued a proposal to update the rules in that space and I don't see that influencing or connecting in any way with our work on FedNow.
Tracy (49:40):
Should I ask a super big picture question since we've been pretty micro? There was a brief moment this summer, sort of post-SVB where it felt like there was a window to suddenly have a sort of existential conversation about the US banking system. There was discussion over what do we actually want this to look like? Do we want a nation of small banks where everyone knows their banker It’s a Wonderful Life-style? Do we want something that's maybe more similar to Canada where we have like six huge banks that are highly regulated and that sort of thing.
When you're making bank rules, when you're evaluating everything that we've discussed today, do you have a vision of what you want the US banking system to look like?
Michael (50:28):
Well, let me just say I very much value the diversity that we have in the United States of different kinds of institutions. We have community banks that are very local, we have smaller regional banks, we have large banks that are not the GSIBs, we have very large banks that are super complex and serve different kinds of markets. I think that that diversity in our financial system is actually really healthy. It makes for a stronger, more vibrant economy. It makes our banking system more resilient to shock. And so I do think that we do take into account and I do think that it's important for us to take into account that diversity of size and type of institution.
Joe (51:11):
Can I ask just like a random question that's totally out of order now?
Tracy (51:14):
Do it.
Joe (51:14):
I should have asked this during the macro part of the discussion. When I think about where the Fed is with the policy trajectory, the one area of the economy that I think everyone agrees on is that the Fed has real influence on housing. Rate policy feeds directly through to mortgage rates and you can slow down. It looks unambiguously like if there's one thing that rates can do, it's slow down housing activity.
But that cuts both ways because it reduces demand for new mortgages, but it can also impair supply. And we are in a time in which many people feel like the United States is perhaps millions of units underhoused. How do you think about the supply side aspect of monetary policy and the point at which rate policy ends up constraining supply when in theory more supply is what drives prices down?
Michael (52:04):
I’ll give you a technical answer and then maybe a broader answer. We really are mostly working on the demand side of the house, if you will, and that the elasticities of demand are faster and larger than the elasticities of supply. So what we're really seeing is overall our country has not had enough housing supply for a long time, we've been behind.
That was true before the rate hikes, it was true before the pandemic. It's been true for a while. So we do need just overall in our society to see more housing supply come in, in order to catch up. But right now, the major effect, the shortest-term effect is really on tamping down aggregate demand. So that supply has a chance to catch up. And I think there is evidence that we were talking about before in the data that supply and demand are coming into better balance overall.
Tracy (53:04):
Well, Joe, I think we've effectively achieved a random walk through a whole lot of topics.
Joe (53:10):
Crossing back and forth a few times.
Tracy (53:12):
Thank you so much to Michael for being a wonderful guest and playing ball with us on a wide variety of topics. Really appreciate it.
Michael (53:21):
Well, it's my pleasure to join you on the show. I've really enjoyed this.
Joe (53:23):
Thank you so much.
Tracy (53:24):
That was great.
Joe (53:46):
That was our conversation with Michael Barr. The Fed's Vice Chair for Supervision at The Clearing House Conference in New York City.
You can follow Michael Barr at
@Michael_S_Barr
.