[TRANSCRIPT] FOMC decision: we’re going to see a lot of volatility no matter what: Sheila Bair

March 16, 2021

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Sheila Bair, Volcker Alliance Director & Former FDIC Chair, joins Yahoo Finance’s Akiko Fujita Zack Guzman, and Brian Cheung to discuss what to expect next from the Fed.

Video Transcript

ZACK GUZMAN: I want to bring I’m Yahoo Finance’s Fed reporter Brian Cheung with more on what to expect when he steps to the mic. Brian.

BRIAN CHEUNG: Hey, Zack, well, nothing expected on the policy itself. Obviously, the Fed has interest rates near zero. It’s been buying $120 billion a month in US treasuries and agency mortgage backed securities, not anything expected to either of those policies. So the big question is going to shift towards the Fed’s projections.

Keep in mind, we get meetings from the Fed every six weeks. But only quarterly do we get the summary of economic projections, which includes that much paid attention to dot plot, which maps out policymakers’ expectations for where interest rates could go in the future. So you think about the last time we got a set of dot plots, that was in December of last year. And a lot has happened since that point in time.

We got a $900 billion package and then a $1.9 trillion package. So if you just look at those two things in and of themselves, you would tend to expect the Federal Reserve’s expectations to get a little bit brighter compared to where the forecasts were in the end of last year. So if that happens, does that mean that the Federal Reserve is also going to maybe pull forward its expectations for a rate hike at some point in time?

Keep in mind, the last projection had no rate hikes through the end of 2023. So if they pull that forward a little bit, let’s say to 2023, or even some policymakers at the end of 2022, how might bond markets specifically react to that, given the rise that we’ve already seen since the Fed’s last meeting? I think all of those things will be very interesting to watch as we do get that decision tomorrow at 2:00 PM.

ZACK GUZMAN: All right well Brian, let’s broaden this out a little bit more here with our next guest. Sheila Bair is Volcker Alliance Director and former FDIC chair. She joins us now. And Sheila, I mean, when we look at it, it’s interesting that Brian’s laying out what kind of expectations there. The last time we heard him speak, of course, there was that spike in the 10 year yield.

When you step back and maybe gauge how difficult a job this is, I mean, thinking about the unprecedented, you can tie it back to what we saw play out in ’08 and ’09, how hard it is for Jay Powell to kind of when this ship now and what you expect?

SHEILA BAIR: Yeah, well, I would agree with Brian. I think they’re going to remain highly accommodative. They’ll probably change their forecast. I’d be surprised if they pull forward any hint of a rate increase. I think he’s going to remain highly accommodative, probably because that would be less disruptive to the markets. Whatever he does, though, the markets are going to react.

He’s in a very difficult situation. Long rates are going up. Consumer price inflation, I think, is more and more people are recognizing this could be a long awaited but now distinct possibility. And it may just be a short bump. A lot of the stimulus money, once it goes to the system, it may not be a sustained consumer price inflation. But it is. We could have a very rough ride ahead, the Fed could, because inflation is hard to tame once it gets going.

And so, yeah, it’s a completely different environment. And of course, so much has been riding on these very low interest rates for so long as valuations are extremely elevated. Those are going to come down if rates go up.

So I would not want to be in Jay Powell’s position right now. He’s got a real job in front of him. But hopefully, he’ll have a steady hand and whether this no matter what. But I think he’s got some real challenges. And we’re going to see a lot of volatility no matter what.

BRIAN CHEUNG: Sheila, I want to shift gears to the regulatory aspect of things. There’s some chatter about whether or not Federal Reserve might make an adjustment to what they call the supplementary leverage ratio. For those people that aren’t kind of in the capital rules, this determines the capacity of banks to take on, for example, US treasuries during this time when we’ve seen quite a lot of interesting dynamics in the bond market.

What do you expect the Federal Reserve to do on that front? Would you expect them to extend some of those extended exemptions, which the Fed put in place last year but expire at the end of this month?

SHEILA BAIR: Yeah. It’s anybody’s guess. If I have to guess, I don’t think they’re going to extend, actually. There’s been a lot of political pushback against it. It was controversial when they did last year. They went out of their way to say it was temporary. A lot of people were skeptical whether it would be temporary, including me, knowing that bank lobbyists would push for it to be permanent.

So I think– the thing is, you know, look, returns, you look at banks return on equity. I mean they’re back in double digits. It’s as high as they ever were since the great financial crisis. They’re not lending. They’re not using this relief to lend. They’re using this relief, surprise, to put more money into treasury securities, because with this change, they can use 100% leverage.

They can use borrowed money completely to invest in treasuries. That’s a nice risk-free return. They can do that as long as they want. They’re not doing a lot of lending. Loan balances are down. The Main Street Lending is not there. They’re paying dividends.

They’re doing buybacks again. I think it’s really, really hard to defend additional capital relief when they’re making so much money and are paying shareholders so much. So I’m hoping, and at this point, I think the trend seems to be that maybe the Fed will not extend. I hope they don’t. It’s really just not justified.

BRIAN CHEUNG: And Sheila, at the same time, there are some interesting concerns, though, from not even people who are in the fin red world specifically, but that are watching the bond markets and saying, where is the appetite for this supposedly risk-free assets going to go, when you especially consider the Treasury general account is supposed to contract because of the changes with, I guess, the stimulus spending here.

So is there an argument to be made that the banks actually do need some help in being able to absorb that with the amount of, I guess, flow in and out of the Treasury market?

SHEILA BAIR: Well, that’s exactly the argument they’re making. But I think it’s hard to make when you’re distributing so much capital to shareholders. If they’re saying they’re capital constrained, why are they distributing so much capital? I mean, the post-great financial crisis framework was to when you get in situations like this, that they should curb those shareholder distributions to expand their capacity.

So I’m not even clear that– you look and they’re significantly higher than their leverage ratios already, so even without this continued exemption, I think they could take it. Now, will they pitch a fit? Will we see a lot of volatility if the Fed doesn’t extend? Probably, could very well be. They make money off of volatility, so I don’t really trust them to behave if they don’t get what they want, to be honest with you.

But if that happens, if I were the Fed, they want to expand the capacity for the Treasury market, then open up. Why use these primary dealers? Why give them a monopoly to be the intermediaries for this huge market? Let the long term investors, let the asset managers buy directly.

Let the Fed buy directly. I mean, the whole reason you have a capital constraint, that this is even an issue, is because you use the banks to intermediate this market. Break up the intermediation, and your problem is solved.

– Sheila, I wonder if we can pull back a bit to look at sort of the bigger picture going into the FOMC decision tomorrow, because it does feel like when you look at where the markets have moved, I mean, this is one of those situations where the expectation is run up so fast, and the messaging needs to match it.

So what specifically do you think Jay Powell needs to message tomorrow to make sure the expectation is pretty much set here? Because he hasn’t necessarily said he’s going to hike rates, and yet, it seems like so much of it has been the expectation of that, especially given the inflation concerns.

SHEILA BAIR: Well that’s right. And inflation can feed on itself just based on the expectations of prices going up. So I think he’s got a really, really tough challenge. I think, first of all, I should speak the truth and let people know what the data is showing.

And if inflation expectations are rising, if there are data to see that, he needs to be forthcoming and honest about that and signal that the Fed will be prepared to step in to curb it if necessary. I think he needs to show that willingness. And that’s going to be hard, because that could create a lot of volatility in the markets.

But I think he needs to be forthcoming about that. If their data is still showing consistent with the previous statements that they think this is going to be, at worst, a short term bump, then I think that would be reassuring. But he shouldn’t say that just because it would be reassuring to the market. He needs to tell us exactly what their best interpretation of the current data at this point. So there are no easy answers for Jay Powell tomorrow.

ZACK GUZMAN: No, there are never any easy answers for that man on a day like that. But when you look back at maybe the policy tools that he used over what was an unprecedented downturn, right? I mean, the pandemic was the pandemic, very different than what we saw play out in the financial crisis.

SHEILA BAIR: Definitely.

ZACK GUZMAN: But some of those things are being critiqued. You’ve hit on one that I enjoy hearing your thoughts on, which would be the Fed’s unprecedented decision to buy up corporate debt and how that maybe did not give a boost to the way that it was intended. Talk to me about that and maybe how looking back on it now, it could have been maybe a driving factor of maybe some of the asset bubble we’re seeing now.

SHEILA BAIR: Well, I think that’s true. I mean it was kind of a massive implicit backstop of the corporate debt market. And boy, did that open up the spigot. I think, what, they did over $3 trillion last year in non-financial corporate debt. So leverage in corporate America is just at nosebleed levels.

And again, if rates go up, this is going to create instability, because they’re more fragile now. They’re more reliant on debt versus equity financing. They have to refinance that debt. So if rates go up, that’s going to create a strain. And then, as we’ve discussed before, for financial assets across the board, really all the assets across the board, if rates start going up, you’re going to see a deflation in asset valuations.

So it’s created a lot of fragility in the system. This is the bottom line problem with trying to drive economic recovery with highly aggressive monetary policy, which is essentially just a way to get people, households, governments, corporations, all to borrow a lot more money. It works until it doesn’t.

And I fear it’s somewhat of a spin tool already. And we’ve tested the limits. And I fear we’re at the end of it. And there may be some challenges ahead. If rates have to go up, those chickens are going to come home to roost. I hope it doesn’t happen. I hope it can be gradual over a period of time.

Rates eventually going up would be a healthy thing to eliminate some of the distortions that we’ve seen. But hopefully, it can be done in a slow, gradual way and will not have to happen suddenly, because inflation starts getting out of control.

BRIAN CHEUNG: Now, I wanted to ask about the payments rail. I know that you had a lot of thoughts on this, especially in your capacity at the FDIC. But it’s interesting to see what the economic impact payments, there is a lot of confusion about why it takes multiple business days for that payment to hit your bank account.

So what exactly is it about the way the banking system is set up? And how do you think the Fed’s project on real time payments is ultimately going to change things or hope to change things?

SHEILA BAIR: Yeah, it’s a good question. Well, it’s a heavily intermediated system. And in point of fact, we do have an antiquated payment system. It takes a couple of days. And a lot of people make money off the float and charge fees the process. But with technology today, it’s really inexcusable that it takes so long.

And if you don’t have a bank account, forget it. I mean, it’ll take weeks, months. You saw what the delays were with the first round of BIPs under the Trump administration. So I do think technology ultimately, digital technology, using cryptocurrency, a central bank issued, digital currency, a cryptocurrency that was on a blockchain where you could get money directly from point A to point B, do it directly, or do it through digital payment providers, there’s some interesting academic proposals to set up a system like that. But the technology is getting to be much easier, much more accessible, much more reliable. And I do think this is the way of the future.

Now, obviously, you’re going to dis-intermediate banks and payments if you do that. There need to be some limits on it. You know, a lot of those deposits that are checking accounts now, you want to keep them there, because those are used to lend and support the economy.

But having some amount where you could either directly or indirectly have, say, $10,000 or whatever to make payments directly, and importantly, give this to the government as a tool to make payments directly to households, instead of having to go through this heavily intermediated process, would reduce cost. It would also have better protections against fraud.

Again, the technology can build in a lot of features to protect against fraudulent transfers, which you don’t have now. We’ve wasted a lot of money on fraud. And I’m afraid that’s necessary, given the need to get money out quickly, but nonetheless has been a real problem as the government has tried to get help out.

So, yeah, I hope the Fed is open to this technology. It’s a first step. I’ve suggested just putting using a blockchain for interbank transfers, so at least from one bank to another get the money pretty immediately from one point to another. That would be a good first step.

– Sheila Bair, Volcker Alliance Director and former FDIC chair. Always good to talk to you, and our thanks to Brian Cheung as well for joining in on the conversation.

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