Latest / The Capitalism and Freedom in the Twenty-First Century Podcast / Banking Crises, Stablecoin Regulation, And Fed Policy With Randal Quarles

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Banking Crises, Stablecoin Regulation, And Fed Policy With Randal Quarles · The Capitalism and Freedom in the Twenty-First Century Podcast

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  [MUSIC]
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  >> Jon Hartley: This is the Capitalism and Freedom in the 21st Century podcast,
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  an official podcast of the Hoover Institution Economic Policy Working Group,
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  where we talk about economics, markets, and public policy.
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  I'm Jon Hartley your host.
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  Today my guest is Randy Quarles, who is an attorney and investor.
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  He served as vice chair of the Federal Reserve for Supervision,
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  is chair of the Financial Stability Board.
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  Undersecretary of the treasury for Domestic Finance in the George W.Bush
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  administration, and is currently the chairman and
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  co founder of the Cynosure Group, a Utah based investment firm.
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  Welcome, Randy.
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  >> Randal Quarles: Thanks for having me.
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  >> Jon Hartley: Well, Randy,
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  I'm super excited to talk to you about all things finrag or
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  financial regulation wise, but I want to start with talking about your early life.
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  You were born in San Francisco, but raised in Utah and state at Columbia.
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  For your undergrad you did your law degree at Yale Law School.
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  Never heard of that place.
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  You worked at Davis Polk, you worked for Nick Brady in the George H.W.
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  bush administration, you later worked at Carlisle.
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  I'm just curious.
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  You know, interestingly,
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  many of those plays are some of the same places that Jay Powell worked as well.
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  I'm curious, at what point did you get interested in financial regulation?
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  Was this something very early on for you or
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  was it something that you sort of grew to enjoy over time?
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  I also know as another fun fact I think you were at,
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  when you were at Yale Law School, you were part of one of the, I think you were part
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  of the founding chapter the Federalist Society at Yale Law School there.
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  I'm just curious, like at what point did you really get into financial regulation?
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  >> Randal Quarles: Well, it wasn't in law school.
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  I had a law school classmate who from the day he walked into school,
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  very, very friend who very much, you know,
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  was focused on financial regulation, international banks.
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  He knew exactly what he wanted to do.
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  And, and I did not probably wanted to be more of
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  a constitutional lawyer and a legal academic.
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  Became a little disillusioned with the academy during my time at
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  Yale Law School and much more interested in the sort of
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  practical application of law and policy went to Davis Polk.
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  Davis Polk is one of the main, I guess you'd say the two main financial law firms
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  in the country, along with Sullivan and Cromwell.
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  And so that then became my exposure to the technical aspects
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  of financial regulation, both bank regulation and
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  regulation of the financial system more generally.
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  And I found it very interesting and it was my job.
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  And after several years there, the, you know, the, the treasury,
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  this is now at the very outset of the George H.W. bush administration.
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  The treasury had taken on, in the aftermath of the savings and
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  loan crisis, a study of financial regulation, the Glass Steagall Act.
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  They asked sort of the usual suspect law firms in New York, there were four or
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  five of them to nominate a candidate to come down and
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  join the team that would be working on that project.
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  Along with Bob Glauber, who was an academic from Harvard.
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  Jay Powell, who by that point had left Davis Polk and
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  was a investment banker at Dylan Reed, which had been Nick Brady's firm.
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  John Dugan, who was a lawyer, who'd been the general counsel of the,
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  of the Senate Banking Committee.
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  And they wanted someone about the.
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  A six year associate seniority, which is where I was at the time, to come down and
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  kind of be the junior person on that team to bring the sort of technical expertise.
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  Davis Polk nominated me.
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  I went down and joined that team.
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  And you know, so it, it was serendipitous as opposed
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  to a result of a long standing strategy.
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  But you know, with hindsight kind of inevitable given the places that I went
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  and the people that I worked with.
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  >> Jon Hartley: Fascinating.
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  I know Bob Glauber, he was one of my own professors at the Harvard Kennedy School
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  and I knew him before he passed.
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  Amazing. You work with Nick Brady and
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  all these other amazing figures I think formed many,
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  many people like Jay Powell and others later on.
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  Later on I guess.
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  So I'm just curious.
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  I want to talk about the financial crisis,
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  I think the financial crisis was a defining moment for financial regulation.
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  I mean, what went wrong in the Global Financial Crisis 2008?
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  As you see it, in terms of sort of underlying causes,
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  what went wrong with banks?
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  Would lack of bank capital be at the top of your list?
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  I know other folks like to talk about contagion a lot.
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  I'm curious, how do you diagnose the global financial crisis and
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  what was wrong with banks?
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  >> Randal Quarles: Capital was obviously relevant, but
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  I wouldn't put it at the top of the list as the cause of the crisis.
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  I think.
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  I mean this sounds quite mundane, but
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  I think the financial crisis was almost an inevitable,
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  certainly an expectable consequence of the combination
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  of human nature and the great moderation.
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  So you know, when I started out as a very young lawyer
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  back in the Coolidge administration, you know,
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  the practices of banks making loans were, you know, extremely tight.
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  They were very buttoned up.
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  And the express job of the young lawyers was to keep the young bankers in line.
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  The, you know, the bankers were the clients, they knew the deal.
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  But you were to ensure that all of the due diligence was done.
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  That all the things that might go wrong had been thought of, that the appropriate
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  measures had been taken to protect against what might go wrong.
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  And at the very top of the systems, at both the banks and the law firms, the,
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  you know, there were very clear instructions to the troops down below that
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  this is how it was supposed to go and people were very careful.
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  And over the ensuing 30 years from, you know,
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  from when I began, the, the people became laxer and
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  laxer because nothing very bad happened.
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  Those practices had developed because some bad things had happened
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  in the 60s and 70s with respect to the extension of credit.
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  And you had the sovereign debt crisis of the 80s,
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  but you didn't have systemic results as a consequence of that.
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  You had the 1987 market crash and which seemed to happen and be extraordinarily
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  dramatic, as I recall at the time and yet nothing really bad happened.
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  And I think you can, yeah.
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  >> Jon Hartley: In the real economy at least, nothing I guess.
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  >> Randal Quarles: Exactly.
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  In the real economy.
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  >> Jon Hartley: All these Latin American financial crises going on in the 80s too,
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  and their inflations and so forth.
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  >> Randal Quarles: Exactly.
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  But, but with respect to the, with respect to the advanced financial economies and
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  the, you know, and sort of credit, you know,
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  widespread credit problems as a result of what was the, you know,
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  of some of these quite significant events, it led to, again,
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  just this is, I think, almost inevitably human nature.
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  It led to a.
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  Well, we don't have to be quite as strict as we have
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  been in the past with respect to the.
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  Just the practical measures that we take in connection with the extension
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  of credit.
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  We can get more creative with the vehicles and
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  mechanisms through which we extend credit.
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  We can increase the amount of leverage.
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  And if we don't, somebody else will.
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  And so within organizations,
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  the inevitable pressure again from the folks who are doing the work to the folks
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  at the top who used to say, you know, let's, let's keep this all together.
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  You know, kind of like raising teenagers, after a while you just say,
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  this is exhausting to listen to you complain.
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  Yeah, go ahead and do it.
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  And which ultimately led to a situation where you had,
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  you know, a lot of poorly structured,
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  poorly underwritten credit in what extended in ways that
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  were not always obvious that it had even been extended,
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  and certainly what the amounts were.
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  And I don't think that that was a result of bad bank regulation or
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  bad bank supervision or, you know,
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  I'm not even sure that you would call it bad management of the institutions.
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  And certainly people were neither crooks nor idiots involved with that process.
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  You know, they were human beings who had lived through an extraordinary stretch of
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  quite good times.
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  And that's what's going to happen now.
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  You know, when the, you know, when the crisis happened, it became clear that,
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  we should have tried to ensure, since we can't, since we are human and
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  can't really feel that that's happening over the course of decades, can't
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  see where, you know, where a big financial stability shock may be coming from.
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  We should have a system that's more resilient to shocks.
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  We should have more capital.
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  But it wasn't really the regulation or
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  the capital levels that were in any way a cause of what happened.
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  >> Jon Hartley: Sure, well, I guess, yeah, had the capital been different,
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  I guess, would it have been a different result, I guess.
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  There's all sorts of,
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  I guess, people who, I guess there's different sort of schools of thought.
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  There's some, I guess, who would say that one.
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  I mean, there was obviously a big buildup in housing and, you know,
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  to what degree that was even preventable, I think, is another question.
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  Whether this lacks lending standards is it something that was
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  a cultural issue versus, I guess, a regulatory issue.
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  Then some people point to the Community Reinvestment act as
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  incentivizing housing in some way, sort of passed in the 90s.
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  And I guess then there's other people who sort of blame mass securitization,
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  CDO squared, as creating too much sort of complexity and
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  financial markets and that sort of complexity.
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  >> Randal Quarles: I really think that all of those are various manifestations.
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  Really almost all of those are various manifestations of the larger
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  kind of the larger theme that, you know, the caution that was drilled
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  into people involved in the extension of credit in its various forms,
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  you know, in the late 70s and early 80s, as I was starting,
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  my career eroded and it eroded because we were living through a pretty good time.
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  And I'm not sure.
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  And, and that will happen again in part because measures that were taken in
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  response to that have again allowed us to live through some pretty good times,
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  some at least with respect to the stability of the financial system.
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  And over the course of a long period of time, humans will be humans.
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  You're not going to change that.
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  And they will get complacent.
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  >> Jon Hartley: Well, I guess so.
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  I guess moving away from some of the causes, you know, crises are,
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  are a fact of, of life and they aren't, you know, recessions,
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  I don't think are ultimately preventable.
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  I mean, there are these disasters that just happen often,
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  almost always for unforeseeable reasons.
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  But I guess so fast forward, 2008, Bear Stern,
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  there's all these problems that emerge with Bear Stearns and later Lehman.
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  Then you sort of, you have September 2008, you have these sort of panic moments
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  where, you know, first Fannie and Freddie are put into conservatorship.
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  So you have that, then you have Lehman, you know, Lehman, you know,
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  declaring bankruptcy.
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  I think Hank Paulson was looking for a buyer for one many of these,
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  you know, JP Morgan came in and bought Bear Stearns, you know,
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  Merrill lynch was bought by bank of America.
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  You had these big commercial banks kind of bringing stability
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  in buying up these distressed investment banks.
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  In some cases there was help from, from the, the federal government,
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  from the Federal Reserve to, to make those acquisitions.
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  And then there was sort of this Lehman moment where there was a question of,
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  you know, what to do with Lehman.
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  And my understanding from, from Hank Paulson, then Treasury Secretary,
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  was that he was trying to find a buyer for Lehman with Barclays.
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  And they were halted by, I think, the UK government.
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  There's something that, I think,
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  Paulson is sort of blamed at least in terms of the Lehman bankruptcy.
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  But I guess, you know, in your mind, would things have been very different had
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  Lehman actually been sort of outright saved in, in some way that the government,
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  I guess, tried to completely backstop in some way rather than letting it go?
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  I mean, in your mind, could things have been played out very differently had
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  Lehman not sort of gone bankrupt the way it did?
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  >> Randal Quarles: No, I actually don't think things would have been that
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  different if they had somehow bailed out Lehman.
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  I may be one of the five people who still believed that was the correct decision.
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  And if you go back and you look at how the financial crisis evolved on
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  kind of a day to day basis during that time, you had the Lehman failure.
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  And if Lehman is going to be the of a crisis of confidence in the system,
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  you can't really see that in the performance of the financial
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  system in the immediate aftermath of the Lehman crisis,
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  in the performance of credit, in the performance of various markets.
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  The actual crisis began almost a couple of weeks later,
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  maybe not quite a couple of weeks later.
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  In my view, the trigger was the failure of WaMu and
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  most specifically the manner in which the failure of WAMU was handled.
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  And I'm not.
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  And because again, markets were, you know, obviously they were under strain
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  because of everything that had been happening over the course of the summer.
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  But in the aftermath of the Lehman crisis, they were not particularly more
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  dramatically affected until the failure of WAMU at Carlyle.
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  We were in the process, for example, of considering kind of a anchor,
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  confidence inspiring investment in Wachovia.
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  Bob Steel, who had succeeded me as Undersecretary of the treasury,
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  was the CEO of Wachovia at the time.
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  And the thought was Carlyle, a private equity firm,
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  even the size of Carlyle is not going to be able to.
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  Put in enough capital to sort of fundamentally recapitalize Wachovia,
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  but that if we would make a significant investment, having done a lot of due
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  diligence on the state of the bank, that that would anchor confidence and
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  would, you know, and would shore up others in being willing to provide
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  various sorts of financing to the bank and settle its situation.
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  And we were prepared to do that up until the failure of WaMu.
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  And, and the FDIC was worried that there could be a number of bank failures
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  that it was facing going forward, given the stress that the situation saw.
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  And so they wanted to preserve the fund.
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  And therefore there were categories of, of obligations of WaMu that were,
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  had traditionally been protected by the FDIC in a bank resolution,
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  although they weren't legally required to be that in this case, the FDIC said,
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  well, since we, since we think we need to really work to preserve our fund,
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  we're not going to preserve them.
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  But there was little advance warning of that with the failure of WaMu and
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  Little and confused communication around it.
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  And that is when you saw kind of the system of financing for
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  banks completely freeze up.
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  Everyone said, well, wait a minute.
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  We now don't know what the rules are.
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  We don't know what's going to happen in the event of a bank failure if we extend
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  credit.
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  And that's, in many ways it's not surprising.
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  It's almost economic one.
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  That uncertainty and unclarity is, you know,
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  perhaps the worst villain in sapping confidence in a system.
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  It's like, if I don't know what's going to happen.
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  And so we immediately stepped back from providing the equity investment in
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  Wachovia.
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  We said, we don't know what the rules are anymore.
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  And Wachovia failed relatively promptly after that because.
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  Because it was now part of the system being swamped by a lot of
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  providers of financing to the banks and to the financial system generally saying,
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  we don't know what the rules are.
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  And in my view, it's an eccentric view, I allow, but
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  in my view, that was the trigger of the financial crisis.
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  It was not Lehman.
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  And I think, you know, going forward, letting Lehman fail was the right thing.
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  It's the moral hazard question that people were concerned about.
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  The moral hazard reason that they did not save Lehman.
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  The view that going forward, you want people to say they don't save everybody.
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  As we're making decisions about what sorts of risk we ought to be taking,
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  we can't count on being bailed out.
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  And I continue to think that that was the right decision.
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  And that it was not a trigger of the crisis.
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  >> Jon Hartley: Got it, but
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  you don't think I guess in my mind one seminal moment was this fact that,
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  in my mind there's a clearly a run on money market funds.
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  Particular prime funds, and the reserve fund,
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  the oldest money market fund in the US broke the buck.
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  And I think a big part of that run on money market funds,
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  again it's an untraditional sort of bank run.
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  It's not a traditional people lining up to get their deposits out of a commercial
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  bank, but essentially money market investors trying to get their money
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  out of money market funds was that there was this Lehman paper that exists,
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  a commercial paper, and people were freaking out about that and that.
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  But that wasn't in your mind that the money market run that kind
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  of existed was not sort of the trigger in your mind?
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  >> Randal Quarles: No, I don't think so.
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  Not as important, not the proximate cause.
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  All of this added up to create an environment in which the financial crisis
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  could happen.
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  If that environment hadn't been building, you could have had a failure even
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  of an institution as large as WaMu without a financial crisis.
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  We just had Silicon Valley bank fail a few a few years ago,
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  which was not quite as big as WaMu, but along the same size.
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  And it didn't trigger anything like that.
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  So part of that was the extra amount of capital in the system, but
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  part of it was just, you know, you didn't have these other elements but,
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  but I don't think they were nearly as important or really the triggering cause
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  and certainly not the failure of Lehman relative to the failure of Walmart.
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  >> Jon Hartley: So another thing that I think comes up in these sorts of global
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  financial crisis diagnoses is in this question, the big banks and
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  Senator Warren I think often, and others often said, well,
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  all the Grand Leach Bliley big bank consolidation in the 90s that was
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  allowed to happen was part of this cause and which break up the big banks.
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  And, and I mean to me that seems like not a great sort of story either or
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  explanation either.
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  In fact, like in my mind, I think if the big banks have been broken up,
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  maybe the financial system would have been less stable.
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  I mean, there's largely investment banks that were stressed during
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  the global financial crisis.
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  The larger, more diversified commercial banks, the JP Morgan Cities,
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  Bank of America, the larger financial institutions were generally safe.
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  And this is an argument that I've heard from Ben Bernanke,
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  sort of against breaking up the big banks is that in diversification, having
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  both commercial banks and Investment banks under sort of one umbrella allows for
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  better weathering of these sorts of shocks.
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  Do you sort of buy that line of reasoning?
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  >> Randal Quarles: Absolutely.
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  I mean a large part of the work that I did both as a private sector lawyer and
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  then in policy work during the course of the 90s, during the,
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  during my time in the Bush 41 administration was,
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  was precisely to allow to increase the financial resilience of the system and
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  particularly the banking system by first, you know, we,
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  we put forward a proposal for the revision of the Glass Steagall Act.
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  It's actually incorrect to say that the Glass Steagall act was repealed because
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  the central provisions of Glass Steagall were never repealed.
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  There ancillary provisions that were repealed.
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  But the revision of the Glass Steagall act to allow the creation of
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  kind of merchant banks to allow investment banks to merge, but
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  the first order of business was simply to allow banks to merge across state lines,
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  which was not possible in the early part of my career, which I guess is
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  a long time ago now, but it's still within the mind of living memory.
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  And, and that was very useful when you had, you know,
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  over the course of that period you had some intense
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  financial problems in Texas at the beginning of that period and
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  then you had finance some intense financial problems in the Southeast.
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  And because we had changed them one of the results of the Bush
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  41 administration was to ease the restrictions on interstate banking.
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  You now had banks, you know, North Carolina national bank, which eventually
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  became bank of America, you know, had for, had required, had acquired a Texas bank.
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  And as a result it had the resources to prevent that Texas bank from failing when
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  there was pressure in Texas and the system and that system had the resources to
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  prevent the bank from failing when there was pressure in the Southeast.
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  And you know, so those mergers were very much.
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  Kind of financial stability supportive, first by allowing geographic
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  diversification and then by allowing business line diversification.
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  And exactly as you said, if we had not modified the Glass Steagall act to allow
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  Morgan Stanley and Goldman Sachs to become bank holding companies,
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  which, you know, before, you know, under Glass Steagall, they could not,
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  in the great financial crisis, those firms would have failed.
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  In the great financial crisis, the first thing they did was we need to
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  let the world know that we are supported by the Federal Reserve and
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  the Federal Reserve's backstop.
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  And so they immediately became bank holding companies, which they were able to
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  do because of these changes that had allowed banks to become larger and
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  more diversified.
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  I mean, it's not.
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  There certainly are issues as any organization becomes extremely large.
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  The largest banks now have hundreds of thousands of employees.
• 24:57
  There are management concerns, totally appropriate official sector
• 25:02
  issues in ensuring that, you know, that the management of those banks
• 25:08
  is up to the challenge of managing organizations that are that complex.
• 25:14
  But from a pure financial stability point of view,
• 25:16
  all of that has been a positive and not a negative.
• 25:21
  >> Jon Hartley: Great, so I guess sort of just moving forward in time here we had
• 25:25
  the global financial crisis.
• 25:27
  We had all the interventions, TARP Tau,
• 25:31
  the Fed was buying up toxic assets off bank balance sheets.
• 25:38
  The first Quantitative Easing or QE1.
• 25:41
  And then we had this thing in 2010 which was the Dodd Frank act.
• 25:45
  And it did a lot of things.
• 25:48
  But, but as far as bank regulation goes,
• 25:51
  some of the bigger things that happened was, you know, imposed capital standards.
• 25:56
  So there's both a risk weighted capital ratio and a risk neutral one.
• 26:04
  The whole idea is just, you know, limiting the amount of leverage that can be taken.
• 26:09
  So for our listeners that aren't as familiar yet, there's sort of beyond just
• 26:15
  the US there's this idea of Basel 3 capital standards which sort of comes out
• 26:20
  of the bank for International Settlements, the BIA assets in Basel, Switzerland.
• 26:25
  And they sort of put forth these capital standard ideas that have
• 26:30
  been implemented across various countries.
• 26:34
  And Dodd Frank was the US manifestation of that.
• 26:37
  And so there'd be risk weighted capital ratios or CT1.
• 26:43
  And the idea is that the amount of equity is a share of risk weight,
• 26:48
  assets is above a certain threshold.
• 26:51
  And similarly your SLR or your leverage ratio,
• 26:55
  your supplementary leverage ratio, is at a certain level.
• 26:59
  And so all this is about the liability side of the balance sheet
• 27:04
  in the sense that we're setting a limit on a minimum limit for
• 27:09
  how much equity there is, which is another way of saying kind of A maximum for
• 27:15
  how much leverage there is as a fraction of the total capital or total assets.
• 27:22
  And so, there's a risk-weighted way of looking at this, anonymous-weighted way or
• 27:26
  a risk-neutral way of looking at this.
• 27:29
  Now, sort of fast forward many years later, something like SLR might be binding
• 27:33
  for this is the sort of risk neutral you might be buying for
• 27:37
  a bank like Goldman Sachs does a lot of treasury market making
• 27:40
  the risk weighted capital ratio might be buying for
• 27:43
  a bank like Capital One that does a lot of sort of risky credit card lending.
• 27:47
  Credit cards sort of get this high risk weight of 1 one.
• 27:50
  So I guess my question for you is, is the financial system today, you know,
• 27:55
  safer after Basel III's gold financial system safer in, in your mind, or
• 27:59
  are the banks too regulated or, or not regulated enough?
• 28:06
  >> Randal Quarles: Well, I think it's unquestionable that the system is safer.
• 28:10
  The increased capital levels, the Basel capital price process,
• 28:18
  beginning all the way back to Basel I in the 80s,
• 28:23
  has been run at the significant insistence or
• 28:28
  impotence impetus from the United States to try
• 28:34
  to ensure that the competitive environment for
• 28:39
  international banking was such that our
• 28:44
  banks could compete without being pushed to
• 28:49
  lower their capital to dangerous levels.
• 28:54
  So in the 80s, the Japanese banks operated with very little capital,
• 28:57
  certainly relative to ours and relative even to the Europeans.
• 29:01
  And Basel 1 was an effort to get international agreement that that capital
• 29:05
  needed to be increased.
• 29:07
  And then, you know, over the course of the 90s, it became clear that
• 29:12
  the European capital levels were lower than those in the United States.
• 29:17
  Our internationally active banks were being disadvantaged.
• 29:22
  And so, you know, Basel 2, which is, you know,
• 29:26
  was really kind of an incredibly complicated, very analytically, you know,
• 29:32
  analytically granular, intelligent, ultimately I think misguided, but
• 29:38
  approach to try to create a framework in which we in the United States
• 29:43
  could be comfortable and confident in allowing our bank's capital
• 29:48
  levels to lower themselves to those of the Europeans by creating,
• 29:53
  you know, sort of a, an agreed and careful risk assessment framework.
• 29:58
  It was very complex, probably excessively complex, but
• 30:01
  no sooner had that been completed than we had the great financial crisis and
• 30:04
  we realized that that was the wrong direction.
• 30:06
  We shouldn't be lowering our capital levels to match the Europeans.
• 30:08
  We should be raising the Europeans capital levels as well as our capital levels to
• 30:12
  higher standards.
• 30:13
  And that was the point of Basel iii.
• 30:15
  I think that, you know, conceptually it was successful.
• 30:22
  You know, it has been successful.
• 30:23
  I think we've seen the increased resilience of the banking system
• 30:28
  to some shocks like those that happened in the spring of 2023 and
• 30:33
  you know, so unquestionably the system is safer.
• 30:37
  Are banks too regulated?
• 30:39
  Well, just to take the capital system, the capital framework as an example,
• 30:44
  it is excessively complicated.
• 30:47
  We have now a very complicated set of, through the cycle capital rules in
• 30:51
  the aftermath of Dodd Frank and through Basel iii, we've layered
• 30:55
  on top of that a stress testing regime which I think is very useful.
• 30:59
  It's very, it's well done by the Fed,
• 31:02
  really competent people who run the process.
• 31:06
  But it is incredibly complicated on top of what is already a fairly,
• 31:11
  you know, a much more complicated kind of,
• 31:14
  of standard capital framework than it used to be.
• 31:19
  We, you know, are now regulating liquidity, which we should be,
• 31:24
  but, you know, in, in a much more direct way than we did before.
• 31:29
  Much more complicated way that may be getting more complicated in
• 31:32
  the aftermath of sdb.
• 31:36
  The supervisory examination of banks is much more burdensome and
• 31:42
  again, particular and covering a broader range of
• 31:48
  activities with much more direct instruction than it used to be.
• 31:54
  So all of that is, again, that's an inevitable human response.
• 32:00
  Response to something like the great financial crisis.
• 32:02
  And I think that directionally it has made things better.
• 32:06
  You can't question that.
• 32:08
  But it's also improvable.
• 32:09
  That can be streamlined, that can be rationalized, that can be, okay, well,
• 32:13
  now we're doing the same thing in three different ways.
• 32:15
  Maybe we can do it in one and a half different ways and that will be enough.
• 32:18
  And thinking all of that through is,
• 32:21
  I think should be inevitably the task of the bank regulators and
• 32:26
  thinking through the practices of bank supervision,
• 32:31
  the task of the bank supervisors.
• 32:33
  You know, once the, you know, the immediate reaction through Dodd Frank and
• 32:38
  Basel 3 to the great financial crisis is in place, then you say, all right, now,
• 32:42
  now, with the benefit of experience, with the benefit of a little calmness,
• 32:46
  how do we improve that?
• 32:49
  >> Jon Hartley: Got it.
• 32:52
  I've worked at Goldman Sachs and after,
• 32:54
  in the aftermath of the financial crisis, or in the years after in the 2010s.
• 33:00
  And yeah, I worked in risk management and kinda had a sense of how some
• 33:05
  of these worked in portfolio structure, risk management in GSM.
• 33:10
  But I had risk management friends that were sorta dealing with the CCAR and
• 33:15
  stress test sorta side of things.
• 33:18
  So I guess like one question and complaint that I've heard is that, you know,
• 33:22
  from people broadly, you know, in general in the policy space,
• 33:26
  not just any particular bank, is that, you know, the stress tests aren't transparent.
• 33:32
  You know, there's a bunch of scenarios that are given and it's not clear
• 33:37
  ahead of time what they are and they sort of change from year to year could,
• 33:42
  you know, and some people say, you know, trans, a lack of transparency is kind of
• 33:48
  a virtue in the sense that banks should be prepared for all sorts of scenarios.
• 33:53
  But I guess, is there some way in which that could maybe be done better?
• 33:57
  I mean, also, at the same rate, you're hearing from folks.
• 34:00
  I think this is a Jamie Dimon question, he asked him and all,
• 34:03
  how many bank regulators we actually have physically in our building any day?
• 34:08
  And it's, you know, it's hundreds of people.
• 34:09
  And I hadn't realized myself when I was working at Goldman Sachs that there were
• 34:13
  actually, you know, Federal Reserve employees or
• 34:16
  regulator employees that were actually in the bank.
• 34:19
  Is that too many?
• 34:21
  So I guess I'm just curious what your thoughts are on just stress testing and
• 34:25
  how that process maybe could be improved, if at all, in your mind.
• 34:29
  >> Randal Quarles: Yeah.
• 34:30
  So first I should say, and there are two aspects to the answer that I'll give.
• 34:37
  One is one sort of Legal, constitutional, but that aspect of policy,
• 34:43
  not legal in the sense of, you know, kind of granular regulation, but.
• 34:49
  And then the other is, you know,
• 34:51
  a different set of policy considerations around the, you know,
• 34:55
  how the stress tests need to be constructed in order to be effective.
• 35:02
  Stress testing is, is an obvious, an obvious good.
• 35:08
  It's something that bank supervisors should be doing and
• 35:13
  in, in some ways not nearly as expansive, you know, and, and
• 35:18
  as rigorous as has happened in the aftermath of the great financial crisis,
• 35:24
  but in some ways have, you know, been doing for a very long time.
• 35:29
  And, and we saw a particularly important example of
• 35:34
  that during the COVID event where the rest of the world,
• 35:39
  almost all of the rest of the world, immediately upon the sort
• 35:44
  of global administrative shutdown of the economy, said,
• 35:49
  well, if businesses can't operate, they can't pay their loans,
• 35:56
  and this could be a huge problem for the banking system.
• 36:01
  And bank regulators around the world shut down the ability of their banks to pay
• 36:04
  dividends.
• 36:04
  They simply forbade them from making any distributions at all.
• 36:09
  And we, we closed off the ability of banks to repurchase their shares,
• 36:15
  which in the US System is a significant, you know,
• 36:19
  is actually the majority of the way that that capital is returned to shareholders.
• 36:27
  But dividends are still important, and
• 36:29
  the dividends is the only thing that's promised.
• 36:32
  Right? The share repurchases are easier to,
• 36:35
  to close off because there's no promise that that's going to happen.
• 36:40
  And because we had just complete, we were just in the process of
• 36:44
  completing the stress test for that year, we had confidence in the,
• 36:49
  we could add in there some additional variations to the scenarios to say,
• 36:54
  well, what if this happens?
• 36:56
  What if that happens as a result of COVID what happens to the system?
• 36:59
  And then over the course of the succeeding 12 months,
• 37:03
  we ran seven different stress tests.
• 37:05
  It was, it was a, I mean, the, it was a great national service on
• 37:10
  the part of the stress testing staff at the Federal Reserve and
• 37:14
  just an almost impossible amount of work for a team that we weren't able to
• 37:19
  increase in size just given the speed with which all of this was happening.
• 37:24
  And, and as a result of doing that,
• 37:26
  we maintained confidence in the resilience of our system.
• 37:29
  That allowed us to say, no, you can keep paying dividends until we see some
• 37:34
  evidence that the system is under a level of stress that it can't support,
• 37:39
  you may keep paying dividends.
• 37:41
  The information that we have from the stress test shows that and our,
• 37:46
  the cost of capital for our banks was, you know, is now, is now much more favorable.
• 37:53
  There are many reasons for that.
• 37:54
  But this is an important reason for it than for European banks,
• 37:57
  because you're providing equity capital.
• 38:00
  European banks, and you say when they get spooked,
• 38:04
  they could just say you can't pay.
• 38:06
  Whereas in the US they do everything they can to preserve those payments if it's
• 38:11
  going to be safe.
• 38:12
  And we had the mechanism to say it was safe through the stress testing.
• 38:15
  So all of that is great.
• 38:16
  Now, on the question of the transparency of the stress tests,
• 38:21
  there's the legal question of these are quite consequential government
• 38:26
  actions because particularly particularly in the aftermath of
• 38:30
  a measure that I took which I thought was necessary and appropriate,
• 38:35
  again as a, just as a good government measure, that there would be
• 38:40
  predictable consequences of a certain result of the stress tests.
• 38:46
  If your stress test shows that you need more capital, then you will be required to
• 38:50
  have a buffer added to your particular bank's capital requirements that will
• 38:55
  increase your capital by that amount according to the stress test.
• 38:59
  Before that,
• 39:00
  the results of the stress test did not have any determinate consequence.
• 39:05
  It was all a result of what the Federal Reserve Board had for
• 39:07
  breakfast on the morning that they were presented with the results.
• 39:11
  And that's just not a way to run a railroad.
• 39:15
  But because of that change, there is a fairly direct and
• 39:20
  important economic and financial consequence for
• 39:24
  individual institutions as a result of running the stress test.
• 39:29
  And our system of law, the Administrative Procedure act, constitutional
• 39:33
  principles would say that can't be the result of a star chamber process.
• 39:38
  You must be transparent.
• 39:41
  People need to know if that, if something like that can happen,
• 39:45
  what they can do to prevent it from happening.
• 39:48
  And you know, the example that I would often use would be to say,
• 39:53
  yeah, if you took all the speed limit signs off the roads and said,
• 39:57
  but there's still a speed limit.
• 40:00
  And it varies from day to day.
• 40:03
  And we're not going to tell you what it is or how it's determined, but
• 40:08
  if you exceed it, you will have a very serious fine.
• 40:12
  Well, people would drive slower, they certainly would.
• 40:16
  But you can't do that in America.
• 40:19
  I don't think you can do it in Russia.
• 40:23
  So there's the legal side of it, that transparency,
• 40:26
  a significant amount of transparency is important.
• 40:29
  And there are lawyers who say that the whole process, all of the models,
• 40:34
  all of the scenarios need to be totally public and subject to comment on,
• 40:39
  making sure that the stress tests are fit for purpose.
• 40:42
  However, I was persuaded in my time at the Fed and
• 40:46
  remain persuaded of the so called monomodel argument that's going
• 40:52
  to be very familiar to many of the folks who listen to your podcast,
• 40:57
  that if the Fed is totally transparent about its framework for
• 41:02
  assessing the resilience of any particular bank's, you know,
• 41:07
  portfolio of assets, then whatever mistakes and eccentricities and
• 41:13
  idiosyncrasies that there are in that framework, and those are inevitable,
• 41:19
  then all of the system will congregate around those and those now become
• 41:24
  the fault lines of the system where there will certainly be breaks going forward.
• 41:31
  And to the extent that you are not wholly transparent, you at least ameliorate,
• 41:37
  you can't eliminate, but you ameliorate the mono model problem.
• 41:44
  I think that's real.
• 41:46
  I think that's, and to ensure that the stress tests are actually fit for
• 41:49
  purpose, I think it has to be taken into account.
• 41:52
  I tried while I was at the Fed, you know, for
• 41:55
  a balance that maybe was not the most ineluctably principled, but
• 42:00
  I thought practical of we can be more transparent,
• 42:04
  we can be much more transparent about what it is, what the models show
• 42:09
  without completely opening the kimono towards the monomodel problem.
• 42:15
  And the staff was making, I think,
• 42:18
  material progress in being more transparent around the models.
• 42:24
  I think that stopped pretty quickly after I left and
• 42:27
  I think it should be picked back up again.
• 42:29
  So that's, that's probably a lot more logaria around your simple question of,
• 42:35
  you know, should the stress test be more transparent?
• 42:39
  I think the answer is they can and should be, probably are required to be under law,
• 42:45
  but we shouldn't completely open the kimono in the way that some would ask,
• 42:51
  because then the stress test would not only not be as useful,
• 42:55
  they could even be counterproductive.
• 42:58
  >> Jon Hartley: Got it, and I guess, yeah, one criticism,
• 43:00
  I guess it could be gamed in some way.
• 43:02
  If it was totally.
• 43:03
  >> Randal Quarles: I think you could say, yeah,
• 43:06
  I was Always less worried about the gaming argument.
• 43:10
  People would say, if you, if you give them the models,
• 43:15
  you're, you're showing them the answers to the test,
• 43:20
  it's like, no, you're giving them the textbook,
• 43:25
  you know, and, and it would not be right to give a test.
• 43:30
  You know, it's not right to give a test that you've given the answers away to, but
• 43:34
  it's also not right to give a test that you haven't given anybody a textbook for.
• 43:38
  >> Jon Hartley: Absolutely.
• 43:39
  That's a great way of putting it.
• 43:42
  I just want to fast forward a little bit here just in
• 43:46
  time to your time at the Federal Reserve.
• 43:51
  You were nominated during the first Trump administration to be
• 43:56
  the first vice chair of the Federal Reserve for supervision.
• 44:01
  And then you are also the chair of the financial disability board from 2018 to
• 44:05
  2021.
• 44:07
  I'm just curious in your mind and just, I guess for some context, too,
• 44:10
  around that time, in terms of what was going on in Finrake, there was
• 44:14
  the Jim Hensling bill that changed the SIFI threshold and increased that.
• 44:18
  So there was kind of that going on in the backdrop as well and
• 44:23
  the SIFI threshold is basically a certain threshold above which you're treated
• 44:30
  very differently in terms of regulation, having to do these sorts of,
• 44:36
  this regulatory scrutiny from the perspective of regulators.
• 44:41
  And I think when it was increased, it affected banks like SunTrust and
• 44:45
  BB&T at the time.
• 44:47
  They've actually since merged.
• 44:48
  That's a whole other story.
• 44:48
  But I'm curious, what, in your mind, were your greatest accomplishments
• 44:52
  during your time at the Fed board and as chair of the Financial Stability Board?
• 45:00
  >> Randal Quarles: So at the Fed, you know, I think you,
• 45:04
  I think I would say it was the,
• 45:07
  it was the whole complex of refining and revisiting and
• 45:13
  streamlining the post financial crisis regulatory framework.
• 45:20
  The principal element of that was the mellifluously named
• 45:25
  Igurkapa legislation that we then implemented.
• 45:29
  We worked, you know, we worked very closely with the Senate and
• 45:33
  the Congress in, in developing that regulation and then, and
• 45:37
  then through the implementation process.
• 45:40
  But there were, you know,
• 45:42
  I think there were over 20 separate measures that we took.
• 45:48
  And I was, you know, I, I, I came in saying there were lots of folks, you know,
• 45:53
  who kind of wear my political jersey, lots of people who think about the industry
• 45:58
  who said, you know, Dodd Frank was an unmitigated disaster,
• 46:02
  you need to strap a napalm tank onto your back and just burn it all to the ground.
• 46:08
  And my tack was to say, look, no, what we're going to do is we're going to
• 46:13
  identify some material things that will make a difference.
• 46:18
  You know, the overall benefit of the increase in capital from Dodd Frank
• 46:23
  is that that is a good thing.
• 46:25
  But we can increase the efficiency of the system,
• 46:28
  which is a public good that is probably equal to the safety of the system.
• 46:34
  We can increase the efficiency of the system in ways that do not harm its
• 46:38
  safety.
• 46:38
  And we can do that in a way that we're very methodical about,
• 46:44
  that we make a very good case for, and
• 46:48
  that we get enough bipartisan political support for that.
• 46:53
  When we're done, the next folks will come in and the pendulum won't swing
• 46:58
  back because the case will have been made and we will have been meticulous
• 47:03
  enough about what it is that we that we did and why we did it and how we did it.
• 47:08
  And I do think, you know, at first, you know, when, when my successor came in,
• 47:13
  who is a smart and good guy, but have very different views than mine,
• 47:17
  and some of the initial proposals, people said, we told you so,
• 47:21
  you know, that was a bad strategy.
• 47:24
  It's a one way ratchet.
• 47:25
  You came in and you said instead of burning it all down,
• 47:27
  if we burn it all down, they'll just put it back in worse.
• 47:30
  And now they're putting it back in worse anyway.
• 47:34
  But at the end of the day, that didn't work.
• 47:36
  That didn't happen.
• 47:37
  And I think one of the reasons it didn't was the way that we constructed our
• 47:41
  approach.
• 47:42
  So I think that was at the Fed, the most consequential,
• 47:47
  and at the fsb, I think the work that we began on non bank
• 47:53
  financial intermediation, which had really stalled in the FSB for
• 47:59
  a long time for a whole variety of reasons.
• 48:03
  You know,
• 48:04
  the FSB had done really good work on bank regulation along with the Basel Committee.
• 48:10
  Nbfi, you know, had really languished.
• 48:15
  And, and, and it, it requires a much different approach than bank regulation.
• 48:20
  And so there are reasons that that's a difficult thing to do.
• 48:27
  But we began a process by creating a separate committee where there was much
• 48:30
  more representation of the non bank regulators relative to the central banks.
• 48:33
  It was a little more equal than in the FSB as a whole.
• 48:36
  And that allowed progress to be made there.
• 48:38
  That again, I think was quite useful.
• 48:41
  >> Jon Hartley: Great, I guess, sort of shifting just for
• 48:44
  a second away from finrag and financial regulation.
• 48:49
  You were also, you know, by virtue of being on the Federal Reserve Board,
• 48:54
  you were also a voting FOMC member.
• 48:57
  And you know, during this time we had everything from,
• 49:02
  during the time we were in office,
• 49:04
  everything from COVID to the beginning of the early 2020s inflation.
• 49:10
  I'm curious, in your mind, did the Fed respond,
• 49:15
  I guess appropriately both to Covid and did it respond
• 49:20
  quickly enough to inflation in terms of raising rates?
• 49:26
  I know you've spoken, I think another podcast before maybe saying that the Fed
• 49:29
  should have raised rates earlier.
• 49:32
  Just thinking that it became clear that it wasn't just a transitory story
• 49:37
  by say October of 2021, in that this was around the time that you were leaving,
• 49:43
  but by that point when inflation first ticked up in April 2021,
• 49:48
  but by October it was clear that it wasn't just used cars anymore,
• 49:53
  and it was not just used car prices, but
• 49:56
  housing rental prices were going up, owner occupied rents were going up.
• 50:02
  It was clearly broad based at that point in time.
• 50:04
  You kind of had left just at that, I think point in time when that became apparent.
• 50:09
  But in your mind was the Fed and your colleagues,
• 50:11
  were maybe they a little too slow to raise rates and
• 50:14
  maybe inflation wouldn't have been as high if they had done something differently.
• 50:18
  I'm curious about what your sort of retrospective take is on the Fed's short
• 50:23
  performance during, during that period.
• 50:26
  >> Randal Quarles: Yeah, I don't, I don't think that there, I don't think the, that
• 50:31
  the Fed is guilty of any serious sin with respect to the timing of its response.
• 50:37
  I think with the benefit of hindsight, and there were a few of us, you know,
• 50:41
  even during, at the, who were there at the time who would have said yes,
• 50:46
  the time to start raising rates was in the fall of 2021, you know, over the summer.
• 50:52
  You know, as you said, I think the data that we were seeing really supported
• 50:56
  the Case that this was a supply constraint driven inflation,
• 50:59
  which is not something that a central bank can effectively respond to, and
• 51:03
  that it was a temporary supply constraint.
• 51:06
  You know, we can't unload, we can't unload containers on the ports and
• 51:13
  we can't make vaccines or anything like that.
• 51:17
  So, but that this would in fact be transitory.
• 51:21
  The data really supported that over the course of the summer.
• 51:23
  But by the fall it was clear that, no, this is really a much more traditional
• 51:28
  fiscal stimulus driven inflation, which is something that we can respond to.
• 51:34
  Some people, Larry Summers, for example, have blamed the framework that the Fed,
• 51:41
  the monetary policy framework that the Fed put into place
• 51:45
  in August of 2020 as kind of the culprit in the Fed not
• 51:50
  responding as soon as it became clear that this was the sort
• 51:55
  of inflation that its tools were designed to address.
• 52:00
  That I don't think is correct.
• 52:04
  Really.
• 52:05
  There probably was a majority on the FOMC in favor of saying, okay,
• 52:09
  well now we need to respond to this in September, October of 2021.
• 52:16
  And, and some were more vocal about it.
• 52:20
  Chris Waller, certainly I was supporting, there were others.
• 52:24
  But we were still purchasing $120 billion of, you know,
• 52:29
  treasury and agency securities a month at that time.
• 52:35
  And some general principles that the Fed operated under that I think with hindsight
• 52:39
  ought to be more flexible where, well, you can't push on the gas and
• 52:43
  the brake pedal at the same time.
• 52:45
  So we can't be continuing to purchase this amount of securities and
• 52:49
  providing accommodation in that way as we're raising interest rates.
• 52:54
  You know, that results in a, in a mismatch.
• 52:57
  So we have to stop the securities purchases.
• 52:59
  But the taper tantrum of 2013 heads had taught everyone that, well,
• 53:03
  you can't stop security purchases on a dime because the markets lose their minds.
• 53:09
  And so first you have to talk about talking about it and then you have to talk
• 53:13
  about it and then you have to have a serious discussion about it at
• 53:16
  the fomc and then you have to announce that you're going to do it in a while.
• 53:21
  So that plan was worked out in the fall that we would
• 53:25
  go through this whole tapering process of purchases and
• 53:29
  then start raising interest rates in response to the inflation.
• 53:35
  And it just quickly became clear that, we need to accelerate the,
• 53:40
  you know, the tapering faster than was originally envisioned.
• 53:45
  I mean, the original plan was that it might have taken as much as a year.
• 53:48
  And I think with the benefit of hindsight, the Fed will have learned the lesson
• 53:53
  that there are circumstances in which it is perfectly okay to start Raising
• 53:58
  interest rates even as you're being gradual in tapering asset purchases.
• 54:04
  And this was one of them.
• 54:06
  >> Jon Hartley: Fascinating, shifting back to banks and pinch regulation.
• 54:13
  I just really want to, in my last question for you is really just on
• 54:17
  deposit insurance because I think the most recent banking crisis that
• 54:22
  we've seen was really the Silicon Valley banking crisis in regional or
• 54:27
  regional banking crisis of 2023.
• 54:30
  And we had these banks in particular Silicon Valley bank,
• 54:34
  large bank, a lot of insured deposit,
• 54:37
  uninsured deposits that really forgot how to manage interest rate risk.
• 54:44
  And that concern around taking losses triggered this
• 54:49
  massive bank run essentially through people's cell phones.
• 54:56
  We've never really seen a bank run quite like this before.
• 54:59
  Typically we're used to thinking of people lining up in a wonderful life or
• 55:03
  these other famous photos of people lined up
• 55:06
  outside of banks when they get their money, to get their deposits.
• 55:10
  But here, you know, now people with a click, you know, can take,
• 55:14
  pull their money out of a bank and cause a bank run overnight.
• 55:19
  The FDIC came in though and resolved these banks and
• 55:24
  you know, took them into, took them over and
• 55:28
  functions the FDIC should, but.
• 55:33
  And there's not just Silicon Valley Bank, there are a few others.
• 55:37
  It's also sort of led to Credit Suisse also eventually being very distressed and
• 55:42
  got bought out by ebs.
• 55:44
  But I think there's sort of this unresolved question of what is going on
• 55:50
  with deposit insurance in that previously the rule still is on the books.
• 55:56
  Everyone has $250,000 of deposit insurance at each bank.
• 56:00
  And you could go Go to each bank and get another for every account,
• 56:03
  get $250,000 of deposit insurance, and you could go to hundreds of banks in theory.
• 56:07
  But I'm curious, you know, at some level,
• 56:09
  we kind of had this de facto sort of unlimited amount of deposit insurance.
• 56:12
  I'm curious where you think, sort of, as a policymaker, where we're at and
• 56:17
  how we should be thinking about the regional banking crisis of 2023 and
• 56:22
  what we should be doing about deposit insurance from a policy perspective.
• 56:26
  >> Randal Quarles: So, so, so I do buy in, you know,
• 56:30
  at maybe an 85% level to the view that the liquidity need for
• 56:36
  the current banking system, and particularly for
• 56:42
  sort of banks of, of Silicon Valley bank size,
• 56:47
  regional banks and, and smaller,
• 56:51
  is durably different than it was 15 years ago as
• 56:56
  a result of advances in communications technology and
• 57:02
  in bank technology exactly as you described it.
• 57:07
  So that the ability of Iran to form and
• 57:11
  to be severe is much greater than it was.
• 57:16
  I mean, just referring back to the WAMU example, you know,
• 57:21
  WaMu failed because it was losing $1.6 billion a day,
• 57:25
  I think, and it did that for 10 days in a row.
• 57:29
  And that was viewed as an unsustainable, you know,
• 57:32
  a completely unsustainable deposit outflow.
• 57:36
  It was slightly larger than Silicon Valley Bank.
• 57:38
  Silicon Valley bank lost $40 billion in an afternoon, and
• 57:41
  $100 billion was lined up to be going out the next morning.
• 57:44
  This is a, and WaMu was the largest and
• 57:47
  most severe bank failure in American history up to that point.
• 57:54
  Something was different, and I don't think that it was purely idiosyncratic
• 57:57
  to Silicon Valley bank, although we all know what its idiosyncrasies were,
• 58:00
  that made that a particularly severe case.
• 58:02
  So I do think that the liquidity need of the system is greater than it was.
• 58:06
  There are two ways, two principal ways to address that systemically
• 58:12
  as opposed to through draconian supervisory measures.
• 58:18
  One is to increase deposit insurance and therefore to increase
• 58:23
  the amount of comfort that I don't have to go for a run on the bank
• 58:28
  because my deposit is protected and to cover a much higher percentage,
• 58:34
  if not all of the sorts of business deposits that were, you know, that.
• 58:40
  That were the lifeblood of Silicon Valley Bank.
• 58:43
  The other, which I think is the preferable approach because there are significant,
• 58:50
  obvious moral hazard concerns with excessive deposit
• 58:55
  insurance, is for the Federal Reserve to return to its
• 59:00
  role as the liquidity provider to the system in the.
• 59:05
  One of the mistakes, I believe, that was made in the aftermath of the great
• 59:10
  financial crisis the focus on the liquidity position of banks, you know,
• 59:15
  the, the increased focus on the liquidity position of banks was, and
• 59:19
  the Fed has been the most extreme about this, is for
• 59:23
  the banks to self insure their own liquidity.
• 59:26
  Basically to say you must have enough liquidity in your
• 59:30
  institution to withstand a very severe run.
• 59:35
  And, and
• 59:36
  we're going to measure that in a variety of ways with liquidity stress tests.
• 59:40
  And a large part of this has to be intraday liquidity.
• 59:48
  And that was an issue even when we were talking about a liquidity
• 59:53
  need that was of the sort that we still thought we were talking
• 59:58
  about at the time of the Dodd Frank act and Basel III.
• 1:00:03
  If we're talking about a liquidity need where a $220 billion able to
• 1:00:09
  support the outflow of $140 billion over the course of 24 hours,
• 1:00:14
  that is, that's unsustainable that, that you can't, you can't remain a bank and
• 1:00:20
  have that many liquid assets inside of your system and self insure yourself.
• 1:00:26
  And the Fed has been quite insistent on that.
• 1:00:28
  For example, when,
• 1:00:30
  when the Fed goes in to do a supervisory assessment of the bank's liquidity, it
• 1:00:34
  doesn't allow it to take into account that it has the right to borrow from the Fed.
• 1:00:39
  And as a consequence, many banks do not prepare themselves to borrow from the Fed.
• 1:00:44
  We all know the famous story that well, Silicon Valley bank didn't
• 1:00:46
  have any collateral at the Fed in order to borrow because why should it?
• 1:00:49
  The Fed had said, you have to have, you know,
• 1:00:51
  we're only counting the liquidity that you keep on your books.
• 1:00:55
  So it borrowed from the Federal Home Loan bank of San Francisco in order to fund
• 1:00:59
  putting liquid assets on its books that it could show the Fed that I have
• 1:01:02
  enough hqla.
• 1:01:04
  So.
• 1:01:07
  I think the Federal Reserve should go back to the fundamental reason that it was
• 1:01:12
  created.
• 1:01:13
  It's the reason we don't call it the central bank of the United States,
• 1:01:17
  but call it the Federal Reserve,
• 1:01:19
  which is that it exists to pool the reserves of the banking system and
• 1:01:23
  direct them to where they are most needed at any point in the event of a run.
• 1:01:28
  And you know, Silicon Valley banks, the structure of its portfolio was such
• 1:01:32
  that if it could have held those assets to maturity, it was perfectly solvent.
• 1:01:36
  It could not hold on to maturity during Iran but
• 1:01:38
  the Fed could hold those assets to maturity.
• 1:01:40
  The Fed could have very safely simply lent the money to Silicon Valley
• 1:01:44
  bank to pay off those deposits.
• 1:01:46
  And eventually what would happen with every run is,
• 1:01:49
  I'm going to get my Money I don't have to run.
• 1:01:51
  But you would do that through the Fed's provision of liquidity as opposed to
• 1:01:56
  kind of non discriminant deposit insurance which allows for
• 1:02:00
  kind of much more intelligent decisions to be made about the ultimate viability of
• 1:02:05
  an institution that the liquidity is being provided to and therefore an amelioration
• 1:02:11
  of the moral hazard problem of any sort of government intervention.
• 1:02:15
  So, so, so that's again that's my logaric answer to the deposit insurance question,
• 1:02:21
  which is I don't think we should be increasing deposit insurance, but the Fed
• 1:02:26
  really needs to kind of go back to basics in thinking about its role as the lender
• 1:02:31
  of last resort and reinvigorate it to what it was originally intended to be.
• 1:02:38
  >> Jon Hartley: That's great.
• 1:02:39
  One last question.
• 1:02:39
  Any last.
• 1:02:40
  Any thoughts at all on stablecoin regulation?
• 1:02:43
  There's some legislation that's going through Congress right now.
• 1:02:48
  There's been I think a lengthy debate about this.
• 1:02:50
  You know, how much should stable coins be treated like banks and so forth and
• 1:02:55
  what should the sort of guide rails be?
• 1:02:57
  And we've had sort of circle which runs USDC led by Heath harbor mutual
• 1:03:03
  friend of ours that this much I think been historically wanting to be regulated.
• 1:03:09
  Tether on the other side that's been a bit more controversial, doesn't kind of quite
• 1:03:14
  want to be regulated, hasn't been quite as transparent as some people would like in
• 1:03:18
  terms of where it's keeping its proceeds, that that's backing the stablecoin.
• 1:03:22
  At the end of the day, they're both investing in treasury bills and
• 1:03:27
  taking the, investing the float and taking this and the interest and
• 1:03:32
  maintaining a stable asset.
• 1:03:34
  But I'm curious from a regulatory perspective,
• 1:03:36
  how do you think about stablecoins?
• 1:03:38
  >> Randal Quarles: Yeah, I think that, you know, I think that stablecoins distinguish
• 1:03:42
  them from sort of crypto 1.0, Bitcoin, Ethereum,
• 1:03:46
  that sort of thing which I have no problem with, but I don't think is ever going
• 1:03:52
  fundamentally be transformative of the payment system or the financial system.
• 1:03:58
  But stablecoins could be quite.
• 1:04:00
  Important in the financial system and
• 1:04:03
  particularly with respect to international payments and across border payments.
• 1:04:08
  And, and the official sector has some legitimate
• 1:04:12
  issues with regard to how the pool of assets by which
• 1:04:17
  the stablecoins value is measured is constructed and run.
• 1:04:24
  I think those issues are pretty obvious.
• 1:04:30
  They're well addressed in the stablecoin legislation that's passing.
• 1:04:33
  They've been well addressed since the President's working group
• 1:04:38
  with Janet Yellen as chair of the treasury, as chair,
• 1:04:41
  as Secretary of the treasury put out at the end of 2021.
• 1:04:47
  You know, the, the issues are clear, the way to address them is clear.
• 1:04:51
  The stablecoin industry is actually quite happy in having them addressed in the way
• 1:04:55
  that has been, you know, know, kind of well understood for a while.
• 1:04:59
  We just went through a period where that whole process was being stymied by well
• 1:05:04
  intentioned but aggressive regulator who wanted to be the crypto cop and
• 1:05:08
  didn't want a, you know, a framework that kind of put clear responsibility,
• 1:05:13
  you know, clearer responsibility on the bank regulators as opposed
• 1:05:17
  to securities regulators for the, for the stable coins themselves.
• 1:05:23
  I think, you know, once we put that framework in place,
• 1:05:28
  which is not politically or intellectually difficult to do and
• 1:05:33
  so I think it will be done over the course of this year probably we
• 1:05:37
  have a great framework for stablecoins to grow.
• 1:05:41
  I think that's not only good for the financial system, I think it's good for
• 1:05:45
  the US dollar and
• 1:05:46
  I think it then prevents some of the concerns that I have about tether.
• 1:05:51
  The people will live in that framework.
• 1:05:54
  It is a livable framework.
• 1:05:56
  It is good for the public, it's good for the industry,
• 1:05:59
  it's good for the financial system.
• 1:06:03
  And the tethers of the world will kind of be relegated I believe
• 1:06:08
  once we get that done.
• 1:06:10
  >> Jon Hartley: Yeah, it's fascinating.
• 1:06:12
  And there's now word that the consortium banks may be starting their own
• 1:06:15
  stablecoin.
• 1:06:16
  It's gonna be very interesting to see where the stablecoin industry goes as it
• 1:06:20
  sort of becomes more regulated.
• 1:06:22
  Randy, I really want to thank you for coming on.
• 1:06:24
  It's been an amazing conversation.
• 1:06:26
  >> Randal Quarles: Thank you very much for having me.
• 1:06:27
  That was a great pleasure.
• 1:06:29
  >> Jon Hartley: This is the Capitalism I'm Free from the 21st Century podcast,
• 1:06:31
  an official podcast of the Hoover Economic Policy Working Group where we talk about
• 1:06:34
  economics, markets and public policy.
• 1:06:36
  I'm Joan Hartley, your host.
• 1:06:37
  Thanks so much for joining us.