Philadelphia Fed’s Patrick Harker On Asset Bubbles, Shadow Banking And Fintech by [email protected]

In the second part of this [email protected] interview, Patrick Harker, president of the Federal Reserve Bank of Philadelphia, discusses whether the Fed should be involved in bursting asset or credit bubbles, “too big to fail” issues, shadow banking, fintech and what surprised him during his first year in his role at the Fed. In Part 1, Harker, a former Wharton dean, talked about the limits of monetary policy, zero-bound and negative interest rates, and a coming labor squeeze from Baby Boomer retirements that is threatening a slower, “new normal” U.S. growth rate, among other topics. Harker’s made his comments during a two-day conference — “The Interplay between Financial Regulations, Resilience, and Growth” – sponsored by the Federal Reserve Bank of Philadelphia, the Wharton Financial Institutions Center, the Imperial College Business School and the Journal of Financial Services Research.

And edited transcript of the conversation with Patrick Harker follows:

[email protected]: You will have been president [of the First Reserve Bank of Philadelphia] for a year as of July 1. What has most surprised you in your position?

Patrick Harker: Two things, I think. One, the seriousness by which people take the responsibilities across the system generally. And specifically, at the FOMC (Federal Open Market Committee). First … it’s one of the more unusual meetings in Washington. You can’t have any electronics in the room, so everybody’s actually paying attention. When was the last time you were in a meeting where nobody’s looking at a cell phone….?

People are listening. People are engaged, for two days, in a very profound way because they know the stakes. I wish we could bring other people from different parts of the government in Washington into that room, which we can’t, to just watch that process. It is really an exemplary process of people who may not always agree. We’re all looking at the same data, but we may have different perspectives. And those perspectives come from whether it’s our academic training, or our life experiences or our business experiences, whatever it is. People bring that diversity of thought to the room. But it’s done very respectfully and people want to know what the other people think. So that surprised me.

The other thing that surprised me is, when the Federal Reserve was set up — we’re a quite unique central bank relative to the rest of the central banks in the world — we were set up in a way that added that diversity across regions, because we are a big, complex country. And I think those voices coming outside are important.

But as a result, governing the system inside is complicated. What surprised me on the other side is how much time we spend just managing things like our technology investments — because it’s a collective. The 12 presidents and the 12 first vice presidents have a series of committees that actually manage the system, day-to-day. There’s no CEO of the system, and so the amount of time that we have to spend not just at the president and first vice president level, but with the head of supervision, or the — you name it, anybody here, or the head of IT. How much time we have to spend collaborating with our colleagues? And some people see that as ineffective. But actually, I don’t. I think it works. It’s not perfect, but it works.

[email protected]: I also wanted to ask you about asset pricing, and what the Fed’s role is or should be. Should you be involved in the business of piercing an asset bubble, or a credit bubble?

Patrick Harker: That question’s come up quite a bit and I know that’s part of this conference as well. It’s a very blunt tool. We have basically one tool. And so if we see an asset bubble, say in commercial real estate, would we exercise — first, we’re assuming we can see the bubble. Right? There’s always that question that emerges: It’s easy to see a bubble in retrospect, but can you see a bubble while it’s forming…? And that question will never go away. But assume you could. Then is our one tool, the Fed funds rate, the tool we should use?

“It’s easy to see a bubble in retrospect, but can you see a bubble while it’s forming?”

I would never say never. I think in my mind, it doesn’t make sense to take a tool off the table and say you’ll never, ever use it, because you never know what you’re going to face in life. That said, there’s a pretty high bar for me to consider using that tool as opposed to other macro-prudential tools. And so as Bill Spaniel [a senior vice president and lending officer at the Philly Fed] mentioned yesterday when he opened up the conference, just looking at leveraged loans and the supervisory side of the house at the Fed, saying we have this concern and then starting to talk to the banks about the concern.

That bully pulpit, if you will, that ability to talk about these issues, also has an effect, which is not surprising. We talk about this a lot when it comes to monetary policy with forward-guidance. So the conversation about issues as opposed to actually implementing something can have an effect. But there are other tools in the world of macro-prudential regulation that can be much more effective than the blunt instrument of changing interest rates to try to pop a bubble.

[email protected]: I want to also ask you about “too big to fail,” because it was part of the conversation in the presidential primaries. It’s this idea of breaking up the large banks — or not — or is there another way to handle this problem? In other words, is the problem size, or is the problem the level of risk, and is there some other way to approach that? What’s your view on that?

Patrick Harker: This is the conversation that we’re having right now across the country, as you said. And actually, it’s the conversation we’ve been having in this room for the last two days. So assume for a moment you say it’s size. What’s the right size? I find that hard to answer. Also, much of what happened in the crisis — we’ll use the Great Recession as an example — it wasn’t caused by the largest institutions, but by the ones that were systemically most important. And that’s a conversation we’ve also been having here at this conference.

I go back to Jeremy Stein’s 2013 speech [as governor of the Federal Reserve Bank of St. Louis], which I really think nailed it, for me. It’s a question of price versus quantity. And for us, it’s easier to think about changing prices than it is to think about changing quantity — prices in the sense of pricing the risk, endogenizing the risk — and for the risks that we can’t quite understand or endogenize, creating buffers. I think that approach — enshrined in Dodd-Frank — is in my mind at least, the more effective approach.

Is it perfect? No. And like any regulatory regime, we imposed regulations and now we’re starting to look back and say, what’s working,

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