Governor Jeremy Stein, Q&A

February 5-7, 2013 | St. Louis Mo.

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about the event | conference materials

   Julie Stackhouse (4:19)
   Michael Sherraden (7:42)

The St. Louis Fed's Household Financial Stability Research Initiative
   Ray Boshara (9:08)

Session One – Household Balance Sheets: Status and Perspectives
- The Current State of U.S. Household Balance Sheets
   John Sabelhaus, Kevin Moore and Paul Smith (22:09)

- Why Did So Many Economically Vulnerable Families Enter the Crisis With Risky Balance Sheets?
   William Emmons and Bryan Noeth (22:31)

   Session One Moderator: Jim Fuchs (4:16)
   Session One Q&A (25:28)

Session Two – Household Balance Sheets: Homeownership and Retirement Security
- The Effects of Health and Wealth Shocks on Retirement Decisions
   Dalton Conley and Jason Thompson (19:12)

- Homeownership, the Great Recession, and Wealth: Evidence from the Survey of Consumer Finance
   Michal Grinstein-Weiss (7:22)
   Clinton Key (11:47)

   Session Two Discussant: J. Michael Collins (19:50)
   Session Two Moderator: Yvonne Sparks (2:29)
   Session Two Q&A (19:41)

   Introduction: Ray Boshara (4:21)
   Keynote: Michael Barr (56:23)

Session Three – Household Balance Sheets: Education and Social Development
- An Experimental Test of Child Development Accounts on Early Social-Emotional Development
   Jin Huang, Michael Sherraden, Youngmi Kim and Margaret Clancy (18:18)
   Session Three Discussant: Robert Pollak (19:37)
   Session Three Q&A (26:45)

Evening Keynote Address
   Introduction: Christopher Waller (3:06)
   Keynote: Christopher Carroll (1:02:19)

February 7, 2013

Breakfast Keynote Address
   Introduction: James Bullard (3:30)
   Keynote: Governor Jeremy Stein (46:29)
now playing  Keynote Q&A (11:22)

Session Four – Household Balance Sheets: Deleveraging and Economic Growth
- What's Driving Deleveraging? Evidence from the 2007-2009 Survey of Consumer Finances
   Karen Dynan and Wendy Edelberg (22:08)
   Session Four, Part 1 Discussant: John Krainer (20:16)
   Session Four, Part 1 Q&A (14:47)

- Household Balance Sheets, Consumption, and the Economic Slump
   Atif R. Mian, Kamalesh Rao and Amir Sufi (21:57)
   Session Four, Part 2 Discussant: Brian Melzer (18:51)
   Session Four, Part 2 Q&A (15:44)

   Session Four Moderator: Daniel Davis (2:14)

Closing Plenary – Facilitated Panel Discussion: Household Balance Sheets and Economic Growth
   Panelist: David Buchholz (10:24)
   Panelist: Steven Fazzari (11:41)
   Panelist: Deniz Igan (12:13)
   Discussant: Barry Cynamon (20:03)
   Panel Discussion Q&A (27:29)

   Ray Boshara (2:09)


Below is a full transcript of this video presentation. It has not been edited or reviewed for accuracy or readability.

Ray Boshara: So, Governor Stein’s going to take a few questions. I’m going to let you manage the–

Governor Jeremy Stein: Okay.

Ray Boshara: . . . and also decide when you’ve had enough.

Governor Jeremy Stein: Okay.

Ray Boshara: He did tell me he preferred softball questions, so . . .

Governor Jeremy Stein: Yes, please.

Bill Ames: Here’s a softball question. Bill Ames, from the St. Louis Fed. Could you apply the decoupling logic to the credit boom that preceded the bust? I think the Fed’s–if there’s an official position, it was that if anything we made the mistake of not being tight enough on the supervisory side, but the monetary policy was not implicated in the credit and housing boom.

Governor Jeremy Stein: So, are you asking me to say–are you asking a normative or a positive question? So, in other words–

Bill Ames: Well, I guess a positive question is that–

Governor Jeremy Stein: Hm-hmm. [affirmative]

Bill Ames: . . . is it convincing to you that the idea that monetary policy was not responsible or in any way implicated to the credit and housing boom?

Governor Jeremy Stein: I’ve actually looked at this question, so it’s–sort of just to restate the question as I’m hearing it, is, you know, is the question to what extent would things have turned out differently had monetary policy been tighter, kind of, in the early part of the decade or was it primary a supervisory failure?

I mean, it’s clearly–you know, there’s clearly a lot of blame to be allocated to some combination of market participants and supervision. It’s less–I’ve actually spent some time looking at the evidence, and it’s a hard case to make. If you ask for really, you know, strong evidence that, you know, for the counter factual that had the funds rate been raised higher, the housing bubble would have turned out differently. I spent a considerable amount of time, could not make the case to, kind of, the standards of evidence that you would want to prove the case, you know, get a t-statistic of three.

A harder question, you know, that I was alluding to is what should the standards of evidence be in a world where we don’t know? And it depends on, you know, your view of–in other words, if you could tell me that we could have gone back in time and done a much better job on supervision, then, obviously, that raises the bar for deploying monetary policy for, you know, the standard of evidence. If you say, “Well, that was the best we could have done with supervision,” then, I think, you know, the standard of evidence should be potentially a little bit lower. I think, as a purely evidence based thing, I know the Chairman has done some work on this, it is hard to find or at least to [inaudible at 00:02:44] my reading of it, it’s hard to find a smoking gun that says, you know, “Had the funds rate been x-basis points higher, things would have worked out okay.” That’s my reading of it. It’s a hard question to answer well.

Yes. Yes, Chuck.

Chuck: So, it’ll be obvious pretty quick this is a question from an economist not a finance person, but why is that in an era of low interest rates, risk free interest rates, that we think about credit spreads–

Governor Jeremy Stein: Hm-hmm. [affirmative]

Chuck: . . . still in levels and not relative to this new lower interest rate? In other words, does the 400 basis point spread that you characterize on the high yield bust–

Governor Jeremy Stein: Yes.

Chuck: . . . as being sort of consistent with history–

Governor Jeremy Stein: Yes.

Chuck: . . . doesn’t that seem larger today relative to the risk–

Governor Jeremy Stein: It’s like a four times the interest rate spread.

Chuck: . . . as opposed to–

Governor Jeremy Stein: Yes.

Chuck: . . . one and a half times.

Governor Jeremy Stein: Yeah.

Chuck: What is it–

Governor Jeremy Stein: Okay. So–

Chuck: . . . the financer is telling us?

Governor Jeremy Stein: . . . here, I think there’s sort of a textbooky finance answer, and Amely [phonetic], you’ll tell me if I get this wrong. But, it’s just––you know, so, in theory, the credit spread is meant to compensate for defaults. Okay? So, what would a 400 basis point credit spread be if you had a portfolio of 100 loans and four percent of them were going to blow up and you were going to have a loss given default of 100 percent? That 400 basis point spread, additively, would just compensate you. Okay? So, and that’s true regardless of whatever the starting level–so, in other words, you’re going to buy a corporate bond and you want it net of default, so you risk neutral. You want it net of defaults to just give you the treasury rate. That will map into an additive spread.

Chuck: Got it.

Governor Jeremy Stein: Okay. So, that part is easy. There is a subtler question. Market participants sometimes say, “Yeah, credit spreads are normal, but the level of rates is low.” You know, people can borrow at an all time cheap level. Isn’t that relevant in some sense? I think the credit spread is the first order thing to pay attention to. It is possible that, you know, when you go to structure a leverage buyout, you’re more aggressive just because you think your total interest expense will be low. In which case, the overall yield on the bonds, you know, has some role, but it kind of gets in there in a sort of second order way.

Yeah, Chris.

Chris: I think the hardest problem that would be the whole enterprise with revolving faces is trying to figure out what complexity it has value and–

Governor Jeremy Stein: Hm-hmm. [affirmative]

Chris: . . . what complexity exists as a–

Governor Jeremy Stein: Right.

Chris: . . . [unintelligible at 00:05:41] transferred risk from those who know it’s there to those who don’t know it’s there.

Governor Jeremy Stein: Right.

Chris: It’s a hard problem, partly, because it’s inherently hard to know the answer to it and it’s, also, a hard problem because figuring out what to do about some new form of complexity–

Governor Jeremy Stein: Right.

Chris: . . . that has just appeared–

Governor Jeremy Stein: Right.

Chris: . . . and whether you should stomp on it or not.

Governor Jeremy Stein: Hm-hmm. [affirmative]

Chris: It is something that raises hard questions. But, I think my bias is in the direction of given that I [unintelligible at 00:06:12]–

Governor Jeremy Stein: Right.

Chris: . . . is mostly motivated by the transferring risk from those who know it’s bigger to those who don’t until the case is proven otherwise. Can you say anything on that?

Governor Jeremy Stein: Well, I mean, so, certainly, you know, the––you know, exactly. When you look at the data, it’s going to be very importantly colored by kind of your priors and just to be a little bit more–in other words, I don’t–

Female: [Unintelligible at 00:06:41].

Governor Jeremy Stein: Yeah, I mean, you want me to just repeat the question? Yeah. Yeah, so the question was, you know, effectively, to kind of boil it down, was, you know, how cynical should we be about financial innovation? To what extent should we––when we see very rapid growth in a new financial product, to what extent should we think it’s something that has these features of trying to beat a measurement scheme versus it’s doing kind of a traditional thing of risk sharing and so forth?

You know, I think one wants to put a healthy amount of weight on both. The one thing I’ll say, as a general observation, in a situation like, you know, you can both believe that financial innovation has been extremely sociably value in an inframarginal sense in getting us to where we are, but of course, the more complete and well-developed markets become, the more risk sharing is already pretty effective. At the margin, you have to think that the likelihood that we’re going to find new innovations that create radical new opportunities for risk sharing is somewhat lower and that will tilt you a little bit.

So, you know, the last thing I would want to do is make this sort of a broad statement about financial innovation, but, you know, you can sort of–and I don’t think you need to. I think it’s just something that helps you in terms of how you look at the data. I think it would be certainly a mistake to do as I think many of us did, and I, you know, I think finance professors, like me, are complicit in this. You know, before, is to basically put a very heavy prior on its risk sharing, its market completing. I think you at least want to be more balanced in looking at the data and that alone, I think, gets you a long way.

Yeah, please.

Male: If I’m remembering right, you mentioned early on both regulation and corporate governance. You came back–

Governor Jeremy Stein: Hm-hmm. [affirmative]

Male: . . . to regulation. I don’t remember you saying or coming back much to corporate governance. Do you have views on, you know, from this perspective of whether there are aspects of corporate governance we need to look at?

Governor Jeremy Stein: Yeah. So, for just one example, when I was talking about kind of changes in, you know, rules of, you know, internal rules, so, for example, if you were worried about these sorts of agency problems, the way you compensate, not only your top employees, but anybody in the organization who’s taking risk, those become important. And, you know, we’ve seen firms on their own, in some cases, prodded a little bit by regulation, doing more in the way of compensation that, you know, you leave the compensation in the firm for X number of years, so I think that stuff is potentially quite important. That’s kind of what I had in mind with that.

Let me take one last one. Yeah. Yeah, please.

Female: So, you mentioned that this–

Governor Jeremy Stein: Use your mic.

Female: Yeah. You mentioned that this reaching for yield might eventually lead to low returns or even losses, but that, in connection with the maturity transformation, collateral transformation, that’s going to lead to another thing altogether. Now, so, I’m wondering, do you think that second piece there is necessary for damage to the real economy and if so, how would you interpret what happened in Japan in the ‘90s where, you know, maybe you did just have that reaching for yield, but not the drying up of equity and that sort of financial meltdown–

Governor Jeremy Stein: Yeah.

Female: . . . that we had here?

Governor Jeremy Stein: That’s a fair question. So, I think, you know, and we’re always a little bit in danger of over extrapolating from the most recent crisis. I would think–so, I wouldn’t say necessary. I think it’s certainly all else equal, take the–all I really want to say is take the same amount of risks, all else equal, add maturity transformation, and that makes things sort of more volatile and more dangerous. Can you have the financial crisis or, you know, major systemic event without it? I’m sure you can come up with examples, but–so, not necessary, but I’d say an important piece of the puzzle.

Female: Okay.

Governor Jeremy Stein: All right, I think we’re good. Okay. All right, thanks very much. Thank you, appreciate it.

Ray Boshara: Thank you so much, Governor Stein. It’s very insightful, very important remarks. We really appreciate your coming all the way to St. Louis to join us for our Symposium. We have a half hour break, and please be back here by 10:00 for our next session on Household Balance Sheets through Leveraging and Economic Growth. Thank you.

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