The third thing is that — I think our monitoring of these markets, and study of these markets, has taken lessons from that experience. Even then, we focused a lot on market intelligence and things, but now we have a lot more analytical tools that can tell us — what are some of the warning signs, that even though markets are functioning well, there are signs that interest rates are getting more sensitive to the daily ups and downs. There’s some research we’ve done here at the New York Fed that’s really trying to develop some statistical methods, saying — hey, you know, everyday we’re seeing more volatility in market interest rates when things happen, maybe that’s a sign that we’re getting closer to ample reserves. We saw some of those signs in 2018, 2019. We saw some of those things, but it wasn’t as clear maybe that — because markets were functioning so well, it wasn’t as clear at the time that maybe there was perhaps less elasticity in those markets when the shocks kind of got bigger.
When you survey financial markets right now, what keeps you up at night?
There are different versions of that question. I always say that the one that’s number one on my list, mainly because it’s so hard to know, is really cybersecurity issues — cyber risks. Obviously, there’s a lot of work that goes in at the financial institutions, here at the Federal Reserve and at other central banks, we put a lot of effort into making sure that our systems and the financial system is secure, but there’s also a lot of effort to break into that, or create risk to the financial system that way. So that’s just something that’s always on our mind, my mind, and it’s something that we’re very focused on, there.
I think the other concerns, that come up, is — we look at the Treasury market. The U.S. Treasury market is the number one, central, most core market in the global economy. As we saw in the spring of 2020, if the Treasury market is not functioning well, other markets don’t function well, and we watched — over many years — as liquidity in the Treasury market has come down to lower levels as the market players there and how the market dynamics work there has changed over time, and that has led, at different points in time, to greater sensitivity to interest rates, to sudden changes in interest rates, due to various shocks that happen. So I think that’s another concern. Anything we, broadly, in government can do to strengthen the resilience in liquidity in the Treasury market and other closely-related markets I think is very important because it’s just so core to everything.
I don’t go back to March of 2020, and say, well: We saw that, we have to protect against March of 2020 as the one example, or the one data point. Because that is so extreme, what happened then in kind of the dash-for-cash kind of set of issues. But I look at the broader context. Well before the pandemic, there were clearly events in Treasury markets that gave concern about liquidity there, and they have occurred since, so I think that’s a number two area that we want to make sure we invest in.
I would say the third, which I will just now cross off officially, was the Libor transition. That took a long time, about 10 years, but Libor was a fundamentally flawed reference rate that was used in hundreds of trillions of financial instruments. It was an incredibly hard project to move off of that, and it was to me one of the top financial sector risks. And — we’ve moved off of it in the U.S., and globally moved away from a lot of those types of reference rates to much more robust, resilient reference rates. In the US, SOFR has taken over that. And to me, that is a great success, but it’s also kind of a reminder that things can creep up on you over years. Because LIBOR started as a relatively small thing and then spread, and spread, to the point where nobody, I’m sure, in the 1980s thought that this was going to be a $400 trillion thing — so just keeping an eye on things that are small but that are growing over time, is another thing.
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