GLG Signature Series: Bill Dudley, Former President of the Federal Reserve Bank of New York

Recently, William C. Dudley, former President of the Federal Reserve Bank of New York, sat down for a 60-minute virtual session with select GLG clients. The session, part of GLG’s Signature Series, was a wide-ranging conversation about the economic impact of COVID-19 and the federal stimulus response.

Bill brought a great deal of expertise to the conversation. In addition to his time at New York’s Fed, he held the position of Chief U.S. Economist at Goldman Sachs. He is currently a senior research scholar at the Griswold Center for Economic Policy Studies at Princeton University and member of the Group of Thirty and the Council on Foreign Relations.

Before Bill’s session, we asked him three questions of our own.

In an interview with Bloomberg, you said “for the Federal Reserve to intervene and support those asset prices, is basically creating a little bit of moral hazard in the sense you’re encouraging people to take on more debt.” Can you expand on this statement?

The Fed’s actions to restore market function helped hedge funds with highly leveraged positions, long cash treasuries, short treasury futures; mortgage REITs with leverage positions in mortgage-backed securities; corporations that were highly leveraged by choice; and high-yield debt investors, who also were invested in that asset class mostly by choice. When the Fed comes to the rescue in this way, that helps these actors avoid the full costs of their decisions. This socializes the cost of such risk taking and thus, in the future, may encourage greater risk taking, necessitating still greater interventions by the Fed. This is a classic moral hazard problem. It’s also difficult to solve. After all, if you don’t intervene, you may teach the risk takers a lesson, but that may not be worth it if the consequence is a depression and lots of damage to innocent bystanders.

In the current crisis, retail tenants are defaulting on their rent and/or shuttering, some banks are allowing people to skip mortgage payments, the current work-from-home strategy is causing some companies to reevaluate their real estate footprint. Do you foresee a mortgage crisis that could ripple through the economy? And, if so, is there anything different today vs. 2008?

There is certainly a risk of stress in the mortgage market as work-from-home activities may become more prevalent and as job losses make it more difficult for households to stay current on their mortgages. But this is very different than the 2008 financial crisis. There is no housing bubble that’s deflating. Moreover, the core banking system is much stronger now than then, with much greater capital and liquidity buffers.

In the 2008 crisis, we saw great cooperation between the Fed, Treasury, Congress, and the executive branch. How do you feel those entities are performing today? Are they communicating effectively? What would be an optimal scenario?

I think the Fed and U.S. Treasury are working very well together. The biggest challenge is that monetary policy may not be sufficient by itself to generate a strong, sustainable recovery. The fact is that the pandemic has and may continue to cause damage to income flows and balance sheets. The Fed’s ability to deal with that is very limited. The biggest issue is whether sufficient fiscal stimulus will be forthcoming to help fill the hole in household, business, and state and local government income. If fiscal policy gets locked on hold because of political polarization in Congress, then we could find ourselves in an even more difficult situation.

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About Bill Dudley

William C. Dudley became the 10th president and chief executive officer of the Federal Reserve Bank of New York on January 27, 2009. In that capacity, he served as the vice chairman and a permanent member of the Federal Open Market Committee (FOMC), the group responsible for formulating the nation’s monetary policy. Previously, Mr. Dudley served as executive vice president of the Markets Group at the New York Fed, where he also managed the System Open Market Account for the FOMC. The Markets Group oversees domestic open market and foreign exchange trading operations and the provisions of account services to foreign central banks. Prior to that, Mr. Dudley was a partner and managing director at Goldman, Sachs & Company, and was the firm’s chief U.S. economist for a decade.