Surveillance: Moral Hazard With Dudley

It's easy to say that Jared Bernstein was an advisor on economics and on politics to Vice President Biden, but far more importantly, he is one of the liberal economists, progressive economists in Washington that every conservative reads and studies. He's been doing it for decades Economic Policy Institute and now at the Center on Budget and Policy Priorities. Jared, we are thrilled you're with us today. What does the

Biden mandate forward? What does Vice President Biden need to do to be not to those committed to MN but the marginal voters looking for the Biden message? What does he need to say? First of all, it's always great to start the day with the three of you. It's just fascinating to hear just sitting here in the green

room listening to your to your wrap. Uh. The vice president is running for office that uh in the midst of really three crises a COVID crisis, health crisis that is an economic one, which of course stems from the health crisis, and now just an outpouring of racial violence, which, as I think I heard at least implicit in some of your comments, feels very justified for for a lot

of people. And uh, this is the time, as you you just played some tape in saying to bring the nation together and to restore a competent federal sector, something we so sorely lack that can meet the kind of shocks that come out a global economy fast and furiously, whether it's a pandemic, or whether it's a massive inequality,

or whether it's a kind of environmental degradation. We said, we need a competent, amply funded federal sector that has the capacity to protect the American people and give them the opportunity they need to just realize their potential out there in the economy. And I think broadly speaking, that's the agenda. Jared as a former chief economist to former Vice President Joe Biden, what is his solution? Is it

a universal income? What does it mean to have a strong federal response, Given the fact that we have seen a strong federal response enhance unemployment benefits, a huge program to get checks out to Americans below a certain income level. What more would find them do well? First of all, let me just say the countercyclical response, which is what you're talking about there, is very key to what we're going through right now. But that's not a plan for

the future. That's a cyclical response. What I think the next president is going to need to do is to resolve structural problems within the economy. Me So one of the problems there's no one solution because there's so many different types of problems. Obviously, people need access to affordable healthcare, and Biden has articulated a path towards the universal coverage. That's very important. Probably at the top of the list

now is going to be jobs. I mean that wasn't necessarily at the top of the list when the unemployment rate was around three percent, but when it's we certainly have to talk about jobs. And there you have a very deep investment agenda, whether it's on the infrastructure side, whether it's on green technology and green jobs, or whether it's UH in the caring professions, critically important healthcare, childcare, UH,

really establishing higher quality jobs for folks in the services. John, he had a long time in Washington to try and engineer those structural changes, eight years in the Obama administration as well. And I asked this diplomatically speaking, I don't want to get too political here, but there will be some people who say he had his chance. What do you say back to that, Uh, you have to recognize,

I mean, we do have to get political here. We have to recognize that before Barack Obama was sworn in, there was literally a cabal of Republicans who were meeting to try to block every aspect of his agenda. Now, he still managed, with the help of the Vice President at the time, UH, to push back hard on the Great Procession, to establish a very important healthcare change that brought our uninsurance rates down by UH and UH and and a financial reform that I think has proved pretty durable.

And that's with tremendous political blowback. Then of course, when the Tea Party got to town, they tried to shut it down even further. So he's going to need political cooperation. And that's one reason I'm sure that Democrats are very interested in trying to get a majority in the Senate. But even amidst the kind of opposition that he in Obama's face. You know, they actually got quite a bit done. Jado was great to catch out with you. You, of course are allowed to get political. I just try and

avoid it wherever I can. I don't like it either, but in place thing that, Jared, thank you. We've had wonderful conversations today with economists Stephen King of HSBC joining us, the Lauria Paul Romer on technology here at New York University, and now the former president of the New York Federal Reserve System, William Dudley, and of course with a distinguished career at Golden Sachs before that, in his service with

Tim Geitner of a bit ago, a crisis ago. I guess we could say Dr Dudley, thank you so much for joining us. UH Today, John and I were talking about inequality, and one of the raps of any FED is that it is monetary policy for the elite. Explain, trickle down Federal Reserve policy. How do they assist in a lesser inequality? Well, the his monetery policy tools are really about supporting economic activity and driving the economy to

higher levels of employment. However, that can actually cause financial asset values to go up, and that could actually exacerbate inequality. So the FEDS choices not have a recovery have less inequality, or have a recovery with buoyant financial asset prices and more inequality. So the fence tools are just not suited to address the inequality problem. Bill, is it that binary or can we find a better balance? I think it

is pretty much that binary. Obviously. You know, when we're in a crisis like this and the FEDS embarked on special facilities, uh, you know, the FED could try to you know, undertake facilities that fund of money more to households and small businesses. But again, the FED is that's difficult for the FED operationally. How does the FED actually get money to millions and millions of households and small businesses.

That's difficult to do operationally. It's much easier to intervene in the capital markets, where the FED can rely on counterparties, primary dealers and others to essentially helped the fit by financial assets. Quite more difficult to land down and one by one millions into millions of different entities. So that again, that's a challenging thing for the FED. But I think it is a challenging thing. But there is a broad consensus that they should be keeping financial conditions loose to

help this economy pick up and recover. You're here very little debate about that. I think whether debate really is about how far the Federal Reserve goes when it does that. You can intervene in credit markets, Okay, might be a debate there as well, but you can help, say, big

companies issue debt to keep people on the payroll. But when you start to go into junk, you do run the risk of running the getting the accusation that you are helping those who made risky bets in this market, and the likelihood that that actually spills over to the broader economy is relatively small. But I guess what I'm trying to ask is, how do you know when you've done too much? Well? I think the FEDS focus has been basically making sure that financial markets work well so

people can have access. You have access to the markets, and that's really the reason for the interventions, even their intervention into the high yeld debt market. It's not so much to ba allow individual borrowers, but to make sure that people actually can access that market and raise my yeld in and I think they've been quite successful in

those efforts. But you raise an important point. People who have high yield debt outstanding a lot of that a lot of times that's happened by choice, and so for the Federal Reserve to intervene and support those asset prices are is basically creating a little bit of moral hazard in the sense that you're encouraging people to take on more debt. So let's talk about the moral hazard and

broaden out the implications of this period of time. There have been some analysts who say the reason why the Federals are of really, I don't want to say had to, but in some ways had to step into the corporate debt market was because of the expansion of the shadow banking system. In some ways, they were bailing out the shadow banking sector rather than the banking sector, which was

actually well capitalized. How important in your view is it to set regular to wor standards for the shadow banking sector that are sort of more similar to what we see on Wall Street. Following this, given the fact that perhaps this can be viewed as they're having the systemic import of Wall Street, of the past. I think you raised a very important point is something is systemic that's been going to require the Central Bank to invene in an unusual way in the middle of a crisis. It's systemic,

then it needs to be regulated to some degree. And so we had a number of players in this last few months that had essentially been bailed out by the FED. People who edge funds that were invested in cash treasuries and short treasury futures said basically their their treasury purchases were helping those entities unwind that what turned out to

be a bad trade. People become very leveraged and they're they're big enough to be systemic, and I think there needs to be some regulation to rehel that in What kind of regulation could the FED push and frankly push for from other government agencies that you think would be appropriate. From the hedge funds, from private equity, from some of the investment firms that have benefited from the Fed's programs and will probably continue to based on what they have

pledged going forward. Well, one thing the FED could do is is basically say, look, well, you know you're lending to these hedge funds. You're doing requot with these hedge funds, there that be a limit on how much leverage you you give them. That be one Another thing would be money mutual funds. We have mutual funds that have overnight

liquidity that are invested in very a liquid assets. You know, the the sec could change in you say, if you're a mutual fund invested in really liquid assets, you can't offer overnight liquid you have to offer monthly liquidity. And that would also reduce the risk of a fire sale of assets. What the FED really wants to avoid in these kind of episodes is where people have to dump lots of assets into the market and there's no buyers

and that then historts markets uh significantly. What the one way to avoid that is to make sure that the people actually have access to liquidity. Other thing that they could do is basically say, look, you have to buy liquid insurance from the FED during peacetime, so it's available

during wartime. So there's a number of things that I think are worth exploring because you know, we've you know, it's one thing, if you have a financial crisis every fifty years, if you start to have a financial crisis every ten years, then the Fed's actions are going to encourage people to take more risk in the future. Long ago and far away, Bill Dudley, you and the great Ed mcelvey wrote a chapter for me on our fiscal position, and you said off of Patrick O'Brien that there was

not a moment to lose. One is our moment not to lose with nine trillion dollars of presumed balance sheet? When is that moment out in the distant future. Well, what's changed, obviously is that the level of interest rates has come down dramatically. So the although we've had this explosion in battle, debt death service cost has stayed a very, very very subdued. I mean, I think we've had were than a tripling of debt outstanding over the last ten years or so, yet the debt service cost that barely

moved upwards. So I think, you know, what, what happens to interest rates are going to be critical in terms of when the federal debt debt bird becomes important. It's not going to be a problem in the next year or two, but looking out further down the road, I think there will be some consequences to having such a large increase in settle bit. But what are your thoughts

on how much we're monetizing the triestory deficit at the moment. Well, we're not monetizing in the sense that the FED isn't actually buying, you know, primary issuance of treasury, but that we are monetizing in the sense that the FEDS intervening in the secondary market and expanding its balance quite shrapiling. I mean, the Fed's balance sheet now is up to seven trillion dollars. It's gone up by more than three trillion dollars just in the last three months. So the

balance sheet is rising very, very rapidly. Uh. And you know that's you know, there's no limit to how big the FED balance sheet can get. But you have to understand that there are some risks there for the set. I mean, the SET is basically becoming taking on quite a bit of interest rate risk, right because most of its liabilities are reserves which are overnight, and a lot of its assets are longer duration assets. So the FED actually has an interest rate risk exposure that doesn't get

talked about very much. But we'll have to get you back to talk about it once more. Built only that before my New York FED president on a situation of the treasury market and on the inequality coming around from the federals eves. Right now, Steven Shivaron joins us. He is with Federated Hermes and we're thrilled it could be with us because he's one of the few people I know and the allocation game that really talks to talk straight. Steve, how do I feel if I rebalanced out of Amazon,

if I rebalanced out of Alphabet? Yeah, I think you feel pretty pretty loudy and and you know some of our thoughts on rebalancing that we've discussed over the years. Look, I think right now, you know, we've lived through an unprecedented period roughly of ten years where economic growth was low but widespread, and it allowed inflation and race to stay down, and so the gulf between winners and losers was relatively narrow. You could own everything and be okay.

That's not the world we're in right now. Right now, the difference between winners and losers our companies doubling or dying. And in that environment, you really need to do your work and be active in the way that you invest. You need to invest professionally. And it's a case where when you see a winner, you hold your winner, Um, and I think it's a little bit of a different game now than it was pre crisis. Steve. That certainly

has been true up until now. We see the big fang names absolutely dominating the returns that we have seen so far. But there's been a shift recently towards the cyclicals. Yesterday we saw an out performance in financials the Russell two thousand. The underperformance came from the NASDAC. How much steam do you think that this trade has? You know,

it's a debate that we have internally. I think it has some steam, and I think what's going on is in a very messy way, we're observing the wisdom of crowds, and you see it when you see folks shoulder to shoulder on the beach and Ocean City, Maryland, or rushing into bars in Wisconsin where even and I know that there's a whole lot more than this to it, but even when you see the large groups gathering for protests,

what we're finding. What we're doing is we're pushing the limits of how hard we can reopen in ways that experts would never approve of. But it's giving us information as to how aggressive we can reopen and the truth is that if as the economy reopens, it's reopening at six capacity instead of thirty for an example, that's a whole lot fewer companies that die, and that's a whole lot more people that are currently unemployed that get back

to work. And so what I think the market is trying to understand is is how long does this social distance per victory? How severe is it the period after we opened but before we get back to full capacity. And because we're pushing it so hard and it is messy, um, I think we're starting to get the impression of the market is starting to sniff out. But the reopening could

be more aggressive than we originally thought. I think that's what's primarily driving the market, and cyclicals benefit from that because they're gonna be where you price in that better economic activity. You know, Steve, we talk a lot on this program about the disconnect between the brutal unemployment data and economic figures that we've been getting out frankly from the world, and the markets that have seemed somewhat divorced from reality. But it really isn't markets as a whole.

It has been the fang names, the big tech shares that have benefited the most from this environment. It has not been the cyclicals which have actually lagged behind and posted losses. Are we pricing in a V shaped recovery? Given the rotation into cyclicals? Yet? Are we still pricing in a V A swoosh uh square root sign. Whatever you want to say, I I don't think it matters. Um, I mean, I think it is a U shaped recovery.

It's going to take us, in our estimation until the end of until GDP levels get back to where they were at the end of nineteen is an example. But if you look back at the history of markets, markets bottom in recessions. They don't bottom after. They don't bottom when things get better. They bottom when data goes from de curating at its fastest rate to a slightly less fast rate. And if this recession really is the first two quarters of this year, well then guess what only

a month away from its end? And so I think what you have to remember is a market is a series of individuals trying to get ahead of each other, because if you get the winning trade on first, you make money when everyone else comes to that realization. And what happened here is when unemployment claims stopped driving at that higher rate the market bottomed. That that's actually typical. It's frustrating because it's illogical, but it's typical of how

markets react in recession. I say, you've always grit to catch out when you might fantastic a half from your Steve Chevron, the a Federated Hermes portfolio manager, My best to you and the whole of the team. A little bit later, of course, Tom hopefully were here from the President of United States to go back to the fiscal debate. Senator Pat Toomey speaking to Fox Business this morning, saying that perhaps another relief bill won't be needed if we

can reopen this economy. And this speaks to something that I know Muhammad al Ain is concerned about as well, that we win the war but don't secure the peace. And I just wonder if that's something we're hear a little bit more about in the months to come. Yeah, that's that's I'm I'm really glad you brought that up, John. That really shows just some of the disparities that we see in Washington. The backdrop for all of this, folks,

is an extraordinary market. We talked to the technician christopheron earlier about the one way move on small caps, the one way move on equities. Someone of great extinction, Tobias Levkovich of City Group, has been watching carefully and he joins us now, Tobias, can you be a buyer of

stocks on this beautiful Wednesday morning. It's a little bit more troublesome at these levels, and markets will come back pretty sharply on legitimate reasons, including um tremendous stimulus both from the Reserve as well as from the peas from the government through the Cares Act particularly, But we've also seen the reopening of the economy. We've starting we've seen better news on the healthcare front in terms of less hospitalizations,

less depths, or more better treatments, hopes on vaccines. All that is fine, and what I call Fox move is kind of played in, which is institutional investors fear of missing are not out, but rather fear of meaningfully underperforming. So as markets go up, they have to participate, and everybody focuses on the techniclos as opposed to some of the fundmentals. For example, m how's the unemployment issue is going to play out over the next six nine months.

It is going to be a more difficult economic period. If as you touched on something really important, we see a price move, and there's always a temptation to if I this neat fundamental narrative that fits it. Are you saying this is just very technical? It's a position squade's momentum, it's the fair are missing out, the fair a missing of underperforming, as you've put it as well. So look, I think again there are some true fundamental backdrops to it.

I think probably the best arguments I have heard from investors is that companies are making structural change. They're learning how to work through, um, the pandemic induced to virtual reality that we're kind of enduring over two and a half months. Companies have really thought, sought out the efficiencies, and they're reacting to it. So they're going to be some structural changes that therefore provide better margin opportunity for

the companies on the outside. I think the problem is that those structural efficiencies also mean those jobs don't come back as quickly and creates kind of a demand problem. Um. Look, we think the forty million numbers are too high in terms of the reported claims, simply because there's a number of duplication people who have signed up weren't sure if they if it kind of you know, correctly submitted another claim, and you're seeing you know, certain states coming on telling

you they're duplicate. So maybe let's say the numbers thirty million, two million, and let's even say half of those people get back their jobs by YR end, that's still another sixteen million people who don't have their jobs. Um, and it's going to be problematic in terms of top line activity for corporations. There are certain industries that are enduring this extraordinarily well, and there's certain ones that are far more damaged. Because what's really happened is the pandemics has

accelerated certain trends that were kind of already underway. So the demise of brick and mortar retail has you know, increased rapidly. The you know, the trend towards telemedicine has also increased the other way very you know significantly. So those are some of the things that are changing secularly. But again, I think companies have really learned how to work through this, and it is a it is a proper argument. The question is is the market move too much?

Um And our sense from our panicky forum model which is now flashing you for you again, is suggesting almost probability that markets will be down in the subsequent of months as opposed to up. Debis look forward to getting you back on the program soon, Sabas Lefkovitch there of

City joining us now. The President of the World Bank, David mel Passed, of course, definitive at bear Stearns for years in economics and assisting President Trump on his economics at Treasury, and now spearheading the effort at the World Bank. We spoke to him recently. We get an update from DVID David mel Pass today. David, there is a clarion call worldwide to spend money to put people to work. How will the World Bank affect that policy? Hi, Tom,

Good morning, UH. Where the World Bank is adding resources where it can uh and also targeting the resources to where the most impact can be can be felt. Or some countries that means supporting core core businesses, either in the public sector or the private sector, ones that if they stopped operation it would be it would be giantly harmful. But in many countries, UH that the focus is also on getting cash to people, either through a social safety

net or through UH, through in kind transfers. UH. We're dealing with countries that are often on the brink of extreme poverty for tens of millions of people. So that's the focus right now, quickly moving on both the health crisis and the alleviation of poverty, setting up systems that will work into the future. One of the interesting things

that's happening is the differentiation of countries. What financial markets are doing is in effect looking at some and saying they're going to be able to move forward with the policies that they've got or that they will be able to put in place, and so it becomes a powerful positive force. Right What is the constraints you have? I mean, our Eric Martin writs encyclopedic on the World Bank, and he's looking at your credit rating and some of the

financial ratios of the World Bank. But I want to know, David Malpass, what's the day to day constraint to deploying

money to those very poor countries. Yes, well, um, we're in a better position because of a recent capital increase in both ib r D and i f C, two of the big parts of the bank, and a large replenishment of the of IDA that was done in December UH, and so by by by chance, by coincidence, by good fortune, the bank has resources, and so the constraint UH, we're we are planning to deploy a hundred and sixty billion

dollars over the next fifteen months. That sounds small by by what's going on in developed countries, but if you think about the developing countries, these are large scale resources, very welcome by the countries, and so that the constraint. The challenge is to UH to not go over exposure limits for individual countries. Some countries are at their at their credit limits, let's think of it that way. But

the bigger issue is what's in their program. They want to create confidence, and so what we're trying to do is have programs that show the world, show their own people that there's confidence in the recovery. On the other side, one of the most important things that we can do in that is transparency. We need transparency both on the health side, meaning what is the situation for COVID also on the debt side, what are the contracts that the

governments are entering into. And that proves to be a major challenge that people all around the world are working on in order to make more transparency on the on the debt that's out there. President Amus, let's talk about that, because you understand how delicate this moment is for many of these economies and countries that you work with. What we need right now is grants and not loans, and what we need for a whole range of countries is

debt relief. Can you talk to us about the scale of debt relief that you can help engineer in the coming months, the coming year. Yes, And with the regard to grant, your point is exactly right. And so as the World Bank looks at it, of this hundred sixty billion dollars, a big chunk, nearly a third UH is is grants, meaning not loans, but actually and no interest

on it, no repayment UH. And so that becomes a very strong positive NetFlow for the countries we're also trying to have or the g twenty countries have agreed to a moratorium on repayments to their creditors. UM. What the biggest of that is China and it agreed to and recently UH within the last week President she confirmed that

China will fully participate in the moratorium. So in in combination that provides a big new chunk of available fiscal space for the countries to we're talking about the seventy five poorest countries in the world. It creates space for them to spend on health, the health emergency itself. So that's important. And what we need now is the commercial creditors to also come in. That means the asset managers,

the banks. We're dealing with the poorest countries in the world, and I think they need they need to find a way that they can also accept a moratorium on the repayment stream so that there's more resources available for the countries. Everybody's working together. It's uh, it's a sizeable amount of money, but there's still quite a few steps to take with regard to especially China and the commercial creditors to have

them fully participate. Also the Gulf States. I should mention that the Persian Gulf States have quite a bit of debt outstanding in the poorest countries and there needs to be participation, full participation by them also in the debt moratorium. President mal Pass, you have a unique position having visibility around the world, and I want to talk about China's presence is probably the dominant lender to developing nations over

the past five years. I believe the estimates say that about five billion dollars of loans that China has extended to some of these countries. Do you have any sense of what that nation's debt forgiveness plan might look like and how that will pressure some of these nations. It's very important to the recovery of the of the poorest countries and and others um that are President she included those remarks and it was very welcome in a speech

that he gave. I guess it was two weeks ago where he said China would fully participate in You know, China is a member of the G twenty countries which endorsed this moratorium. So now we're at the point of implementation for China's official creditor agencies that's the China Development Bank, China x M Bank, these are official agencies of the Chinese government and they need to fully participate in the moratorium. And then the next level will be the commercial creditors.

That's the banks in China for example, that have that have lent a lot. And it's not just China, it's they're one of many of the lenders that that are able to participate, and and that gives them. I think there's going to be a two way benefit. The poorest countries themselves are helped immensely by this, but then the the lender countries will be creating a better environment for

the future. And so I think I'm hoping people will look to the longer run and see that if they participate now, they'll be there'll be a better environment in the future for for their markets, for their exports and things and so on. David, thank you for the hard work. It's been a while and look forward to catching up with you again soon. Hopefully we can continue this conversation the President of the world. Thank that. David Malpast, thanks

for listening to the Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud, or whichever podcast platform you prefer. I'm on Twitter at Tom Keane before the podcast. You can always catch us worldwide. I'm Bloomberg Radio.