In this episode of The SIFMA Podcast, SIFMA’s Kenneth E. Bentsen, Jr. sits down with the 78th Secretary of the Treasury of the United States, Janet L. Yellen, to discuss the state of the markets and their resiliency in the face of volatility.

This conversation was recorded live from the 2022 SIFMA Annual Meeting in New York City.

Ken Bentsen: Hi and welcome to The SIFMA Podcast. I’m Ken Bentsen, SIFMA’s president and CEO.

Recently, SIFMA held our 2022 Annual Meeting in New York City. We gathered leaders from a cross-section of public policy and finance to discuss issues critical to the effective and efficient functioning of our capital markets.

We were honored to have the Secretary of the United States Treasury, Dr. Janet Yellen, join us for a discussion on the state of the markets and their resiliency in the face of volatility. It is my pleasure to bring you her prepared remarks and our one-on-one conversation today.

Healthy and efficient capital markets finance the real economy, allocate risk, and support economic growth and financial stability.

The U.S. equity markets are the largest in the world, representing 46.2% of the $111 trillion global equity market cap. An average of 10.9 billion shares are traded each day, making them also among the deepest, most liquid and most efficient in the world. Investors in U.S. equity markets enjoy narrow spreads, low transaction costs and fast execution speeds, with plenty of opportunity for price improvement, especially for individual investors.

Fixed income markets are an integral component to economic growth, providing efficient, long term and cost-effective funding. The U.S. fixed income markets are also the largest in the world, comprising 39.2% of the $128 trillion securities outstanding across the globe, or $50 trillion (as of 1Q22).

After you’ve listened to the podcast, I encourage you to go to sifma.org to explore our resources, data and research in support of effective and efficient capital markets.

But first, let’s listen in.

Janet Yellen: Thank you for that introduction. I’d like to begin by thanking Ken and SIFMA for inviting me to your Annual Meeting. I’m delighted to be here with all of you.

Just over a week ago, I had the opportunity to meet with my counterparts from across the world at the IMF and World Bank in Washington. We spoke about many topics. But one thing was clear: we are at an important moment for the global economy. In the United States, we are focused on transitioning our economy to stable and sustained growth. The U.S. economy retains significant strength. But inflation remains too high, and we are contending with serious global headwinds.

So today, I’ll focus first on our Administration’s policies to address the immediate challenges we’ve faced: those that led to a historically strong recovery and subsequently, our concerted actions to address high inflation and energy costs.

Then I’ll turn to our longer-run strategy of investments in the strength of the American economy. As we tackle our immediate challenges, we must not lose sight of what lies on the other side. The United States has long faced structural pressures that have held back our economic potential. But I believe our Administration’s recent legislative accomplishments position the United States to lead the global economy in the decades to come.

Starting with our actions to address immediate challenges, at the time of the President’s inauguration, the pandemic was at its peak. The virus had taken over 400,000 lives in our country. And it was claiming an additional 3,000 Americans each day. The economic toll was also staggering. Millions of jobs had been lost. Each week, an average of more than 800,000 new jobless claims were being filed. In many respects, our economy had been brought to a standstill.

And there was no guarantee that we would achieve a rapid recovery. Less than 1 percent of Americans had been fully vaccinated. And the Omicron and Delta waves had yet to hit our shores. We faced unprecedented uncertainty about the course of the economy. In fact, throughout 2020 and 2021, the tail risk was a downturn that could match the Great Depression.

To ensure this economic catastrophe would not materialize, the federal government took action: to support households, businesses, and state and local governments through a once-in-a-century public health emergency. We brought the United States back to full employment in record time, in large part due to the American Rescue Plan and our vaccination campaign. As of last month, over 10 million jobs have been created since President Biden took office. Our recovery has also been historically inclusive: 2021 saw the fastest calendar year decline in the number of unemployed Black and Hispanic Americans on record.

As we mark this significant progress, it’s important to recognize that we now face serious global headwinds and challenges with elevated inflation. Growth is slowing globally. And energy and food prices have risen, driven partly by Putin’s terrible war in Ukraine and the pandemic’s lingering effects abroad. Climate change continues to devastate communities, exacerbating energy and food shortages in Europe and across the world. Our economy remains resilient, bolstered by President Biden’s economic plan, but we are highly attuned to these risks.

Two immediate priorities are to tackle inflation and to monitor potential vulnerabilities in the financial system.

Let me be very clear: inflation in the United States remains far too high. Our Administration’s top economic priority is to rein it in. We recognize that the Federal Reserve bears the primary responsibility, but we are taking a broad range of complementary actions to lower costs. They range from de-congesting our ports to bringing down the costs of prescription drugs.

We have paid particular attention to energy prices. And we are encouraged by the difference our actions have made. Here at home, our Administration is completing the release of 180 million barrels of crude oil from the Strategic Petroleum Reserve to boost supply. Treasury analysis indicates that the release has reduced the price of gasoline by 17 to 42 cents per gallon this year.

We have also worked with other countries in our effort to stabilize energy prices. The United States has partnered with the G7 to finalize and implement a cap on the price of Russian oil. The goal of this cap is to keep Russian oil flowing onto global markets — at lower prices — while reducing revenue that Putin can use to fund his illegal war. This effort will help stabilize energy markets. It will also provide developing countries with greater leverage to negotiate better prices for Russian oil.

Overall, while there are risks, I believe that there is a path toward lowering inflation while preserving the historic economic gains of the past two years. Today, our labor market remains remarkably healthy. Household and business balance sheets do not appear overextended. And banks have strong capital and liquidity positions due to the reforms that we implemented after the Global Financial Crisis.

We are closely monitoring the financial sector, as global developments have led to increased market volatility. To date, the U.S. financial system has not been a source of economic instability. While we continue to watch for emerging risks, our system remains resilient and continues to operate well through uncertainties.

Still, we can do more to mitigate potential risks. Our work begins with the Treasury market — the bedrock of our financial system. The Treasury market today is reflecting greater uncertainty about the economic outlook, but trading volumes are robust and investors are able to execute transactions. However, in the past few years, we have seen some episodes of stress in this critical market. These episodes underscore the importance of enhancing its resilience. Treasury is working with financial regulators to advance reforms that improve the Treasury market’s ability to absorb shocks and disruptions, rather than to amplify them.

We are also attentive to the possibility that higher market volatility could expose vulnerabilities in nonbank financial intermediation. Since I arrived at Treasury, financial regulators have been working together to better monitor leverage in private funds and develop policies to reduce the first-mover advantage that could lead to investor runs in money market funds and open-end bond funds.

Looking ahead, we are considering the impact of emerging technologies on our financial system. Innovation is one of the hallmarks of a vibrant financial system and economy. But innovation without adequate regulation can result in significant disruptions and harm. As part of that effort, the Treasury Department and its agency counterparts recently completed the federal government’s most comprehensive review of digital assets. These reports represent our most significant effort yet to promote responsible innovation in this area. Our goal is to realize the potential benefits of digital assets while mitigating and minimizing their risks.

As we continue to make progress on our immediate priorities, I believe it’s equally important to strengthen our long-term economic outlook.

For decades, our economy had been suffering from longstanding structural issues. Our economic potential had been weighed down by sluggish productivity growth and declining labor force participation. Inequality had soared, with profound disparities by race and geography. And our economy had been over-exposed to the actions of malicious geopolitical actors like Putin, vulnerabilities in our supply chain, and the growing impacts of climate change.

Over the past year, the Biden Administration has advanced an economic plan to tackle these structural issues. Taken together, I believe that the trifecta of legislation that the President has signed into law over the past year — the Bipartisan Infrastructure Law, the CHIPS and Science Act, and the Inflation Reduction Act — constitute among the most important economic investments we’ve ever made. Let me discuss three specific ways these laws generate strong, resilient, and inclusive growth.

First, our economic plan boosts the productive capacity of our economy. Earlier this year, I laid out an approach to strengthening our potential for economic growth. I called it “modern supply-side economics.” I argued that, with an economy at full employment, we are uniquely suited for a supply-side expansion that raises the ceiling of what our economy can produce.

I’m glad to report that we’ve enacted key elements of this proposal less than a year later.

Take infrastructure. Economists have long underscored how basic public infrastructure can increase the productivity of American workers. Studies show that a 10 percent increase in government infrastructure investment grows national output by over 1 percent in the long run. Yet we have neglected our roads and bridges for decades. The result? A staggering one in five miles of highways and major roads in America are in poor condition.

The Bipartisan Infrastructure Law provides a historic surge in funding for America’s transportation system. These construction projects will have reverberating economic benefits. More efficient movement of goods means fewer costly supply-chain disruptions. Better transportation can connect workers to more training opportunities and higher-productivity jobs. And our efforts go beyond physical infrastructure. We are also closing the digital gap: both by expanding broadband infrastructure and lowering the costs of service for millions of Americans.

We expect our “Internet for All” plan to broaden economic opportunity and lead to a sustained increase in the productivity of our workers.

Second, our economic plan will bolster our resilience to global shocks. The pandemic and Putin’s terrible war in Ukraine have taught us the costs of supply-chain vulnerabilities. We’ve seen empty shelves and volatile prices at the pump — as well as factories idled by the shortage of microchips. Three decades ago, the United States produced over a third of all microchips. Now we’re down to just 12 percent. By one estimate, the recent chip shortage resulted in $240 billion in lost U.S. economic output last year.

Our plan is expected to change this dynamic. The CHIPS and Science Act will create a full semiconductor ecosystem here in the United States. We will provide tens of billions of dollars in public capital to strengthen semiconductor R&D, fabrication, and workforce training. We are already seeing a crowding-in effect on private investments. Just this month, two large chip manufacturers announced up to a $120 billion investment in chip production and other advanced technologies here in New York State.

Third, our plan spurs inclusive economic growth across the country. For too long, private capital has been highly clustered in a few cities on the coasts. Equality of opportunity is not just a fairness issue. It’s also an economic issue. Our modern supply-side agenda understands that some of the best opportunities for growth come from investing in people and places that have been overlooked. These investments often have a higher relative return on investment, given the law of diminishing returns. And they raise our growth potential by enabling us to tap all of our resources.

The Biden economic plan puts this theory into practice. Take the Inflation Reduction Act. It’s the most aggressive action on climate in our nation’s history. This law will help mitigate the worst consequences of climate change, which are borne most disproportionately by the poorest. But it’s also expected to create good-paying jobs across non-coastal areas and regions that have been historically dependent on fossil-fuel extraction. One innovation in our clean energy plan is to provide additional tax incentives for businesses to invest in low-income communities. We’re also incentivizing investment in historic energy communities, like those dependent on coal production. I believe that these concerted economic investments can have cascading effects on the renewal of local communities themselves.

In the coming months, we expect to see significant movements of capital into growing industries like semiconductors and clean energy. Many of you here will play a critical role in financing these projects across the country. These are exciting investments: beyond boosting long-term economic growth, they will revitalize communities and bolster the resilience of our country for years to come.

Of course, there are serious challenges directly ahead of us. And I know it has been a tough few years for the American people. But our progress thus far shows what our country can do. We have experienced among the strongest recoveries of any major advanced economy. And we’ve made a generational investment to expand our economic capacity. I believe that we can navigate through this current moment as well.

Thank you very much.

Ken Bentsen: Thank you Madam Secretary, thank you so much for being here and for those comments. It’s an honor to have you.

You’ve touched on so many things, I’d like to come back to financial stability and what you’re thinking. You pointed out unprecedented times that we’re in today between the pandemic, the recovery from the pandemic, reoccurrence of inflation, and the war in the Ukraine.

How are you thinking, sort of digging into the financial stability, what concerns you may have?

Janet Yellen: That’s a great question. Let me start by saying I believe the U.S. economy is healthy and our financial system is resilient. Credit quality at this point is good, lending standards remain high, banks are well capitalized.

We are in a rising interest rate environment. There is some risks but, we haven’t seen U.S. financial institutions deleveraging as rates have been crazy and of course volatility has risen. Unemployment is low economic activity continues to expand and when you look how household and business balance sheets, they’re really in good shape.

On the other hand, it is a dangerous and volatile environment in many ways. We’ve experienced energy shocks, food shocks, supply shocks, persistent high inflation in many countries around the world, rising interests rates in many parts of the world and we have seen some financial market volatility and rising liquidity and credit concerns.

So, we do not see problems in the U.S. financial system right now to derive concern but, I wanna say that since the day this Administration’s started, certainly since the day I walked into Treasury, financial stability and making sure that we have a resilient financial system we are monitoring carefully, addressing risks that we know are there, this has really been a very high priority for me.

I have previously served on the Financial Stability Oversight Council, I think it’s an important organization and we’ve taken on over the last two years a very meaningful agenda of work.

So, there are open issues that we need to address, we are carefully monitoring financial risks in the United States an intent of that this is an environment in which we could see risks materialize.

We had an object lesson I think when the pandemic broke in March of 2020, when we saw what came close to a meltdown of our financial system without a massive intervention, I think that would’ve happened and so we’re being very careful. Understand this could emerge, but for now I think the U.S. economy is healthy and I don’t see financial stability risks that are concerning to me.

Ken Bentsen: You’re being humble, you served on the FSOC before, you’re now the chair of the FSOC. You talked about the treasury market and you pointed out March 2020, you know obviously tremendous volatility in all markets, within the treasury market and something we’re very interested in in terms of treasury market structure that the departments been looking at for many years now but, obviously now it’s more pronounced.

Are you, and you mentioned this a lot of volatility and for sure we’re in a rising interest rate environment, the Fed has moved to a quantitative tightening and deleveraging, are you concerned about Treasury market liquidity and do you think it’s better or worse than what we had in the March 2020 period?

Janet Yellen: So, when we first say, of course we are, in treasury, very focused on the treasury market. Both because it is our own funding market but, much more broadly the treasury market is the key market in the global financial system and it’s critically important that it be deep liquid, well functioning, serving as a benchmark for all other assets. So that’s a critically important goal.

We did see a great deal of pressure in the treasury market in March of 2020. I would say right now, while we have seen some decline in liquidity, in the sense that it’s a bit more expensive to transact, markets are volatile. It’s not unexpected that in a world of increased volatility that liquidity should diminish somewhat, or that the cost of transacting might rise a little. But, my assessment is that markets are well functioning, trading volumes are large and traders are not having difficulty executing trades. So, while you do see some sign of higher costs and a little bit less liquidity, we do not have a problem at this point they continue to function well.

That said, we want to make sure that going forward our treasury markets remain deep liquid and well functioning. The things that we saw in March of 2020 were of concern. Some steps have been taken to address those but, we have an internal agency working group, we are working actively to try to bolster the functioning of that market to take a careful look at what might be appropriate.

I think the ability of broker-dealers to intermediate that market their capacity has not grown in line with the size of the market. So, we’re looking at a number of ways to improve resilience, make sure that intermediation is available, enhance oversight of trading venues, increase the transparency and have better data on markets. The SEC is looking at initiatives in central clearing and this is an ongoing work program that we wanna see strengthen the treasury market but, I’m not seeing a problem now in the market.

Ken Bentsen: Thank you for that and we echo that point that we made is that primary dealer balance sheet is that their capacity has been flat over this period of time.

Beyond the near-term focus on the financial markets developments that you spoke to in your comments and obviously, you’re ever vigilant, beyond the Treasury markets what is your medium term focus for financial stability?

Janet Yellen: So, one focus and I think this is true not just in the United States but, globally it’s been identified by the Financial Stability Board, is nonbank financial intermediation. So, we always understood we had the potential for runs in the banking system and that they could be devastating. In fact, this year’s Nobel Prize Award is for the fundamental insights about how banking can be a source of instability and how it’s been addressed in the United States but, there are other nonbank financial sectors that can suffer from similar concerns. First-mover advantages that can essentially lead the runs.

We saw that in money market funds back in 2008, we saw that same thing in March of 2020, so that’s a focus. The FSOC is focusing on that and the SEC has issued proposed rules to address the instabilities associated with money market funds. Open-end and bond funds have a similar issue of promising daily liquidity while holding assets when their fire sells, there can be stresses when it comes to liquidating the underlying assets.

The hedge funds sector, we’re beginning to monitor more closely, trying to get better insight into what’s happening there. There can be concentrated positions and funds that may have a lot of leverage and conceivably they were also involved in the turmoil we saw in March of 2020. So those areas all have our attention.

We’re also looking at digital assets. I mentioned in my remarks that we have written a set of very comprehensive reports trying to look at risks and potential regulatory holes when it comes to digital assets. Our report found that there are too many instances of fraud and scams and operational failures. There are some existing enforcement authorities, we would like to see those beefed up and greater enforcement this area.

At the point, we really didn’t find that crypto assets pose significant risks to financial stability. They have many of the vulnerabilities you see in traditional financial systems but, it’s not yet big enough or connected enough to out banking system, the connections are not sufficiently deep that we think at this scale it poses a risk, nevertheless, it could pose a risk and we would like to see regulatory holds there.

In the sit of reports we indicated a number of areas where we think regulation is necessary and appropriate. One example I would give you is spot markets for crypto assets that are not securities, that’s a regulatory hole. We’ve been very focused on stablecoins, the president’s working group issued a series of proposals, that’s kind of an example of regulatory arbitrage and we think that that’s essentially a banking pipe product that really needs a much firmer regulatory framework to operate safely.

There are areas where we’re seeing vertical integration by crypto asset firms so that customers would be given direct access to markets, and when that happens they may be missing some of the customer protections like segregation of assets that we normally see when their dealings with the markets are intermediated. So, we would like to see an improvement in regulation in these areas, but that’s something else we’re looking at.

Ken Bentsen: We noted that in both the Treasury paper and the FSOC paper and in fact, SIFMA submitted comments and I think we were in similar views of where Treasury and recently we sent a letter to the Congressional committee leadership both the banking committees and the agriculture committees with commodities oversight about the need to your point of traditional investor protection rules, custody, segregation, the things that we are subject to in the securities world and that the FCM’s are subject to and we would argue that there’s quite an existing foundation of regulation in the securities and the banking sector that can lay over but, obviously Congress has a role to play here as well.

In the couple of minutes that we have left, climate change, you talked about it, you talked about the legislation but, how else are you looking at this from Treasury standpoint?

Janet Yellen: Well, I think climate change is a very important area, treasury has become very involved in that world and so has FSOC. Two initiatives, first, want to make sure we’re working with a group of regulators who are all in FSOC to make sure that they’re working with the firms they supervise to adequately assess and address climate-related risks that financial institutions face and pooling information and strategies to do this is something relatively new for all of the regulators. All of them are taking this on and we’re sharing information and learning about how to go about doing this.

Second, the provision of information that the investment community really needs to understand firms’ climate-related risks and strategies. This is a worldwide movement. The SEC published a proposed rule I know they’ve received an enormous number of comments on it on disclosure of climate-related risk and they’re working through how they should respond in going about finalizing a risk but, provision of information and understanding of the impact on financial institutions, these are two big focuses for FSOC.

Beyond that, I’d say in treasury we’re very excited by the fact that so many financial institutions and asset managers have taken on and embraced net zero commitments. We find this very encouraging and it compliments our own commitment to try to achieve net zero by 2050. So, one thing we’re doing is engaging with financial institutions and trying to understand how they are implementing these commitments and accounting for them.

Another area, we think that the development of voluntary carbon markets might be something that’s very helpful, especially to institutions that have taken on the net-zero commitments and we’re looking into what we might do to promote the development of a strong voluntary carbon trading market that has appropriate guardrails. So, we understand that dealing with climate change is not something the government can do on its own, that its going to require private efforts, private capital, both in the United States and around the world and so working with financial institutions to create a structure to facilitate capital flow. It is a focus of our work as well.

Ken Bentsen: Thank you, Secretary Yellen. We’re out of time but I can’t thank you enough for being here today. As I said, a real honor to have you at our first in-person Annual Meeting since 2019 so thank you very much.

Janet Yellen: Thank you so much, a pleasure to be here.

—

Dr. Janet Yellen is the 78th Secretary of the Treasury of the United States.

Kenneth E. Bentsen, Jr. is President and CEO of SIFMA. Mr. Bentsen is also Chair of the International Council of Securities Associations (ICSA), Co-Chair of the British American Finance Alliance (BAFA) and Chairman of Engage China.

Related Resources

• Speech

  Remarks by Secretary of the Treasury Janet L. Yellen at the SIFMA’s Annual Meeting

• Comment Letter

  Additional Transparency for Secondary Market Transactions of Treasury Securities

• Study

  A Study on the Impact to the Market and Market Participants