By Steven K. Beckner
(MNI) – New York Federal Reserve Bank Executive Vice President
Simon Potter Tuesday said that a “constantly evolving” global financial
system requires “constant monitoring.”
Potter, who heads the New York Fed’s Markets Group that includes
the open market trading desk, stressed the need for Fed staff to develop
hands on, real-time experience in the intricacies of financial market
operations — not merely rely on statistics which can be “misleading.”
And in fact the New York Fed staff has developed “deep expertise in
particular asset classes and detailed knowledge of market behavior and
infrastructure,” which helped the Fed craft various emergency credit
facilities during the financial crisis, said Potter.
That “deep expertise” has also enabled the New York Fed to advise
the Fed’s monetary policy body, the Federal Open Market Committee, on
the best way to carry out unconventional policies such as large-scale
asset purchases, he said in remarks prepared for the New York University
Stern School of Business.
Because of the detailed market knowledge of its staffers, Potter
said, “The Desk is able to structure and execute operations to achieve
the objectives of policymakers.”
With the advent of so-called “quantitative easing,” the staffers in
charge of implementing monetary policy, collectively known as “the
Desk,” have had to broaden their purview, he suggested.
“The scope of the Desk’s market expertise has had to expand in ways
beyond supporting new modes of operation,” said Potter. “As the
financial crisis revealed the importance of maintaining a wide range of
financial market knowledge, Desk staff covered a broader set of
financial markets and instruments compared to the pre-crisis period.”
“We also more explicitly focused on linkages between markets and
underlying, longer-term trends that could present financial stability
risks in the future,” he said.
“With the expansion of monetary policy into less conventional
territory, our analysis of monetary policy expectations had to evolve as
well, as evidenced by an increasingly comprehensive survey of primary
dealer economists each FOMC cycle,” he continued.
“Lastly, our own internal analytical capabilities have also
deepened, for instance with the creation of a portfolio analytics unit
to better assess the risks and outlook associated with the Federal
Reserve’s expanded asset holdings,” he added.
Potter predicted that “as the economic and policy environment
changes, the Desk’s interactions with the market will continue to
evolve, both in terms of its operational capabilities and the focus of
its market monitoring and analytical responsibilities needed to support
Federal Reserve operations and the information needs of policymakers.”
New York Fed President William Dudley named Potter, then co-head of
the Research and Statistics Group, to head the Markets Group in June. He
was also selected as Manager of the System Open Market Account (SOMA).
Harking back to his days as a research economist at the Bank,
Potter said he learned several lessons during the financial crisis —
chief among them “the absolute criticality of a central bank’s
interactions with financial markets as a basis for properly diagnosing
financial disruptions that threaten the economy and developing effective
remedies.”
Potter said his experience has taught him that “published
statistics and market prices may at best tell part of the story of
developments in financial markets and how they might be affecting the
economy as a whole.”
“These experiences highlight the need of policymakers for real time
market intelligence and having staffs with operational experience and a
solid grasp of market functioning to develop appropriate policy
responses,” he said.
During the crisis, for example, he said statistics were showing an
expansion in bank lending, when in fact liquidity was drying up as a
result of the contraction of loan securitization. When the New York Fed
staff realized the problem, it helped design the Term Asset-Backed
Securities Loan Facility (TALF) in March 2009.
Citing another example, Potter recalled that “the decline in
interbank lending was also questioned.”
Although statistical releases showed high volumes of interbank
lending, “such statistics ignored the significant decline in term
lending and most importantly did not capture one of the most important
stresses in unsecured lending, the difficulty of foreign banks in
obtaining dollar funding,” he recalled.
“This was fully appreciated by the staff within the Federal Reserve
monitoring interbank activity on a real time basis,” said Potter. “And
the policy response to this decline was to open up dollar swap lines
with a number of major central banks in conjunction with the TAF in late
2007.”
Potter claimed the Fed staff also also quick to notice that new
issuance of commercial paper was “grinding to a halt” during the crisis,
leading to the creation of the Commercial Paper Funding Facility (CPFF).
Summarizing the lessons learned, Potter said:
– “Published statistics and market prices only tell part of the
story of developments in financial markets, at best;
– “Beliefs of market participants and the distribution across
markets matter, and information on them needs to be collected and
analyzed on a frequent basis;
– “Active operations in financial markets allow central banks to
flexibly respond to unexpected events and understand market functioning
issues and changes in market infrastructure,” and
– “Most importantly, the global financial system is constantly
evolving and it requires constant monitoring and analysis since it is
not a self-regulating system.”
** MNI **
[TOPICS: M$U$$$,MFU$$$,MGU$$$,M$$CR$,MT$$$$,MMUFE$,M$$BR$]
