Former Federal Reserve Board Chair Janet Yellen is worried about another financial crisis.
In a conversation with Nobel Memorial Prize-winning economist Paul Krugman at the CUNY Graduate Center Monday night, Yellen said, “I do worry we could have another financial crisis” though she said the core banking system now has more liquidity and quality capital since the last financial crisis.
“I think things have improved, but then I think there are gigantic holes in the system,” Yellen said. “I’m not sure we’re working on those things in the way we should, and then there remain holes, and then there’s regulatory pushback.”
(Related: Are We Ready for the Next Financial Crisis?)
Yellen said that regulators don’t necessarily “have the tools” to deal with emerging problems because of the “unfinished work” on new rulemaking, including those from Dodd-Frank legislation.
The former Fed chair, the only woman who has held that job, said she’s particularly concerned about “leveraged lending … corporate indebtedness” which is “quite high,” and CLOs, or collateralized loan obligations. CLOs are adjustable-rate loans to businesses that are pooled, securitized and sold to investors.
“Investors may not know how risky the loans are,” said Yellen. The loans are made to non-investment grade companies that don’t qualify for traditional bank loans.
When the next recession comes, the Federal Reserve will be limited in its ability to address the crisis by cutting interest rates, according to Yellen.
“Historically the Fed cuts rate by 500 basis points (5%),” but the “normal level” of short-term rates is usually around 3%. “That means there’s much less scope to cut short-term rates than there’s been historically in the United States,″ Yellen said.
The current federal funds rate is set between a range of 2%-2.25%, and is generally expected to increase another 0.25% before year-end, at next week’s Federal Open Market Committee meeting. After that, the outlook is more murky.
Economists are scaling back expectations for Fed rate hikes next year from three or four hikes to two or fewer, and several Fed policymakers, including Chairman Jerome Powell, have said publicly that the fed funds rate is approaching neutral — a rate that would neither speed up nor slow down growth.