WASHINGTON Federal Reserve Board Chair Janet Yellen added her name to a growing list of policymakers at least open to the idea that recent heightened regulation may be contributing to market liquidity problems.
In wide-ranging testimony Wednesday before the House Financial Services Committee, Yellen was careful not to declare a clear link between recent rules and volatility like the sharp fluctuations in Treasury yields in October. But she echoed other Fed officials in saying that concerns about potential regulatory effects on liquidity in addition to other potential causes deserve more study.
"I'm not ruling out the possibility that regulations could play a role here," Yellen said in her first of two appearances on Capitol Hill this week. "There are a lot of different factors, we will need to look at it more to sort out what the different influences are."
Yellen, who is obligated under the Humphrey-Hawkins Act to go before the House and Senate twice a year to discuss monetary policy, also reiterated concerns about the supervisory burden on community banks and support for easing smaller institutions' regulatory pain.
In a new development, she backed a carve-out for community banks from the Volcker Rule, the Dodd-Frank Act provision proposed by former Fed chief Paul Volcker that bans bank proprietary trading. However, she was not specific on how broad such a carve-out should be. Some, including Fed Gov. Daniel Tarullo, have supported an exemption for banks with less than $10 billion in assets.
"The regulatory burdens that" community banks "face have been really quite high, and they're struggling with it," Yellen said.
While Yellen's comments on market liquidity add more credibility to concerns about the impact of new rules, she was also quick to point out that she has not yet been shown convincing data that demonstrate that fixed-income markets are experiencing massive liquidity problems. Even if they are, she noted, that does not mean there is a definitive connection between illiquidity and regulations.
Some have raised concerns about requirements such as those implemented by the Basel Committee forcing banks either to take on abnormal levels of Treasuries or on the flip side unload them in the interest of riskier assets. For example, a Basel liquidity standard encourages use of high-quality liquid assets, sparking fears that banks could dominate the market for certain assets at the expense of other participants. Critics also worry that the Volcker Rule could hinder banks' ability to support certain liquidity markets.
"It's not clear what's happening in these markets and whether or not there is a problem," Yellen said. "By some metrics, liquidity looks adequate like bid-ask spreads, trading volumes we see other metrics that suggest there is a problem."
The question of whether Dodd-Frank and its implementing regulations have led to market disruptions has been a source of increasing concern among the financial services industry. Banks have warned that the rapid and sustained holding of U.S. Treasuries for liquidity and capital purposes is skewing the market. Liquidity is also the latest bugaboo for the law's opponents in Congress, who say that a lack of liquidity in bond markets is empirical proof that Dodd-Frank is a failure.
Financial officials have pushed back against the connection between regulations and illiquidity with varying degrees of urgency. Treasury Secretary Jack Lew told the Financial Services Committee last month that he did not see any connection between regulations and liquidity, while Fed Gov. Lael Brainard suggested last week that a link could be possible.
Yellen's position appeared somewhere in the middle. She also signaled some agreement with a point Tarullo made last month about whether the liquidity that has supposedly dried up was ever there at all.
"This is something we need to study further," she said.
Meanwhile, Yellen acknowledged that Dodd-Frank rules and supervisory burdens have affected small banks in a way that is regrettable, and said she and other regulators are looking for ways to reduce that burden.
"We're looking to do everything in our power to reduce the regulatory burden," she said.
In addition to her Humphrey-Hawkins appearances, Yellen also seemed willing to testify before the House committee more often on regulatory issues.
Committee Chairman Jeb Hensarling, R-Texas, asked Yellen if she would appear in Congress semiannually in the stead of the Fed's vice chairman for supervision a position focused on regulatory issues that was created by Dodd-Frank but for which no one has ever been nominated.
"I certainly stand ready to respond to requests of this committee for me to testify " Yellen said.
"Thank you, I'll take yes for an answer," he said. "We will certainly issue those invitations."
But as in previous hearings, Yellen gave little ground to committee Republicans on most of the other areas of their inquiry.
Rep. Bill Huizenga, R-Mich., asked Yellen whether she would agree that some rules-based monetary policy the so-called Taylor Rule idea would be more transparent and accountable than the current arrangement, where the central bank's Federal Open Market Committee has full reign to set policy as it sees fit.
Yellen said that the FOMC and the Fed are highly transparent in the decision-making and that such a rules-based policy would leave the central bank unable to navigate around obstacles like the financial debacle in Greece.
"I don't agree that a rule-based policy is a better way to go," Yellen said. "There is not a single central bank in the world that follows a rule that would rely on only two variables."
Yellen also pushed back against legislative proposals, including one by regulatory hawk Sen. Elizabeth Warren, D-Mass., that would further limit the Fed's emergency lending authorities. She said the power to be lender of last resort was changed in Dodd-Frank to prevent any single firm from benefitting from a bailout, but to curb it further still would be contrary to the purpose of the Fed or any central bank.
"The rule of lender of last resort is a critical responsibility of central banks around the world, and is why the Federal Reserve was created," she said. "It's a very important power."