Good morning. I am pleased to be here
today to join SP in welcoming you and to
introduce our first panel, a fireside
chat on current global macroeconomic
trends affecting our capital markets. From
my vantage point in regulating the asset
management industry there are really few
topics as important as the one our
distinguished panelists will be
discussing this morning. Global
macroeconomic trends have resulted in
big changes in the asset management industry
and more broadly in our capital markets.
Both market participants and regulators
are operating within a new and evolving
landscape.
One striking aspect of this landscape
is the level of global debt which now
stands at approximately 250 trillion
dollars or 320 percent of the world's
GDP. In the United States alone outstanding
non-financial corporate debt is nearly
10 trillion and almost 50 percent of the
U.S. GDP. Now the increase in debt is
driven by various factors and I'm sure
the panel will be delving into that.
For example monetary easing by central
banks has resulted in interest rates at
historic lows. Further, global regulators
have encouraged banks to hold highly
liquid assets and less corporate debt
especially lower rated debt. The
combination of monetary policy and
regulatory constraints on banks has
contributed to a migration of debt
investments from banks to other holders
including funds. In addition direct
household investments in debt have
declined with investments through funds
accounting for some of that change. A
report from our Division of Economic and
Risk Analysis summed this up with the
following observation. From 2009 to 2016,
the percentage of corporate and foreign
bonds held by households decreased from
22 percent to 8.6 percent while the percentage of corporate and foreign bonds held by
funds increased from 8.5 percent to 18.3 percent. This shift makes it more
critical than ever that we understand
the connections between banks and
non-banks and from my perspective banks
and funds. These connections include
exposure of banks to funds through both
lines of credit and as counterparties
in derivatives and other transactions, exposures of funds to banks
through holdings of equity securities,
overlaps in portfolio holdings
particularly holdings that are more
susceptible to liquidity shocks, and
clearing banks' supply of a balance sheet
capacity to permit client
clearing. Interconnectedness, leverage, and
liquidity are all topics we have talked
about for years, but the conversation
should not be static and should be done
with the evolving market in mind. There
are a few other areas where the shifting
landscape requires an adaptive
regulatory approach, for example,
increased globalization has intertwined
domestic and foreign markets and policy
considerations. This is why we at the SEC
spend a great deal of time working with
our international counterparts including
through organizations such as the FSB
and IOSCO. Advances in technologies have
enabled efficiencies and innovations in
recent years. With that however comes
heightened cyber risks as well as new
business models and products including
Robo advisors and digital assets. The
growth and evolution in the asset
management management industry has
increased opportunities for investors. It
also has given rise to public debates
about concentration risks, common
ownership, and the effects of index
investing to name a few. To be clear
observing the activities or risks have
changed is not to offer an assessment on
whether these changes are good or bad.
Thus said, change does mean that market
participants and regulators need to
re-evaluate risks continuously and make
the necessary shifts in risk management
oversight. Recognizing change and
modernizing oversight to meet that
change will enable us here at the SEC to
meet our mission to protect investors,
maintain fair orderly and efficient
markets, and facilitate capital formation.
As regulators I believe that we have to
work harder and use all available tools
more effectively in this changing
landscape. We don't operate in a vacuum
of course so an important tool is
engagement with market participants. In
that regard events such as today's
conference help keep us informed of
market developments that impact our
mission. Let me now turn to our
distinguished panelists for their take
on macroeconomic trends and how they
affect the markets. Our Chairman Jay Clayton will be
joined by Gary Cohn, former director of
the US National Economic Council, and
Glenn Hutchins co-founder of Silver Lake
partners. The accomplishments of these
individuals speak for themselves and I
will refer you to the program for their
detailed bios. That said I do want to
note that this group brings unique
perspectives and experience as global
investors, advisors to governments and
leading companies, crafters of public
policy initiatives, and supporters of the
study of markets. I'm sure you're gonna
appreciate their perspectives and with
that please join me in welcoming our
first panel. Dalia thank you, thank you
very much and let me just extend
on behalf of my colleagues here at the
SEC thanks to Gary and Glenn. We're gonna
talk about where the markets are -- I wasn't told
I had any choice being here Gary, how about you? I'm in a similar camp. Okay good.
So when the SEC calls you still come. Yes, especially you Jay. I couldn't think of two better
people to give us an assessment of where
we are and where we're going in terms of
market function and the risks and
opportunities we face, so just thank you
both very much for being here. So let's
get right into it, Glenn you founded
Silver Lake two decades ago and you had a
belief that the power of technology was
underestimated, that it was gonna
transform our economy. How do you think
technology is affecting our markets
today? Where is it gonna be 10 years
from now? Your thoughts, I mean
this has been a driver of your investing
philosophy for years. Sure so for people
who don't know, I was into
FinTech before FinTech was cool and
investing at the intersection of
financial services technology for the
last 20 plus years. I helped to build
companies such as Ameritrade, the NASDAQ stock market, and now Virtu which is a
high-frequency market maker. And I think the
biggest thing that happened in
financial services technology over that
time period, and Gary and I had a conversation about this a couple years ago I recall, is
when I first addressed these markets
20 years ago cost of trading was
for a retail investor was an eighth to a
quarter plus a commission. And you waited,
you made a phone call and you waited a
couple of hours to see if you got the trade
and then you settled five days later
 or something like. Now,
at virtuant across the markets, we trade
securities in microseconds which is a
millionth of a second, the binding
constraint is literally how fast you can
move electrons. That's the binding
constraint on how fast you can trade. And
at spreads that are less than a penny. And
that means that the cost of trading has
been reduced by 99 percent or more over the
course of that time period and the speed
is increasing at an infinite level. And
then for a whole bunch of other kind of
reasons we're moving, as we'll talk
later on there's a new level of, we
have the same capacity to make as big a
transformation in the next 10 years as we had
in those last 10 to 20 years for reasons
we'll get to later on. I think that's the
biggest change. Look Gary through
policymaking and whatnot you've been
able to identify where conventional
wisdom holds true and where conventional
wisdom no longer holds true going
forward. You know technology other areas
as you see government policy, where are
we going where maybe technology's gonna
change conventional wisdom? Well look, I
agree with everything Glenn just said on
what technology has done to the markets
today as we know them as far as speed of
execution ease of execution. We still
haven't figured the clearing thing out
yet Jay we're still clearing like
we move physical securities in horse
and buggy but we'll get to that later.
I don't understand why we're not
real time clearing there's no
technological constraint there's no
technological constraint there's other constraints
there's really no other constraints. We
just need to start going to real-time
clearing. When you talk about safety
and soundness that's a way to get safer
and sounder but when you think about
where we are right now and look the
United States has enjoyed an enviable
position being the dominant capital
market in the world both debt and equity.
We've owned that position for a long
period of time. We are on the fringe and
the fringe is important we're not in the
middle we're on the fringe of potentially
losing that position. And I say that
because the capital markets around the
world are developing quite quickly in a
much more digitized fashion than
the US has developed. The U.S. although
we've gone to high frequency trading
we've gone to digitized trading we now
see a lot of technology being used in
other parts of world. Whether it's as
simple as payments in China and look
it's a lot easier to use payments in
China digital payments because you have
a relatively unregulated banking system
and I'm not espousing that we should go
to an unregulated banking system at all
I think we have to do payments in a very
regulated fashion but we have to embrace
that we are now seeing digitization of
more and more assets and more and more
securities. I think that we have to
embrace this digitization. We can't say
that everything's gonna trade in the
traditional way its traded for the last
100 years and this is our sandbox and
we're gonna stay in the sandbox. So I
think the fringes around the edges are
starting to get clawed away. I still
think that this is the dominant capital
markets in the world and it's sort of in
the hands of the regulators right now to
sort of lead not follow and I think you
have an interesting opportunity to lead.
So you're telling me in a nice way
recognize this is happening and
and make it happen in the right way.
You said that I didn't but what I'm saying
is look we've been so dominant for so
long we could always be the slowest
moving animal in the and survive. I don't
believe we can be the slowest moving
animal and survive. The world's too big the
world's to global there's too much money.
We need to get in the middle of the pack
and right now I don't believe we're in
the middle of the pack in
technological evolution of our
marketplace. So if you think of it
one way to think about this is we've
built out the internet over the course
of my 25 years investing around this
stuff. First we used it to
create messaging TCP/IP then we used it to
create mail SMTP then we used it to get
their websites HTP there was something
called FTP in the middle which allowed
you to attach files HCP/TTP for
websites VoIP for voice now we're
building it out for video that's what
all this streaming is all about and all
the investment is happening there and
the next thing is going to be value and
the question is how can we use the
Internet to move anything of value at
the speed of light at no cost the way
we've done all those other things that
we've done. And to do that we have to
have a regulatory framework Gary
suggesting that can keep up with that
rather than try to fit that new paradigm
into an old regulatory paradigm but also
we need to recognize that we have to
adopt a technological leap forward
because the reason why the Chinese in
particular, I've invested in some of these
Chinese payment modalities as well, we're
able to do this is because they didn't
have the payment the credit card
system with which to contend. It wasn't
there so they could go right it's like
they skipped over landlines went right
to cellular and a whole bunch of reasons
why in so they now pays but even without
fundamental technological innovation the
cost of payments in China is about 30 to
40 percent of what it is the United
States. Look the message I'm
receiving from you is safety and
soundness transparency investor
protection all very KYC AML audit trail
all important, don't give up on those,
but those can all happen in the digital
world the technology exists, they had too much a reason to. Don't use yesterday's
technology to achieve those goals
use tomorrow's technology to achieve
those goals. Yes another way I look
at this is you know you look at I mean
Glenn gave you an actually unbelievable
tour of the Internet in 30 seconds I
don't know how he did that without notes,
but if you look at sort of
the phone which is where the
world is right now you know we went from
you know landline to what I would call
the the brick phone. I mean I remember my
first cellular phone you needed your own
briefcase to carry it around and you
walked around with the brick
phone and then we went to the you know
we went to the smaller phone so we went
to sort of the flip phone and then
we went to the smart phone and now we're
gonna have to go to the secure phone so
that's the next part of it and once
we get to the secure phone we're gonna
be able to use that secure phone for
everything we need financial and
we're when I say we need to go to the
secure phone we're virtually at the
secure phone line right now and 5G and
we're at the edge right now. Talk about
5G if you like yeah keep going.
Look message received on technology but
we can keep hammering on it no no I
think it's it we can't let
it pass us by, right. We are already
behind, in other words, the payments
modalities in Asia are much better than
they are in the United States and this is not
but it's not primarily a
regulatory problem. It's primarily a legacy
issue associated with the credit card
companies because the credit of
payments system in the United
States is the only place I've seen in my
career as a technology investor where
the introduction of technology caused
the price to go up. Usually you know
we've had these cost curves that drive
prices down like we talked
about in securities trading but in
payments they've gone up because you
Apple pay adds a quarter, Stripe adds a
quarter of a point, Square adds a quarter
adds maybe even a point more. So
payments go from 2 percent to 2.2 and a quarter to 2.75
that's actually ripping off the
consumer and making financial inclusion
harder to accomplish rather than easier
and if you actually thought about the
broader purpose of this kind of
organization like this we ought to
actually be out there facilitating the
introduction of technologies to take
these prices down, to increase consumer
fairness, and expand financial
inclusion so I think about it that way.
Now I think, and to be clear, I'll
give you I'll give my usual disclaimer
that my views are my own and I'll also
say I'm not gonna pass views on any
particular company you guys are welcome
to but I will say the one thing we are
devoted
here over our 85 years is that
transparency and pricing
benefits the consumer absolutely and we
that is clear and to the extent technology
enables us to provide transparency and
pricing it benefits investors and
consumers. All right so let's shift from
technology well we're not gonna shift
it's gonna keep coming back in every
answer just so you know. I've never ever
been able to control Gary Cohn. Okay,
monetary policy, now I know you have you
have a disclaimer right
your board members work Fed and your
views here are your own not those no they don't listen to me either so
don't worry so but we've had a
run of accommodative monetary policy a
lot probably the longest run in history
affects how we should look at that? Where
do you think we're going?
I believe it's driven some changes in
the market but including as Dalia
outlined in her introduction a shift to
more debt and due to some other
regulatory events a shift in debt from
debt being held by banks to being held
in our capital markets but your
thoughts. So I think the thing that most
concerns me as an investor in the space
an investor in this moment is that these
very low nominal interest rates, we can
come back to what real interest rates
really are later, but these real very low
nominal interest rates causing every layer
of the risk structure to search for
yields. So people who would normally have
bank deposits buy Treasuries, people who
normally buy treasuries buy corporates, corporate buyers go to high-yield, high-yield buyers go to
equity, equity buyers go to illiquids.
The people who are normally in the
illiquid space take on more debt and go
to late stage growth and the whole the
whole layering of risk involves with
people reaching for yield and take
above and taking risks that they're not
accustomed to taking are not
professional at managing and then when
that reverses itself it has a chance to
it has the risk of reversing itself
rapidly in a way that's
reasonably predictable so that's my
biggest concern about how the markets
are operating right now and we can get into
what that means in each of those
segments. So but actually let me tee this
up for Gary this way there are some
people that believe we're in a
lower for longer and then there are some
people who believe that a snapback, how
do we get to somewhere in the middle?
Can I make one comment before you say that?
One of my rules of investing is widespread
capitulation is the first sign of the
bottom so as soon as people say we're
interest rates are gonna stay lower for
a very long time period that's when you
ought to be prepared for this trying to
go back up again. Glenn I've been saying
lower for longer for five years just so you know, if you
remember back five six seven years ago
we were talking about interest rates in
the economy and we were using letters of
the alphabet. We were talking about V shape
U shape J shaped and I said think of L
shaped okay so I've been saying it
for five plus years but look Jay I think
you almost have to back up here. It's
almost difficult to answer this question
without saying how did we get here and I
won't drone on how he got here but
you've got to go back to 2008 you've got
to go back to the financial crisis. You
have to understand that central banks
around the world in a coordinated effort
basically decided and justifiably, I'm
not saying they did anything wrong,
justifiably decided to flood the system
with as much possible liquidity as they
could and threw every dollar, yen,
sterling, euro anything they could at the
system and they literally put it in the
system and they put it in and
they wanted to stimulate growth and
they wanted to make currency available
as cheap as possible. They also did that
simultaneously with the two big saving
economies aging into that older
population where Germany and Japan
they're not gonna spend the money no
matter what, we've already
proven you can put negative interest
rates out and they won't take
the money out of the bank and so this
idea that we can get savers to become
spenders because we
set a negative influence by taking rates
negative we've proven that if you're a
saver you're a saver if you're a spender
you're a spender. We could say the same
thing in the United States we could
probably make interest rates 10 percent and people
wouldn't save. In Japan you can make
rates negative and they won't spend, so we started with
this whole issue of creating global
liquidity. We're now at the sort of 10
years from the other side of that
pendulum where you know '08/'09
flood the markets with liquidity lower
interest rate ease ease ease ease ease,
and now we're trying to figure out
okay we really haven't created growth
out of that easing policy. We have not
stimulated the way we wanted to
stimulate. How do we stimulate from here?
Negative interest rates, and this is a
personal opinion I guess all these are
personal opinions, have this very
negative unintended consequences
especially you have aging populations
and they dissuade savings which is
exactly the wrong thing to dissuade and
they make people on fixed incomes
more financially insecure not more
secure. So now we're in this part of the
equation where we're trying to say okay what
should we do, how should we do it, how do
we get the economy growing? We've proven
that sort of throwing money at the
situation doesn't just create growth in
the world and a lot of this I believe
happens to simultaneously go with a lot
of the regulation that happened after '08 and the fact that the world has
become more and more globalized. And so
one obvious example I'll use, since we're
at the SEC I'll talk about a financial
service example, you know you look at the
financial services industry in '08
the regulation that was forced upon
financial services industry was so
enormous that every financial service
company basically in the large asset managers down to every
bank was forced to add enormous amount
of regulatory cost to their system but
they couldn't afford that regulatory
cost. So they all of a sudden figured out
if we can export labor to cheaper
markets, an arbitrage labor cost,
we can then afford to be in the system.
So lo and behold you know Bangalore City
where I couldn't have found on a map 15
years ago now is a city with millions
and millions of financial services jobs
where we can hire someone for $35,000 a
year doing the same job that someone in
New York would do at a
$135,000 a year. So we've created this labor arbitrage
market that we all got very smart to in
the world
and once Bangalore got to $40,000
because we were hiring everyone we
found the Philippines or we found Poland
or we found all these other markets, and
because of necessity we've now created
this global labor market where you just
keep finding cheaper and cheaper labor
and when you find cheaper and cheaper
labor you don't have wage inflation to
the extent you want wage inflation you
don't have any inflation in the system.
So in a lot of reasons throwing
money at the situation and regulating
the situation just forced people to get a
lot more creative on the situation. So in
my opinion we almost have to figure out
a way to start withdrawing the liquidity
from the system and it's it look it's
gonna be a slow long slog and in many
respects the Fed tried to do that, they
tried to cut their balance sheet down
they tried to go through a very slow
process of retiring their balance sheet
and these are the right steps to go back
to what we would consider a normalized
environment. Yeah now Gary touched on
some things I'm going to do a little bit
of a segue here but I know it's an area
you know a lot about, the way the macro economy operates today
we touched on technology
Gary's talking about availability of
labor being a global issue. We know
capital moves faster. We know supply
chains are real-time. Glenn, are we
measuring technology and the effects of
technology in the right way when we make policy? Listen this is a very good
question so if you if we were sitting
here two years ago roughly and we
started talking about Fed policy you
would have we would have all assumed
that we were heading toward something
called normalization, which was basically
rates are gonna go up the balance sheets
are gonna go down and we're gonna be
to a place where there it looks more
normal relative to historical
experiences and there's what's called
policy rooms so then when the next
recession comes you can drop rates, you
can expand the balance sheet, you can do it all
over again. And we sit here two years
later and the markets couldn't digest
that right the little bit of rate
increase had not just market effects but
also real economic effects, and
recently as the balance sheet was being
shrunk the repo markets sending
signals that there's not enough
liquidity out in the system. So what's
wrong what do we if you look at
that and you say what don't we understand,
and as Gary suggested earlier I think
today you have to extrude every question
through this dimension of what is the
impact of the transition we're under, the
fundamental historic transition we have
from the industrial to the information
economy and what aren't we understanding
well? So let's think and one of the
things people telling us is
economists tell us is the reason we
haven't got good growth economists tell
us is demographics and low productivity
growth, that's the answer in the numbers.
I mean you talk about some of the
demographic trends earlier but there
it is it strikes me as unlikely that we
are experiencing low productivity growth
during the information revolution, in
fact, it strikes me that we have enormous
productivity growth which we're not
measuring. Do an experiment one day if
you have a few minutes take put two
columns on a piece of paper and put on
what you pay for everything on
this device and then the other column
what you used to pay for all the things
you bought that this device now does for
you, and I stopped when I got a thousand
dollars on one side of the page and
twenty thousand dollars on the other.
This is the greatest deflationary tool
I've ever experienced so if you think
about maybe we're not measuring
productivity correctly. If we aren't
measuring productivity correctly perhaps
that means that the economy is growing
more rapidly than we think and we're not
really measuring it well, and if that's the
case the math means that we're actually
in deflationary times rather than
inflationary my modest inflationary
times. So let's just take a number FOREX
seems to be experiencing two percent deflation
rather than 1.5 and 1.7 percent
inflation then real interest rates at
about 1.7 percent 10 year are more like
370 basis points which is about the
historical average for real interest
rates, and so that and if you imagine
that we're at the real the normal average
for real interest rates the economy's
behaving almost exactly the way
you would expect it to as you try to
increase interest rates in that
time period. So it could well be that we
just don't we're not measuring the
economy correctly as a consequence of
which not understanding the effect of
the policies that we're applying
and as a consequence in which aren't really
thinking about the right policy mix. Sound
right? Yeah no I don't disagree with
that
it's just hypothesis I'm not saying
that's the case in the US economy. It's
a different lens but it provides some insight. Right it's a different lens and remember our economy in some
respects gets harder and harder to
measure as we become a dominant dominant
service economy, and we're 80 percent
service economy GDP and jobs in the
United States. So we're not measuring our
economy on how many cars and how many
machines and how many airplanes we put
out, we're measuring our economy based on
how many people are going to get
Starbucks coffee and how many people are
going to drycleaners and how many people
are going to the nail salon and how many
people are going out to dinner. I mean
that's really our economy, how many
people are buying banking services and
accounting services and the big poise is
how many people are buying our
technology and technology products and
are they actually paying for our
technology and technology products but
maybe we'll get into that or maybe we
won't get into that later. And if the price
of one of the things goes down that's less
GDP. It's less GDP and so like airplane
transportation air travel in itself
right is one of the very deflationary
things like price of an airplane ticket
price of computing power Moore's law. All
these things become very deflationary
and as higher end retail stores selling
things have moved out of inner
cities and more service businesses have
moved in the marginal rate for rent
they're willing to pay is less than
someone selling goods. So rents have come
down a little bit so retail space is
worth less today but you're employing
more people at different wage levels so
I a lot of what Glenn is saying resonates
with me,
that we're just we're trying to use
20 and 30 year old isolated domestic U.S.
measures in a globalized world. Older
more domestic than global we
need to look at where we are today and
I do want to before we shift to
technology because I want to we're shifting to technology just kidding. No I love it. The
discussion we had about more credit
being in the capital markets versus in
the banks, how should we be thinking
about that? So look this is one of
these issues that sort of irks me
because getting out of the banks is
probably the right place. I mean the
financial crisis of 2008 was the banks
balance sheets overlevered with credit.
When you get it into the capital markets
or into the asset managers or into the
consumer, all those asset managers and
all those other places are basically the
consumer.
There's this great idea that US citizens
don't own credit and US citizens don't
own equities is really kind of
interesting because you know back in my
good old days when we used to work for a
living, you know and we sold stock and we
sold bonds our biggest buyers were the
pension funds from the teachers unions
and the police unions and all those
things. I thought those were just normal
people and so they actually owned
those assets so we were
disseminating those assets into what I
would call retail America. The question
to me is not who owns those assets I
mean it's really not who owns those
assets. The question to me is how much
leverage is there behind those assets
because that's what ultimately comes
down to the whole financial crisis the
whole stability and safety and soundness of the system,
is if there are hedge funds owning those
assets or they're asset managers owning
those assets and they're paid in full
there's no issue there's no problem. The
only problem is they can go down in value
but like there's ways that's
what happens markets go up markets go
down. To the extent that they're
leveraging them, and they're being
provided a lot of leverage to the
banking system, the banking system
ultimately owns the risk anyways because
the banking system can ultimately you know
if the ultimate owner defaults or
can't repay them because they're overlevered on their credit portfolio the
banking system bears the brunt of it. So
to me that's the question Jay and I
think based on where we are on the
regulation that we have today, and this
is one place where regulation works,
where the banks are stress tested they go
through their CCAR and they go through
all of their testing with the Fed
I don't think the banks are overlevered
and extending credit to people that own
credit. Two things, you guys might disagree
with this but I think first thing we
ought to do is I think understand history
correctly which was it was really the
securities firms not the quote unquote
banks that were the ones that failed and
got into trouble.
Well thank you for saying that but
that would have been self fulfilling
for me to say. Just so we know, right, it was Lehman
Brothers and Bear Stearns and maybe some
thrifts oh I was a security firm back then
yeah you were a security firm back then, well until Sunday that has a bank, and the solution was for you to
become a bank so it wasn't quote unquote
the banks had failed
it was the securities firms that were
doing maturity transformation. So if you
had deposits you were in pretty good
shape. It was the securities firms
that were borrowing short and lending
long and accumulating in many cases
bridging things before they could
securitize them, and it was also money
funds doing a very similar thing as I
talked about earlier sort of
reaching for yield that were kind of you
know supposed to have short term
securities were buying slightly
longer-term securities in order to kind
of get more yield. So what I would do
is I've really been trying to understand kind
of where the risks are in the system
it's really where people are doing
maturity transformation which is what
the economists
call borrowing short and lending long.
So I'd look for that through the
system so you mentioned something we
were talking earlier about where the
leverage is. In other words I'd be less
concerned about a private equity a
credit private equity fund that's got
commitments of capital for ten years
with two one year extensions so that's
twelve year money. They're out buying
high-yield debt in the markets and that
debt might go up might go down it might
have to be mark to market they might
have some bad reports but there's no
capacity for the investor to say I want
my money back. The big problem that
happened in the financial crisis was there
was this massive capital call all across
the economy everybody said I want my
money back. I want to sell my securities
in order to cover my
obligations and that's the place where I
would look and make sure that there
wasn't a problem. So it would be leverage
inside these companies short-term
leverage inside these companies that are
lending long by buying long-term credit
based assets. That's where I'd be
concerned. And are subject to liquidity stress.
Yeah exactly that's borrowing
short where as the lender can say I want my money back. Duration mismatch. We should
always be looking for duration mismatch that's the place to look. We saw one of those this year but I
think there is there's something I do
worry about a little bit that is out
there and it's less this issue but it's
more because the problem always
comes from where the bubble is and the
bubble right now one of the bubbles in
the world right now looks to me by this
massive movement of money towards
index funds. That's been the biggest thing that's
happened post the crisis I know so I take
a very good look inside that and see
what the ramifications were of that
reversing itself in some important way
because that's the biggest
transformation in flow of funds that's
happened, other than what's going on the
Chinese banking system which is a
whole different kind of thing, that's
happened since the financial crisis.
That's the part that I look at and
wonder about what the implications of it
are. Yeah let me give you one
data point that I ask people and I
think this is an
appropriate forum to say that I ask
people this. About indexation I often say
to companies well if it's kind of a passive
strategy, how much would a company pay to
be in a very popular index? I think the
answer's a lot. A lot. So tells you
something right? Well you look I can give
you some relative values that you know
so it used to be and I'm dating myself
now you know you got announced that
you were added to the Dow you know I
think that was like worth 7 to 12
percent of the value of your stock you
know back in the days when we used to do
big index add index rebalances and
you know the movement on any day
when a stock would go in or out of a
bigger index you know would be
anywhere between 2 and 12 percent.
And you guys are investors you know this
better than I do but that means your
cost of capital it actually goes down it's got value.
It's got a lot of value. Nothing
happened in the company except
more people had to own more people were
forced to own the security. Now the contrary
happens when you come out of an index.
Right but the thing if
you're hanging toward kind of where's
the risk in the system one should be
worried about, can I expand on that just
a little bit? I think the two
places that we're paying insufficient
attention to the risk of the capital
markets is climate change and cyber risk
and with respect to climate change Mark
Carney, the head of the Bank of England,
has spoken I think very intelligently
about in that there's a potential risk
in the insurance markets in London which
are a very important part of the
financial system in London to the cost
of the growing insurance claims for
climate change-related kinds of issues.
And so I would say that if I look from
your perspective I would say making sure
that companies are adequately disclosing
their exposure to climate change and the
risk in their businesses associated with
that is very important and on with
respect to cyber risk I
think the potential next financial
crisis is more likely to come down that
dimension than the dimension of sort of
maturity transformation. You know there's a book I think
everybody should read called The Perfect
Weapon I know you have it I think I gave
it to you and what the end of it which
is about the last eight years of cyber
competition among nations and the author
who's a Pulitzer Prize winning New York
Times reporter hypothesizes in the last
chapter what the next war could look
like and it would start with our
adversary turning off our electrical
grid and our financial system and then
telling us to surrender before they
attack without firing a shot. And the
vulnerability of our financial system to
cyber almost every one of them's been intruded upon. If any company out there or
bank tells you they have been intruded
upon they're not telling you the truth.
All of them have been intruded upon. All
of them are vulnerable and being able to
kind of put up those defenses and
understand their financial soundness
implications is very important. Yeah I
think what I can say this is an ongoing
conversation, it's a very important
conversation. My view is the conversation
has matured to some extent. We're now
talking about resiliency as opposed to
defenses you know when something happens how do
we recover? I think that kind of
conversation needs to go on. I also think
let me just say the liquidity issues we
talked about, as history shows us, there's
usually a catalyst right that drives those
yeah yeah that's a good point and I could see
technology being that kind of
catalyst. I hope that our investors
and consumers understand that we will
have technology issues, they will happen.
The question is how we deal with them
you know are we prepared do we
have the resiliency can we move forward.
But that's a good shift, crypto assets?
What do we think about crypto assets? Do
you have problem with your left hand
today? For once your to the left of
me so yeah it's hard to get to the left
of you. Crypto assets, so look I
think you gotta break this down because
we conflate crypto and blockchain in
America. We think they're
synonyms. They're not at
all synonyms. So I will be pretty quick
on crypto. I am not a real believer in
sort of the cryptocurrency world. Glenn
may vehemently disagree with me on this but
I am much more of someone that thinks
in the United States we still believe in
safety and soundness, we believe in KYC,
we believe in AML, we believe in audit
trail, and some regulatory oversight and
in the crypto assets that are out
there are sort of the antithesis of that
so to me they are gonna be tough assets
in the United States. That said,
so take the currency side of it out, the
technological side of it is unbelievably
important and is going to be part of a
huge evolution that's revolutionary in
our business and you're already starting
to see what the blockchain can do and
how the blockchain can be used in all
industries, but it is extraordinarily
relevant in financial services in
consumer credit in areas where we as a
financial service country we as a
capital markets country
we'll use it day in and day out and I
think it will have an enormous impact
across the entire spectrum. I think if
you're not thinking about it really
broadly when it comes to financial
services you're missing enormous
opportunities and there are an enormous
amount of companies out there in each of
these little silos trying to perfect and
figure out exactly how they make it work
and it's really kind of simple. Glenn
got on this topic and I'll just
elaborate on it for a minute, you know this
old idea that we created all these data
warehouses and we kept all this
important information on individuals and
on their credit worthiness and on their financial
information we kept it in data
warehouses well that was cutting-edge
technology when it was built, but the
people that the bad people out in the
world they knew those warehouses existed
so if you wanted that information you
might as well go to the place where all
that information is stored. That's why
people rob the banks because that's
where the money is. If you're looking to
steal identities you go to the place
where all the identities are held. In the
blockchain world you can get rid of all
of those data warehouses you can create
the identity real time instantaneously
have it created and then have it
disappear, and so think of the ability to
create things on a real-time basis as
you need them, use them, and then have
them go away and you can get real-time
information not the information that was
sent to the warehouse. So there's just
an enormous amount of applications for this
and whether it's digitizing securities,
moving securities, fragmenting securities,
it just has an enormous use. So I am very
very bullish on what its gonna do to the
industry and this goes back to where we
started how you know the SEC, the CFTC,
the Fed they're gonna have to understand
that this is gonna happen with or
without you and it's better off to
happen with you. Okay a couple things all
that is accurate let me just give a
slightly different perspective
on it, let's talk first about digital
currencies and then let's talk about crypto
stuff. Digital currencies today, roughly
92 percent of all currencies of the
world is digitized. You're talking about
fiat versus crypto just currency
all right so break them up though so look,
I totally believe in digital fiat so
digital dollars, digital yen, digital
euros those aren't crypto to me that's digital fiat so I
just want everyone to understand that
we're probably in more agreement on this. No
I'm just saying I'm just making I'm
dividing these two things apart just
like you just did. So the first thing you
have to understand is that moving to a
digital currency is a very
straightforward thing to do. People call
and the two things can
interact of course some people call them
stable coins some people call them you
know the Chinese are working on their
own taking that thing on paper and
turning it into a digitized thing is a very straightforward
thing to do, and it's only and today the
vast majority of money in the world is
already digital because it's just
electronic entries in banks and central
banks so the notion that it's some big
revolutionary thing only can take you
up eight percent. By the way Ken Rogoff's book The End
of Cash, says that 80 percent
80 to 90 percent of US
hundred-dollar bills are used in organized
crime and tax evasion so the thing
that's most useful to the bad guys is
cash. That's the ultimate sort of you
know anonymized security but anyway so
that's a straightforward easy thing to
do it should be done and kind of we just
gotta get there agreed that's easy amen. Now to
talk about the whole crypto kind of world,
we I got to this from the kind of
the payments thing because I've been
looking for a way in which we could take
the cost of payments down by 99 percent the way we take them out of the cost of
trading and securities. In the payments
world we use the term we often times
use the term of the payments rail so
there's credit card rails, there's checking
rails, there's the federal wire rails. So let's take so understand,
how I think to think about the
cryptocurrency world, is there are three
parts of it the blockchain, the
the token, and the protocol and the three
of them operate together to create one
solution one integrated solution that has the
capacity to revolutionize the way we
move things of value around the world.
Let me use a railroad analogy to make the point. The
token is the equivalent of the boxcar.
It's the thing into which you embed
something of digital value that needs to
be moved from one place to another from
one part of a blockchain to another. The
blockchain is the cargo invoice is the
invoice in the cargo manifest and the
rails is the protocol and you have to
think about all three as one integrated
solution that enables you to accomplish
the purpose of moving anything of
value around the world at the speed of
light at no cost the way we talk about
email today. People who just talk about
blockchain are talking about something
very interesting but it's a piece of
enterprise technology
that's an advanced database, and a
private blockchain unconnected to the
global to the Bitcoin or another digital
currency blockchain is the equivalent of
the intranet. Remember when we had intranets
to begin with where it was really cool
you could do internal communication with
people in your own companies, you know
but it wasn't really until those
intranets were connected via the
Internet Protocol to other intranets to
create the world wide web of intranets
called the Internet that the world
changed. The world is going to change in
finance when we connect the private
blockchains via the Bitcoin or Ethereum
or other protocol to the other
blockchains in the world have a global
blockchain that's the worldwide web of
block chains that will fundamentally
change the way in which not only do we
move value around the world at the speed of
life, but also in which we actually
fundamentally change the way in which we
compute because it's the fourth
computing paradigm I've experienced in
my lifetime the decentralized computing
paradigm. That is the vision of where we
can really go with this that's
transformational. Now the first step will
be the intranets the block chains as
those get deployed, but that's not the
endpoint that's just the first step and
I'd go in to all that stuff in greater
length than you'd like me to but that's a
beginning. No I look transformative I
want to go back to something we talked
about around monetary policy which is if
this happens, which I think it's I say
if I think you're saying when, I get it
you have a little bit more to do with the if than
we do I'm just kidding.
Look Jay my view is it's happening,
what is the U.S. role? I'm gonna go
further because we're both involved in
companies that are doing it. We'd like to
do it here but we're gonna do it. Well
let me ask this back to what
we were talking about measuring things in our
global economy.
This also sounds incredibly deflationary
because of the costs that will be driven
out of our system. Agree disagree I mean
if we're going from
paying a percent on a retail basis two
percent three percent to move things around
to virtually nothing. Well let's
maybe it's the nomenclature that's important.
Deflation is not necessarily a bad thing. No
I completely understand that if it's cost saving to consumers if my being able to buy something at a lower price
it's just part of the dual mandate that's where the problem is.
The dual mandate is about real interest rates.
Jay the question is who pays
all right then ask your question. My question is you wanna be in the position where you've
introduced this cost savings across the
globe. You don't want to be a taker you
want to be somebody who leads in those
areas I think what you're saying you
know because we now do have a global
economy and these savings are global
that you want to be a leader look you
know be a leader in many things. So look
the issue is and Glenn and I haven't talked
about this before, it's interesting we're
having our first conversation on us
both attacking sort of the same problem,
the friction in the payments system is
huge. It's not seen by the consuming
public. It takes away from their
purchasing power because they just pay
the marked price but the seller
the retailer gets 97 96 or 98 cents on
the dollar when they go turn in their
credit card receipts or their payment
receipts, they just know
they're getting less than par every time
they sell you something in the store. If the retail seller could
get par this is the interesting question,
would the prices come down two or three
percent? We don't know the answer but
someone eventually would probably figure
that out. With the amount of
technology and digital sales and digital
outlets you know what will happen
you know and it takes one first mover.
The power of shopping is unbelievable.
Most people can see prices and shop prices.
Exactly right the market has become pretty efficient and
pretty transparent, and there are a
bunch of companies out there that will
basically take your grocery list today
and put it in the computer and tell you
what grocery store in your neighborhood
to go to where your all-in grocery list
will be the cheapest and so
you'll get more and more evolution on
this space. I just think that we ought to
come back to at the end consumer welfare
because that's kind of what we're after
right and that's not necessarily
measured in prices it's not necessarily
measured in productivity it's not
necessarily measured in GDP growth or
inflation, but the extent that you are
offering something to a consumer that's
better faster and cheaper than what they
had before that's a good thing and
the way we add it up in our economy and talk
about it needs to be subsidiary to that
insight and policy needs to address the
change needs to be open to, just like we
talked about with crypto just like we talked
about now with Fed policy, and needs to
address needs to change how it what
tools it uses how it addresses
that based upon how the economy changes
in the pursuit of that greater consumer
welfare rather than try to use old tools
and old frames of reference and
old lenses to understand the modern
economy. So look on that consumer policy
side I will add one thing I think is
important you know Glenn's talked about
a couple of the major problems in the
world whether it be climate or things
like that. There's another
issue on social side. We all talk
about banking the unbanked. A big problem
you know the payday lender
should not exist in American name. It's one
of those things that when I drive by them in New York City and
see payday lenders it's kind of shocking
to me. In a digitized dollar stable token
whatever you want to call it world we
would eliminate payday lending. That has
to be a stimulant to the U.S. economy. If you
could basically get your paycheck into a
digitized wallet or into a stable token
take that wallet to any ATM even if you
pay the two dollar and fifty cent
ATM fee or pay the four dollar ATM fee
you know, versus paying 10 or
12 or 15 or 18 percent to
a payday lender to get your money into
your pocket or use your digital wallet
at point-of-sale, you're adding a huge
amount of disposable income back into
the system and to me that is one of the
huge potential opportunities and
windfalls that comes out of this
technology. And it has to be consistent
with the SEC's specific mandate and the
government's broader mandate of consumer
welfare, social justice, and financial
inclusion.
So thinking about it in that perspective is
something we ought to go make sure it
gets done as opposed to putting
impediments in the way of it getting done.
One more quick then you get to what
Glenn said about the 100 dollar bills
if you literally could get to a cashless
society, you would basically have a
society where your income taxes would
become digitized you basically would
almost push a button at the end of the
year. Everything would go in the system
and you'd hit "Calc" or you could hit "Calc" everyday
and see and you could end up in a
real-time tax society. There'd be no
fraud. There'd be no anything in the
world you would have everything go
through the system and then this whole
fraud and lack of collection tactics you
know people say 30 percent of our taxes in the United
States don't get collected, that's the
problem.
I don't know if it's true or not but we
can fix it. The other thing the point I would make you
guys understand is that you talk to law
enforcement people who have actually
spent time trying to track, why
do all the Bitcoin guys get caught?
Because the public blockchain is a
permanent unauditable record available to
law enforcement. Right so there's
actually a whole, one of the ways
in which you get rid of fraud is that
the public blockchain is out there for
everybody to see and the community
is the one who validates every
transaction so you can go find exactly
who did what when. One of the things,
public service
announcement for my colleagues here at
the SEC the women and men, investor
education is so important to us.
Investor education becomes a lot easier
when you get rid of opacity and
complexity. When people can see what they're
paying they, you know I often say in our
economy there are people who pay 8
to 18 percent and there are people who
collect 8 to 18 percent. You want to
transition from being the borrower at
8 to 18, and as close to 8 not 18 as you can, to the person who's getting those
returns over the course of your lifetime.
We are trying to help people
understand that and the to extent
technology helps people understand that
it's a wonderful thing. See I want to do
something entirely different right, which
is I want to get rid of that. In other words
that's just a cost in the system that
is an inefficiency that needs to go
away. I agree with Glenn, we can get rid of
those 8 to 18 percents.
That's just like the eighth and a quarter
plus a commission. It's just like doesn't
have to be there for the markets to
operate anyway so go ahead. By the way
but the funny thing is at the time we
had it you couldn't imagine it ever
going away, but we are now
in a place where we can get rid of that
8 to 18 percent and I can
not only can I imagine I
can see it. You need to set up economic
constructs in which not that one person
gets it versus another person getting it
which it's irrelevant.
I agree. All right last topic what's
going on today? Brexit? Trade? Markets? What
do we think about markets today
any comments from either of you? That was
your right hand was a
right hand gesture not a left hand gesture. So
look that's a how long is a
piece of string question. So Brexit look
Brexit comes down to an election right I
mean were on a very short timeframe here.
If Boris wins which I guess is the
polling now he's got sort of end of
December to notify the EU he's leaving.
I assume he does that. Look let
me give you a more sophisticated answer you
know looks like he's polling at a high
enough margin to get a majority
government but right on the edge. I assume he would notify the Union
he's leaving. He's got a year basically to leave then
he can extend a couple years. So I think
that's sort of where we end up. So
it's a I guess people call that a quasi-hard Brexit, which to me I've said this
before it's probably the right answer
you know we just can't keep living in
the world of the unknown in Europe
probably the best thing that could
happen we'd stop talking about what is
going to happen and what could happen in
the future. I think it will be fine you
know the whole thing is what do we do
with trade agreements you know how do we
keep airplanes taking off
from the United States to Europe and
trade agreements and, most likely what
will happen is we'll just take the
existing trade agreement will re-sign
it and keep extending it out for six
or twelve months at a time until we can
renegotiate new trade agreements which will
take years. So I think the UK
election well I know it will come and
go and there'll be a winner and if
that happens if we end up with a
surprise on the other side
we'll just live in this turmoil for like
we have been living for multiple multiple
multiple years. So you know
someone last night I was at an event they
said you know the bid offer is parity on
sterling and 145 on the upside so
we're somewhere between parity and 145.
The US to me
we're in an interesting spot here in
many respects because the consumer
continues to do what they're really good
at in the United States. They're really
good at spending money. Like I
said, it doesn't matter what interest
rates are in the United States the consumer
here knows how to spend. The consumer has
basically worth three percent wage
growth. They're taking the three percent
wage growth and spending it. They're
taking their tax savings to the extent
they got tax savings or they got
additional child care credits or they got
additional credits in the tax system
they're saving it. They're taking their
deflationary savings in other areas
and spending it. They're taking their
lower energy cost and they're spending
it back in the economy you look at
Friday's Black Friday which was really
online sales and you take Monday's Cyber
Monday sales, those were two record
days I mean monster sales days if you
look at the credit card data so the
consumer is doing what the consumer
should do. So that part of the economy
looks really pretty good. The one concern
I have in the US and I've had this now
for a year and a half
is corporates are not spending money in
the United States, and I totally get why
they're not spending money. If I was a CEO
I probably wouldn't be spending money. If I
sat on a corporate board, I wouldn't be
doing big CapEx right now. First of
all if you start down a big CapEx
project it's property plant and
equipment it's buildings it's things like
that, first thing you're gonna buy is
steel and aluminum. Why would you buy a
steel and aluminum at the world price
plus huge tariffs? So you look
at that the cost of that is
expensive on one side, and then you look
at the other side of the equation with
the geopolitical uncertainty in the
United States to what is it gonna be
potentially if we get a change of
presidency? What is healthcare gonna look
like? Are you gonna be able to have
corporate profits? Are we gonna have surtaxes
on corporate profits? What are they
gonna do with corporate buybacks? What
are they gonna do with corporate
legislation? It's a really tough
environment to say hey let's take you
know 10 or 20 billion dollars and
invest it in the US economy right now
and look at it on a 30-year payback.
I think a prudent CEO or prudent board
would say hey, let's wait a couple years and
we could probably make that investment
in the future or worse we can make that
investment in another country and import
those products. So unfortunately I
understand why CapEx and corporate
spending is down in the United States
which is disappointing to me
because one of the big motivating facts
behind the tax legislation was to
incentivize companies to spend money in
the United States. That said again though
we still are at three percent wage growth. We're
at sort of three and a half percent
unemployment. We still have 7.2 million
job openings in the United States, so
from that side of the equation it looks
pretty good. So you know I continue to
be cautiously optimistic in the United
States. Glenn? So okay so I've got three or
four things on my mind that fit in that
bucket. One is a fundamental change in
the nature of the relationship between the US and
China that's going to affect the world
economy for the next generation. It
turns out that we misjudged Xi and he
turns out to be a real hardliner, and
rather than the process we had of
China moving toward a capitalist economy
they are now very firmly adopting the
model of state control of very important
parts of their economic sectors and the
state use of private actors for
espionage and intelligence purposes.
That's not going to change anytime soon
and so we're going to have a very very
different way in which the United
States and China manage their
relationship with each other in the
coming years than we have in the past.
One very good example of that and now is
largely an assumption among in the
technology community that we're gonna
have two internets on either side of a
great Chinese firewall, that's kind of
one.  The second is that I was a public
critic of the tax cut because I doubted
seriously that it would increase
economic growth and it hasn't it didn't,
and whatever economic growth it offered
was gonna be fleeting which it proved to
be the case. I thought at that
stage of recovery given the level of
federal taxes as a percentage of GDP
which was at well below historic
averages, that it was time to get our
fiscal house in order. I'm very very
concerned about the nature of these
massive deficits the United States is
running during a period of peacetime and
recovery, and if you want to maintain the
United States centrality in the capital
markets one of the things you need to do is
be a capital provider not the world's
largest borrower whose
sovereign credit risk is deteriorating
systematically. That's the second thing I
worry about. Third thing I worry about is even though the economy is strong and not strong but the economy is
growing
call it two percent trend and unemployment is at
historically low levels, you still have a
massive amount of economic insecurity in
the American household. The volatility in
people's wages and the volatility in
their spending, their low level of
their savings without any cushion means
that there's even in a very strong
economy we still have this very profound
sense of economic insecurity in very
important parts of our country and
that's reflected in a whole host of
political and social economic trends
and we need to address that and the
strong economy hasn't addressed it.
Fourth thing is I'm very
optimistic because I am on the board of
a company that I know is
America's largest capital spender right
now AT&T, and is one of the largest
capital spenders in American history and
we're building out the 5G infrastructure.
By the way my personal view is the
reason why companies that have good
commercial propositions and
can grow in the technology economy are
actually investing and investing quite
aggressively take Amazon for instance as
an example, and we're gonna build out a
5G network that's gonna offer wireless
speeds at 50 to 100 times what you get today.
You'll have a wireless experience as
good if not better than your wired
experience just as 4G enabled the
creation of a whole host of companies on
top of that platform that didn't
exist before everything from GrubHub to
Airbnb to Uber. There will be a whole
host of new kind of economic constructs
that'll be able to be created on top of
the 5G infrastructure that are gonna be
we're gonna create a whole new layer of
economic growth. It's one thing that the
United States will be competitive in
though China's ahead of us for a bunch
of reasons.
We'll be competitive in unlike the
digital currency stuff where that might
migrate outside the United States for reasons we've
talked about and so that's a real life
reason to be optimistic. It's going to be
a lot of fun to both invest in those
companies and then watch them deploy
products and services. Well I'm
gonna close this out. I'll give you a
chance to say any final things but let me
close it out with a few
words here.
First of all it's wonderful to work in
this job in a country where you can have
this kind of discussion about how we
look forward, the risks we face, the
role of government. Have it in front of
people out in the open
talk about risks, talk about different
perspectives. It is a great privilege I
know you you've experienced it but it is
a great privilege to be able to live in
a country where we can talk candidly,
learn from each other, look forward, and
try and do our job better. That's
what today is all about and
I just want to say I appreciate your
sharing your views and sharing them in a
way that we can all digest them and be
better for it. Can I say one
thing before we go which is
I don't want people to misinterpret what
Gary and I both said which is one of the
reasons why we have the greatest capital
markets in the world is because they're
the ones that are the most
effectively regulated and in which the
all the rights and expectations that
investors have can be enforced, yeah, can
be predicted and enforced in any States.
So please don't interpret anything that
we said today as being critical to this
organization because I see it as the
centerpiece of kind of the financial
markets. I have a huge amount of respect
and admiration for everybody who does and everybody here does and I just want to
make sure everybody understands that.
Agree completely look, we would not be in
the position we're in without the
regulatory system we have in the United
States and I applaud it.
Sometimes I'm angry at it but I applaud
it. So thank you for what you're doing we really
appreciate it. Thank you. Please join
me in thanking these wonderful guests.
