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20–948 PDF 2017

S. HRG. 114–319

EXAMINING CURRENT TRENDS AND CHANGES IN

THE FIXED-INCOME MARKETS

JOINT HEARING

BEFORE THE

SUBCOMMITTEE ON SECURITIES, INSURANCE, AND 

INVESTMENT

AND THE

SUBCOMMITTEE ON ECONOMIC POLICY

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE

ONE HUNDRED FOURTEENTH CONGRESS

SECOND SESSION

ON

EXAMINING THE RECENT EFFORTS BY SEVERAL REGULATORS, INCLUDING THE DEPARTMENT OF TREASURY AND THE FEDERAL RESERVE, 

TO UNDERSTAND THE OCTOBER 15, 2014, TREASURY ‘‘FLASH RALLY,’’ 

CHANGES IN THE TREASURY MARKET STRUCTURE, AND LIQUIDITY 

CONCERNS IN THE FIXED-INCOME MARKETS

APRIL 14, 2016

Printed for the use of the Committee on Banking, Housing, and Urban Affairs

(

Available at: http://www.fdsys.gov/


BANKI-41578DSA with DISTILLER
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

RICHARD C. SHELBY, Alabama, Chairman

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

DEAN HELLER, Nevada 

TIM SCOTT, South Carolina 

BEN SASSE, Nebraska 

TOM COTTON, Arkansas 

MIKE ROUNDS, South Dakota 

JERRY MORAN, Kansas 

SHERROD BROWN, Ohio 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

JON TESTER, Montana 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

ELIZABETH WARREN, Massachusetts 

HEIDI HEITKAMP, North Dakota 

JOE DONNELLY, Indiana

WILLIAM D. DUHNKE III, Staff Director and Counsel 

MARK POWDEN, Democratic Staff Director

DAWN RATLIFF, Chief Clerk 

TROY CORNELL, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor

SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT

MIKE CRAPO, Idaho, Chairman 

MARK R. WARNER, Virginia, Ranking Democratic Member 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

TIM SCOTT, South Carolina 

BEN SASSE, Nebraska 

JERRY MORAN, Kansas 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

JON TESTER, Montana 

ELIZABETH WARREN, Massachusetts 

JOE DONNELLY, Indiana

GREGG RICHARD, Subcommittee Staff Director

MILAN DALAL, Democratic Subcommittee Staff Director

SUBCOMMITTEE ON ECONOMIC POLICY

DEAN HELLER, Nevada, Chairman 

ELIZABETH WARREN, Massachusetts, Ranking Democratic Member 

PATRICK J. TOOMEY, Pennsylvania 

TOM COTTON, Arizona 

MIKE ROUNDS, South Dakota 

BEN SASSE, Nebraska 

JERRY MORAN, Kansas 

JON TESTER, Montana 

JEFF MERKLEY, Oregon 

HEIDI HEITKAMP, North Dakota

SCOTT RIPLINGER, Subcommittee Staff Director

BHARAT RAMAMURTI, Democratic Subcommittee Staff Director

(II)


BANKI-41578DSA with DISTILLER
CONTENTS

THURSDAY, APRIL 14, 2016

Page

Opening statement of Chairman Crapo ................................................................. 1

Opening statements, comments, or prepared statements of: 

Senator Warner ................................................................................................ 2

Senator Warren ................................................................................................ 3

Senator Heller ................................................................................................... 4

WITNESSES 

Jerome H. Powell, Member, Board of Governors of the Federal Reserve System ......................................................................................................................... 5

Prepared statement .......................................................................................... 32

Responses to written questions of: 

Chairman Crapo ........................................................................................ 45

Senator Sasse ............................................................................................ 46

Antonio Weiss, Counselor to the Secretary, Department of the Treasury .......... 6

Prepared statement .......................................................................................... 34

Responses to written questions of: 

Senator Toomey ......................................................................................... 50

Senator Sasse ............................................................................................ 52

(III)


BANKI-41578DSA with DISTILLER

BANKI-41578DSA with DISTILLER
(1)

EXAMINING CURRENT TRENDS AND CHANGES 

IN THE FIXED-INCOME MARKETS 

THURSDAY, APRIL 14, 2016

U.S. SENATE, 

SUBCOMMITTEE ON SECURITIES, INSURANCE, AND

INVESTMENT, JOINT WITH THE SUBCOMMITTEE ON

ECONOMIC POLICY, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC. 

The Subcommittees met at 10:02 a.m., in room 538, Dirksen Senate Office Building, Hon. Mike Crapo, Chairman of the Subcommittee on Securities, Insurance, and Investment, presiding. 

OPENING STATEMENT OF CHAIRMAN MIKE CRAPO 

Senator CRAPO. This hearing will come to order. 

I want to thank Senators Heller and Warner and Warren and 

their staffs for working with me on this joint Subcommittee hearing on ‘‘Examining Current Trends and Changes in the Fixed-Income Markets.’’

The U.S. Treasury market—oh, I also want to say, we have 

asked each of the Chairmen and Ranking Members to keep their 

introductory remarks to about 3 minutes so we can get to the witnesses, and we have all discussed that previously. 

The U.S. Treasury market is one of the largest and most liquid 

financial markets in the world and is critical to the U.S. and global 

economy. On October 15, 2014, the yields of the 10-year Treasury 

experienced a 37-basis point trading range, one of the biggest 

swings of all time. The unusually high level of volatility has generated a robust debate about why this occurred and what it could 

mean during future bouts of market volatility. I have heard that 

several factors, including new regulations, have reduced certain 

participants’ market-making capacity, and that during stressed 

market conditions, liquidity may disappear at times when it is 

most needed. 

Following the October 15 event, several regulators, including 

Treasury, the Board of Governors of the Federal Reserve, the SEC, 

and the CFTC, have been working to better understand the causes 

of the event and, as well, how the Treasuries market has evolved 

to its present state by holding conferences, producing a report, and 

issuing a request for information. It will be helpful to understand 

what are the key take-aways from these efforts and how this information and feedback will be used going forward. 


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2

While many market participants and regulators may have different opinions or definitions of liquidity, there is agreement that 

this topic merits attention. 

A recent report by the Bank for International Settlements Committee on the Global Financial System discussed how the fixed-income markets are in a state of transition. It identified technology 

and competition, bank deleveraging and regulation, and monetary 

policy as factors that have a bearing on market liquidity. The report shows that it is not just the U.S. Treasury’s market that is 

affected, but the global fixed-income markets. 

These are complicated issues and I look forward to hearing and 

following the witnesses’ information on these topics. How are the 

factors set forth in the BIS report impacting liquidity, especially 

during stress markets conditions? What is the likelihood of future 

October 15 events? What options are being explored to mitigate liquidity from disappearing at times when it is needed most? And 

many other questions. 

I want to thank again our witnesses for being here and I will 

turn to Senator Warner. 

STATEMENT OF SENATOR MARK R. WARNER 

Senator WARNER. Well, thank you, Mr. Chairman. 

You know, you and I have spent a lot of time over the past couple years investigating particularly the equity market structure 

and asking the folks at the SEC to implement pilots to improve the 

way our stock markets trade. And while there are very legitimate 

concerns about the intricacies of the stock market that lead to 

questions about fair and orderly operation in that space, that equity space differs greatly from the complexity of the fixed-income 

markets, which, as we all know, lack a central exchange or a system for trading, have significant capacity with only post-trade reporting for corporate and municipal bonds, not Treasuries, and generally have margin of spreads that would make actually even most 

equity investors blush. 

As you pointed out, a lot of focus on the events of October 2014. 

I think we have before us two extraordinarily distinguished public 

servants, and my questioning, and I hope they will even get to 

some of this in their opening, will focus on a couple of areas: Posttrade transparency, the role of prudential regulations, the actual 

fixed-income market structure, especially the role of hourly trading 

and we all know there are questions about liquidity—I sometimes 

do question some of our high-frequency folks who always at the 

altar of liquidity seeming to trump everything else, and the interaction between futures and other markets. 

I had a longer statement that I will submit for the record, but 

to try to make sure I actually stick to my 2 1⁄2 minutes, I will pass 

it back to you, Mr. Chairman. 

Senator CRAPO. Well, thank you, Senator Warner. 

Senator Heller is actually presiding on the floor and may or may 

not make it before we start with the witnesses, so we will let him 

have his shot maybe after the witnesses. 

And, so, Senator Warren. 


BANKI-41578DSA with DISTILLER
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STATEMENT OF SENATOR ELIZABETH WARREN 

Senator WARREN. Thank you very much. I appreciate it, Mr. 

Chairman. 

Thank you to the witnesses for being here today. 

I just have a couple of other comments to add to the opening 

statements. The title of today’s hearing is ‘‘Examining Current 

Trends and Changes in the Fixed-Income Markets.’’ I want to start 

with congratulations to the members of the audience who made it 

through that title without falling asleep. While it sounds dry, it is 

a powerfully important topic that goes to the heart of how our financial markets operate. 

Liquid bond markets give participants confidence that they will 

be able to sell their holdings when they want to. That, in turn, 

gives them confidence to buy those bonds in the first place. This 

means that ensuring sufficient market liquidity is, in many ways, 

key to having a robust demand for Treasuries, for corporate debt, 

and for municipal debt. 

That said, there seems to be no single measure of liquidity that 

everyone agrees on. In preparing for this hearing, I have seen some 

analysis that liquidity in the fixed-income markets is significantly 

less than before the 2008 crisis. I have seen other analysis that liquidity is not that different. I have seen some analysis that liquidity is less, but it does not really have much actual impact on the 

functioning of the market. And with such divergence in even the 

basic measure of liquidity or what it means for the markets, someone might conclude that any claim that liquidity is shrinking or 

growing is offset by someone else who can claim the opposite. 

The other issue that often comes up, and mostly from the financial services industry, is the impact of our post-crisis rules on liquidity, and perhaps this—because it is such a slippery concept, liquidity seems like a convenient bogeyman that for companies that 

just want to see rollbacks to Dodd-Frank and other post-crisis financial reforms. Any claim that liquidity was much higher before 

the 2008 crash must address the question of whether there was too 

much liquidity, that is, too much leverage, too much short-term 

lending, leading up to the crash, and once the crash hit and the 

liquidity disappeared at exactly the moment when it was actually 

needed, right when the market started to panic, which suggests 

that the so-called liquidity in the pre-crash years was little more 

than an illusion. 

If the post-crisis rules have reduced liquidity by some measures, 

although not by others, it may be that the current forms of liquidity are both more stable and more likely to stick around when they 

are really needed, and so I hope that is an issue that our witnesses 

will be able to address. 

Thank you, Mr. Chairman. 

Senator CRAPO. Thank you very much, Senator Warner. 

And now, we will turn to our witnesses. We appreciate both of 

you for being here today and sharing your expertise on these 

issues, which have been—I think we have opened up some of the 

critical issues that we really need to understand better. 

Our witnesses today are Jay Powell, Governor of the Federal Reserve Board of our Federal Reserve System, and Antonio Weiss, 

Counselor to the Secretary at the Department of Treasury. 


BANKI-41578DSA with DISTILLER
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Gentlemen, as I think you know, we allocate you 5 minutes for 

your opening statements. We will put your full statements on the 

full record, and I think you will get some very interesting and robust questioning from the panel today. 

You know what, Senator Heller just arrived, so before I start 

with the first witness, if you are ready, Senator Heller, we will 

turn to you for your opening statement. 

STATEMENT OF SENATOR DEAN HELLER 

Senator HELLER. Sure. Thank you. Thank you, Mr. Chairman, 

and to all the Chairs and Co-Chairs and everybody else on this particular Committee, it is great to be here and I am glad that we are 

taking some time for this particular hearing. 

I want to thank our witnesses for being here today, also, Governor and also Mr. Weiss. 

The fixed-income markets are critical in the U.S. capital markets 

and our national economy. I do not think anybody in here disagrees 

with that. It may not be as sexy or as exciting as the equity markets, but in Nevada, entities like the Truckee Meadows Water Authority, the Nevada System of Fire Education, Clark County School 

District, cities of Las Vegas and Reno, all rely on issuing bonds in 

the fixed-income markets. 

The fixed-income markets in the United States are very large. 

Market liquidity is critical in having effective and functioning markets. So, there is no doubt that the fixed-income markets are transforming. There are early warning signs that fixed-income markets 

are becoming more fragile, less liquid than they used to be. My fear

is that sometime in the future, there may be a major period of 

stress in the markets that cause significant deterioration in liquidity, and if unchecked, these liquidity problems will spill over into 

our economy. 

Recently, on August 12, 2015, the Global Financial Market Association and the Institute of International Finance released a commission study by PwC on the state of global markets liquidity, and 

in their conclusion, they said it would be helpful for all stakeholders to better understand liquidity conditions and the link between regulations and market liquidity so that future regulations 

strike the right balance between promoting stability and maintaining financial market liquidity. 

So, the fact that this Congress, financial regulators, and the private sector are evaluating the current state of liquidity in the fixedincome markets shows a growing concern that the bond markets 

are not functioning as efficiently and as effectively as in the past, 

and I believe that the financial regulators need to devote more attention to the state of our fixed-income markets. 

I also think that we can improve the fixed-income markets while 

also ensuring proper safety and soundness, and it is my hope moving forward that our collective agenda should be to preserve and 

restore liquidity in the markets. 

So, I look forward to hearing from our witnesses. Mr. Chairman, 

thank you. 

Senator CRAPO. Thank you very much, Senator Heller. 

We have already introduced the witnesses, so we will begin, and 

Governor Powell, we will start with you. 


BANKI-41578DSA with DISTILLER
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STATEMENT OF JEROME H. POWELL, MEMBER, BOARD OF 

GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Mr. POWELL. Thank you, Chairmen Crapo and Heller and Ranking Members Warner and Warren. I know there are Subcommittee 

Members. I want to thank you for inviting me here to testify on 

fixed-income markets. 

These markets perform important functions in our economy and 

it is imperative that we understand the significant changes that 

they are currently undergoing. As I will discuss, a number of factors have been driving these changes. 

Some market participants have expressed concerns about low

liquidity across fixed-income markets, although many recent studies have found it difficult to identify such a broad reduction. It may 

be that liquidity has deteriorated only in certain market segments. 

It may also be that even if liquidity is adequate in normal conditions, it has become more fragile or more prone to disappearing 

under stress. 

I will offer just a couple of thoughts about the highly unusual 

price movements of October 15, 2014, in the Treasury market. As 

you know, the staff of the Treasury, Federal Reserve Board, SEC, 

CFTC, and Federal Reserve Bank of New York compiled a joint 

staff report that analyzed the factors that could have caused the 

rapid rise and subsequent reversal of Treasury prices in such a 

short span of time. This analysis did not point to a single factor 

accounting for the sharp swing in prices. 

But, as in equity markets, advances in computing and communications technologies have allowed proprietary trading firms, 

sometimes called algorithmic firms or high-frequency trading firms, 

to capture a majority of the interdealer market in Treasuries, and 

as a consequence of these changes, trading in Treasury markets 

now moves at extreme speed. And it may be that these changes 

have also lead to greater liquidity risk or the risk of sudden declines in liquidity. 

For example, researchers at the Federal Reserve Bank of New 

York have found that there are spikes in volatility and sudden declines in liquidity becoming more frequent in both Treasury and in 

equity markets. There is also evidence that liquidity shifts more 

rapidly and, hence, is less predictable in these markets. By contrast, researchers have not found these behaviors in corporate bond 

markets where traditional dealers still intermediate most trade 

and there is much less high-frequency trading. 

Apart from such episodes of sudden volatility, questions about 

whether liquidity in fixed-income markets has broadly deteriorated 

are very difficult to answer definitively, and in exploring these topics, it is essential to distinguish between the Treasury markets and 

the corporate bond markets, which have different characteristics. 

In Treasury markets, traditional measures of liquidity like bidask spreads have been fairly stable in recent years, but the changing market structure has also meant smaller average trade size 

and participants now must break up their larger trades and employ 

complicated strategies to avoid moving prices. Accurately

measuring the effect of trading on prices, which is perhaps the 

most fundamental measure of liquidity, can be quite difficult in 

such an environment. 


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6

There are also differences between the on-the-run Treasury market and the off-the-run Treasury market, where less liquid off-therun securities are traded. However, the spread between those two 

markets has not appreciably changed since the crisis. 

Turning to corporate bond markets, estimated bid-ask spreads 

have actually declined, which could create the argument that liquidity has actually improved. However, given the nature of the 

corporate bond market, those measurements are based only on actual transactions as opposed to quotes to buy and sell bonds. 

What we can directly observe is that trade sizes and turnover 

have declined in the most actively traded corporate bonds as they 

have in Treasury markets, and although observable measures of 

overall liquidity in corporate bond markets appear good, there is 

some evidence that liquidity in lower-rated bonds has deteriorated. 

Trading in these less liquid segments may rely heavily on intermediation by dealers, and dealers have scaled back their capital 

commitments and inventories in corporate bonds since the financial 

crisis. 

As I have mentioned, a number of factors are driving these 

changes in fixed-income markets. The financial crisis gave the dealers a heightened awareness of the risks of large portfolios and of 

liquidity provision and they substantially reduced their portfolios 

and their market-making footprints soon after the crisis and, 

frankly, well before the new regulations took effect. 

On the other hand, in the interdealer cash Treasury market, the 

main theme is really the increased importance of trading that is 

enabled by high-speed telecommunications and computer power. 

Finally, regulation has, by design, increased the costs of balance 

sheet usage and in doing so has encouraged a smaller footprint 

among these firms and their market-making activities. I would say, 

though, that no one seems to doubt that the same regulation has 

also made the core of the financial system much safer and sounder 

and much more resilient. 

My view is that these regulations are new and we should be willing to adjust them as we learn. That said, we should also recognize 

that some reduction in market liquidity is a cost worth paying in 

helping to make the overall financial system significantly safer. 

And, I will close by noting that the supervisors do have inadequate regular data access in the cash markets. This is something 

that is a principal focus of the Treasury’s request for information 

and it is a very important thing. 

I will stop there, and I look forward to our conversation. 

Senator CRAPO. Thank you. 

Mr. Weiss. 

STATEMENT OF ANTONIO WEISS, COUNSELOR TO THE 

SECRETARY, DEPARTMENT OF THE TREASURY 

Mr. WEISS. Chairmen Crapo and Heller, Ranking Members Warren and Warner, and Members of the Subcommittees, thank you 

for inviting Treasury to testify today. We have been partners with 

the Federal Reserve and Governor Powell, in particular, on several 

topics related to today’s hearing. 


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7

Fixed-income markets, as you have all noted, play a central role 

in the U.S. economy, channeling savings into investment and providing credit to households, governments, and businesses. 

Now, the primary markets for fixed income are functioning

exceptionally well. Indeed, the past 4 years have seen record 

issuance of corporate bonds, as both domestic and foreign companies continue to rely on U.S. markets to raise capital. Trading in 

secondary markets is, for the most part, also functioning well. 

There is little compelling evidence of a broad-based deterioration in 

liquidity. But, there have been episodes of volatility in Treasuries, 

as Governor Powell noted, most notably on October 15, 2014, as 

well as anecdotes that large transactions in corporate bonds are 

challenging to complete. 

Now, prior to the crisis, liquidity was abundant by almost any 

measure. However, this liquidity was a result of soaring financial 

sector leverage and an over-reliance on short-term funding. And 

when the crisis hit, that liquidity not only disappeared, but led to 

forced selling that greatly exacerbated financial distress. 

Reforms adopted in response to the crisis have demonstrably 

strengthened the core of the financial system and reduced markets’ 

vulnerability to these fire sale dynamics. Since 2009, the largest 

banks have more than doubled their capital levels and holdings of 

high-quality liquid assets, while cutting short-term funding in half 

and increasing their deposit base. 

At the same time, fixed-income markets, as you have all noted, 

are undergoing a period of structural change, and this is driven by 

technology, changing risk appetites and business models, changes 

in the investor base, and much needed financial reform. 

The Treasury market today remains the deepest and most liquid 

securities market in the world. We should have confidence in that 

reality. Nearly half-a-trillion dollars of Treasury securities change 

hands every day, and Treasuries remain the global benchmark 

risk-free asset. And traditional measures of liquidity in Treasury 

markets are healthy. 

But, the extraordinary volatility in Treasuries on the morning of 

October 15, 2014, with no clear catalyst, raised the possibility that 

improved day-to-day liquidity may have come at the cost of rarer 

but severe bouts of volatility. 

The joint staff report that Governor Powell mentioned highlighted important changes underway in Treasury markets, including the increased presence of algorithmic trading in the interdealer 

market, and we are currently seeking public comment on the evolution of Treasury market structure and the implications for market functioning, liquidity provision, and risk management practices. The comment deadline is April 22, and we would be happy 

to report back to the Subcommittees with key findings. 

Now, the most immediate conclusion from our work to date is 

that the official sector needs more access to data and more effective 

data sharing mechanisms. We expect to have a comprehensive plan 

in place by the end of this year for regulatory reporting of cash 

Treasury transactions. 

Now, in corporate bonds, measures of transaction costs are also 

within historical ranges and trading volumes have increased, showing no broad withdrawal from the market. Average trade sizes 


BANKI-41578DSA with DISTILLER
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have begun to decline, though, as well as the proportion of large 

block trades. As Governor Brainard recently noted, these data 

points are consistent with anecdotes from market participants of 

the need to break up large trades into smaller ones over time. Now, 

in itself, this is neither good nor bad, but it does require adjustment by both investors and intermediaries. 

Concerns have also been raised about the potential liquidity mismatch present in open-ended investment funds that offer daily liquidity to investors but invest in less liquid assets. The SEC has 

proposed new roles to improve liquidity risk management, and 

FSOC has engaged in a thorough analysis of these risks as part of 

its ongoing review of asset management activities. 

In summary, fixed-income markets are healthy, providing support to the economic recovery, but they are in a period of transition. Policy makers are focused on enhancing financial stability and 

maintaining well functioning markets through periods of stress. 

And financial reform has built a buffer for volatile times. We now 

need to build on that progress and adapt to the dynamics of the 

new marketplace. 

Thank you, and I look forward to answering your questions. 

Senator CRAPO. Thank you very much. I appreciate the testimony 

both of you have provided. 

I will begin the questioning. I will begin it with a statement. I 

appreciate the attention that you are both, and that our regulators 

are, giving to this issue. I think one of the messages I heard both 

of you give is that we need more data and we need to analyze this 

better and understand all of the factors that we are dealing with 

in terms of liquidity in these fixed-income markets, and I appreciate that. I do believe that we have got to get the answers to these 

questions, because as has been indicated by both the introductory 

statements by the Senators as well as your testimony, there are 

some serious questions there about just exactly how are the markets functioning and what are the causes of the issues that are 

being raised. 

In that context, I would like to essentially read a few highlights 

to you from the European Parliamentary Financial Services Forum 

that recently analyzed these issues and just ask your comment on 

these highlights. So, what I am going to read to you is from the 

European Parliamentary Financial Services Forum that recently 

analyzed this issue. 

Quote:

Since the crisis, there have been a significant number of regulatory initiatives that have impacted banks and nonbanks and their clients. On a standalone basis, many of these reforms have been successful in that banks and 

investment firms are now holding far greater amounts and higher quality 

of capital with ample liquidity, intended consequences of financial reform. 

However, the linkages between all the regulatory reforms and the market 

liquidity are not always well understood, which can create unintended consequences. In particular, banks have been deleveraging, refocusing activities, exiting from markets and capital and funding intensive areas, such as 

market making in fixed income, repo, credit, and derivatives. These responses appear to be reducing the resilient liquidity of some financial

markets and with it passing trade execution risk from banks to end investors or issuers.

Let us start with you, Governor Powell. Could you react to that 

analysis. 


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Mr. POWELL. Senator Crapo, that is generally in line with a great 

deal of what the research has shown, which is that firms have reduced the size of their portfolios. They have reduced their marketmaking activities in many markets, in fixed-income, and it does 

raise questions that we need to address about what the liquidity 

is in the underlying markets. 

I think you actually have to look at markets one by one, though. 

Prudential regulation is really not the headline in the Treasury 

markets. If you were going to find problems that were driven by 

prudential regulation, you would find them in a corporate bond 

market, where much smaller portfolios, much more demand, tremendous amounts of primary issuance, and you would find them 

there. But, at the same time, read the report by FINRA, which 

looks carefully at many, many different elements of liquidity, and 

it just does not find a consistent story of a broad reduction in liquidity. 

So, nonetheless, we hear from market participants and also from 

the group that you read about, and, you know, I do not want to dismiss those concerns. I think we have to keep paying attention. But, 

it just is not a case that is proven on the data that we have. 

Senator CRAPO. So, before I go to you, Mr. Weiss, are you saying 

that the evidence is not there that banks are moving to other markets? 

Mr. POWELL. It is very clear that banks have reduced their portfolios of fixed-income securities. No one disagrees with that. But, 

if you look at measures of liquidity, such as bid-ask spreads, such 

as the impact of trades on price, you just do not see a consistent 

story. You see those measures, price impact and things like that, 

as well within historical ranges. They move up and down——

Senator CRAPO. Well, you indicated that they were actually closing, the bid-ask price ratios were closing, is that correct? 

Mr. POWELL. In corporate bonds, interestingly enough, the bidask spread has actually declined. 

Senator CRAPO. But, how deep is that? Do we know how deep 

that liquidity is? 

Mr. POWELL. So, market depth is well within historical ranges, 

but has decreased just a little bit here. Same thing in the Treasury 

market. I think the issue, really, with the corporate bond market 

is more that you only see bonds that actually trade. If liquidity is 

preventing certain bonds from trading, you do not see that. 

At the same time, everyone is looking at the same data, which 

is the TRACE data, and I would steer you again, and your staffs, 

to the FINRA report, which looks at this in great detail. And, we 

are looking for this story, but it is just not in the data that we have 

so far. 

Senator CRAPO. Thank you. 

Mr. Weiss. 

Mr. WEISS. Senator, I am looking at the clock, and you asked a 

pretty complicated question. I will perhaps answer just one aspect 

of it and build on Governor Powell’s remarks, which were about 

dealer inventories. 

Now, it is the case that dealer inventories were far higher in the 

period prior to the crisis than today, but the vast majority of those 

inventories were RMBS and structured credit that are no longer 


BANKI-41578DSA with DISTILLER
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being issued today for good reason. And if you look at corporate 

bond inventories per se, there was a report from Goldman Sachs 

which actually suggested that corporate bond inventories in 2005 

were about $40 billion and today have contracted to around $19 billion. But, there were $5 trillion of corporate bonds outstanding in 

2005 and there are $8.5 trillion today, so the inventory was not 

really the core of the liquidity market in 2005 and it really, in our 

judgment, is not a good measure for inventories today. 

Senator CRAPO. All right, thank you. We can get into this further, but I do need to go on to the next Senator. 

Senator Warner. 

Senator WARNER. Well, thank you, Mr. Chairman. 

I would just echo what the witnesses have said. I think if we are 

going to make comparisons, comparing back to that 2005–2008 

time period is not the appropriate comparison marker, as Mr. 

Weiss just said. Liquidity was higher, but it was filled with instruments that led to the crisis. And if we are going to look particularly 

in the corporate bond market, we ought to be comparing back to 

earlier historic numbers, and I think that is what Governor Powell 

pointed out. 

Going to a slightly different place, one of the things you and I 

have both worked on is a greater transparency in both the corporate and the muni bond markets, particularly in questions 

around disclosure of mark-up and mark-downs, and we are hopeful 

that FINRA will come out with rules that will not be toothless, 

quite honestly. 

I have also been interested, as we think about some of this transformation taking place in Treasuries, as we see more move toward 

algorithmic trading, which has positives and negatives I would be 

happy to hear a comment from both witnesses on some of the concerns about that movement. 

One of the things I have been interested in is transparency 

around post-trade trading in Treasuries, and obviously, folks make 

the argument that that would give away a bank’s position and 

there would be front running, although that was the same arguments that were made against TRACE and EMMA before they 

were put in place. So, I guess, in your opinion, if we were trying 

to improve post-trade transparency in the Treasury market, can we 

do that without impairing liquidity, and is the Treasury Department doing anything on a structural basis to improve that transparency? 

So, if you want to both address the question around the comparison back as well as the move toward algorithmic trading, any value 

judgment around that, and then in particular around post-trading 

of Treasuries. 

Mr. WEISS. So, in the RFI which we have issued comments in 

April 22, a whole section, Senator Warner, is on post-trade transparency, around the level of transparency that should be attached 

to official sector data. And, this is a controversial topic. I do not 

think we are here to make any announcements about that today. 

What we do expect is that by the end of the year, we will have 

a process in place to ensure that the official sector has access to 

all cash Treasuries data and that we will have articulated a point 

of view about post-trade reporting. 


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Your analysis of TRACE is exactly right. The market participants anticipated a huge amount of upheaval. I think the data 

would suggest, as Governor Powell reviewed, that a lot of that has 

not come to be. 

As regards algorithmic trading, the second part of your question, 

you know, we think a couple of things. Number one, you had hearings about equity market structure just recently and algorithmic 

trading really started in equity markets, moved into FX, and then 

into futures, and is now present for the past 10 years or so in cash 

Treasuries. And, really, all standardized securities are now traded 

predominately algorithmically, certainly on the interdealer market 

for Treasuries. 

And, we asked a couple of questions in this regard in the report 

and in the RFI. Number one, there are questions of operational resiliency. Some of the entities that trade cash Treasuries, for example, are not regulated for those activities. There are questions as 

to the robustness of the pre-test environment for algorithms and 

introduction of algorithms into markets. CFTC has a proposed rule, 

Reg AT, which addresses some of those questions. And, you know, 

there are also valid issues of practices, such as spoofing and 

layering and order stuffing, which in our judgment do need to be 

addressed and monitored. 

Senator WARNER. Governor Powell, a comment, because I do 

want to get in one more question, as well, but——

Mr. POWELL. Yes, just quickly. I would agree with everything Mr. 

Weiss said. 

On algorithmic trading and all that, it is driven by technological 

advance. It is not going away. It is with us, and it has benefits and 

it also has risks. The risks may be, and it is not firmly established, 

but may be that liquidity can be more flighty under stress. I would 

also say it is not just the principal firms that are using this. All 

market participants are electronic traders now, and it affects the 

structure of the markets and the functioning of the markets and 

we have to get used to it and adapt to it, and it is something we 

are looking at very carefully. 

Senator WARNER. And I agree, we are not going to roll back technology, but I do think sometimes, and nobody wants to sound like 

a Luddite, but the idea of speed for the sake of speed at least has 

to be evaluated. 

I am going to just take one more question, then, Dean, if I can, 

and then I will head off, and this is directed to you, Governor Powell. One of the things that the Fed has recently acted on, the Fed’s 

proposal to confer Level 2B status on certain municipal bonds, the 

purpose of LCR. I really worry about this. It seems like a very conservative move. The FDIC and the OCC have not even ruled in on 

this, and it is just kind of hard for me to understand why we would 

say we will take a triple-A bond rated Virginia debt instrument, or 

New York Port Authority debt instrument, and somehow make that 

a lower status in terms of LCR than, say, sub-sovereign bonds 

issued by European nations. Why should Bavaria get a higher 

ranking in terms of the level of quality of capital than a triple-A 

rated United States muni? 

Mr. POWELL. Senator, the LCR, of course, requires these largest 

financial institutions to hold amounts of highly, highly liquid


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instruments that can be turned into cash to a near certainty to 

cover 30 days of potential outflow. So, it is really all about liquidity. It is not about the creditworthiness of the underlying issuers 

or anything like that. So—and what we have done is we want them 

to be mostly in Treasuries, and then there is a middle box for the 

GSEs, and then there is corporate bonds and munis. It simply is 

just that it reflects the liquidity, the amount of trading that occurs 

in these instruments, so we wanted to include them. 

By the way, banks can own as much of them as they want. This 

is not a limit on what banks can own—or as much as the law allows. This is a limit as to what counts for highly liquid. And, so, 

for investment-grade bonds that are general obligations, they can, 

you know, amount to up to 5 percent of your highly liquid assets. 

Senator WARNER. The effect, I think, and I will again turn it over 

to Senator Heller, is that you are, in effect, giving sub-sovereign 

debt that may be European-based, does not have the same level of 

restriction that American muni debt would have. And, again, I understand the need to have that liquidity, but it does seem to be a—

and, you know, we are going to urge you to reconsider or look at 

legislative solutions. 

But, thank you, Senator Heller. 

Senator HELLER. [Presiding.] Senator, thank you. 

As you probably heard, the bell went off for a vote down on the 

floor, so as you can tell, I am the only one up here right now. My 

job is to hold down the fort until they make themselves back. I do 

not know if that is good news or bad news for you, but I want to 

again thank you for your time and for your expertise on this particular effort. 

I would like to ask a question based on what you were just talking about when it comes to liquidity. It seems to me, and maybe 

you can answer this question, electronic trading seems to have 

made the equity markets more liquid. Why does it appear that it 

has made the debt markets less liquid? Is that——

Mr. POWELL. I do not know that I would say it has made the debt 

markets less liquid at all. I think the question really is—these are 

new liquidity providers who are providing liquidity in a different 

way, in a different form, in different amounts, and at certainly a 

different speed than traditional providers had. That does not mean 

that there is less liquidity. I would not say that at all. 

I think the question with the high-frequency traders is when 

they become the dominant liquidity provider, is that liquidity—and 

it is a question, it is not an answer, it is a question—does that liquidity become somewhat more fragile, more likely to disappear, as 

happened on October 15. That is not to blame October 15 on the 

high-frequency trading firms, but that is a question we have a responsibility to answer and understand as it relates to this change 

in market structure. 

Senator HELLER. Thank you, Governor. 

Let me quote from former Treasury Secretary Larry Summers. 

He stated recently that there is a legitimate concern that through 

your regulatory actions, you are losing sight of keeping markets 

open and liquid. Can you respond to that, Mr. Weiss. 

Mr. WEISS. So, I believe what former Secretary Summers was referring to was this so-called tradeoff between financial institution 


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stability and market stability, and I think as I made clear in my 

opening remarks, our view is that this is comparing two completely 

different environments, really, that do not bear comparison. 

The liquidity that was in place in 2005, 2006, and 2007 was 

fueled by banks that were leveraged 40-to-1, 50-to-1, 30 percent 

short-term wholesale funding, substantial off-balance sheet lending 

that came on-balance sheet, and the liquidity conditions that exist 

today, however one may characterize them, are far more stable as 

a result of all of the reforms that have been made. 

There was a letter from JPMorgan’s CEO attached to the 2015 

annual report, and I quote, he concluded, ‘‘We may have had artificially higher liquidity in the past and are returning closer to normal.’’ Now, that is not to say that there are not profound changes 

taking place in the nature of liquidity provision and the structure 

of fixed-income markets, but it is important to note that the liquidity benchmark of pre-crisis really should not apply to any future 

assessment, in our judgment. 

Senator HELLER. So, do you believe or not believe it is fair to 

question whether regulations are having a profound impact on 

these fixed-income markets? From your testimony, unlike the Governor’s, I think you mentioned that taking a look at these regulations may make some sense. Do you feel that the regulations that 

are currently in place are doing exactly what they intended to do? 

Mr. WEISS. I think the prudential regulators, and I would defer 

to them in the first instance, really have tailored regulatory tools 

in order to differentiate between smaller financial institutions, regional financial institutions, and the largest ones, and the tailoring 

that is available to the prudential regulators through the design of 

these rules, coupled with the discretion which is afforded to prudential regulators to develop—to react to developments in the marketplace, you know, in our judgment gives the current framework 

ample flexibility to address changing conditions. 

Senator HELLER. OK. So, let me ask you this as a follow-up. Was 

it your intention through regulations to push banks out of their 

traditional role of fixed-income market makers? 

Mr. WEISS. As a matter of fact, the banks are still, you know, a 

majority of market making, you know, both in Treasuries, if one 

aggregates off-the-run securities and on-the-run securities, and in 

corporate bonds, and are active market makers as we speak in all 

fixed-income markets. And, so, to the contrary, because——

Senator HELLER. But you are not disagreeing that their participation is decreasing? 

Mr. WEISS. Their participation is still at the core of the way 

fixed-income markets are intermediated. 

Senator HELLER. Well, the market participants themselves, I 

think, may raise some questions to those comments, believing that 

it is much more difficult for them to stay in these debt markets 

with the regulations that are currently in place. Is that a fair assessment on their part? 

Mr. WEISS. I think market participants are adjusting to all of the 

factors which Governor Powell highlighted and which I have stated, and those include technology, changes in risk appetite. They include, as well, changes in business models. Different banks are 


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pursuing different business models and strategies. And, they reflect 

much needed reforms, which I referred to in my opening comments. 

But, I would like to go back to our premise. Liquidity conditions 

as a whole in fixed-income markets, while evolving, do not show on 

an evidence-based approach broad deterioration. 

Senator HELLER. OK. Governor, do you have any comments? 

Mr. POWELL. I am in the same place. I would agree with that. 

Senator HELLER. At the end of your opening statement, you 

talked about the Treasury Department looking for information, 

asked for a request for information from industry participants. 

What do you anticipate doing with that information? 

Mr. POWELL. So, this is Treasury’s—it’s Treasury’s request for information, but I will just say that we do not actually have posttrade reporting that is available to any regulator on a routine basis 

in the cash Treasury market, either on the interdealer platforms or 

on the dealer to customer market. So, doing the analysis to deal 

with one 12-minute trade event took almost a year. It took several 

months to get an interagency agreement. So, this is not where we 

need to be. I think for us to do our jobs and provide the kind of 

oversight we need to provide for these markets to assure the public 

that they are safe and sound, I think we do need to have better 

information. The question of what to do with it is also the subject, 

though, of the Treasury’s request for information. 

Senator HELLER. Yes. Would you follow up, please? 

Mr. WEISS. I would concur with Governor Powell’s comment that 

it is clearly inadequate, given all of the technology evolution that 

has taken place in cash Treasuries, for it to take five supervisory 

agencies 9 months to put out a report that is comprehensive on 

what took place October 15. And, I would point out that if that report itself was really based on only partial data, it was based on 

interdealer markets where we had access to data, there was then 

the Federal Reserve Bank of New York introduced a subsequent report a couple of months later. 

You know, all of that suggests that with transactions happening 

in microseconds, the agencies which are charged with overseeing 

these markets do need more robust access to data, and we will 

have a plan in place by year end to assure that that happens. 

Senator HELLER. Thank you very much. 

I need to get down to the vote, so I will kick it over to Senator 

Warren for now for her questions, and hopefully, the Chairman will 

get back before she is done. Senator Warren. 

Senator WARREN. All right. Thank you. 

So, thank you all for being here. Let us pick up on this issue. 

Republicans have suggested that the changes in the law to prevent 

another 2008 crash have undermined market liquidity, and I just 

want to dig into what that really means. 

Mr. Weiss, you wrote an op-ed in the Wall Street Journal last 

year in which you noted that while there may have been more liquidity before the crisis than there is now, quote, ‘‘pre-crisis liquidity built on excessive leverage and unstable funding turned out to 

be available in good times, but not in bad. During the crisis, those 

inventories did little to prevent the financial markets or the broader economy from freezing up.’’ And I think that is consistent with 

the testimony that you have offered today. 


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I think this is a very interesting point, and what I want to ask 

is whether you think that because of the new rules, including 

Dodd-Frank, there is now a better chance that liquidity will be 

available the next time there is panic in the markets. 

Mr. WEISS. So, Senator, that is really at the heart of the question, and it is absolutely the case that pre-crisis liquidity, for reasons that we have all stated, is a poor benchmark for overall liquidity. And, it is our judgment that however one wants to characterize 

liquidity conditions today, and again, I think Governor Powell and 

I have given generally a sense that liquidity is sufficient in fixedincome markets, although there are those who argue to the contrary, but the evidence again suggests it is within normal ranges, 

I do think that what regulation has produced is a higher likelihood 

that the liquidity conditions that exist today will be available tomorrow in a period of stress. 

Senator WARREN. So, let me just underline that point and make 

sure we are exactly on the same page. I do not want there to be 

any ambiguity about this. Do you think that Dodd-Frank and the 

ancillary rules have made financial markets more resilient and better equipped to handle the kind of stress we saw in 2008? 

Mr. WEISS. Without a doubt. 

Senator WARREN. Thank you. You know, I think some of this discussion of liquidity may miss the forest for the trees. Liquidity that 

disappears exactly when the market needs it is not very valuable. 

Our focus should be on ensuring liquidity during times of stress, 

and it sounds like Dodd-Frank has helped us do exactly that. 

Now, while we are on the subject of liquidity, Governor Powell, 

I wanted to ask you about the Fed’s recently finalized rule on the 

liquidity coverage ratio, and I think Senator Warner may have 

started this while I was gone. As you know, the liquidity coverage 

ratio is a joint requirement of the Fed, the OCC, and the FDIC. It 

currently applies only to a small group of the largest financial institutions, largest banks in the country, and it requires those banks 

to hold a certain amount of highly liquid assets. The idea is that 

the biggest banks should have a minimum amount of liquidity so 

they can weather a crisis without needing a bailout. 

How much credit a bank gets for an asset depends on the asset’s 

liquidity. So, for example, cash and Treasuries are considered Level 

1 assets and they are given the most credit. Fannie Mae and 

Freddie Mac securities are considered Level 2A assets and given 

less credit than Level 1 assets. And then certain highly liquid and 

marketable corporate debt securities are considered Level 2B assets and given less credit than Level 2A assets. Originally, municipal debt was not given any credit at all. 

Now, the Fed recently changed this rule to allow certain highly 

liquid and readily marketable municipal securities debt to count as 

Level 2B assets. The Fed determined, however, that municipal securities were not liquid enough to count as Level 2A assets. 

So, my question is, can you explain why the Fed was more comfortable counting certain municipal debt securities as Level 2B assets rather than Level 2A assets? 

Mr. POWELL. Yes, Senator. First, I think you accurately stated 

the point, that the Level 1 assets are highly liquid, highly reliably 

turned into cash in moments of stress when they are needed to do 


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so. Level 2B is the middle ground and it tends to be the GSEs in 

our market. And Level 2B is——

Senator WARREN. You meant 2A. 

Mr. POWELL. I am sorry, 2A. Level 2A is the GSEs, effectively, 

and Level 2B is corporates, highly rated corporates that have good 

liquidity. It just—it seemed to us, and it seemed to me, in particular, as well, that investment-grade munis that are general obligation bonds were more akin in their liquidity, if you look at their 

actual liquidity trading statistics, they were more akin to highly 

rated corporate bonds than they were to, you know, the subsovereigns, which trade almost like Treasuries. 

Senator WARREN. OK. Would you have concerns about liquidity 

in a time of crisis if municipal debt securities were counted as 2A 

Level assets instead of 2B Level assets? 

Mr. POWELL. I think that would give them too much credit. You 

know, we have to make a judgment here, and I think they are—

in their liquidity characteristics, they are much more like corporate 

bonds. We really want these large institutions to have highly liquid 

assets. I do not think that munis qualify to be 2A. 

Senator WARREN. OK. So, these characterizations are what really 

go to the heart of the liquidity issues that we are dealing with now, 

and making sure that the liquidity is there when we really need 

it, which is also what we are trying to accomplish here. 

It is critically important that our biggest banks have sufficient 

assets in a time of crisis and that those assets be liquid, but it is 

also important that municipal bonds are treated fairly under the 

new rules, and I appreciate your perspective on how we try to get 

that balance. Thank you. 

Thank you, Mr. Chairman. 

Senator CRAPO. [Presiding.] Thank you very much, Senator Warren. 

As you can see, a lot of the Senators have had to leave for a vote. 

I do not know how many of them we will be seeing pulled back 

here, because they all have multiple hearings and activities today, 

but I am going to take the next round. 

First, I want to get back into the topic we were discussing before 

I had to yield my time for further questions earlier, and I guess 

for both of you, I have a question. Do you have concerns that the 

liquidity for corporate bonds that do not necessarily trade in high 

frequency has deteriorated over the past few years? 

Mr. WEISS. I mean, this is something we are obviously monitoring. I think, as has been mentioned, it is important to break corporate bonds down into subcategories, and I will go back to the fact 

that issuance has been strong, primary issuance, over the whole 4-

year period. In fact, a record has been set for the category as a 

whole in each of those years, and that volumes, trading volumes 

have also been strong. 

What we have noticed by the evidence are two trends. One is 

that there was a decline in the size of corporate bond trades immediately following the crisis, and although it has picked up somewhat, as the chart attached to my testimony shows. And the second 

point is that there has been a decline in the proportion of block 

trades, large transactions, and, therefore, intermediaries and


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investors are having to internalize and take greater responsibility 

for achieving liquidity for larger transactions. 

Senator CRAPO. Governor Powell, did you want to add anything 

to that? 

Mr. POWELL. Sure. So, I agree with that. I would add two quick 

things. One is that we are now seeing a significant number of electronic platforms springing up in the corporate bond market for the 

first time, which would enable buyers and sellers to meet, and that 

is a new thing which we will see if it pans out. But, this is the kind 

of thing that is constantly happening as these markets transition. 

The second is corporate bond markets have been through, really, 

two significant shocks in the last year, one of which would be the 

significant decline in oil prices and the other of which was really 

the global turmoil and recession fears and that sort of thing that 

went through the market. And in both cases, the corporate bond 

markets navigated through that with pretty normal behavior. 

There was some increase in bid-ask spreads and things like that, 

but very high volumes of trading and really well within the historical range. So, we do not see the kind of problems. 

Senator CRAPO. In your analysis, are you not seeing a decrease 

in dealer inventories and a reduction in market-making activities? 

Mr. WEISS. I mean, I think I gave the figures previously about 

dealer inventories were, in corporate bonds, by independent estimates, at about $40 billion in 2005 and that are about $20 billion 

in 2015, and that is relative to outstanding levels of $5 trillion in 

2005 and around $8.5 trillion in 2015. So, I think however you position the numerator and the denominator, the outstanding has always been well in excess of dealer inventories. 

Senator CRAPO. I want to get back into the question of post-reform regulatory impact. I do not think there is any question, as 

Senator Warren indicated in her questioning, that following the 

post-regulatory, or the post-crisis regulatory impact that we have—

the reform impact that we have seen, that we see greater leverage 

and higher quality of leverage in the system, which is a good. 

The question that I think that I see raised by a number of those 

who are studying this is, and I think, Governor Powell, you referenced this, there is a tradeoff, is there not, between this regulatory safety and soundness that we are seeking to achieve here 

and the liquidity in the markets. And the question, is it not, whether we have achieved the right balance in this process, or do you believe that we have reached the right balance and that there is no 

issue here to evaluate? 

Mr. POWELL. Senator, I do not know that there is a tradeoff, and 

I think, again—I do not want to look at the pre-crisis levels of liquidity as any kind of a benchmark. So, we are in a new world 

post-crisis where we are trying to strengthen the core of the financial system, trying to strengthen these firms, trying to make them 

less risky, and that is having the effects that we have talked 

about—smaller portfolios in some fixed-income securities and

others. 

So, what you would worry about is that you would see the capital 

markets not functioning well, not performing the service they are 

supposed to perform for borrowers and lenders, and we do not really see that. We see isolated examples of it, but the case is really 


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not made, in my mind, and I try to keep up with this pretty carefully. 

Senator CRAPO. Well, I guess you may have answered this, but 

I have not suggested that we should be comparing to pre-crisis levels. What I am talking about is today and whether we see an impact on liquidity in the markets, whether we see market participation going down, market makers leaving the market. And are you 

telling me that you are not seeing that? 

Mr. POWELL. I would say, by most measures, if you look across 

a broad set of liquidity measures in most markets, you really do 

not see—you cannot prove a broad decline in liquidity as it really 

matters for buyers and sellers. You do not see that big of a decrease in market depth. There is no story to be told around bid-ask 

spreads, for example, which are a key indicator of liquidity. In 

terms of the impact of trades on price, which is a very important, 

probably the most fundamental one, there is no clear trend there 

that would say, yes, there is a liquidity problem here that is hurting the financial markets and, hence, the economy. 

Mr. WEISS. You know, if I could just build on that, there is kind 

of a basic premise here, which is is it the case that it is a law of 

nature that under all market conditions, all market participants 

can sell large blocks of exposure without impacting market price, 

and there is no such law of nature. And, in fact, it has never been 

the case that under all stressed conditions, there would be no 

movement in price. 

And, there was a recent op-ed put out by PIMCO which was articulate on this point, and what it concluded was, in essence, that 

not all repricing events are themselves liquidity events, and, you 

know, we agree with that. 

Now, that being said, we do bear a real responsibility as regulators and as agencies to monitor the liquidity conditions, and in 

our judgment, the right reference period is not today’s liquidity 

conditions, and it is not the pre-crisis liquidity conditions, it is potential liquidity conditions 5 years from now and 10 years from 

now as technology evolves, as markets evolve, as the world becomes 

more interconnected, and as we anticipate future events of potential stress. And, the work that we should be held accountable for 

is the anticipation of those market conditions. 

And, so, as I mentioned at the outset, we are heavily engaged in 

a review of Treasury markets, which is the first such Treasury 

market review since 1998. And, we are also working at the FSOC 

in looking at asset management activities and the questions that 

have been raised about underlying liquidity conditions in mutual 

funds that may hold less liquid assets and at the same time offer 

daily redemption. 

And, so, our agenda is rather full looking forward. What we 

would not advocate is to revisit the regulations that have been put 

in place in the United States and globally which have created

confidence in our financial institutions and solidity in our liquidity 

conditions. 

Senator CRAPO. Well, so, you know, I have read most of the studies that we have referenced here today, and it seemed to me that 

in every one of them, a list of possible factors for the issues we are 

dealing with was put out, and in every one of them, if I


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recall correctly, one of the issues that it was suggested we need to 

look at was the regulatory climate and the impact and the balance 

there. For example, the European Commission has issued a call for 

evidence on the EU regulatory framework and its impact on liquidity in these markets, to look at it and study it. 

I am afraid I am hearing you saying that you do not even think 

we need to look at those kinds of issues because that is not an 

issue. Is that what you are saying to me? 

Mr. POWELL. Senator, I think every study does consider the question—every study I have seen—I have not read them all, but I have 

read a lot of them—every study that I have seen does consider the 

question and consider regulation as one of a series of factors. I 

have not found any studies that think that this is all about regulation——

Senator CRAPO. No, I am not suggesting that, either. 

Mr. POWELL. No, I know you are not. I am just saying it is clearly a factor, and, you know, some of that is by design, frankly. You 

know, if you take, like, take the repo market, for example, which 

is—there is no question, I think, that capital requirements and 

prudential regulatory requirements generally have raised the balance sheet costs of repo, and so there is an effect in that market. 

But, what comes with that is significant increases in safety and 

soundness. 

Senator CRAPO. And I understand that, and I do believe there is 

a tradeoff in here. But, what I want to hear from the two of you 

is that you recognize this is an issue and that you are looking at 

it among the other issues that you are studying. 

Mr. WEISS. Again, as I stated earlier, Senator, it is a fair question. The response that I think you are hearing from both of us is 

that liquidity provision in fixed-income markets is evolving, that it 

is a period of historic change, that technology, changing business 

models, changing risk appetite, and much-needed regulatory reform 

are all playing a role in that, that we have our work to do with 

the agenda that we have set that is forward looking. And, again, 

I would underline, we need to focus on where markets are headed 

in the future and the potential for how those future markets may 

react to stress events. 

Senator CRAPO. Well, thank you. I have gone way over my time. 

Senator Warren, do you want another round? 

Senator WARREN. Yes. Thank you very much, Mr. Chairman. 

You know, let us pick up on this question about regulatory climate and market security. Yesterday’s announcement by the FDIC 

and the Federal Reserve Bank that five of the largest financial institutions in this country did not have credible living wills is a 

clear statement that too-big-to-fail is still a problem. The finding 

was that with these five financial institutions, there is no credible 

plan in place that if they start to get into financial trouble, that 

they will not bring down the entire economy. 

Now, many of the plans were found deficient because the banks 

were said not to have sufficient liquidity in a crisis situation. Governor Powell, could you talk for just a minute about the role that 

liquidity played in the living-will determinations? 

Mr. POWELL. Sure. So, we look at these, at all of these plans 

across multiple dimensions, and that is one of them, and it is a


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different thing. Many of these firms have plenty of liquidity for the 

ordinary course of events. This is really about having a plan and 

having the right quantity of liquidity and having it in the right 

places for that event, which we hope never comes, that you actually 

have to be resolved. And, so, what we require of them is to have 

a model that clearly estimates that and a system throughout their, 

what can be very complicated global structures, of placement of the 

liquidity and, really more importantly, a way to think about it, are 

they thinking about it correctly, and that kind of thing. 

So, we identified deficiencies for a number of them and I think 

we gave clear guidance as to what they need to do to address that 

deficiency, and all the other deficiencies, for that matter. 

Senator WARREN. You know, the giant banks want to advance 

the story that they are over-regulated, but it seems to me that the 

report yesterday on living wills demonstrates that, if anything, 

today, they continue to be under-regulated. That is, they pose significant threats to the entire economy, and I think that is something we have to take into account when we think about what regulations and what changes are needed going forward. 

I want to ask one more question and that is a question about 

data. Both of you have said that the Government needs more data 

to adequately oversee the Treasury markets. Mr. Weiss, could you 

explain what kind of data you are lacking and what kind of 

vulnerabilities it creates not to have those data. 

Mr. WEISS. Yes, Senator. So, in the futures market, which is centrally cleared through a single exchange in Treasuries, there is 

ample visibility and access to data. 

Cash Treasury markets are fragmented. We have access to interdealer markets on request, which is what we produced in the October 15 report. We have relatively less access to the dealer to customer flows, which still account for, I should highlight, a majority 

of trading activity in cash Treasuries. 

And, so, what we believe is imperative, and it is the first course 

of action we are going to pursue, is to have a concrete plan in place 

that cannot be reversed by year end such that in the future, if and 

when there is another event, it will not take five agencies 9 months 

to put in place information sharing agreements and compile data 

and release to the public further analysis. 

Senator WARREN. So, I am hearing you say you are on the path 

here, and by the end of the year, you will have in place the ability 

to gather the data you need on an ongoing basis, both the data you 

need and in a timely fashion to gather those data, so that you will 

be able to make faster decisions about liquidity and other shifts in 

the market, is that right? 

Mr. WEISS. Senator, I think we will have a plan, and that plan 

will lead to the gathering of the data——

Senator WARREN. OK. So, you will have the plan. You just will 

not have it executed by that point. 

Mr. WEISS. Senator——

Senator WARREN. You will have a plan. 

Mr. WEISS. We will have a plan and it will happen. 

Senator WARREN. And, how long will it take for this to be executed? Do you have any clue? 

Mr. WEISS. Not long after year end. 


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Senator WARREN. OK. All right. Not long after year end. That 

sounds good. All right. 

Senator CRAPO. All right. Thank you, Senator Warren. 

Senator Warner. 

Senator WARNER. I am trying to get the update on what I 

missed. 

Senator WARREN. You missed some good stuff. 

Senator WARNER. Good stuff. 

[Laughter.] 

Senator WARNER. I think, because I missed Senator Warren’s 

questions, but I would like to, maybe not right now, but come back 

again to the muni bond conversation at some point. I, just again, 

basically feel that the notion that foreign-based debt is going to 

have a higher capital standard than American-based equivalent 

debt is not the right way to proceed. 

Let me—this is a little, kind of in the bucket that we are in, but 

slightly off topic, an issue that I have discussed with both of you 

a number of times, and that is the overall question of our balance 

sheet and the $19 trillion of debt and the effect, I think, that the 

rise in interest rates will have on the Federal Government’s ability 

to, frankly, invest in anything in the discretionary realm. 

I give the Fed a lot of credit, and others, for stepping up when 

we as policymakers have not stepped up, but you are almost out 

of tools. One tool that I would like your comments on, Governor 

Powell, is inside our current debt portfolio at the Federal level, I 

think the average duration of most of the bond portfolio is about 

69 months. Yet, if you look at the United Kingdom, their average 

sovereign debt has terms of about 10 years. We have the longest 

term instrument we use, which is a 30-year instrument. Japan 

uses a 50-year instrument. Princeton uses a 50-year instrument. 

Has there been thought inside the Fed about looking toward, you 

know, with interest rates at such record lows and, unfortunately, 

us still borrowing at the rates we are, and obviously everyone 

agrees that the deficit numbers are going back up, looking at 

longer-term instruments in terms of locking in more of this debt at 

these record low levels in terms of interest? 

Mr. POWELL. Senator, that is very much a Treasury Department 

question, if I may so. It is not something we have responsibility for. 

Senator WARNER. You are right. 

Mr. WEISS. It would have been a question of Governor Powell 20 

years ago. 

[Laughter.] 

Senator WARNER. And, I actually——

Mr. WEISS. I was going to ask Governor Powell to defer. 

Senator WARNER.——back to in his earlier private sector experience, and then switch to you, Mr. Weiss. 

Mr. WEISS. But, in any case, you know, so we look at this constantly. We look at the composition and issuance of the Federal 

debt constantly. You know, in the wake of the financial crisis, the 

duration of the Federal bond portfolio was 49 months. We issued 

masses of bills at a time when there were two wars and huge deficits following the Great Recession. That number is, as you suggest, 

Senator Warner, now up to 69 months, and our policy has really 

been to extend this. 


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We have two tenets we try to stick to at Treasury, which are, on 

the one hand, to issue at the lowest cost possible over time, and 

on the other hand, to be regular and predictable. And, what this 

does underline is that Treasuries are different. We do not introduce 

new instruments and then withdraw them. The market views 

Treasuries as a risk-free asset. I mean, our short-term rate is 19 

basis points for 1-month bills now, 10 years at 1.75, long bond is 

at 2.6-something. So, we try to issue and maintain low rates across 

the curve, and the steadiness of issuance and the predictability of 

our issuance is really a core tenet of——

Senator WARNER. I guess I would just comment that when we 

see—and, obviously, because of the depth of the Treasury market, 

you need to have that predictability. I understand that. But, when 

you look at similar, you know, the United Kingdom having an average timeframe of 10-year framework, when you look—I think Senator Crapo and I spent a long time on balance sheet issues, and 

those debates have disappeared, unfortunately, from most of the 

political discussion today, but they are coming back. Any prediction, left or right, shows the deficit going up dramatically, and 

the deficit really, my belief is, is not necessarily the sole driver 

right now. 

It is the challenge of the aggregate debt totals and the effect of 

even relatively modest interest increase in rates has an enormous 

effect in terms of decreasing the ability, again, for this Government 

to have any kind of discretionary spend. So, I just ask for further 

consideration on this. 

Mr. WEISS. Senator, I would be happy to come with my team and 

brief you in great detail, along with Senator Crapo. We do have a 

policy of extending the maturity. There are some limitations to how 

quickly that can be done. They stem from the regular and predictable need for issuance, but also the fact that our deficit has come 

down so dramatically in the last few years. But, I would be happy 

to go through——

Senator WARNER. Which is also starting to ramp back up. 

Mr. WEISS. But at the same time, given the $13 trillion of marketable securities, the ultimate duration of that portfolio does not 

change quickly. 

Senator WARNER. I would love to have that brief. 

Thank you, Mr. Chairman. 

Mr. WEISS. Happy to do it. 

Senator CRAPO. Senator Heller. 

Senator HELLER. Mr. Chairman, thank you. 

I will mention that I am probably less than satisfied with the direction this particular hearing is going. I am more concerned that 

here on this panel, most of us on this panel are concerned about 

the liquidity of these markets, and yet with regulators in front of 

us, I feel that the only message that I am really getting from them, 

that there is nothing wrong with the debt market. Yet, the market 

participants are all concerned that we have seen some dips and 

some volatility in these markets that we should be concerned 

about. And, my concern about it is we have got two regulators in 

front of us that, frankly, do not share the concern that market participants have about the viability of long-term debt. 


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I will give you ample time, if you need it, to share with us, but 

hearing from our witnesses today, outside of one cheerleader here 

on our side, that, frankly, most market participants are very, very 

concerned about the long-term viability of our debt market. So, 

maybe I can try again. 

Let me ask you this question. Do either of you believe that ultralow interest rates and perhaps quantitative easing is masking some 

of the impacts that we have on reduced market liquidity? 

Mr. POWELL. I guess I should take that. So, I think very low interest rates have been a big factor in promoting primary issuance, 

which has been at record levels and greatly expanded. Any company that could finance has financed and certainly should have 

done by now. So, I do not think that has masked—I would not say 

that it is masking liquidity. 

I guess the question I would worry about is what will happen as 

the process of raising interest rates goes on. And, that will happen 

in a changed marketplace, it is very fair to say, and in that marketplace, asset managers, asset holders are going to bear more of 

the liquidity risk, because the dealers, however much they were 

bearing before, are going to be bearing less, although it is not clear 

that they were really going to be there in stress, anyway, for the 

corporate bond market. 

So, the question there is, are the asset holders, mutual funds, 

HFTs, hedge funds, and the like, are they going to be able to deal 

with stressed market conditions if they arise, and in any case, with 

a higher rate environment. So, I think those companies need to 

focus on that, and if you talk to the big asset managers, they are 

very focused on this. They are very focused on having enough liquidity on hand and on being ready to manage this new and changing environment, which is very different from the pre-crisis environment. 

Senator HELLER. Mr. Weiss. 

Mr. WEISS. I would concur with Governor Powell. As to our level 

of focus on this topic, it is intense. I would say it is among our top 

priorities at Treasury to understand the evolving nature of fixedincome markets. This is why we commissioned and published the 

joint staff report which was made public in July of last year on 

Treasury markets, and it is also why we have initiated the first 

fundamental review of secondary markets in Treasuries since 1998. 

We feel an awesome responsibility to maintain the depth and liquidity of this vital market, you know, not just for today, but for 

the decades ahead. 

Senator HELLER. Changing subjects just a little bit here, in your 

review of the global regulatory markets and the rules that are out 

there in order to—frankly, are you reviewing some of these global 

rules in order to avoid some of the harmful liquidity that we have, 

may have, or has occurred or may occur here in the United States? 

Mr. Weiss. 

Mr. WEISS. I mean, I would defer to Governor Powell. 

Mr. POWELL. I am sorry. Which rules, Senator? 

Senator HELLER. Basel. 

Mr. POWELL. The Basel rules, OK. I guess I would say it this 

way. We are—I am, and I think we are, and I know Treasury is, 

as well, very focused on conditions in fixed-income markets, and 


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that includes Treasury, cash markets, and futures, and it includes 

the corporate bond markets, investment grade, non-investment 

grade, and such. 

Senator HELLER. Do you think capitalization has any effect on liquidity? 

Mr. POWELL. I do think capital requirements—the capital requirements that we have imposed on the largest financial institutions have raised the cost of balance sheet. They have made balance sheet heavy businesses more expensive for them to run, and 

undoubtedly that is one of the reasons why they have—running 

smaller balance sheet. Repo would be sort of the center of the 

bull’s-eye on that for me. So, yes, there will have been an effect 

there. But, I would say again, it is not an effect that was unintended and we do not think it has negative consequences, particularly, that cannot be dealt with in an evolving marketplace. 

Senator HELLER. Mr. Chairman, thank you. 

Senator CRAPO. Thank you, Senator Heller. 

I have just got a couple more questions, and then we will see if 

anybody else wants to——

Senator WARNER. Mr. Chairman, I am going to have to leave, but 

I am going to leave Senator Warren to ably——

Senator CRAPO. In charge. All right. Very well. That will just reduce the number of questions. 

Senator WARREN. But not the intensity. 

Senator CRAPO. Not the intensity. 

[Laughter.] 

Senator CRAPO. I am just going to come at this one more time 

from a different direction, and I am going to talk—let us talk about 

liquidity risk. In one of the New York Fed’s research posts entitled, 

‘‘Has Liquidity Risk in the Treasury and Equity Markets Increased?,’’ the authors noted that, frankly, liquidity risk has risen, 

and I am going to just quote an excerpt and ask for your reaction 

to this. This is a quote:

While current levels of liquidity appear similar to those observed before the 

crisis, the sudden spikes in illiquidity, like the equity market flash crash 

of 2010, the recent equity market volatility on August 24, and the flash 

rally in Treasury yields on October 15, 2014, seem to have become more 

common. Our findings suggest a tradeoff between liquidity levels and liquidity risk. While equity and Treasury markets have been highly liquid in 

recent years, liquidity risk appears elevated.

Do you agree with that? 

Mr. WEISS. In fact, that is one of the areas in our request for information where we pose a whole set of questions, and it has very 

much to do with the evolution in market structure. Equities started 

to be traded primarily algorithmically, as you know, in the 1990s. 

That then moved to FX and to futures and it began in Treasuries 

in around 2003. This creates a new paradigm. The speed of markets today is measured in microseconds, as you know, and the difference between the equity market hearing which you held, I think 

it was a month ago, and the discussion of Treasuries is a difference 

in kind, not of degree. 

When the market structure changes that radically for Treasuries, 

which are a benchmark security, although we have not noted an 

impact on trading volumes or the ability to issue debt or the ability 

to transact, we do need to look forward and to make sure that the 


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operational risk measures that need to be in place are strong and 

that the protections against practices which have arisen in other 

markets are strong, as well. And, so, our whole effort is made to 

be forward looking and to assure that those safeguards are in place 

for our deepest market. 

Senator CRAPO. Governor Powell. 

Mr. POWELL. I cited that and referred to that in my testimony, 

so I do not think you can take any single piece of research as wholly dispositive. It is probably a good idea not to. But, nonetheless, 

I found that to be persuasive. And, I would just point out that they 

found no such effects in the corporate bond market. And, as I was 

referring to earlier—that is where you would expect to find these 

problems, because that is where prudentially regulated firms do 

their business, the on-the-run interdealer platform is so entirely 

electronic, that story of what is happening there is really not about 

prudential capital requirements. It is about what is going on with 

trading at billions of seconds and how that affects liquidity. 

Senator CRAPO. All right. Thank you. 

I will just conclude on this aspect before I go to my last question, 

which is a wholly different topic, by saying I appreciate the investigation and the activity that you have already engaged in. I am 

heartened by the request for information, and I just encourage and 

hope that you will look at all potential aspects of the cause of the 

issues that we are dealing here with regarding liquidity in the 

fixed-income markets. 

I am going to just go into one other question really fast. I hope 

I do not open up a whole big discussion by this, because I do not 

think this is going to be controversial, but earlier this week, the 

Government Accountability Office released its report, which Senator Warren has referenced, with regard to its recommendations on 

improving the transparency and timeliness of the Federal Reserve 

and the FDIC living-will process. I guess this question is going to 

be for you, Governor Powell. 

The credibility of the living-will process was undermined that 

very same day when the results of the Federal Reserve and FDIC 

living wills were leaked to the press the day before they were made 

public, and my question has to do with that leak. Whatever one 

thinks of the results of the living-wills process, this is not how the 

process is supposed to play out, and it shows that the process needs 

to be reformed. Something is wrong. 

And, so, my question is, Governor Powell, do you expect that the 

Inspectors General of the Federal Reserve and the FDIC will be 

tasked with finding the source of this leak and how this leak could 

have occurred? 

Mr. POWELL. Senator, let me say that I am very troubled by the 

leak, and I think both at the FDIC and at the Fed, the matter has 

been referred to the Inspector Generals. I would add, if I may, that 

the GAO report—offered some things that are well worth

considering around—and I think we have actually followed through 

on some of those recommendations already. 

Senator CRAPO. All right. Thank you. 

I note that Governor—I mean, that Senator Rounds has joined 

us. I do not know if you have any questions——


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Senator ROUNDS. I do, and thank you for the compliment, Senator. 

[Laughter.] 

Senator ROUNDS. I do have just a few, if——

Senator CRAPO. If you would like. We will do that. 

Senator ROUNDS. Thank you, and just a couple. I apologize for 

not being here. I had floor duty today, so that takes precedence. 

I know that the issues that we are talking about, they are very 

important, and that there was a real question that occurred during 

this particular event back in October of 2014. Specifically, though, 

I understand that Senator Warner had some specific questions on 

high-quality liquid municipal bonds. We have been discussing these 

issues, and I think it is an important issue that needs to be addressed. 

So, my question today is, with the fact that these Treasuries 

make up a significant part of the total bond, but there are other 

types of bonds, as well, that are also important, does this event 

support the argument that banks should be incentivized to hold a 

wide variety of potentially liquid capital rather than concentrate 

their liquid capital in assets such as Treasuries, and in particular, 

we are thinking of municipals and so forth. Would you care to comment on that? 

Mr. POWELL. I guess that is probably for me, Senator. 

Senator ROUNDS. Please, yes. 

Mr. POWELL. The liquidity coverage ratio requires that you have 

a certain amount of liquid assets to cover a 30-day outflow in stress 

conditions and it counts different securities that have different levels of liquidity at different——

Senator ROUNDS. Two-A, 2B——

Mr. POWELL. Right. You have got it. So, we put them in 2B. I 

think the other regulators did not want to count them at all——

Senator ROUNDS. Right. 

Mr. POWELL.——and are not counting them at all, so we are 

counting them to some extent. It does not in any way limit the ability of a financial institution from holding more than that. It just 

does not count in liquidity coverage ratio, that is all. And the reason that they are in that bucket is that they are just a little less 

liquid, or significantly less liquid, than the 2A assets. 

Senator ROUNDS. But, is there enough—and, once again, I understand that you have identified and have accepted 2B. Someone said 

is it 2B or not 2B, and I think 2B is better than not at all——

[Laughter.] 

Senator ROUNDS.——but, nonetheless, you are one of the organizations, not all—my question is, just in terms of a discussion on it, 

it seems to me that there is a logic behind promoting not just 

Treasuries, and it seems to me that having other types, and this 

particular event that occurred in October of 2014 seems to bring 

that to the forefront, that there are other types of securities besides 

Treasuries that are also very, very valid and that should be

considered. And, I guess I am using this as a way to point that out, 

and any other comments you may have, I would appreciate. 

Mr. POWELL. So, I would agree. We do not want our banks to 

turn into Government mutual funds, where they hold only Government securities. That is not the intention. That is not the plan. It 


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would be highly undesirable because we need them to be making 

loans and intermediating credit in our economy, performing the 

role that they are supposed to perform. So, that is not what we are 

trying to achieve with this at all, and, I think, certainly not what 

we are—what any part of our supervisory or regulatory program is 

aimed at. 

Senator ROUNDS. I also understand that I have come into this 

meeting late today, and you have been working on it already, but 

I understand that the need for stronger capital standards, but do 

you ever worry that requiring banks to hold more and more capital 

may have unintended consequences? 

Mr. POWELL. Yes. We try to set the levels—when we make a proposal for capital requirements, we put it out in a Notice of Proposed Rulemaking and we get plenty of comments and we consider 

them very carefully. We do. We try very hard to calibrate these 

things at the right level to take into consideration all of the things 

that matter. With the very largest institutions, there is a surcharge 

that they have which is supposed to really force them to internalize 

the cost of their systemic-ness, if you will. So, you know, it is a constant concern that we do the right level, certainly not too little, but 

we are also not trying to do too much. 

Mr. WEISS. I think we know that the wrong level was the level 

of capital that existed in 2006 and 2007, when banks and investment banks were capitalized at 40-to-1 or 50-to-1, with large 

amounts of off-balance sheet financial leverage and an over-reliance on short-term wholesale funding. And, so, that has now been 

remediated through the prudential standards that have been put 

in place, and we now know that in periods of volatility, and I would 

not suggest that the last 9 months have been a stress event, but 

I would suggest that they have been highly volatile market conditions as market participants would say, that we heard a lot about 

oil markets and structured—and credit markets. We heard nothing 

about the health of our financial institutions and we heard nothing 

anecdotally about hedge funds who are unable to deliver on margin 

calls. And, so, the solidity that we have built into our financial institutions really does confer on the broader market a level of confidence that we cannot take for granted. 

Senator ROUNDS. Thank you, gentlemen. 

Thank you, Mr. Chairman. 

Senator CRAPO. Thank you, Senator Rounds. 

And, I think we are done with questions. 

Senator WARREN. Can I just say one thing, Mr. Chairman——

Senator CRAPO. Sure. 

Senator WARREN.——just because of Mr. Weiss’ last comment 

and Senator Rounds’ comment about the unintended consequences 

of higher capital reserves, the fact that you say over the last 9 

months we have heard nothing about the health of our largest financial institutions. We just got a report yesterday from the Federal Reserve Bank and the FDIC that there are five banks in 

America that are too big to fail. And if we have a regulatory problem, what that suggests to me is the regulatory problem is we still 

have not done enough in terms of capital reserve, in terms of regulation, in terms of making sure that these banks are reined in and 

do not put the rest of the economy at risk. 


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The report is there. And, the report makes it clear. We are all 

at risk, not because of over-regulation, but because of under-regulation of the biggest financial institutions. 

That is it for me, Mr. Chairman. 

Senator CRAPO. Senator Rounds. 

Senator ROUNDS. And I think it is a healthy discussion to have. 

The important part, I think, is that when we take a look at making 

changes in it, naturally, there is a reason why they settle on a particular number. I do not think any number is perfect. I think the 

question becomes, talk to us about how you come up with the numbers involved and what type of analysis is done, and then as you 

move through and you learn, go up, go down, but when you analyze 

them, what is the process in place in order to do that. 

And, I think it is healthy to have that discussion, because if you 

require more capital, then that is money that is not going to be 

available for other resources. And, that does not mean that we 

have a perfect number at any point in the process. And, while we 

want stability within the market, we also want those regulators to 

have a process that the individuals, the institutions that are being 

regulated understand and have the opportunity to give positive 

input in making changes in the future. 

And, that is the reason why I ask. I just do not simply think that 

one determining time period, one decision should be infallible. And, 

so, I like the idea of being able to revisit, and the idea of being able 

to have that on an ongoing basis, but in a stable manner, one in 

which the members have a process, the institutions understand the 

process, and there is input which makes for a better decisionmaking process. That is the reason why I asked the question. 

Senator WARREN. And I very much appreciate that, that we have 

to have the right process in place. But we also have to pay attention to the fact it is now 8 years after a crash that brought us to 

the edge of economic oblivion. And what the Fed and the FDIC are 

saying very publicly today is that we have at least five too-big-tofail banks in this country, that if any one of them starts to go 

down, they risk taking the entire economy with them. 

And that tells me, you are right, we need to keep checking, but 

the place we need to keep pushing is we need to keep pushing on 

tougher regulations over these financial institutions. They come to 

Congress and want to lobby us on, oh, it is too tough, and let me 

tell you why it is too costly and we want fewer, fewer, fewer regulations. But the reality is, they put everybody else at risk when they 

are not properly supervised. 

Senator ROUNDS. It is good to have the give and take. 

Senator CRAPO. I was about to wrap it up. I was going to take 

the last word, and I still will, but I am going to go to Senator Reed, 

if you have some questions, Senator Reed. 

Senator REED. Thank you very much, Mr. Chairman, and thank 

you, Senator Warren, for making sure I—no, thanks. 

[Laughter.] 

Senator REED. I am going to be, I hope, succinct. Thank you, gentlemen, for your wonderful testimony. 

It struck me as we talked about the liquidity of Treasuries, particularly, that there are many factors, and you describe them, the 

market structure, et cetera, but one factor which Mr. Weiss


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highlighted in his comments, at the Federal Reserve back in 2015, 

is the debate here about the debt ceiling, about suggesting that we 

might not respond favorably to—can you comment about that as a 

factor that would affect liquidity or market activity with Treasuries. 

Mr. WEISS. Well, I have lived through one debt ceiling from inside Treasury and I can confirm that it is truly scary from inside 

the institution. Fortunately, Congress worked with the administration to agree to a 2-year budget deal which also dealt with the debt 

ceiling in that particular period, but, Senator, you are quite right. 

If you look back at 2013, and 2013 was different in that there was 

a Government shutdown, as well, but consumer confidence declined 

by, I think it was 12 percent. The S&P traded off. The U.S. had 

its sovereign debt rating downgraded. And there are some estimates that GDP growth was cut by as much as a half-a-percentage 

point, a half-a-percentage point which is hard to recover. 

And, so, all I can say, Senator, is I hope that following the 

smooth process that was in place at this past year end, that we not 

revisit these kinds of self-inflicted wounds due to the breadth of 

damage they do to the economy. 

Senator REED. Just a final very quick point, too. As I would assume that you were trying to count, figure out what would happen 

to Treasuries in that situation, because it is uncharted terrain, and 

mercifully we did not get there, but for a moment, it looked as if 

all the rules would be erased and you would have these——

Mr. WEISS. Absolutely. As Governor Powell will remember from 

his time at Treasury, we had our fiscal teams and our debt management teams in hourly standby to deal with every possible

eventuality. 

Senator REED. Thank you. 

And, Governor Powell, again, thank you, not only for your testimony, but for your service for the many years. We appreciate it. 

One of the points that you made in your testimony and also in 

your comments is about the role of high-frequency trading on October 15, 2014. I know my colleagues have been asking questions, but 

do you have any further thoughts about high-frequency trading and 

its effect on the crash or its ongoing sort of challenges? 

Mr. POWELL. Senator, I just would say that it is here to stay. 

Electronic trading, algorithmic trading is now very prevalent in the 

equity markets and in the interdealer part of the Treasury market. 

It is enabled by technology and telecommunications, and we need 

to know that it is here to stay and we need to make sure that it 

takes part in these markets in a way that protects the safety and 

soundness and allows the public to retain confidence. And, that is 

just how we look at it, and I think it is—I would not blame the 

events of October 15——

Senator REED. No——

Mr. POWELL. I would not, and I know you did not. 

Senator REED. Right. 

Mr. POWELL. But, nonetheless, I think our obligation is to understand the evolution of these markets and make sure that the public 

has a basis for continued confidence. 

Senator REED. And, I have one final question for both of you. We 

all, or many of us engaged—Senator Crapo particularly was an


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incredibly thoughtful, active Member of the Committee when we 

passed the Dodd-Frank reforms. I know there are things we would 

like to rearrange, change, improve, et cetera. But, by and large, do 

you have a sense of whether they are helping to stabilize the financial institutions in a positive way? Governor Powell first. 

Mr. POWELL. I think it is, to me, very clear that financial institutions are much stronger, safer, sounder, more resilient, better capitalized, more liquidity, less risky, and all of those things than they 

were before the financial crisis and Dodd-Frank certainly gets some 

of the credit for that. 

Senator REED. Thank you, Governor. 

Mr. Weiss, please. 

Mr. WEISS. You know, it is undoubtedly the case. It is also the 

case that we have work cut out for us and this is why we have 

issued our request for information on Treasury markets. It is also 

why the FSOC is looking into issues of liquidity and redemption 

risk in certain asset management activities. So, I would not want 

to say that we are satisfied. There is plenty of work to do, but as 

to the past, those regulations have stood us in good stead. 

Senator REED. Just a final point. In your research now, I hope 

you can fully engage OFR——

Mr. WEISS. Absolutely. OFR will be central. 

Senator REED.——and do it in a very positive, constructive way. 

That would be another aspect of Dodd-Frank that could be very 

productive. 

Thank you, Mr. Chairman. Thank you for waiting for me. 

Senator CRAPO. Well, thank you, Senator. 

So, let me wrap this up. You know, toward the end of the hearing 

today, and actually throughout the hearing, we had several occasions when the question of what is the appropriate level of regulation has arisen, and I would just like to throw in my two cents before I rap the gavel. 

Undoubtedly, as I said in my opening statement, and as you just 

both have reiterated, our financial institutions are stronger, safer, 

sounder, better capitalized with higher quality capital than they 

were before the crisis, and that is a positive development. 

I personally believe that, and as I indicated to you, Governor 

Powell, from my reading of the studies that have been done with 

regard to our fixed-income markets and the question of whether we 

have a liquidity risk increasing in those markets, that one of the 

factors that has been identified, I think by every entity that has 

studied it, is whether the—and this is not just the capital regulatory issue. It is whether the cumulative effect of regulations by 

the different regulators on the different aspects of the financial system is creating liquidity risk. 

And, I think, first and foremost, we need to recognize, I believe, 

that there is a tradeoff, and it is a tradeoff that is one we need to 

make. We need to understand it and we need to reach the right 

levels of tradeoff in these decisions. 

And, so, while we can all have different opinions about what may 

or may not be the right level of capital that is required, the right 

level of leverage, the right qualities of capital, or as we go on to 

increasing issues that are covered in the regulatory system, to me, 

the point that I would like to make is, and I hope that you are 


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doing this, is that we have got to look at these issues and evaluate 

what the causes are—that is what your request for information is 

seeking to do—evaluate what the causes are if there is a liquidity 

risk issue in these markets, and then identify those causes and 

then make a decision as to whether those causes can be remedied 

or whether there is other risk or danger that would be created by 

proposed or by adjustments in those. 

That is the kind of decision that we need to engage in, and so—

and you are the experts. You are the ones who are charged, along 

with some of the other regulators, to make these evaluations and 

assure that our system is promoting the maximum safety and 

soundness that we can achieve with a recognition of the impacts 

on liquidity and other impacts on our markets that are caused by 

that. 

That is what I am trying to get at here, and I am very hopeful 

that as you go forward in your analysis, that you will take those 

into consideration. We will probably continue to have political debates about this for a long time, but what we hope to see is that 

our regulators will continue to review their own activities in terms 

of the impacts of their activities on these markets and make sure 

we get that balance right. 

I am just going to make one other observation here. I think you 

are aware, we have a Federal law that requires some of our regulators to review their own regulations on a regular basis, the 

EGRPRA process. Not all of our Federal regulators or financial regulators are subject to EGRPRA. I have got a bill that says that all 

of them should be subject to EGRPRA, simply because of the principle that we should always be reviewing the status of our regulatory system and the legal system that we put into place to assure 

that we have safety and soundness and vibrant and strong markets. 

So, with that, I want to thank you both for being here. I appreciate the attention you are giving to these issues. I am sure that 

you will continue to get a lot of input from the members of this 

panel as you move forward, and we look forward with anticipation 

to the outcome of your analysis. 

Mr. WEISS. Thank you. We would be happy to come and share 

the outcome of the RFI when it is complete. 

Senator CRAPO. Thank you. This hearing is adjourned. 

Mr. POWELL. Thanks very much. 

[Whereupon, at 11:45 a.m., the hearing were adjourned.] 

[Prepared statements and responses to written questions supplied for the record follow:] 


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1See Joint Staff Report: The U.S. Treasury Market on October 15, 2014, U.S. Department of 

the Treasury, Board of Governors of the Federal Reserve System, Federal Reserve Bank of New 

York, U.S. Securities and Exchange Commission, U.S. Commodity Futures Trading Commission, 

July 13, 2015, www.treasury.gov/press-center/press-releases/Documents/JointlStafflReport

lTreasuryl10-15-2015.pdf, and Conference Summary: The Evolving Structure of the U.S. 

Treasury Market (October 20–21, 2015), Federal Reserve Bank of New York, October 20, 2015, 

www.newyorkfed.org/medialibrary/media/newsevents/events/markets/2015/Conference-Summary.pdf. 2See Tobias Adrian, Michael Fleming, Daniel Stackman, and Erik Vogt, Has Liquidity Risk 

in the Treasury and Equity Markets Increased?, Liberty Street Economics (blog), October 6, 

2015, http://libertystreeteconomics.newyorkfed.org/2015/10/has-liquidity-risk-in-the-treasuryand-equity-markets-increased.html#.Vv7UvOab-p0. 3See Dobrislav Dobrev and Ernst Schaumburg, The Liquidity Mirage, Liberty Street Economics (blog), October 9, 2015, http://libertystreeteconomics.newyorkfed.org/2015/10/the-liquiditymirage-.html#.Vv7Woeab-p0. 4See Tobias Adrian, Michael Fleming, Or Shachar, Daniel Stackman, and Erik Vogt, Has Liquidity Risk in the Corporate Bond Market Increased?, Liberty Street Economics (blog), October 

6, 2015, http://libertystreeteconomics.newyorkfed.org/2015/10/has-liquidity-risk-in-the-corporate-bond-market-increased.html#.Vwu8lOab-p0. 5See Tobias Adrian, Michael Fleming, Daniel Stackman, and Erik Vogt, Has U.S. Treasury 

Market Liquidity Deteriorated?, Liberty Street Economics (blog), August 17, 2015, http://

libertystreeteconomics.newyorkfed.org/2015/08/has-us-treasury-market-liquidity-deteriorated.

html#.Vv7HQDP2bT4. 6 Ibid.

PREPARED STATEMENT OF JEROME H. POWELL

MEMBER, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

APRIL 14, 2016

Chairmen Crapo and Heller, Ranking Members Warner and Warren, other Subcommittee Members, I would like to thank you for inviting me to testify today on 

trends in fixed-income markets. Because these markets perform important functions 

in our economy, it is imperative that we understand the significant changes they 

are currently undergoing. As I will discuss, a number of factors have been driving 

these changes. 

Some market participants have expressed concerns about low liquidity across 

fixed-income markets, although many recent studies have found it difficult to identify such a broad reduction. It may be that liquidity has deteriorated only in certain 

market segments. It may also be that, even if liquidity is adequate in normal conditions, it has become more fragile, or prone to disappearing under stress. 

The sharp swing in Treasury prices that took place on October 15, 2014, led the 

Federal Reserve Board, in conjunction with the Treasury Department, the Commodity Futures Trading Commission, the Federal Reserve Bank of New York, and 

the Securities and Exchange Commission, to create a Joint Staff Report and to host 

a conference on the structure of Treasury markets at the Federal Reserve Bank of 

New York (FRBNY) in October 2015.1 The staff of the four agencies and the FRBNY 

compiled transactions data across both Treasury cash and futures markets and analyzed the factors that could have caused the rapid rise and subsequent reversal in 

Treasury prices in such a short span of time. This analysis did not find a single 

factor that caused the sharp swing in prices. 

As had already occurred in equity markets, advances in computing and communications technologies have allowed proprietary trading firms (PTFs, also often 

called high-frequency trading firms) to capture a majority of the interdealer market 

in Treasuries. As a consequence of these changes, trading in Treasury markets now 

moves at extreme speed. It may be that these changes have also led to greater liquidity risk, or sudden declines in liquidity. Researchers at the FRBNY have shown 

that spikes in volatility and sudden declines in liquidity have become more frequent 

in both Treasury and equity markets.2 There is also evidence that liquidity shifts 

more rapidly and hence is less predictable in these markets.3 In contrast, researchers have not found evidence of these behaviors in corporate bond markets, where 

traditional dealers still intermediate most trades and there is much less high-frequency trading.4

Apart from such episodes of sudden volatility, questions about whether liquidity 

in fixed-income markets has broadly deteriorated are difficult to answer definitively. 

In exploring these topics, it is important to distinguish between Treasury and corporate bond markets, which have different characteristics. 

In Treasury markets, traditional measures of liquidity, such as bid-ask spreads, 

have been fairly stable in recent years.5 But the changing market structure has also 

meant smaller average trade sizes,6 and participants now must break up their larger trades and employ complicated strategies in order to avoid moving prices.


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7See for example, Terrence Hendershott, Charles M. Jones, and Albert J. Menkveld, ‘‘Implementation Shortfall with Transitory Price Effects,’’ in High Frequency Trading; New Realities 

for Trades, Markets and Regulators, David Easley, Marcos Lopez de Prado, and Maureen O’Hara 

(editors), Risk Books (London: 2013), http://albertjmenkveld.org/public/papers/chap- terlELOv5.pdf. 8See Bruce Mizrach, ‘‘Analysis of Corporate Bond Liquidity,’’ Financial Industry Regulatory 

Authority (FINRA), Office of the Chief Economist Research Note, December 2015, 

www.finra.org/sites/default/files/OCElresearchnotelliquidityl2015l12.pdf. 9 Ibid.

10See Tobias Adrian, Michael Fleming, Erik Vogt, and Zachary Wojtowicz, Further Analysis 

of Corporate Bond Market Liquidity, Liberty Street Economics (blog), February 10, 2016,

http://libertystreeteconomics.newyorkfed.org/2016/02/further-analysis-of-corporate-bond-market-liquidity.html#.Vv7ZcOab-p0. 11See Hendrik Bessembinder, Stacey E. Jacobsen, William F. Maxwell, and Kumar 

Venkataraman, Capital Commitment and Illiquidity in Corporate Bonds, Social Science Research Network (SSRN), March 21, 2016, http://papers.ssrn.com/sol3/papers.cfm?

abstractlid=2752610. 12 Conference Summary: The Evolving Structure of the U.S. Treasury Market (October 20–21, 

2015), Federal Reserve Bank of New York, 2015, www.newyorkfed.org/medialibrary/media/

newsevents/events/markets/2015/Conference-Summary.pdf. 13See Evangelos Benos, Richard Payne, and Michalis Vasios, Centralized trading, transparency and interest rate swap market liquidity: evidence from the implementation of the DoddFrank Act, Bank of England, Staff Working Paper No. 580, January 15, 2016, 

www.bankofengland.co.uk/research/Documents/workingpapers/2016/swp580.pdf. 14See Tobias Adrian, Michael Fleming, Daniel Stackman, and Erik Vogt, What’s Driving Dealer Balance Sheet Stagnation?, Liberty Street Economics (blog), August 21, 2015, http://

libertystreeteconomics.newyorkfed.org/2015/08/whats-driving-dealer-balance-sheet-stagnation.

html#.Vwz69Oab-p0.

Accurately measuring the effect of trading on prices, perhaps the most fundamental 

gauge of market liquidity, can be quite difficult in such an environment.7 There are 

also differences between on-the-run Treasury securities, the securities that were 

most recently issued and that are the most liquid, and off-the-run Treasury securities. However, observable measures such as the spread between on- and off-the-run 

Treasury securities do not show any trend change in liquidity between the two market segments since the financial crisis. 

In corporate bond markets, estimated bid-ask spreads have declined, indicating 

that, if anything, liquidity may have improved.8 However, given the nature of the 

corporate bond market, these estimates are based on transactions rather than on 

direct observations of quotes to buy or sell these bonds. What we can directly observe is that trade sizes and turnover have declined in the most actively traded corporate bonds as they have in Treasury markets.9 And although observable measures 

of overall liquidity in corporate bond markets appear good, there is some evidence 

that liquidity has deteriorated for the lowest-rated bonds.10 Trading in these less 

liquid segments may rely heavily on intermediation by dealers, and dealers have 

scaled back their capital commitments and inventories in corporate bonds since the 

financial crisis.11

Immediately after the financial crisis, dealers began to move away from a principal model of market making, whereby they would facilitate trades using their own 

inventories and assume some risk, toward an agency model. Many point to post-crisis regulation as a key factor in this process. One area in particular where market 

participants point to the impact of regulation is Treasury repo markets. At the 2015 

conference, participants noted that required spreads on Treasury repo trades have 

widened significantly since the crisis and attributed some of this increase to regulation.12

But post-crisis regulations have also greatly strengthened the major banks and 

made another financial crisis far less likely. Evidence also indicates that certain regulations have increased liquidity; for example, the mandate that more standardized 

derivatives be traded on organized exchanges or platforms appears to have improved 

market functioning.13 My view is that these regulations are new, and we should be 

willing to adjust them as we learn. That said, we should also recognize that some 

reduction in market liquidity is a cost worth paying in helping to make the overall 

financial system significantly safer. 

It is important, however, not to overemphasize any effects of regulation. Banks 

have independently recalibrated their own approaches to risk and scaled back their 

market-making activities. Dealers significantly reduced their fixed-income portfolios 

beginning in 2009, well ahead of most post-crisis changes in regulation.14

Corporate debt issuance has been at record levels in recent years. With dealer balance sheets shrinking, buy-side investors now bear greater liquidity risk. It is important that mutual funds and other investors in fixed-income securities continue 

to take measures to understand and manage these risks. In addition, we should


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15See SIFMA Electronic Bond Trading Report: U.S. Corporate and Municipal Securities, Securities Industry and Financial Markets Association (SIFMA), February 17, 2016, www.sifma.org/

issues/item.aspx?id=8589958906.

distinguish between systemic risk and market risk. The risks to investors generally 

represent market risk and do not appear to pose risks to the financial system as 

a whole. The movement of these risks away from the Nation’s most systemically important financial institutions is one of many reasons that they are far stronger and 

more resilient than before the crisis. 

Markets are adapting to this new environment. Where there is an unmet demand 

for liquidity, new market makers are emerging to meet that demand. For example, 

some PTFs are seeking entry to dealer-to-customer platforms for Treasury trading. 

Seven new electronic trading venues entered the market for corporate and municipal bonds over the last 2 years, and several more are preparing to launch this 

year.15 While there is no guarantee of success for these entrants, markets will continue to evolve. Thus, it is too early to judge the ultimate impact of factors affecting 

fixed-income liquidity. 

One thing that will help in this judgment is better data. At the 2015 conference, 

many market participants expressed a desire for more publicly available data on 

Treasury markets. It is striking that so little data is available—even to regulators—

on trading in our Nation’s Treasury market. It took considerable effort to gather detailed trade data for just the single day of October 15, 2014, in writing the Joint 

Staff Report. The Board has been supportive of the Treasury Department’s current 

Request for Information (RFI), which will be concluding on April 22. The RFI will 

provide information on this issue, as we reassess the adequacy of public information 

and of the data available to the official sector for its own monitoring of these markets. 

Thank you. I would be pleased to answer any questions you may have. 

PREPARED STATEMENT OF ANTONIO WEISS

COUNSELOR TO THE SECRETARY, DEPARTMENT OF THE TREASURY

APRIL 14, 2016

Chairmen Crapo and Heller, Ranking Members Warner and Warren, and Members of both Subcommittees:

Thank you for inviting me to testify today on behalf of Treasury and alongside 

Governor Powell from the Federal Reserve Board (Fed). We have been partners with 

the Fed, and Governor Powell in particular, on several topics related to today’s hearing. Thank you to both Committees for choosing to hold a hearing on fixed-income 

markets, which are at the heart of our financial system and are undergoing substantial change. 

The primary markets for fixed income are functioning exceptionally well in the 

United States. Indeed, the past 4 years have seen record issuance of corporate 

bonds, as both domestic and foreign companies continue to rely on U.S. markets to 

raise capital. 

By most traditional measures, U.S. secondary markets are also functioning well. 

There is no compelling evidence of a broad deterioration in liquidity. But financial 

markets, fixed-income markets in particular, are undergoing structural changes, 

driven by technology, changing risk appetites and business models, much-needed financial reform, and changes in the investor base. 

Moreover, these developments are occurring against a cyclical backdrop in which 

the United States is transitioning toward normalization from nearly a decade of

unprecedented monetary policy, a transition long expected to be accompanied by

volatility. 

Policy makers are focused on enhancing financial stability and maintaining wellfunctioning markets through periods of stress. In this regard, reforms adopted in

response to the crisis have demonstrably strengthened the core of the financial system. Markets have experienced several bouts of turbulence over the past few 

years—from the ‘‘taper tantrum’’ to European sovereign debt crises to the volatility 

last August and earlier this year. In each case, U.S. financial institutions have demonstrated resilience, instilling confidence in the broader system. This is no accident. 

Financial reform has built stronger, more stable institutions. And the stress tests 

every large bank undergoes annually are far more severe than anything experienced 

since the crisis. Financial reform has created a buffer for volatile times. 

But the tests will surely become more difficult, and we cannot afford to become 

complacent. At Treasury, our focus is on understanding the transitions that are


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underway, and anticipating the demands of the new environment. Treasury is working with the other agencies with authorities in Treasury markets to undertake the 

most comprehensive review of the Treasury market since 1998. And U.S. market 

regulators continue to address potential operational risks associated with technological changes in their respective markets. 

Record Issuance in Fixed-Income Primary Markets 

Fixed income markets play a central role in the U.S. economy, channeling savings 

into investment and providing credit to households, governments, and businesses. 

Well-functioning markets facilitate critical financing to Federal, State, and local governments, to households for mortgage and automobile loans, and to businesses for 

investments, job creation, and innovation. 

Capital markets play a larger role in the U.S. economy than in other large, developed economies. Roughly two-thirds of credit is provided by capital markets in the 

United States, and one-third through bank lending, compared to a roughly 50/50 

split in the European Union (EU). The EU, in fact, is taking steps to develop a ‘‘capital markets union’’ to foster more dynamic markets and reduce reliance on bank 

funding, which proved costly in the crisis and has likely contributed to Europe’s 

slower pace of recovery relative to the United States. 

Primary markets for fixed income in the United States have performed exceptionally well for the past several years. Issuance has been strong—indeed, corporate 

bond issuance reached record levels over the past 4 years. Companies have taken 

advantage of low interest rates and strong investor demand to issue $7.8 trillion in 

bonds since the beginning of 2010. This funding is being used for investments in 

plants, equipment, software, research and development, and new workers, to return 

money to shareholders, or to build cash buffers to provide financial flexibility. 

Issuance has not been limited to U.S. companies—foreign corporations raised over 

a trillion dollars in debt in the U.S. market in the same period. 

The market for private residential mortgage-backed securities has yet to recover. 

Investor confidence was badly damaged during the crisis and economic incentives 

for banks to securitize their non-agency mortgages remain weak. But the market 

for residential mortgage securities backed by Fannie Mae and Freddie Mac has remained strong, and mortgage rates remain near record lows, supporting the ongoing 

recovery in the U.S. housing market. 

The Administration remains focused on expanding access to credit for creditworthy individuals and businesses who remain underserved. But for borrowers with 

access to the capital markets, the past several years have been a time of plenty. 

Secondary Market Liquidity 

For the most part, U.S. secondary markets are also functioning well, demonstrating resilience through recent periods of volatility that were driven by an

uncertain global economic outlook. 

Despite repeated claims to the contrary, there is no compelling evidence of a 

broad-based deterioration in liquidity. In fact, most traditional measures of liquidity 

across U.S. fixed-income sectors are well within historical levels. 

There is no standard definition of liquidity that encompasses all the variables that 

matter across products and investor categories. In the broadest sense, market liquidity refers to the ease with which buyers and sellers can meet in the marketplace and transact. Market participants point to a number of measures as proxies 

for liquidity, including bid-ask spreads, trading volume, market depth, and the price 

impact of trades. Each of these measures captures some aspect of liquidity, but none 

is comprehensive. Which measure of liquidity matters also depends on which element of liquidity you prioritize. For certain professional investors who trade frequently, low transaction costs and minimal impact on price may be important. For 

long-term investors, keeping costs down over time may matter more than short-term 

transaction costs. For large investors such as pensions or retirement funds, the ability to execute a large transaction may be most important. And these priorities will 

shift in response to changing market conditions. 

In the Treasury market, bid-ask spreads and measures of the price impact of 

trades in the market for the most-recently issued Treasury securities are all well 

within historical ranges (Charts A and B). Market participants often cite as evidence of worsening liquidity conditions smaller trade sizes or recent declines in 

measures of depth—i.e., the amount available to be purchased or sold at the top levels in the order book. However, smaller trade sizes are consistent with the increasing predominance of electronic and algorithmic trading in the Treasury market. And 

while depth appears to have declined from recent high levels, it is well within historical ranges. The elevated levels from late 2011 into 2013 may have been due to 

investor conviction regarding a stable outlook for interest rates (Charts C and D). 


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There have, however, been isolated episodes in recent years of brief spikes in volatility, associated with deteriorating liquidity conditions during those spikes. The 

most extreme example was the October 15, 2014 ‘‘flash rally’’ in Treasuries, when 

the yield on 10-year notes experienced a 37-basis point roundtrip over a span of 

roughly 12 minutes. This episode raises the possibility that improved day-to-day liquidity, as measured by bid-ask spreads and price impact, may have come at the 

cost of rare but severe bouts of volatility and strains in liquidity. 

If these episodes remain rare and fleeting, like October 15, the ultimate impact 

on the Treasury market will likely be minimal. But if the disruptions become more 

frequent, the effect could be more significant. We have seen similar episodes in U.S. 

equities, such as the May 2010 ‘‘flash crash,’’ and foreign exchange markets—two 

other markets with significant levels of algorithmic trading. But we must be especially watchful when it comes to the world’s risk-free benchmark, and this is why 

we initiated the first comprehensive review of the Treasury market since 1998. 

Market participants also report challenges in the market for aged, or ‘‘off-therun,’’ Treasuries. The price differences between on- and off-the-run Treasuries do 

not indicate a great disparity in liquidity conditions (Chart E), but due to data limitations we do not have as granular a view into off-the-run markets. As discussed 

further below, we are working to address these data limitations. 

In U.S. corporate bond markets, measures of transaction costs are also well within 

historical ranges, and perhaps even healthier than in the early 2000s (Chart F). 

Some have pointed to a decline in dealer inventories of corporate bonds since 2006 

and 2007 as a harbinger of declining liquidity, because dealers would be less likely 

to act as ‘‘shock absorbers.’’ But analysis by Goldman Sachs and others shows that 

pre-crisis inventory levels were inflated by holdings of mortgage-backed securities 

and esoteric structured products that are no longer used. Actual corporate inventories have declined, but were not large in relation to the overall market to begin 

with. Moreover, the relationship between inventories and liquidity is far from clear. 

Research from the Federal Reserve Bank of New York shows that dealer positions 

tend to be procyclical (Chart G). In other words, rather than acting as shock absorbers, dealers have historically reduced their positions during periods of stress. 

Overall, corporate bond trading volumes have increased (Chart H), a sign that 

there has been no broad withdrawal from the U.S. market. Average trade sizes have 

begun to decline, as well as the proportion of large ‘‘block’’ trades (Charts I and J). 

These data points are consistent with trends toward greater electronification and 

more ‘‘agency-based’’ intermediation, which are discussed below. As Fed Governor 

Lael Brainard recently pointed out, these data points are also consistent with reports by market participants of the need to break up large trades into smaller 

trades over time. 

Financial Reform Strengthened the Core of the Financial System 

Market liquidity is an important element in a well-functioning financial system. 

As we learned so painfully in the crisis, and less dramatically in many other instances, when secondary markets cease to function effectively, firms and households 

can lose access to the primary markets, cutting off their access to financing for investments, hiring, and home purchases. 

But liquidity is also a function of market dynamics, and varies across markets 

and over cycles. Prior to the crisis, liquidity was abundant by almost any measure. 

However, this liquidity was a result of soaring financial sector leverage, an overreliance on short-term funding, and financial activity driven by a proliferation of 

structured and synthetic vehicles, often held off-balance sheet. Some investment 

banks were leveraged 40- or 50-to-1, while short-term wholesale funding had grown 

to over 30 percent of the largest banks’ and investment banks’ total assets. That 

apparent liquidity not only disappeared when it was needed most, but led to forced 

selling that greatly exacerbated financial distress. 

Policy makers have taken significant steps following the crisis to strengthen the 

core of the financial system, to reduce the vulnerability of markets to those kinds 

of fire sale dynamics. In particular, financial reform has created more resilient financial intermediaries, more stable funding profiles, and sounder market structures. 

These steps have contributed to more resilient financial markets that are better prepared to continue to support the economy through periods of stress. 

A major pillar of post-crisis reform has been to create more resilient financial institutions, most fundamentally by increasing capital requirements. Stronger market 

intermediaries are better able to absorb risks under stressed conditions, and reduce 

the risk of market disruptions. Policy reforms and changes in market practices following the crisis have also led to significant declines in leverage, as the largest 

banks have more than doubled their capital levels since 2009. 


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A second pillar of reform is more resilient funding structures. The largest financial institutions have more than doubled their holdings of high-quality liquid assets, 

increased their deposit base, and reduced their reliance on short-term funding by 

nearly half. Off-balance sheet funding vehicles have all but disappeared. 

A third pillar in these efforts is building more fundamentally sound market structures. Financial reform required certain standardized derivatives to be centrally 

cleared and traded on transparent platforms, and all derivatives contracts to be reported to swap data repositories. According to CFTC Chairman Massad, 75 percent 

of interest rate swaps are now centrally cleared, compared to 15 percent in 2007. 

These reforms are enhancing resilience and transparency in one of the largest markets in the world, a market closely linked to other fixed-income markets. 

In the remainder of my testimony I will describe the changes underway in U.S. 

fixed-income market structure, and the efforts by Treasury and other policymakers 

and market participants to respond to these changes. 

Changes in Fixed-Income Market Structure 

The structure of fixed-income markets is undergoing significant transition. This 

transition is driven by advances in technology, changes in business models and risk 

appetite, and much-needed regulatory reforms adopted in response to the crisis. 

Many of these changes are also contributing to a change in the way intermediaries 

match buyers and sellers in these markets. Shifts in the composition of asset owners 

are also playing an important role. 

In a trend that pre-dates the crisis, technology is enabling the spread of electronic 

trading across fixed-income markets. In markets for standardized, benchmark securities, algorithmic trading has become predominant. This transition began in the 

1990s in equities, and then spread to futures and foreign exchange markets. Beginning just over a decade ago, the inter-dealer market for the most recently issued 

Treasury securities-so-called ‘‘on-the-run’’ securities-began to transition toward algorithmic trading. Partly as a result of technology upgrades in recent years, algorithmic trading by principal trading firms (PTFs) now accounts for over half of trading volume in this market on most days, and up to 70 percent of volume during 

volatile trading. 

In markets for securities with a greater degree of customization, like corporate 

bonds, algorithmic trading has not taken root, but more basic electronification has 

begun. In some cases, the old ways of doing business over the telephone—that is, 

customers requesting dealers to provide quotes—have simply migrated to the computer screen. There is also a small, but growing, portion of corporate bond trading 

happening on ‘‘all-to-all’’ venues—that is, trading directly between end investors 

without a dealer between them. 

There is also a transition underway in how intermediaries match buyers and sellers. Fixed-income securities markets have historically been a predominantly ‘‘principal-based’’ market. Intermediaries bought securities from investors looking to sell, 

and held them on their own balance sheet until a buyer could be found. The majority of fixed-income securities markets remain principal-based, with dealers accounting for well over half of all volume in both Treasury and corporate bond markets. 

But ‘‘agency’’ intermediation, where intermediaries match buyers and sellers for a 

commission, is increasingly prevalent in fixed-income markets, especially markets 

for standardized, benchmark securities. 

Changes in business models, competition from new entrants, and much-needed 

regulatory reforms adopted in response to the crisis have likely contributed to the 

shifts described above. Large banks and broker-dealers have significantly reduced 

their leverage, reined in their risk appetites, and sought more resilient sources of 

funding. Meanwhile, new entrants such as PTFs, previously active mostly in equities and futures markets, are increasingly competing with traditional dealers for 

market share in standardized products such as on-the-run Treasuries. 

The composition of buyers and sellers is also changing. The growth of open-end 

mutual funds investing in corporate bonds has received significant attention—mutual funds now own over 20 percent, or over $2 trillion, of U.S. corporate bonds. 

There is concern that funds offering daily liquidity to investors but investing in less 

liquid assets may be forced sellers in a stressed environment, or may contribute to 

spillovers by selling more liquid assets to meet redemptions. 

At the same time, large investors like pension funds, sovereign wealth funds, and 

insurance companies have continued to grow. These investors typically buy and hold 

large portfolios of bonds, as they seek to match their long-term liabilities with fixedincome returns. In total, there are over $30 trillion of fixed-income securities held 

by this diverse set of buyers, with differing investment objectives. These investors 

may ultimately be the buyers of last resort during periods of turbulence. Indeed, research shows that was likely the case during the 2013 ‘‘taper tantrum.’’ These shifts 


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are all taking place against a backdrop in which the United States is transitioning 

to a path of normalization from nearly a decade of unprecedented monetary policy. 

Market participants have always expected this period of adjustment would be accompanied by turbulence as expectations for economic and financial conditions adjust. Indeed, volatility in Treasuries has typically preceded other recent rate hiking 

cycles. 

In this regard, it is important to distinguish between re-pricing events, driven by 

fundamental factors, and breakdowns in market functioning that may be exacerbated by poor liquidity. As PIMCO noted in a recent op-ed, ‘‘[a]brupt changes in 

valuations are not necessarily liquidity events.’’

All of these shifts are changing the way buyers and sellers meet and transact in 

fixed-income markets. The end-state for fixed-income trading remains far from certain, but it is important to understand that economic and financial cycles, advances 

in technology, financial product innovations, and policy all play a role. 

Policy Priorities to Build More Resilient Market Structures 

At Treasury, we are engaged in several efforts to understand and respond to the 

changes underway in financial markets, and safeguard the resilience of the U.S.

financial system. Most importantly, we are focused on completing and safeguarding 

financial reform. Nothing would do more to undermine the resilience of our markets 

than rolling back Wall Street Reform. The Administration is working with regulators to implement all remaining material elements of Dodd-Frank by the end of 

the year. Internationally, Treasury is working to ensure other countries follow 

through on their commitments as well, to reduce risks that may emanate from 

abroad. 

We are also working to address potential vulnerabilities in financial market structure. Most notably, Treasury is engaged, together with the Fed, Federal Reserve 

Bank of New York, CFTC and SEC, in the most comprehensive review of the Treasury market since 1998. As part of this review, in January Treasury issued a Request for Information (RFI) on the evolution of Treasury market structure seeking 

feedback on a series of detailed questions across four areas:

• The evolution of the Treasury market;

• Risk management practices and market conduct across the Treasury market;

• The types of data that should be made available to the official sector regarding 

Treasury cash market activity, and numerous practical considerations associated with gathering that data; and

• Potential additional reporting of Treasury market transactions to the public. 

The comment deadline is April 22, and we look forward to reviewing all responses, and would be happy to report back to these Subcommittees with key 

findings.

At this point, the most immediate conclusion from our work is that the official 

sector needs access to more data, on a more timely basis, with more effective data 

sharing mechanisms. The RFI seeks comment on the most effective and efficient 

way to achieve these objectives, and by the end of the year we expect to have in 

place a comprehensive plan for reporting of transactions in the Treasury cash market to the official sector. 

Separately, the Financial Stability Oversight Council, or FSOC, is closely examining potential vulnerabilities related to changes in market structure, which it highlighted in its most recent annual report. FSOC is analyzing potential risks along 

three dimensions, which dovetail with the themes identified in the Joint Staff Report on October 15th:

• First, risks related to operational resiliency and preparedness arising from the 

increase in electronification across several markets;

• Second, the need to coordinate, to the extent possible, prudential and supervisory standards across different venues for products that share similar risk 

characteristics; and

• Third, to look at ways to improve data collection and sharing in certain

markets.

FSOC is also analyzing risks associated with asset management activities, including potential risks arising from mutual funds offering daily liquidity to investors 

while investing in less liquid underlying assets, particularly fixed-income assets. 

Policy makers and market participants have increased their focus on these potential 

risks as the proportion of corporate bonds owned by mutual funds has more than 

doubled over the past several years. 


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A recent example of the potential risks associated with that liquidity mismatch 

occurred in December, when the Third Avenue Focused Credit Fund suspended redemptions because it could not sell assets quickly enough to meet large redemption 

requests. Third Avenue’s actions came in the midst of overall stress in the broader 

high-yield market, contributing to pressure that led investors to pull nearly $10 billion—four percent of assets under management—from high-yield funds during a 3-

week period in December. 

FSOC is analyzing these and other risks related to asset management products 

and activities, and will be providing an update on its work this spring. The SEC 

has pending proposals in this area, and additional proposals are expected, including 

standards for stress testing by asset managers. 

Finally, I should note the efforts by market regulators, the CFTC and SEC, to

address risks related to evolving technology and market structures in their respective markets. Most recently, the CFTC proposed Reg AT to impose risk controls, 

transparency measures, and other safeguards to enhance the regulatory regime for

algorithmic trading in futures. In addition, the SEC proposed rules related to alternative trading platforms in the equities market, and asked a series of questions

related to the operation and regulation of similar platforms in fixed-income markets. 

Treasury will continue to engage with both regulators in areas of common interest. 

Conclusion 

In the years since the crisis, primary market issuance has been robust, helping 

to support the economic recovery in the United States. But the structure of fixedincome markets is undergoing a period of major transition, and the nature of liquidity provision in these markets is changing in parallel. Technology, changing risk appetites and business models, and policy changes are all contributing. One would

expect the public and private sectors to make significant changes following the second largest financial crisis in 100 years. 

The past 9 months have seen a period of heightened volatility in financial markets, and the U.S. financial system demonstrated resilience. Financial reform has 

strengthened the core of our financial system, increasing confidence in volatile 

times. But inevitably the tests will become more difficult, and neither market participants nor policymakers can afford to become complacent. 

In fixed-income markets, it’s clear we haven’t reached an end state. At Treasury, 

we are in the midst of the first comprehensive review of the Treasury market in 

nearly two decades, and working with regulators to collect and share information 

more effectively. We are also working with FSOC member agencies to identify and 

address potential risks to financial stability arising from changing market structures and shifts in the composition of market participants. Internationally, we are 

working with our counterparts to analyze and monitor market liquidity trends in 

overseas markets. There is much left to do. But the progress made since the crisis 

is real, and the financial system is more resilient as a result. These efforts ultimately provide the foundation for deep, liquid, and resilient capital markets, and 

will provide ballast when the next period of market turbulence strikes.


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1Dodd-Frank Act § 165(h). 

RESPONSE TO WRITTEN QUESTION OF CHAIRMAN CRAPO 

FROM JEROME H. POWELL 

Q.1. It has been brought to my attention that Federal Reserve examiners are seeking access to board meetings of companies in the 

normal course of business and that this is a new practice. Could 

you please tell me what guidance or process the Board of Governors provides to regional examiners as to their interaction with 

the boards of the bank and whether regional banks have a uniform 

practice for their examiners with respect to this practice?

A.1. As you are aware, the Board is authorized by statute to examine and obtain information from State member banks and bankholding companies to ensure that the companies are operated in a 

safe and sound manner. 12 U.S.C. §§ 248(a), 1844. Board supervisory staff meet with boards of directors or board members of regulated institutions to allow for the exchange of information and 

presentation of supervisors’ examination findings to the institutions’ boards of directors. 

The Federal Reserve has a long-standing practice whereby supervisors attend an annual board meeting of a financial institution to 

present the Federal Reserve’s annual supervisory assessment to 

the board of directors. This presentation is often coordinated with 

presentations by the Federal Deposit Insurance Corporation or the 

Office of the Comptroller of the Currency on their assessment of 

the underlying insured depository institution. 

This is part of the normal interactive supervisory process, and 

often serves as an opportunity to ensure that the entire board of 

a banking organization is aware of supervisory concerns. In some 

cases, supervisors ask to meet separately with the independent 

board members (those who do not have other roles in the banking 

organization) in order to ensure that those directors have access to 

all relevant information relating to risk management and other supervisory concerns. Supervisors also meet periodically with the individual board members to discuss the firm’s strategic plans and 

current areas of supervisory focus, often on the firm’s initiative. 

The Board views banking organization boards of directors as key 

players in ensuring the safety and soundness of banking organizations. Congress emphasized the importance of involvement by 

boards of directors in risk management by requiring, through the 

Dodd-Frank Wall Street Reform and Consumer Protection Act 

(Dodd-Frank Act), that the Board of Governors adopt regulations 

requiring each bank-holding company with assets over $50 billion 

and each firm designated for Board supervision by the Financial 

Stability Oversight Counsel (FSOC) to establish a risk committee 

of the board of directors.1 The Dodd-Frank Act requires the risk 

committee to be responsible for oversight of the enterprise-wide 


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risk management practices of the firm and to include both independent directors and at least one member with risk management 

experience at large, complex firms. 

Meetings by supervisory staff with members of the board of directors are thus part of the cooperative, iterative communications 

between a supervised banking organization and its regulator and 

allow board members to directly gain access to supervisory

insights. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SASSE 

FROM JEROME H. POWELL 

Q.1. Mr. Weiss argued in this hearing that liquidity measures during the run-up to the 2008 financial crisis serve as an inappropriate ‘‘liquidity benchmark’’ because this liquidity was illusory, 

and more ‘‘a result of soaring financial sector leverage and an overreliance on short-term funding.’’ If, arguendo, this is true, what historical era should serve as an appropriate benchmark?

A.1. The degree of liquidity in a given market will change over 

time as economic circumstances and market structures change. 

Thus, it is not clear that there is an obvious benchmark period that 

one could easily refer to in order to determine whether current 

market liquidity is either too low or too high. The Trade Reporting 

and Compliance Engine or ‘‘TRACE’’ began collecting data on corporate bond trading in 2002 and widespread electronic trading in 

the interdealer Treasury market began at roughly the same time. 

As noted by Mr. Weiss, this period is the run-up to the financial 

crisis. It is not clear that that period, or the current post-crisis period represent a proper benchmark. 

Rather than compare current conditions to a benchmark period, 

it may be more appropriate to ask whether the pricing of liquidity 

services accurately reflects all the costs and risks of providing 

those services. As Mr. Weiss noted, there are good reasons to believe that this was not the case prior to the financial crisis, as it 

became clear during the crisis that many participants had relied on 

unrealistic assumptions about the stability of market volatility and 

funding sources in making their investment decisions. Currently, 

financial sector leverage and short-term funding stand at much 

more appropriate levels and banks have reassessed their own risk 

appetites to perhaps better reflect business risks, which all should 

lead to more pricing of market liquidity that more accurately reflects the risks involved. An assessment of market liquidity also 

needs to analyze whether the level of liquidity is an impediment to 

economic growth. This is always difficult to measure, but with robust demand for corporate and Treasury debt, there are no signs 

that liquidity conditions are currently inhibiting either private or 

Government funding or the economic recovery.

Q.2. Governor Powell testified in this hearing that ‘‘[i]t may be that 

liquidity has [currently] deteriorated only in certain market segments.’’ Please describe which market segments are most likely to 

have experienced liquidity deterioration and why.

A.2. As discussed in my the testimony, it is important first to note 

that observable measures of overall liquidity in fixed-income


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1See Tobias Adrian, Michael Fleming, Daniel Stackman, and Erik Vogt, Has U.S. Treasury 

Market Liquidity Deteriorated?, Liberty Street Economics (blog), August 17, 2015. 2See Bruce Mizrach, ‘‘Analysis of Corporate Bond Liquidity,’’ Financial Industry Regulatory 

Authority (FINRA), Office of the Chief Economist Research Note, December 2015. 3See Tobias Adrian, Michael Fleming, Erik Vogt, and Zachary Wojtowicz, Further Analysis 

of Corporate Bond Market Liquidity, Liberty Street Economics (blog), February 10, 2016. 4See Hendrik Bessembinder, Stacey E. Jacobsen, William F. Maxwell, and Kumar 

Venkataraman, Capital Commitment and llliquidity in Corporate Bonds, Social Science Research Network (SSRN), March 21, 2016.

markets do not point to any deterioration. Measured bid-ask 

spreads in the interdealer market for on-the-run Treasury bonds 

have been stable in recent years, while estimated price impacts of 

trading are at levels comparable to those in 2005.1 Observable 

measures such as the spread between on- and off-the-run Treasury 

securities do not show any trend change in liquidity between the 

two market segments since the financial crisis. In corporate bond 

markets, estimated bid-ask spreads have declined and estimated 

price impacts are lower than in the early 2000s, indicating that, if 

anything, liquidity may have improved.2

However, at the same time, we must recognize that our ability 

to measure market liquidity is imperfect. We have less data on 

dealer-to-customer trading in Treasury markets than in the interdealer market, and, given the nature of the corporate bond market, 

estimates of liquidity are based on transactions rather than on direct observations of quotes to buy or sell these bonds. Changes in 

market structure have also meant that participants now must 

break up their larger trades and employ complicated strategies in 

order to avoid moving prices. Accurately measuring the effect of 

trading on prices, perhaps the most fundamental gauge of market 

liquidity, can be quite difficult in such an environment. 

With this in mind, it is difficult to identify specific market segments in which liquidity may have deteriorated with a great degree 

of confidence. As the testimony noted, there is some evidence that 

liquidity has deteriorated for the lowest-rated corporate bonds. Although work by staff at the Federal Reserve Bank of New York 

have found that estimated price impacts of trading have declined 

across all issue sizes in this market, they also find some weak evidence that price impacts may have increased for bonds rated CC 

or lower.3 This evidence is suggestive, but far from conclusive. 

Some industry participants have also pointed to a bifurcation in 

corporate bond markets, with smaller, less-traded bonds suffering 

from a deterioration in liquidity. We have not found evidence that 

supports these claims but are continuing to investigate this issue 

and trends in market liquidity more generally. 

To the extent that liquidity has deteriorated in some less liquid 

corporate bond segments, there could be several explanations. As 

my testimony noted, these segments may rely heavily on intermediation by dealers, and dealers have scaled back their capital commitments and inventories in corporate bonds since the financial

crisis.4 Investors, particularly mutual funds and other asset managers that now comprise a larger share of the market, may also 

prefer to concentrate trading in more liquid segments. To the

extent this was the case, it would lead to decline in liquidity in less 

frequently traded segments of the market. 


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Q.3. Please provide a list of upcoming new rules or regulations either from your agency, or others that you are aware of, that may 

have a material impact on liquidity in the fixed-income markets.

A.3. It is not easy to predict ahead of time which rules either may 

affect fixed-income market liquidity or may be perceived to affect 

fixed-income market liquidity in light of the inherent uncertainties 

in measuring market liquidity. At the same time, some market participants have claimed that the Net Stable Funding Ratio rule recently proposed by the U.S. banking agencies may have an impact 

on fixed-income market liquidity. The U.S. banking agencies assessed the potential impact of the proposed rule and expect the 

benefits to outweigh the costs. The agencies have asked for public 

comment on the impact of the proposed rule on firms and on the 

broader economy, and staff will be analyzing comments and impact 

data carefully as we move forward. The Board takes steps to help 

ensure that each of its financial regulations achieves its intended 

outcome at least cost to market liquidity and other beneficial aspects of economic activity.

Q.4. Governor Powell said that ‘‘some reduction in market liquidity 

is a cost worth paying in helping to make the overall financial system significantly safer.’’ Is there also a risk that reducing liquidity 

in the marketplace also makes the marketplace unsafe? If so, how 

should regulators discern the difference between an unsafe reduction in liquidity and a safe reduction in liquidity?

A.4. A central insight that was revealed during the financial crisis 

is that liquidity provision is a risk-bearing activity that can result 

in significant losses during a period of financial stress. Post-crisis 

regulatory reform efforts have focused in ensuring that the risks if 

liquidity provision are appropriately accounted for in the context of 

capital and liquidity regulation. Regulation that penalizes liquidity 

provision by ascribing to it a degree of risk that is not commensurate with the actual risks incurred could lead to an unnecessary

reduction in liquidity provision that would not be warranted by

market fundamentals such as supply-demand dynamics. Accordingly, the Federal Reserve is committed to assessing the impact of 

post-crisis reform legislation on an ongoing basis to assess whether

enhanced capital and liquidity regulations treat liquidity provision 

in a manner consistent with the risks incurred by the provision of 

such services.

Q.5. Governor Powell testified at this hearing that ‘‘there is some 

evidence [that] liquidity in lower rated bonds has deteriorated.’’ 

What are potential negative economic effects of this deterioration, 

including for newer companies, and smaller- to medium-sized 

firms?

A.5. As noted in the response to question 2, it is difficult to identify 

specific market segments in which liquidity may have deteriorated 

with a great degree of confidence, however, my testimony did note 

that there is some evidence that liquidity has deteriorated for the 

lowest-rated corporate bonds. Although work by staff at the Federal Reserve Bank of New York has found that estimated price

impacts of trading have declined across all issue sizes in this


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5See Tobias Adrian, Michael Fleming, Erik Vogt, and Zachary Wojtowicz, Further Analysis 

of Corporate Bond Market Liquidity, Liberty Street Economics (blog), February 10, 2016. 

market, they also find some weak evidence that price impacts may 

have increased for bonds rated CC or lower.5

This evidence is suggestive, but far from conclusive, that if liquidity has indeed declined in these market segments, there could 

eventually be a negative impact on primary issuance for lower 

rated firms if the decline was large enough. However, we do not see 

evidence of this. Corporate bond issuance has been strong over the 

post-crisis period, both in the investment grade and high-yield segments. While there was some decline in issuance in the second half 

of 2015 and the first months of 2016, issuance declined only moderately from very high levels. This decline appears to have been 

linked more to a pull-back in risk sentiment over this period rather 

than to any decline in market liquidity. More recently, issuance 

has shown signs of picking back up as risk sentiment has improved.

Q.6. Governor Powell testified at this hearing that ‘‘questions about 

whether liquidity and fixed-income markets has broadly deteriorated are very difficult to answer definitively.’’ Governor Powell 

also testified that ‘‘these regulations [that have been imposed since 

the 2008 financial crisis] are new and we should be willing to adjust them as we learn.’’

a. What process is in place or should be in place at the financial 

regulatory agencies to understand the impact of these new 

rules and regulations on liquidity?

b. Given the importance of liquidity in the marketplace and the 

admitted uncertainty surrounding this issue, is there merit to 

considering delaying the imposition of new financial rules and 

regulations, to facilitate a broader examination of the cumulative impact of these new rules and regulations on liquidity 

in the marketplace?

A.6. The Federal Reserve is committed to analyzing liquidity conditions across a wide array of financial markets as market liquidity 

is important for the conduct of monetary policy, the health of the 

financial system and financial stability. Federal Reserve staff regularly assess and monitor liquidity conditions on an ongoing basis 

for all of the reasons previously cited. Moreover, the Federal Reserve in conjunction with the Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, Securities and

Exchange Commission and Commodity Futures Trading Commission regularly submit a report on fixed-income market liquidity to 

the House Financial Services Committee as a result of Chairman 

Jeb Hensarling’s request to regularly monitor fixed-income market 

liquidity and any potential effects that the Volcker rule may have 

on market liquidity. It is expected that these efforts will continue 

and that new efforts to understand the state of market liquidity 

and the effect of financial regulation on market liquidity will continue to evolve over time as the regulations mature and any effects 

become easier to measure overtime. 

While the effects of financial regulation on market liquidity are 

uncertain, there is less uncertainty around the idea that post-crisis 


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reform measures are needed to address significant shortcomings in 

the regulatory regime that were revealed during the financial crisis. Accordingly, halting financial reform risks continued exposure 

to shortcomings that are relatively well-documented and understood, while any benefits on market liquidity are uncertain. This is 

not to say, however, that market liquidity should not be an important consideration in the design and implementation of financial 

regulation. Rather, in the designing of financial regulation, steps 

should be taken to ensure that regulation does not unduly suppress 

market liquidity or other beneficial aspects of economic activity. As 

these regulations are implemented, regulators should assess 

whether regulations should be modified to better manage any identified tradeoff between the principal goals of regulation, that is, enhanced capital or liquidity, and market liquidity. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY 

FROM ANTONIO WEISS 

Q.1. You argued before the Committee that pre-crisis levels are a 

‘‘poor benchmark for liquidity.’’ But, if you examine the post-crisis 

period, there is a consistent decrease in liquidity. As an example, 

dealer balance sheets of corporate credit and securitized products 

have declined approximately 30 percent. Some analysts expect it to 

decline further by another 5 percent to 15 percent. Spreads in 

many fixed-income products have widened and turnover has declined, which is further evidence of a less liquid market.

• Do you still maintain that liquidity has not declined during the 

post-crisis period?

• If so, could you please indicate those data points you find relevant to tracking liquidity levels which indicate no change in 

the post-crisis period?

A.1. Despite repeated claims to the contrary, there is no compelling 

evidence of a broad-based deterioration in liquidity. Market participants point to a number of measures as proxies for liquidity, including bid-ask spreads, trading volume, market depth, and the 

price impact of trades. Most of these traditional measures of liquidity across U.S. fixed-income sectors are well within historical levels. 

Bid-ask spreads for U.S. Treasury securities have remained 

tight, and spreads for corporate bonds are consistent with or below 

recent historical levels. Turnover has declined in some markets, 

but is not a good proxy for liquidity. For example, turnover may increase during periods of high volatility, such as October 15, 2014, 

a day with especially high turnover. In corporate bonds, volumes 

have increased, but the strength in issuance, especially among 

many new issuers whose bonds don’t trade frequently, has resulted 

in lower turnover. Finally, while some have cited the decline in 

dealer inventories, this is a poor measure of liquidity. Inventories 

represent a very small percent of the total corporate credit market, 

even prior to the crisis, and despite claims that inventories serve 

as a shock absorber, historically dealers have decreased their

positions during periods of stress and potentially contributed to 

sell-offs.


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Q.2. I have read research that suggests, in light of the record corporate debt issuance of late, that the need for liquidity has never 

been greater but we are in an environment when there is diminished capacity to provide that liquidity due to a widespread reduction of dealer market making.

• Is it possible that some of these problems are being masked at 

the moment by exceptionally accommodative monetary policy 

and a reach for yield by many investors?

• If the Fed were to actually move forward on a defined path of 

policy normalization, whereby interest rates would substantially rise, do you believe that there is sufficient liquidity to 

maintain orderly markets?

A.2. Fixed-income markets have been influenced by a number of 

both secular and cyclical factors, including electronification, a 

changing mix of participants, record-breaking issuance, changing 

dealer business models, economic cycles, and monetary policy. 

Emerging from a period of historically low interest rates and low 

volatility could result in an increase in volatility, consistent with 

historical experiences. Price movements, even significant ones, in 

response to changes in economic and policy outlooks are not necessarily a result of illiquidity. For example, the so called ‘‘taper 

tantrum’’ in 2013, in which long-term interest rates increased over 

100 basis points, saw significant price movements but no obvious 

breakdown in market functioning. Treasury is focused on understanding the transitions that are underway and anticipating the 

contours of the new environment.

Q.3. It appears that there remains a strong difference of opinion 

on whether liquidity impairment is an unintended consequence of 

recent financial regulations. Given the state of the debate, it seems 

as though data points being used to argue both sides of the argument are worthy of further investigation. Other jurisdictions, like 

the European Union, are establishing formal review mechanisms 

designed to evaluate the impact of financial regulatory measures 

on markets and the broader economy.

• Would you be willing to conduct a formal and holistic review 

of the impact financial regulation is having on U.S. capital 

markets, analogous to that being performed under the EU’s 

‘‘call for evidence?’’

A.3. Reforms adopted following the financial crisis have created a 

stronger, more resilient financial system. However, neither market 

participants nor policymakers can afford to become complacent. 

Treasury continues its work analyzing developments in financial 

markets and market structures, including those related to policy 

developments. For example, Treasury is engaged in the official sector’s most comprehensive review of the Treasury market since 

1998. In 2015, Treasury, together with the Federal Reserve Board, 

the Federal Reserve Bank of New York, the CFTC and the SEC, 

issued the Joint Staff Report on the events of October 15, 2014. 

Earlier this year, Treasury issued a request for information on the 

evolution of Treasury market structure and has recently reviewed 

the public comments received. We are also working with FSOCmember agencies to identify and address potential risks to


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financial stability arising from changing market structures and 

shifts in the composition of market participants. The FSOC also recently released a study on the economic impact of possible financial 

services regulatory limitations intended to reduce risks to financial

stability. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE 

FROM ANTONIO WEISS 

Q.1. Mr. Weiss argued in this hearing that liquidity measures during the run up to the 2008 financial crisis serve as an inappropriate ‘‘liquidity benchmark’’ because this liquidity was illusory, 

and more ‘‘a result of soaring financial sector leverage and an overreliance on short-term funding.’’ If, arguendo, this is true, what historical era should serve as an appropriate benchmark?

A.1. There is no standard. definition of liquidity that encompasses 

all the variables that matter across products and investor categories. Market participants point to a number of measures as 

proxies for liquidity, including bid-ask spreads, trading volume, 

market depth, and the price impact of trades, each of which may 

be influenced by the changes in market structure that inevitably 

occur over time. Similarly, given the changing nature of market 

structure and other secular and cyclical factors, there is no one historical period that can serve as a perfect benchmark to assess liquidity conditions. We attempt, where possible, to analyze market 

developments over a sufficiently long time period that multiple 

points in financial and economic cycles are represented. For example, many of the charts referenced in my testimony present data as 

far back as 2005, and in some cases as far back as 2002. In many 

cases, however, a lack of available or consistent data constrains the 

ability of policymakers and market participants to conduct that 

kind of analysis.

Q.2. Governor Powell testified in this hearing that ‘‘[i]t may be that 

liquidity has [currently] deteriorated only in certain market segments.’’ Please describe which market segments are most likely to 

have experienced liquidity deterioration and why.

A.2. Despite repeated claims to the contrary, there is no compelling 

evidence of a broad-based deterioration in liquidity. In fact, most 

traditional measures of liquidity across U.S. fixed-income sectors 

are well within historical levels. Market participants point to a 

number of measures as proxies for liquidity, including bid-ask 

spreads, trading volume, market depth, and the price impact of 

trades. Each of these measures captures some aspect of liquidity, 

but none is comprehensive.

Q.3. Please provide a list of upcoming new rules or regulations

either from your agency, or others that you are aware of, that may 

have a material impact on liquidity in the fixed-income markets.

A.3. The only remaining rule which Treasury is responsible for implementing is the QFC recordkeeping rule.

Q.4. Governor Powell said that ‘‘some reduction in market liquidity 

is a cost worth paying in helping to make the overall financial system significantly safer.’’ Is there also a risk that reducing liquidity 


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in the marketplace also makes the marketplace unsafe? If so, how 

should regulators discern the difference between an unsafe reduction in liquidity and a safe reduction in liquidity?

A.4. Post-crisis financial reform has made the financial system 

safer and more resilient. Financial reform has created more resilient financial intermediaries, more stable funding profiles, and 

sounder market structures, providing the foundation for deep, liquid, and resilient capital markets.

Q.5. Governor Powell testified at this hearing that ‘‘there is some 

evidence [that] liquidity in lower rated bonds has deteriorated.’’ 

What are potential negative economic effects of this deterioration, 

including for newer companies, and smaller- to medium-sized 

firms?

A.5. While there have been anecdotal reports of periods during 

which liquidity conditions have been challenging, the market for 

lower-rated bonds has always been less liquid than many markets 

and Treasury’s analysis of the available data has not shown convincing broad-based evidence of deterioration. In addition, primary 

markets for fixed-income issuance in the United States have performed exceptionally well for the past several years, with corporate 

bond issuance reaching record levels over the past 4 years. In particular, while most newer and smaller- to medium-sized firms have 

traditionally not issued bonds, some first time and smaller issuers 

have been able to leverage the strong market conditions in recent 

years to issue bonds and raise funds for their businesses.

Q.6. Governor Powell testified at this hearing that ‘‘questions about 

whether liquidity and fixed-income markets has broadly deteriorated are very difficult to answer definitively.’’ Governor Powell 

also testified that ‘‘these regulations [that have been imposed since 

the 2008 financial crisis] are new and we should be willing to

adjust them as we learn.’’

a. What process are in place or should be in place at the financial regulatory agencies to understand the impact of these 

new rules and regulations on liquidity?

b. Given the importance of liquidity in the marketplace and the 

admitted uncertainty surrounding this issue, is there merit to 

considering delaying the imposition of new financial rules and 

regulations, to facilitate a broader examination of the cumulative impact of these new rules and regulations on liquidity 

in the marketplace?

A.6. Reforms adopted following the financial crisis have created a 

stronger, more resilient financial system. At the same time, our financial markets continue to evolve in response to a variety of factors and forces. For instance, advancements in technology, and the 

associated growth in high-speed electronic trading, have contributed to changes in intermediation and the provision of liquidity in 

many financial markets. Treasury has been engaged, and will continue to be engaged, in rigorous, data-driven analysis of financial 

markets and market structures, and Treasury staff has published 

some of its analysis as blog posts available on the Treasury 

website. Treasury’s analysis of conditions in the U.S. Treasury 

market suggests that liquidity is consistent with historical levels. 


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More broadly, Treasury is engaged in the official sector’s most 

comprehensive review of the Treasury market since 1998. In 2015, 

Treasury, together with the Federal Reserve Board, the Federal 

Reserve Bank of New York, the CFTC and the SEC, issued the 

Joint Staff Report on the events of October 15, 2014. Earlier this 

year, Treasury issued a request for information on the evolution of 

Treasury market structure and has recently reviewed the public 

comments received. In July, the SEC published for comment a proposed rule from the Financial Industry Regulatory Authority that 

would require its member brokers and dealers to report Treasury 

cash market transactions to a centralized repository, giving the official sector better access to Treasury market transaction data. In 

addition, Treasury, CFTC, SEC, and the Federal Reserve Board 

signed a memorandum of understanding that permits sharing of information on U.S. Treasury cash and related derivative markets 

among the agencies, which facilitates analysis across the interest 

rate complex. We are also working with FSOC-member agencies to 

identify and address potential risks to financial stability arising 

from changing market structures and shifts in the composition of 

market participants.


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