william c dudley : regulation and liquidity provision remarks by mr william c dudley, president and chief executive officer of the federal reserve bank of new york, at the sifma liquidity forum, new york city, 30 september 2015. * * * the charts can be found at the website ( federal reserve bank of new york ). the financial crisis and the ensuing recession exacted a high cost on the country. real gross domestic product ( gdp ) declined by over a half of a trillion dollars. total nonfarm payroll employment declined by 8. 7 million jobs, and 5. 8 million households lost their homes to foreclosure. extraordinary fiscal and monetary policy efforts were required to prevent a collapse of the financial system and the onset of a world - wide economic depression. in the aftermath, new regulations, such as basel iii and the dodd - frank act, were implemented to strengthen the financial system and to limit the risk of a future financial crisis. some opponents of tougher bank regulation claim that the increased regulatory requirements, such as the higher capital requirements and new liquidity standards, that have been imposed on large financial institutions in the aftermath of the financial crisis have reduced these firms ’ market - making capacity. as a result, so the argument goes, this is leading to less liquidity for trading securities, and to more illiquidity events in which the prices of financial assets move sharply and become temporarily unmoored from their fundamental valuations. the contention is that higher liquidity costs and more frequent illiquidity events will, over time, drive up the borrowing costs of households, businesses and the u. s. government ; and that this is a substantial, largely unintended cost imposed by tougher regulation. thus, the argument concludes, the regulatory burden should be rolled back. this is a noteworthy assertion and would have significant implications for regulatory policy if it were correct. however, as i will lay out in my remarks, i don ’ t think the hypothesis is wellsupported by the available evidence. first, the evidence to date that liquidity has diminished markedly is, at best, mixed. second, even if one were to interpret the evidence as indicating that liquidity has been reduced, it is not clear whether regulation is the primary driver, as other changes have played important roles as well. moreover, even if higher capital and new liquidity requirements were found to result in greater transaction costs, these costs would need to be assessed against the benefits of having a

for example, there was a sharp deterioration in liquidity, which was associated with a sharp rise in some measures of yield curve fitting errors to a peak of about 20 basis points. this compares to less than 2 basis points prior to the crisis. in contrast, yield curve fitting errors have been low and stable recently and not outside historical norms. ( exhibit 5 ) of course, the federal reserve ’ s large scale interventions in the treasury market over this period may also have had an impact on this measure. turning to corporate bonds, given their heterogeneous nature, liquidity in the corporate bond market depends on the ability and willingness of dealers to hold these securities on their balance sheets while they find buyers. disaggregated data on dealer balance sheet holdings have only been published since april 2013. while limited in terms of its history, these data indicate no clear reduction in investment grade security holdings over time, but do show a significant reduction in high - yield security holdings since the end of the financial crisis. this might be indicative of deterioration in market liquidity in corporate bonds. to investigate corporate bond market liquidity in more detail, let ’ s examine three liquidity measures : the average trade size, “ effective ” bid - ask spreads and price impact. the evidence on the average trade size for investment grade corporate bonds indicates a slight reduction from between $ 700, 000 to $ 800, 000 in the early 2000s to around $ 500, 000 in the last few years. ( exhibit 6 ) however, price measures of corporate bond liquidity do not substantiate the trend in this quantity measure. the effective bid - ask spread has been trending down since the early 2000s, around the same time that trace reporting was introduced. the spread spiked during the financial crisis, but is now lower than its pre - crisis levels. ( exhibit 7 ) similarly, price impact – the effect on price from a $ 1 million trade – has also been trending down since the early 2000s apart from the jump during the financial crisis. ( exhibit 8 ) although liquidity in the treasury and corporate bond markets does not appear to have changed much recently, liquidity risk may have risen. for the treasury market, our liquidity risk measure increased sharply with the financial crisis, and declined from 2009 to 2013. however, over the last two years treasury liquidity risk has moved higher and relative to the pre - crisis period is currently somewhat elevated. for the corporate bond market, liquidity risk also increased sharply during the