That's why I think you'll continue to hear from Fed officials the need for more fiscal stimulus. We fell off the fiscal cliff at the end of July. It hasn't had much negative consequence up to now, mainly because the fiscal stimulus was so large and it boosted household savings and because the re-opening of the economy that we saw through the summer into the fall also helped support economic activity. But if the reopening of the economy is stalled and the fiscal stimulus effects from before wear off, I think you definitely are going to see the monthly economic statistics show a distinct weakening trend in coming months.

BRIAN CHEUNG: Now you mentioned that the Federal Reserve could consider other tools. It's been very clear from what Chairman Powell and other Fed officials have said that they're not out of ammunition by any means. But you mentioned negative interest rates. Do you feel that that's a possibility that could be on the table for the Fed to do if conditions really deteriorate significantly worse?

BILL DUDLEY: No, I don't think they're going to do that. There was a FOMC meeting a while ago where they reported that all participants were opposed to moving to negative interest rates, and nobody was even slightly interested in it. I think the assessment of the FOMC, Federal Open Market Committee, is just that the cost of moving into negative interest rates exceeds the benefits. And I think after showing so much reluctance to even contemplate moving to negative interest rates, if they were actually to do so, I don't think it would be reassuring to people. I think people would actually take that as a sign that the outlook was even worse.

You know, the last thing you want to do is introduce a new policy. That scares people. You want-- when you introduce a new policy, you want people to be more reassured, and I don't think moving to negative interest rates at this juncture would be helpful in terms of supporting economic activity.

BRIAN CHEUNG: So I want to rewind the clock back. For those that aren't aware, you managed the Fed's trading desk at the beginning of the last crisis in 2007. You were then bumped up to head the New York Fed, and in 2009, really in the thick of the crisis. The concern in the spring was that the health crisis was going to evolve into a financial crisis if the Fed didn't do something. I guess in your assessment-- I know you weren't at the New York Fed during this particular COVID-19 event-- but how close were we to going into a full-blown financial crisis, and how do you think the Fed's actions played into what we ultimately had as the outcome?

BILL DUDLEY: Well, I think that financial markets were really close to a period of, you know, not working, of dysfunction. The Treasury market was in turmoil in March and April as people were unwinding leveraged trades, long cash, short futures. As the dealer community had lack of capacity to essentially provide balance sheet. People needed balance sheet at that time. Also saw a lot of stress in the corporate bond market and municipal bond market as people started to contemplate a much worse economic outcome.

I mean, the pandemic came on so quickly, and we went from a find economy to a horrible economy just within a few weeks. And that put a tremendous amount of stress on markets. I think the Fed appropriately came to the rescue and said we're going to be the market maker of last resort. We're going to buy treasuries. We're going to buy agency mortgage-backed securities. And then with the CARES Act and the support from the US Treasury, I introduced a whole slew of programs to backstop markets-- backstop the corporate bond market, the municipal bond market.

And I think with that-- with the Fed there as the buyer of last resort-- that really reassured private-sector investors that markets would be OK. And the markets subsequently recovered quite sharply. So the Fed, I think, did a good job during that period of time. And, you know, they were in good position to do that in part because of what happened during the great financial crisis. A lot of these tools were on the shelf. They'd already been developed before, and so they could be taken off the shelf quite quickly. And because they'd been effective last time around, I think it also increased the expectation that they would work in these particular places.

BRIAN CHEUNG: So I wonder if we could drill down specifically on what happened in the US Treasury markets. That's the most liquid, deepest market in the world, and a weird dynamic where Treasury yields were spiking up in the second week of March despite the fact that there was a sell-off in equities-- not typical risk-off behavior. What exactly happened in your view? There's been talk about maybe a Darrell Duffie-like way to do sort of central clearing of US treasuries. It seems like there's some acknowledgment from Randy Quarles at the Fed to reform in some way the Treasury market. What do you think the remedy is?

BILL DUDLEY: Well, people are still unpacking exactly what happened in the Treasury market in March and April. Initially it was all about the hedge funds having these levered trades, long cash, short futures. But then as people looked into it with more detail, they realized there was a lot more than that going on. In fact, the lack of capacity among the dealer community to provide balance sheet, I think, was an important factor.

I think what we found is that the Federal Reserve is the only entity that actually has an elastic balance sheet that can grow to supply liquidity to meet the demand. And I think what the Fed's going to be looking at is can we have something in place-- not ex post, after the fact, but ex ante-- that's available as a place for people to go if they need to finance their treasuries or the agency mortgage- backed securities. If we had that in place, it would do two things.

One, people would know that their balance sheet, you know-- there was balance sheet available that they could finance these securities so they'd be less hesitant to dump those securities. And that would be very reassuring to people. So I think, you know, a standing repo facility of some sort I think is something that the Fed's going to take a very long look at. Now doing that is not going to be something that happens very quickly because the devil's in the details. You know, if you have a standing repo facility, what rate do you charge? Who's eligible? How does it work? How does the plumbing work? In other words, how do you actually do the transactions? So I don't think that's something that's going to arrive in the next six months or a year, but I think the Fed is going to do a very deep dive into what happened in the Treasury market and ask themselves the question what can we do to make the Treasury market function even in bad times-- function well in bad times.

BRIAN CHEUNG: Well, let's zoom out because I don't know how many viewers we may have lost talking about the standing repo facility, but in regards to the Fed's overall actions, right-- lowering interest rates to near 0, quantitative easing as you mentioned with the expanding balance sheet. The Federal Reserve though has called on fiscal policymakers to really take the leg from here because they can do more targeted support. Do you feel the Fed has been aggressive enough or maybe too aggressive when it comes to calling on the White House, calling on Congress to do some sort of CARES 2?

BILL DUDLEY: I think they're saying what's obvious-- that monetary policy can only do so much. I mean, monetary policy can reduce the level of interest rates. Monetary policy, as we've seen, can restore market function, and the Fed's done both of those things. But that's sort of it. The Federal Reserve cannot create income. Only Congress can do that through fiscal support. And the coronavirus is about the forces that are pushing down business activity, which has a depressing effect on income, and it's also causing a lot of business failures. That's also going to weigh on the economy going forward. And the Fed can't do much about that. So I think the Fed is properly shown on the spots, the flashlight, on the need for fiscal policy that monetary policy can only do so much. I think it's be-- you know, it would be problematic for the Fed if they didn't say anything because then it would be-- the Fed would be somehow implying that they can take care of the entire problem when they can't.

BRIAN CHEUNG: And this brings up the very interesting question about Fed independence, which brings us to the op-ed that you wrote last August that suggested that the insurance cuts at that time, well before COVID, were perhaps enabling President Trump's tariff war with China. There was a lot of pushback from even within the Fed itself to that op-ed. I guess I'm wondering, you know, we're a year out from that. Do you have any regrets about publishing that piece in Bloomberg Opinion or any sort of, I guess, follow-up thoughts given the nature of what we're in right now?

BILL DUDLEY: I mean, the piece was basically a thought experiment, basically saying that if one thought that your actions were, you know, going to enable or facilitate a bad policy, would you want to actually take those actions? That's what I was actually saying. And it was a thought experiment. I wasn't saying that the Federal Reserve should behave in a way that somehow tries to effect the electoral-- election outcome. That'd be totally inappropriate. The Fed needs to set monetary policy based on giving dual mandate objectives. And I believed that then, and I believe that now.

BRIAN CHEUNG: And I guess that brings up though right now because as we kind of talked about the Fed officials kind of pressing on fiscal policy makers to do something, it's not necessarily to the exact content of what you were writing about last August. But it does bring up what is the proper interaction between monetary policy and fiscal policy during times like these? Because yes, there is supposed to be Fed independence, but right now we have Steven Mnuchin and Chairman Powell working together hand in hand to engineer this crisis. Now obviously these are different times, so what is the appropriate balance of the interaction between the Fed and fiscal policymakers, even outside of a crisis times?

We know that there's a congressional liaison office at the Fed. They had a hand in engineering even of the minutia in Dodd-Frank during 2010. So I guess what's the proper balance between the communication and the level of coordination between fiscal and monetary policy makers?

BILL DUDLEY: Well. I think you want to have good communication so you know what the Treasury is thinking and what the Fed is thinking. I think in the current environment, there's not a real conflict. The goals of both the fiscal authorities and the monetary authorities are to try to support the economy and generate a sustainable economic recovery.

I think the independence of the Federal Reserve comes into question when the political timetable leads to political pressure to pursue a program of interest rates that are inconsistent with the Fed's objectives in terms of employment and inflation. So if you got into a situation where inflation was rising yet the political leadership in Washington was trying to put pressure on the Fed to keep rates low despite the fact that inflation rising, becoming problematic, that's when the Federal Reserve's independence becomes at risk. But I don't think there's a real issue right now in terms of the Fed's independence. I don't see a conflict. What the Fed want and what the administration and Congress wants are the same thing, in essence-- working on recovery.

BRIAN CHEUNG: And at the same time though, the Federal Reserve has gotten a number of credit-- you know, a lot of money allocated to it from the original CARES Act. It only used up about $195 of the up to $454 billion to backstop corporate markets, municipal debt markets, what have you. But there's been some criticism that maybe the Federal Reserve hasn't been as willing to take on more credit losses in those programs to more aggressively offer help to the states and local municipalities that really need it or to the small- and medium-sized businesses that are supposed to be targeted under the Main Street Lending Program. What say you to whether or not the Fed should be taking on more credit risk or if they have a calibrated just right right now?

BILL DUDLEY: Well, I think for most of the programs which are backstopping markets, you know, the amount of take-down of the program isn't really that important in terms of how-- in terms of judging the effectiveness. I mean, I think the Fed has restored market function in the corporate bond market and the agency mortgage-backed securities market and the municipal bond market, even though they haven't actually purchased that many actual securities. They don't have to because they're a credible backstop.

I think the one area where people are more critical about the Fed is the lack of take-up of the Main Street Lending facility. That was a program designed to provide loans to medium-sized businesses that were bigger than what was relevant for the Paycheck Protection Program but smaller than large corporations that have access to the US capital markets.

You know, it's possible-- you know, one could make the case that the Fed could make the terms of the Main Street Lending Program more lenient and therefore get a greater amount of take-up. I think the fundamental problem of the Main Street Lending Program though is actually quite different. If banks have good loans to make, they're just going to make good loans. They're not going to spit out those good loans to the Fed.

BRIAN CHEUNG: So let's expand out to the broad topic of liquidity facilities. The Federal Reserve has 13 of them stood up. Now what's interesting is that I was talking with a source in the beginning of March about specifically a primary dealer credit facility which the Fed had launched at that time. In 2009, it was the biggest deal. It was, wow, the Fed is doing this type of lending to its primary dealers. Right now it seems like it's an afterthought. People forget that the PDCF exists because of everything that the Fed's been doing with corporate debt markets, municipal lending, things like that.

How has the Fed's function as a lender of last resort-- we don't need to get into the Bagehot's dictum or anything like that-- but how has that changed over the last 11 to 12 years?

BILL DUDLEY: I don't think it's changed in a particularly-- a big way. I mean, I think what's happened this time is the Fed arrived before the crisis actually got underway in terms of the financial sector. Last time the Fed arrived sort of grudgingly as the financial crisis was well underway. I mean, the Primary Dealer Credit Facility in 2008 was enacted, you know, as Bear Stearns was actually failing.

The second thing I think it's an important distinction is that the financial sector itself is in much better shape. I mean, the things that were done to require big banks, which now include most of the major securities dealers, to hold more liquidity, more capital, a stress testing of capital, means that the people have confidence that the banking system is going to make it through this crisis period in reasonably good shape. Last time it was the loss of trust in the banking system that contributed to the downturn in economic activity. So I think the financial system this time is mostly working well, especially in the banking portion. The non-bank portion has shown a few signs of strain, but then the Federal Reserve is coming in and basically providing support there through these backstop of market-making facilities.

BRIAN CHEUNG: And you bring up a good point about financial stability. That's a huge part of the reaction function for the Fed now under its new framework which it released at Jackson Hole virtually in August. So the idea here being that the Fed would tolerate inflation moderately overshooting its 2% target, also prioritizing maximum employment. But that's not unconditional, that the Fed could still raise rates early if it felt like there were financial instability risks that were bubbling up in whatever market you want to look at. What do you see as that meaning? What could that look like if financial stability risks kind of end up coming up, and then the Fed says, you know what? We actually-- we need to lift off a little bit early.

BILL DUDLEY: I think the bar is pretty high to doing something like that because monetary policy just isn't a very good tool to try to tamp down financial excesses in particular markets. So the Fed could in theory design a tight monetary policy early because they're worried about markets becoming too exuberant, but I think the bar to doing that is actually-- would be quite high. I think the Fed would be looking at other actions. You know, for example, the countercyclical capital buffer where they could raise capital requirements for banks, or just jawboning the market and saying, look, this is an area where we think the markets are excessive valuation.

The Fed, unlike, know know, 10 years ago, the Fed now publishes a semi-annual financial stability report, so it actually has a medium to communicate to people about how they see financial markets. The reality, it is though in the United States, the Fed doesn't really have great tools to tamp down market excess.

BRIAN CHEUNG: So I want to ask about the ballooning balance sheet. You manage the market desk at the New York Fed, which executes the US Treasury mortgage-backed securities purchases when the Open Market Committee decides it wants to change the pace or the types of purchases. John Williams, who is currently at the New York Fed, has a lot of work I'm sure ahead of him with the amount of purchases that they made at the beginning of this crisis. But did you ever think you'd see a day where the Fed balance sheet would be at $7 trillion, and what's the consequence of that?

BILL DUDLEY: I mean, the honest answer is, no, I didn't expect it to be $7 trillion, certainly from $4 trillion, you know, in just a few short months. That was a very rapid increase in the size of the belt.

That said, there's no maximum limits to the size of the Fed's balance sheet, and given how monetary policy is executed today-- in other words, by setting an interest rate on reserves-- the Fed can operate monetary policy totally independent of the size of its balance sheet. So if the Fed needs to go to a $10 trillion balance sheet, they could, and they would still maintain control of their ability to separately execute monetary policy.

The big issue-- and I think from the Fed's big balance sheet-- is the Fed has interest-rate risk. You know, most of their liabilities are these short-term reserves, and they hold long-duration assets. So in principle, if short-term interest rates went up very, very sharply, the Fed's net interest margin could be under pressure, and the Fed-- that would mean that the Fed would probably-- earnings would be lessened. The amount of money that the Fed would pay back to the Treasury would be quite a bit less.

And if you took this, you know, to its logical conclusion-- you know, very high short-term interest rates that occur very, very rapidly-- it actually mean-- you know, generate losses on the Fed's belt. But that's not something that the Fed is very worried about today when they don't think that they're going to be tightening monetary policy for three or four years at a minimum.

BRIAN CHEUNG: Well, a lot to chew on right there. We've talked about everything. We even squeezed a mention of the PDCF in addition to repo markets in there, so a pretty in-depth conversation. But again, former New York Fed President Bill Dudley joining us here on Yahoo Finance at the All Markets Summit. Thank you so much for stopping by.

BILL DUDLEY: Thank you.