UDSKRIFT 🔗
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Speaker 1: Bloomberg Audio Studios.
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Speaker 2: Podcasts, radio, news.
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Speaker 3: Former New York Fed President Bill Dudley warning, if a bust might lie ahead, we should worry that the current boom may be sowing the seeds for a future financial crisis. Bill joins us now for more. Bill, great to see you. Thank you for being with us. I'm sure when you wrote that, you were not thinking about an affair at the second biggest company in the world.
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Speaker 1: No, I was not.
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Speaker 3: I'm sure that wasn't on your necessarily your big old card, but how much should the Fed be paying attention to turmoil right now in the tech trade?
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Speaker 1: Well, I think they need to be paying attention for a couple of reasons.
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Speaker 4: Number one, obviously, the AI trajectory has big implications for the economic outlook in terms of how strong the economy is. And then also upward pressure on interest rates as AI demand is taking down.
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Speaker 1: A lot of credit.
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Speaker 4: But the bigger question, I think, longer term is, is AI going to go from boom to bust? And if it goes to bust, are we going to have a repeat of the great financial crisis where the stress on the financial system caused things to fall apart?
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Speaker 1: I think there I'm a little bit.
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Speaker 4: More optimistic because, number one, people are talking about the risk of AI being a bust. They really weren't talking about the great financial crisis occurring as we were going up to it. Housing never declined on a national basis. Subprime lending wasn't risky. There were a lot of beliefs out there that sort of ruled out a great financial crisis. This time, people are talking about the AI boom turning into a bust.
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Speaker 3: So what do you think should be done by regulators, by the Federal Reserve, to prevent it from getting to a level that could threaten the financial system?
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Speaker 1: Well, I think there's a couple of things.
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Speaker 4: Number one, we need better insight to what's happening in the non-bank financial sector because a lot of the activity in AI financing is moving from the equity market and from cash flow now to off-balance sheet borrowing. And we really don't really have a good sense of who owns what to whom and under what conditions. So I think greater transparency would be very important. I also think it's important that we have someone responsible for financial stability in the non-bank financial sector you know, the Securities and Exchange Commission really doesn't have a financial stability mandate. So they either need to give one explicitly to the Fed or to the Financial Stability Oversight Council and say, we need to look into this sector a little bit more to understand where the counterparty risks are. I think one of the good things here is that the financing is mostly from big companies, big established companies.
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Speaker 1: So it's not quite, you know, spread out through.
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Speaker 4: A lot of mom-and-pop organizations that you saw during the great financial crisis in terms of subprime lending. But I do think this is a big enough boom that it could definitely lead to a bust, especially because of the fact that everyone's trying to get to the finish line first. It's a winner-take-all kind of game. You have about seven or eight different hyperscalers that all want to win. There's not going to be room for seven or eight winners.
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Speaker 2: Do you think there's anyone at the Fed right now who can currently address some of these issues you just laid out?
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Speaker 4: Well, the Fed does look at financial stability issues semi-annually. That's one of the things that they use for their federal market committee meetings to discuss. But I'm not really sure that they have the information to actually understand all the counterparty risk that is going on. And some of the risk is a little scary because it's wrong-way risk. So NVIDIA is guaranteeing the value of their chips. So what happens if the value of their chips goes down? Not only do they have to come up with the money to make good those guarantees, but their earnings are going to suffer because they're going to have lower chip prices. So I think we need to look a little bit more deeply into where the risks are in the sector. If U.S.
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Speaker 2: Growth is so tied to AI, where does this leave the Federal Reserve if this starts to slow down in terms of the rate hiking cycle?
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Speaker 1: Well, I think if.
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Speaker 4: The AI investment boom turns over, it's definitely negative for growth and definitely going to put downward pressure on interest rates. The question is, when is that going to happen? You know, there's been a lot of speculation that the election outcome is going to lead to a dramatic slowing in AI data center construction. I think that's probably correct mostly in the medium to longer term, but I'm not sure how fast it's going to happen. A lot of data centers are already been improved. They're already under construction. So 2027, I still expect investment spending to be higher than in 2026. And so that's continued to add upward pressure to the economy.
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Speaker 3: Bill, do you think that the Fed should refrain from hiking rates because of the turmoil that we've seen in the AI trade, because of the threat to growth that could come on the heels of it?
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Speaker 4: Well, I think that it's important not to overreact to what's a relatively small correction. Obviously, if financing to AI just evaporated and investment spending next year was going to be weaker than this year, then that has big effects both for economic activity in terms of investment, but also in terms of the stock market. If it goes far enough, then of course the Fed has to take that into consideration. But so far, look, the stock market is still up this year. The stock market is up a lot over the last five years. Financial conditions are still quite accommodative. So people are talking about, oh, the tightening of financial conditions means that the Fed doesn't have to tighten anymore. I don't think that's really borne out by the economic news. I mean, the payroll employment report we saw on Friday suggested that the economy is still growing pretty strongly.
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Speaker 1: And there's really very.
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Speaker 4: Little sense that the level of interest rates is exerting a lot of restraint on economic activity currently.
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Speaker 3: Well, this is exactly where I was going with it. And it's ahead of CPI tomorrow that no one's focusing on because instead they're focusing on an affair of Jensen Huang's. I mean, to me, I just wonder how much the Fed could get sidetracked by watching the volatility and not necessarily target inflation to the degree that some people are seeing and feeling every day.
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Speaker 4: Well, there's always a risk that you say, well, I want to wait to see more information. Therefore, I don't do the tightening that I actually need to do in a timely way. But I think the Fed is less inclined to look at every little wobble in the equity market and think that that has meaningful implications for monetary policy. I remember 1987, we had the stock market crash in 87.
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Speaker 1: Everyone thought that was going to generate a really weak economy. It did not.
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Speaker 4: And one of the reasons it did not was all that stock market crash did in 1987 was unwind the advance earlier in the year. So by the end of the year, we're just back at the stock starting point for the beginning of 1987. So I think it's important to take stock market. A stock market decline of large magnitude obviously would have consequences for the economy. But it's got to be large relative to what's already happened. And the stock market's gone up a lot in the.
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Speaker 1: Last few years.
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Speaker 2: What about the fact that we have oil prices seriously declining? Brent under 100, WTI under $ 90 a barrel.
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Speaker 4: Well, that's good for the inflation outlooks, clearly, but it's also going to actually be positive for growth because people's real income is going to be boosted as energy prices decline. So, again, we don't really know what the outcome is going to be in terms of the Iran war. And so I think from the Fed's perspective, you can't make bets on what could happen. You have to sort of be looking out the window and saying what actually is happening. And I think none of these things are very definitive as of yet.
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Speaker 3: I hope that I someday get a view of the window outside of the Fed building, because I think that would be very clarifying. Bill Dudley, thank you so much for being with us, former Fed president of the New York institution.