Former Fed Chair Yellen Worries About Another Financial Crisis

"Investors may not know how risky the loans are," said Yellen. The loans are made to non-investment grade companies that don't qualify for traditional bank loans.

(Related: Fed Chief Concerned With Rising Debt of Highly Leveraged Companies)

When the next recession comes, the Federal Reserve will be limited in its ability to address the crisis by cutting interest rates, according to Yellen.

(Related: In Leveraged Loans, It's Beginning to Look a Lot Like 2008)

"Historically the Fed cuts rate by 500 basis points (5%)," but the "normal level" of short-term rates is usually around 3%. "That means there's much less scope to cut short-term rates than there's been historically in the United States,″ Yellen said.

The current federal funds rate is set between a range of 2%-2.25%, and is generally expected to increase another 0.25% before year-end, at next week's Federal Open Market Committee meeting. After that, the outlook is more murky.

Economists are scaling back expectations for Fed rate hikes next year from three or four hikes to two or fewer, and several Fed policymakers, including Chairman Jerome Powell, have said publicly that the fed funds rate is approaching neutral — a rate that would neither speed up nor slow down growth.