WEBVTT - How Banks Turned Into Giant Synthetic Hedge Funds 0:00:00.200 --> 0:00:03.360 Hey, they're ad Loots listeners. It's Tracy Alloway. 0:00:03.000 --> 0:00:04.000 And Joe Wisenthal. 0:00:04.280 --> 0:00:07.720 We are very excited to announce that Oudlots is going 0:00:07.800 --> 0:00:09.680 to Washington That's right. 0:00:09.760 --> 0:00:11.560 For the first time, we are going to do a 0:00:11.640 --> 0:00:16.439 live public Odd Lots recording in our nation's capital. That's 0:00:16.440 --> 0:00:19.680 going to be March twelfth in Washington, DC at the 0:00:19.760 --> 0:00:23.560 Miracle Theater and guests will be announced in the coming days, 0:00:23.600 --> 0:00:25.960 but in the meantime you can find a ticket link 0:00:26.000 --> 0:00:27.880 at Bloomberg dot com, slash odd. 0:00:27.800 --> 0:00:44.480 Lots, Bloomberg Audio Studios, Podcasts, Radio News. 0:00:47.159 --> 0:00:51.040 Hello and welcome to another episode of the Odd Lots podcast. 0:00:51.159 --> 0:00:53.600 I'm Joe Wisenthal and I'm Tracy Alloway. 0:00:53.760 --> 0:00:54.920 Tracy remember SVB. 0:00:56.120 --> 0:00:59.880 I vaguely remember something happening with a bank called Silicon Valley. 0:01:00.880 --> 0:01:03.880 Here's actually sort of something I've been wondering about, is like, Okay, 0:01:04.160 --> 0:01:07.800 there was this moment where suddenly people got anxious about 0:01:07.920 --> 0:01:10.760 regional banks and stuff like that. You know, we like 0:01:10.840 --> 0:01:13.520 did episodes like how should we reform banking? And should 0:01:13.560 --> 0:01:16.320 banking be semi public and all this stuff, but like 0:01:16.360 --> 0:01:17.720 nothing happened in the week of it. 0:01:17.720 --> 0:01:21.440 Right, No, And in fact, I mean, the basel endgame 0:01:21.560 --> 0:01:25.000 stuff seems to be pretty much off the table at 0:01:25.000 --> 0:01:25.520 this point. 0:01:25.560 --> 0:01:27.840 But yeah, what, actually I haven't been following that. What's 0:01:27.880 --> 0:01:28.360 happening with that? 0:01:28.520 --> 0:01:31.600 I don't think it's happening. Michael Barr has like he's left, 0:01:31.640 --> 0:01:34.759 hasn't he? So yeah, I mean it seems like there's 0:01:34.800 --> 0:01:37.399 not going to be a big change on that front. 0:01:37.520 --> 0:01:39.720 I will also say, like one of the interesting things 0:01:39.720 --> 0:01:42.080 when it comes to bank regulation is there was a 0:01:42.080 --> 0:01:46.720 twenty eighteen change where I think the Trump administration made 0:01:46.720 --> 0:01:51.880 it easier for regional banks to do some potentially riskier stuff. 0:01:52.440 --> 0:01:55.280 And the argument there was that regional banks should be 0:01:55.360 --> 0:01:59.440 treated differently to large banks, they should be able to 0:01:59.440 --> 0:02:02.560 do certain things blah blah blah blah blah. And I 0:02:02.560 --> 0:02:05.000 guess you could argue that that might have fed into 0:02:05.080 --> 0:02:06.800 some of the SVB drama as well. 0:02:07.280 --> 0:02:09.639 Actually it's good that we're talking about this because when 0:02:09.680 --> 0:02:12.360 we talk about financial markets these days, like so much 0:02:12.400 --> 0:02:15.480 of it is about tech in particular. But if you 0:02:15.520 --> 0:02:18.120 go back and look at a chart of KRE, the 0:02:18.160 --> 0:02:21.040 regional bank ETF, that is another one that was just 0:02:21.080 --> 0:02:24.640 a straight line up on November fifth, and there's a 0:02:24.680 --> 0:02:28.720 widespread expectation, and I think pretty well founded that the 0:02:28.760 --> 0:02:31.320 Trump administration is going to have a much more sort 0:02:31.360 --> 0:02:35.760 of liberal attitude towards financial market regulation than the last administration. 0:02:36.280 --> 0:02:38.600 And so we shouldn't go too long with, you know, 0:02:38.639 --> 0:02:41.480 take our eye off the ball of financial regulatory issues 0:02:41.560 --> 0:02:44.240 because also, if history is any guide, like the next 0:02:44.280 --> 0:02:46.560 thing that happens, like we'll get no warning of it. It 0:02:46.560 --> 0:02:48.000 will just happen one day. Yeah. 0:02:48.040 --> 0:02:51.280 Also, I love talking about banks, like let's just do 0:02:51.360 --> 0:02:53.239 it for bank purposes. 0:02:53.520 --> 0:02:56.520 Okay, Well, I'm very excited about this episode. It's a 0:02:56.520 --> 0:02:58.799 guest I've actually wanted to have on for a very 0:02:58.840 --> 0:03:02.120 long time. We're going to be speaking with Elham Saidenishon. 0:03:02.480 --> 0:03:05.760 She's a term assistant professor of economics at Bernard College 0:03:05.800 --> 0:03:08.560 at Columbia as well as an adjunct professor at NYU, 0:03:09.000 --> 0:03:11.840 and also the author of a recent paper sort of 0:03:12.040 --> 0:03:15.760 revisiting the collapse of SVB and plying a new lend 0:03:15.840 --> 0:03:19.280 to it. The paper is called Banks a Synthetic hedge Fund. So, Elham, 0:03:19.320 --> 0:03:21.239 thank you so much for coming on out lots. 0:03:21.160 --> 0:03:23.239 Thank you so much for having me. I'm very happy 0:03:23.240 --> 0:03:23.760 to be here. 0:03:24.160 --> 0:03:26.799 Absolutely, I'm not used to this phrase. So this term 0:03:26.880 --> 0:03:29.680 synthetic hedge funds, I could sort of take a stab 0:03:29.720 --> 0:03:32.160 in my mind of what it means. But what is 0:03:32.200 --> 0:03:34.160 this term synthetic hedge funds mean? 0:03:34.720 --> 0:03:37.320 A synthetic hash fund is a type of activity and 0:03:37.480 --> 0:03:40.520 rather than being a specific type of like firm. And 0:03:40.560 --> 0:03:43.560 this is when a non hedge fund wants to replicate 0:03:43.600 --> 0:03:45.960 the activities of a hedge fund and therefore get the 0:03:46.000 --> 0:03:49.120 same type of return. And this is about a replication, 0:03:49.520 --> 0:03:52.480 but it's about the replication of the return and risk 0:03:52.520 --> 0:03:55.360 of a hedge fund without being an actual hedge fund. 0:03:55.800 --> 0:03:58.880 So this is when we call an institution doing what 0:03:58.920 --> 0:04:01.720 we call SYNTHETI had fun type of activity. 0:04:02.360 --> 0:04:05.000 Tracy. I already like this conversation because normally we talk 0:04:05.040 --> 0:04:07.200 about shadow banks, right, and so the idea that there's 0:04:07.240 --> 0:04:11.280 banks inside regulated institutions and then other non banks sort 0:04:11.320 --> 0:04:14.200 of replicate their activity. And it feels like we're looking 0:04:14.240 --> 0:04:17.080 through the other end of the telescope here talking about, 0:04:17.800 --> 0:04:21.640 you know, hedge funds being replicated inside regulated institutions. 0:04:21.720 --> 0:04:25.000 Yeah, it's replication all the way down. But okay, talk 0:04:25.040 --> 0:04:28.800 to us about how SVB fits into the category of 0:04:29.160 --> 0:04:31.919 synthetic hedge funds because I think that'll help us understand 0:04:32.000 --> 0:04:33.000 exactly what's going on. 0:04:33.640 --> 0:04:36.120 So basically, a SVP kind of like FeAs in this 0:04:36.279 --> 0:04:40.080 category from two different perspectives, and like one type of 0:04:40.120 --> 0:04:44.120 activity is actually being generated through the unbalanced it kind 0:04:44.120 --> 0:04:46.560 of like operation, and the other one is being generated 0:04:46.600 --> 0:04:49.280 through off balance it operation. So I want to start 0:04:49.320 --> 0:04:51.480 with the off balance it operation and then I kind 0:04:51.480 --> 0:04:54.600 of like continue the conversation to discuss what SWEP has 0:04:54.640 --> 0:04:57.080 done and the balance it as well. When it comes 0:04:57.080 --> 0:04:59.240 to the off balance it operation, it is like the 0:04:59.400 --> 0:05:03.800 way as we have used interest rates, SWAB replicates what 0:05:03.920 --> 0:05:06.560 a hedge fund does in order to conduct a fixed 0:05:06.640 --> 0:05:10.240 income arbitration strategy, rather than what a bank does in 0:05:10.320 --> 0:05:13.760 order to protect itself against interest rate risk. So, to 0:05:13.800 --> 0:05:16.160 be more specific, what do I mean by that? Like 0:05:16.520 --> 0:05:19.840 when you try to kind of like match the activities 0:05:19.880 --> 0:05:23.200 of the SVB risk managers with the narratives of the 0:05:23.240 --> 0:05:27.000 CFO of the SVB, we see that the timing of 0:05:27.360 --> 0:05:31.000 entering and exiting the interest rates toob by SVP really 0:05:31.080 --> 0:05:34.360 replicates what a hedge fund would do in order to 0:05:34.480 --> 0:05:37.240 kind of like exploit the so called mispricing in the 0:05:37.279 --> 0:05:40.920 bond market. And that mispricing in the bond market would 0:05:40.960 --> 0:05:45.040 generate this so called like arbitrage opportunity that a hedge 0:05:45.080 --> 0:05:48.919 fund wants to naturally exploit. So I want to start 0:05:48.960 --> 0:05:52.240 with what happened to the SVB in order to decide 0:05:52.279 --> 0:05:55.600 to exit the interest rates to oppositions. So when you 0:05:55.640 --> 0:05:58.039 look at like the timing of the exit, it just 0:05:58.080 --> 0:06:00.480 doesn't make sense if you think of a VB as 0:06:00.520 --> 0:06:04.080 a bank that wants to actually hedge itself against interest 0:06:04.120 --> 0:06:07.640 rate movements, but if you think of it as a 0:06:07.680 --> 0:06:12.320 hedge fund who has entered this particular position of having 0:06:12.320 --> 0:06:15.520 a long position in the US treasuries and a short 0:06:15.560 --> 0:06:19.680 position in interst rate swap because it was actually thinking 0:06:19.760 --> 0:06:23.080 that the swop rate, which is the difference between the 0:06:23.120 --> 0:06:26.120 swap spread, which is the difference between the swap rate 0:06:26.200 --> 0:06:29.480 and the US treasure rate, is too narrow, and like 0:06:29.520 --> 0:06:32.479 the hedge fund was predicting that this spread is going 0:06:32.520 --> 0:06:35.039 to widen in the future. But at some point it 0:06:35.160 --> 0:06:39.240 realizes that that prediction was wrong and the swab spread 0:06:39.360 --> 0:06:42.599 is not actually going to widen, and in order to 0:06:42.640 --> 0:06:45.320 minimize as the losses, it tried to kind of like 0:06:45.800 --> 0:06:50.040 exed that particular position sooner rather than later. This is 0:06:50.080 --> 0:06:53.960 the narrative that the SVBCFO was kind of like offering 0:06:54.000 --> 0:06:57.280 to the rest of us that they tried to minimize 0:06:57.440 --> 0:07:01.880 losses and that's why they exist the interest rate stop position, 0:07:02.440 --> 0:07:06.400 which again matches with what the very same CFO and 0:07:06.600 --> 0:07:09.320 very same type of like people from the SVP group 0:07:09.360 --> 0:07:13.280 were telling us about their prediction about the shape of 0:07:13.480 --> 0:07:17.880 the yield cave, which informs such a strategy, But it 0:07:17.960 --> 0:07:22.440 does not align with what a typical bank risk manager 0:07:22.520 --> 0:07:26.960 would do if it wanted to actually protect itself against 0:07:27.000 --> 0:07:30.960 interest rate risks because it was holding very long term 0:07:31.120 --> 0:07:35.280 US Treasury securities. So in short, when it comes to 0:07:35.320 --> 0:07:39.640 the off balanceet operation, the timing of entering and exiting 0:07:39.680 --> 0:07:43.600 the swap positions, and the reason the SVIB has actually 0:07:43.920 --> 0:07:48.840 conducted both operations matched with their understanding of what the 0:07:48.920 --> 0:07:52.400 yield care should be and what the yield cave is 0:07:52.800 --> 0:07:56.400 rather than what the interesst rate risks are, and they 0:07:56.480 --> 0:08:00.960 wanted to protect themselves against those type of risks. So 0:08:01.000 --> 0:08:03.480 if you want to understand it from the traditional bank 0:08:03.560 --> 0:08:06.000 risk management, this doesn't make sense. If you want to 0:08:06.080 --> 0:08:09.200 understand it through a hedge fund strategy that want to 0:08:09.240 --> 0:08:13.600 actually exploit mispricing in the bond market, and then realizes 0:08:13.640 --> 0:08:17.400 that that mispricing was mistake, that estimation of a mispricing 0:08:17.480 --> 0:08:20.240 was mistake, then it does make sense to do what 0:08:20.320 --> 0:08:23.440 the SWEB did. At the same time, when it comes 0:08:23.480 --> 0:08:27.400 to the unbalanced operations, when we look at the asset 0:08:27.560 --> 0:08:30.320 side of the SVB, there is this item in the 0:08:30.360 --> 0:08:33.040 asset site which I think we should explore more and 0:08:33.120 --> 0:08:35.920 we haven't done so yet. And that's what we call 0:08:36.000 --> 0:08:39.760 the subscription line or a capitol call line of credit, 0:08:40.160 --> 0:08:42.920 which is something that I think is growing in the 0:08:43.000 --> 0:08:46.360 commercial banking world, and in terms of the economics of 0:08:46.400 --> 0:08:50.280 this credit line is a very unusual type of bank credit. 0:08:50.720 --> 0:08:53.600 I just want to ask a question on the swaps, right, So, 0:08:53.679 --> 0:08:56.320 I remember this came up a lot when the vocal 0:08:56.440 --> 0:08:59.319 rule was coming into being. But a reality of the 0:08:59.360 --> 0:09:01.760 way banks are operate is that the line between a 0:09:01.800 --> 0:09:06.000 hedge and a trade can be pretty thin, and hedges 0:09:06.080 --> 0:09:09.280 can end up being very profitable or they can end 0:09:09.360 --> 0:09:12.240 up losing a lot of money. How do you actually 0:09:12.360 --> 0:09:16.960 distinguish between the two, because again, one man's hedge is 0:09:17.000 --> 0:09:18.000 another man's trade. 0:09:18.080 --> 0:09:22.320 Right, that's a very very good question. Like, one way 0:09:22.360 --> 0:09:25.600 to distinguish between the two is that again listening to 0:09:25.679 --> 0:09:29.160 what they are saying and the reasoning behind their entrance, 0:09:29.240 --> 0:09:32.760 and they entering a particular position and they exit from 0:09:32.760 --> 0:09:36.360 that particular position. So it's really about collecting narrative. That's 0:09:36.440 --> 0:09:39.320 one thing. The second thing is to match what they 0:09:39.320 --> 0:09:42.840 are doing with what they also doing in peril and 0:09:43.000 --> 0:09:45.959 saying in peril about their prediction of what the shape 0:09:46.000 --> 0:09:49.200 of the yield care should be. Because when it comes 0:09:49.240 --> 0:09:53.280 to like most hedge funded strategies, especially the fixed income 0:09:53.400 --> 0:09:57.959 hedge funded strategies, is all about what a particular head 0:09:58.080 --> 0:10:01.760 fund manager thinks they yield curve should be and what 0:10:01.880 --> 0:10:05.080 the yield cave in the market actually is today. And 0:10:05.160 --> 0:10:08.120 if there's a difference between the two, a hedge fund 0:10:08.200 --> 0:10:12.240 is going to conduct a sort of an intere and 0:10:12.800 --> 0:10:17.720 compose a portfolio that enables the hedge fund to actually 0:10:17.800 --> 0:10:21.880 exploit that's so called mispricing. So what I would say 0:10:21.960 --> 0:10:27.520 is that the defining point here is whether that particular entity, 0:10:27.600 --> 0:10:29.960 it can be a synthetic hash fund such as a 0:10:30.040 --> 0:10:34.160 bank or an actual hedge fund, is connecting is activity 0:10:34.280 --> 0:10:38.520 with the mispricing in the bond market. And what the 0:10:38.559 --> 0:10:41.160 shape of the yield cave should be versus what the 0:10:41.200 --> 0:10:44.520 shape of the yield cave is or what they do 0:10:44.600 --> 0:10:48.920 think about, like a particular direction in the prices, and 0:10:48.960 --> 0:10:52.320 then they want to actually kind of like very immediately 0:10:52.400 --> 0:10:56.559 and short term exploit those particular directional benefits. 0:10:56.840 --> 0:11:00.199 So I take your point about Okay, the if I 0:11:00.280 --> 0:11:02.360 were saying one thing, we're doing a hedge, but some 0:11:02.440 --> 0:11:06.480 of the stuff doesn't line up, could it be inconfidence? Right? Like, 0:11:06.559 --> 0:11:09.160 so there's one stay, Okay, this does not look like 0:11:09.200 --> 0:11:11.920 a hedge. They're making a trade. They're taking some sort 0:11:11.920 --> 0:11:14.240 of risk that's different from the economics of the bank. 0:11:14.840 --> 0:11:16.240 Could it just be bad management. 0:11:16.960 --> 0:11:19.480 It can be, But in terms of SVB, I don't 0:11:19.520 --> 0:11:22.560 think it was. I do think it was incompetence, but 0:11:22.679 --> 0:11:24.920 not because they were incompetent in terms of being a 0:11:24.960 --> 0:11:28.000 bad risk manager as a bank or as a banker. 0:11:28.400 --> 0:11:31.560 But I think they were a very bad hedge fund manager. 0:11:31.640 --> 0:11:33.679 And again I want to go back to what they 0:11:33.720 --> 0:11:37.800 were saying about, like what they think the market is doing, 0:11:37.880 --> 0:11:40.160 which they thought is this wrong? And they thought that 0:11:40.520 --> 0:11:42.800 the swop press are too low, and they thought the 0:11:42.840 --> 0:11:45.720 swop pres they're based on the fundamental value they should 0:11:45.760 --> 0:11:48.360 be higher. And then when you look at their action, 0:11:48.520 --> 0:11:52.040 they were actually acting based on that particular belief, and 0:11:52.080 --> 0:11:55.720 I would not call that incompetence. I would call that 0:11:55.880 --> 0:11:59.640 someone in this case a banker who is actually trying 0:11:59.640 --> 0:12:02.400 to see like a hedge fund and it's trying to 0:12:02.480 --> 0:12:06.960 align his action based on that particular belief about the 0:12:07.000 --> 0:12:10.520 shape of the yield cave. And the other important difference 0:12:10.520 --> 0:12:12.800 between a hedge fund and strategy and a trade, just 0:12:12.840 --> 0:12:15.360 going back to the previous point, is that a trade 0:12:15.400 --> 0:12:17.680 is usually shorter term, but when it comes to the 0:12:17.679 --> 0:12:20.480 hedge fund of strategies, these guys are patients. At least 0:12:20.520 --> 0:12:22.800 some of these guys are very very patient, and especially 0:12:22.880 --> 0:12:26.079 in the world of fixing comarbitrash, you need to be patient, 0:12:26.600 --> 0:12:29.800 but when you are acting, you need to be very quick. 0:12:30.400 --> 0:12:33.520 And that's also one of the distinctions between just like 0:12:33.960 --> 0:12:36.200 you are entering the interest rate saw because you just 0:12:36.240 --> 0:12:38.880 want to trade a particular a derivative in this case 0:12:39.320 --> 0:12:42.760 SAB versus your intering interest rate SAB because it is 0:12:42.920 --> 0:12:47.800 part of your brother portfolio. And I do think that 0:12:47.840 --> 0:12:51.240 in the case of a SWEEB, the very interest rate 0:12:51.320 --> 0:12:55.600 SWAB because it was part of a broader portfolio, and 0:12:55.840 --> 0:12:59.559 that portfolio, the goal of that core portfolio was not 0:12:59.720 --> 0:13:03.360 to head a particular risk, in this case the interest 0:13:03.440 --> 0:13:06.880 rate risk of the those US treasuries, but rather the 0:13:07.000 --> 0:13:11.760 goal was to exploit a mispricing in the yieldcare. 0:13:27.040 --> 0:13:30.240 Talk to us about the on balance sheet activities you 0:13:30.280 --> 0:13:34.319 mentioned them earlier. So alternative credit line, subscription lines. How 0:13:34.360 --> 0:13:38.240 did those actually factor into this idea of SVB being 0:13:38.240 --> 0:13:39.280 a synthetic hedge fund. 0:13:39.840 --> 0:13:42.440 That's a very good question. And when it comes to 0:13:42.640 --> 0:13:46.600 the capital line of credit, there are so many interesting 0:13:46.640 --> 0:13:50.800 differences between this particular credit line and a typical bank 0:13:50.840 --> 0:13:54.400 credit line. I want to start by saying something which 0:13:54.480 --> 0:13:57.880 is very different from what banks do. So, as a bank, 0:13:57.920 --> 0:14:00.560 when you extend a line of credit, you extend the 0:14:00.600 --> 0:14:04.840 loan which earns interest. Your biggest incentive is to actually 0:14:04.880 --> 0:14:08.120 earn return based on the interest you are actually kind 0:14:08.120 --> 0:14:11.280 of like earning, and your biggest fear is for the 0:14:11.320 --> 0:14:14.520 guy for your counterparty not to show up. You don't 0:14:14.520 --> 0:14:17.559 want to actually be engaged in this type of credit activity. 0:14:18.160 --> 0:14:21.360 But when it comes to the capital line of credit 0:14:21.440 --> 0:14:25.840 or subscription line, is actually the opposite. When it comes 0:14:25.920 --> 0:14:29.040 to the interest rate on these lines of credit, the 0:14:29.080 --> 0:14:32.240 interest rate is actually very low. They are a structured 0:14:32.240 --> 0:14:34.520 to below. They are a structure to be too low, 0:14:35.000 --> 0:14:38.360 so that in this case, this is actually a line 0:14:38.400 --> 0:14:42.440 of credit between the bank and usually a private equity 0:14:42.600 --> 0:14:46.000 fund manager. So the interest rates are very low because 0:14:46.000 --> 0:14:49.160 you want to attract those private equity fund managers to 0:14:49.240 --> 0:14:53.720 come to you and actually postpone the capital call and 0:14:54.000 --> 0:14:57.800 in instead bring those funding gaps through this particle a 0:14:57.880 --> 0:14:58.480 line of credit. 0:14:58.800 --> 0:15:00.760 I explained that, sorry, don't understand that. 0:15:01.160 --> 0:15:05.280 Basically, like, the first thing is that these subscription lines 0:15:05.360 --> 0:15:08.160 are not a credit line between a bank and a 0:15:08.160 --> 0:15:11.920 private equity It is a credit line between a bank 0:15:12.160 --> 0:15:16.640 and a private equity fund manager. So the reason the 0:15:16.640 --> 0:15:20.640 private equity fund manager goes to the bank in order 0:15:20.720 --> 0:15:23.640 to kind of like establish this line of credit is 0:15:23.680 --> 0:15:28.160 that they want to postpone capital call from their limited partner, 0:15:28.760 --> 0:15:33.640 because that's how the private equity fund manager can actually 0:15:33.840 --> 0:15:38.120 kind of like synthetically or artificially increase the internal rate 0:15:38.200 --> 0:15:42.960 of return and therefore increases own compensation. So we know 0:15:43.200 --> 0:15:47.680 why private equity fund manager is doing so, but why 0:15:47.760 --> 0:15:51.720 the bank is involved in this type of activity. Given 0:15:51.760 --> 0:15:54.680 that the interest rate on this particular alone is not 0:15:54.800 --> 0:15:58.040 very attractive. The answer to this question is the type 0:15:58.040 --> 0:16:02.400 of collateral. The other type of credit lines where the 0:16:02.400 --> 0:16:06.440 collateral is usually let's say the physical assets or you know, 0:16:06.600 --> 0:16:10.040 another type of like financial assets. In this case, the 0:16:10.160 --> 0:16:17.880 collateral is the imployed liability of private equity limited partners, 0:16:18.600 --> 0:16:22.760 even though these limited partners may have no idea. As 0:16:22.840 --> 0:16:25.640 a matter of fact, they do not have any idea 0:16:25.760 --> 0:16:28.440 that this line of credit has been established at all. 0:16:29.400 --> 0:16:33.480 In this case, the incentive is a structure. In a 0:16:33.600 --> 0:16:36.960 very interesting way, the incentive for the bank care is 0:16:36.960 --> 0:16:41.520 a structure so that if for any reason, the private 0:16:41.680 --> 0:16:44.960 equity fund manager doesn't show up and does not clear 0:16:45.080 --> 0:16:48.280 the loan or the line of credit and it defaults, 0:16:48.640 --> 0:16:53.040 that's where the money and the profit and the attraction 0:16:53.240 --> 0:16:55.400 is going to be for the banker. So what is 0:16:55.440 --> 0:16:58.320 going to happen in this case. In this case, the 0:16:58.400 --> 0:17:02.119 banker can use what we call the power of attorney 0:17:02.760 --> 0:17:07.720 and then it becomes a synthetic limited partner in that 0:17:07.840 --> 0:17:12.400 particular private equity and the amount of loan, the amount 0:17:12.400 --> 0:17:16.639 of credit that was extended to the private equity fund 0:17:16.760 --> 0:17:20.600 manager now is going to be like as if the 0:17:20.680 --> 0:17:25.200 banker was actually one of the limited partners in that 0:17:25.320 --> 0:17:30.840 particular private equity investment, and the rate of return for 0:17:30.960 --> 0:17:33.560 the banker in this case is going to be the 0:17:33.600 --> 0:17:37.920 intelal rate of return of the private equity fund, which 0:17:37.960 --> 0:17:42.080 is considerably higher than the interest rate. In a sense, 0:17:42.800 --> 0:17:46.239 if you're a banker and if you have extended this 0:17:46.560 --> 0:17:49.880 type of line of credit, you're just like praying and 0:17:50.000 --> 0:17:53.120 like you're hoping that the fund manager doesn't show up 0:17:53.480 --> 0:17:56.800 so that you become the synthetic private equity fund manager. 0:17:57.480 --> 0:18:02.320 So in this paper, basically I am actually highlighting this 0:18:02.480 --> 0:18:06.720 activity which was actually a significant part of sweb's activity 0:18:06.760 --> 0:18:09.960 as well to say that in this case, what the 0:18:10.080 --> 0:18:14.159 banker wants to be is to become a synthetic private 0:18:14.200 --> 0:18:18.280 equity limited partner, and this particular line of credit is 0:18:18.400 --> 0:18:21.120 enabling the bank to do so. And I also want 0:18:21.160 --> 0:18:24.159 to say something about the prospect of like other banks 0:18:24.240 --> 0:18:27.600 using this This is actually a growing business. Wells Fargo 0:18:27.800 --> 0:18:32.040 now does have a whole department trying to exploit this 0:18:32.160 --> 0:18:35.640 type of line off credit. And I do think if 0:18:35.680 --> 0:18:38.320 a bank is interested in this, it is because the 0:18:38.359 --> 0:18:42.960 bank wants to become a synthetic private equity investor. 0:18:43.680 --> 0:18:47.200 Wait, talk to us more about how endemic this actually is. 0:18:47.280 --> 0:18:50.239 And I'm curious as well, like how you know that 0:18:50.320 --> 0:18:53.399 other banks are doing this? And I can think of 0:18:53.480 --> 0:18:57.560 one to posit taking institution that does this, and loads 0:18:57.600 --> 0:19:00.960 has been written about them over the years, But where 0:19:01.000 --> 0:19:02.919 are you getting the data from and how are you 0:19:02.960 --> 0:19:03.840 making that judgment? 0:19:04.840 --> 0:19:09.240 So basically like, I am connecting this research on market microstructure, 0:19:09.359 --> 0:19:13.199 and this project is called Market Microstructure Project. And because 0:19:13.240 --> 0:19:16.200 of this project, I am actually kind of like reading 0:19:16.440 --> 0:19:20.800 everything that the bankers, the fund managers are saying, like 0:19:20.920 --> 0:19:24.359 in the news, in the newspaper, in the news articles. 0:19:24.760 --> 0:19:27.560 So to answer your question, I would say that, unfortunately, 0:19:27.600 --> 0:19:30.639 as of now, I do not have access to the 0:19:30.760 --> 0:19:34.160 data set that gives me this kind of like concrete 0:19:34.240 --> 0:19:37.600 picture of like how many banks are actually using these 0:19:37.880 --> 0:19:41.840 subscription lines or extending these subscription lines. But the good 0:19:41.920 --> 0:19:44.040 news here is that I'm in touch with a few 0:19:44.040 --> 0:19:46.640 people in the fat they might extend such a data 0:19:46.720 --> 0:19:48.959 to me. So this is hopefully going to be the 0:19:49.000 --> 0:19:51.879 next project for me to formalize that and showing that 0:19:51.960 --> 0:19:55.600 in the data. But I'm collecting narratives I'm listening to 0:19:55.640 --> 0:19:58.960 the people, and also because of this market microstructure project, 0:19:59.000 --> 0:20:01.720 I'm talking to all the bankers, Like I go to 0:20:01.760 --> 0:20:04.320 this like let's say a half hours of the bank 0:20:04.359 --> 0:20:07.760 cares like the hedge fund association like parties, and I 0:20:07.800 --> 0:20:11.240 talk to these guys and I'm hearing or and or 0:20:11.320 --> 0:20:14.520 again that like the bankers are either using this in 0:20:14.560 --> 0:20:17.600 their business model as part of their business model, or 0:20:17.680 --> 0:20:21.159 they are trying to actually adopt it. So as of now, 0:20:21.320 --> 0:20:24.439 this is me as the one professor who is just 0:20:24.640 --> 0:20:27.919 trying to listen to the market. But hopefully this is 0:20:27.960 --> 0:20:30.480 soon going to be formally shown to the rest of 0:20:30.560 --> 0:20:33.560 us through the data that I will have access to. 0:20:34.280 --> 0:20:36.760 So they're like multiple things going on. There's the question 0:20:36.840 --> 0:20:39.800 of is the bank hedging or is the bank trading. 0:20:40.080 --> 0:20:43.560 There's the question of are they trying to establish collateral 0:20:43.800 --> 0:20:46.280 that's in a sort of like hedge fund or private 0:20:46.320 --> 0:20:49.879 equity structure so that they can get higher returns and 0:20:49.960 --> 0:20:53.119 so forth. If the data is available, is this the 0:20:53.160 --> 0:20:56.160 type of thing that like that you believe is detectable 0:20:56.200 --> 0:20:59.040 in advance? This bank is starting to look more like 0:20:59.080 --> 0:21:01.800 a synthetic hedge fund than what we think of as 0:21:01.800 --> 0:21:04.160 the economics of a bank, I do. 0:21:04.000 --> 0:21:06.720 Think it is, and I do think like the data 0:21:06.960 --> 0:21:10.200 is an amazing source, and I'm very glad that the central bankers, 0:21:10.200 --> 0:21:12.400 at least they do have access to so many data. 0:21:12.800 --> 0:21:14.919 At the same time, I think right now there is 0:21:14.960 --> 0:21:17.520 not that much the question of like data, but rather 0:21:17.600 --> 0:21:21.159 our framework, the lens s trivish while looking at and 0:21:21.240 --> 0:21:24.200 also the lens TRUVISI we are looking at this data. 0:21:24.320 --> 0:21:26.320 If you are looking at the same data and the 0:21:26.359 --> 0:21:30.399 only framework that you have adopted is the industrial organization 0:21:30.480 --> 0:21:33.040 of a bank, you're going to see what you want 0:21:33.119 --> 0:21:35.320 to see. That this was a bank who did a 0:21:35.480 --> 0:21:39.000 very bad and even a stupid type of like risk management, 0:21:39.560 --> 0:21:44.280 and because they just exited their interest rates opposition just 0:21:44.400 --> 0:21:47.720 before the FED started to increase the rates. So it 0:21:47.800 --> 0:21:52.680 is about the industrial organization that you adopt in order 0:21:52.800 --> 0:21:56.480 to assess the data that is being provided to you 0:21:56.640 --> 0:22:00.199 by banks. And I really think that in order for 0:22:00.560 --> 0:22:03.320 the regulators not to fail, it's not that much the 0:22:03.400 --> 0:22:06.760 question of supervision. I think banks are being supervised, but 0:22:06.960 --> 0:22:09.960 you have to supervise and assist the bank through new 0:22:10.040 --> 0:22:13.639 perspectives and understand that the banks do not want to 0:22:13.680 --> 0:22:17.119 be banks anymore, and they want to actually have some 0:22:17.400 --> 0:22:21.720 share of doors higher returns that are actually being accumulated 0:22:21.840 --> 0:22:25.879 and generated in the private market and also like in 0:22:25.920 --> 0:22:29.400 the alternative investment fund market. So once you look at 0:22:29.480 --> 0:22:33.640 what banks are doing through the business model and industrial 0:22:33.800 --> 0:22:37.560 organization of alternative investment fund, I think then you can 0:22:37.640 --> 0:22:40.920 become even a more effective bank supervisor. 0:22:41.560 --> 0:22:43.560 By the way, Tracy, I'm looking at a blog post 0:22:43.640 --> 0:22:46.199 right now from MSCI, and it doesn't look at it 0:22:46.240 --> 0:22:49.119 from the bank level, but through the fund level, you 0:22:49.160 --> 0:22:51.280 can just see the rise in charge. Whether it's looking 0:22:51.320 --> 0:22:55.119 adventure capital, buy out, various forms of private equity, the 0:22:55.280 --> 0:22:59.760 number of them using subscription lines of credit, pretty interesting 0:23:00.400 --> 0:23:02.840 charge lines going up into the right, lots. 0:23:02.600 --> 0:23:04.919