WEBVTT - The World's Most Controversial Interest Rate Is Haunting Us Again 0:00:08.520 --> 0:00:11.719 Hello, and welcome to another edition of the ad Thoughts Podcast. 0:00:11.760 --> 0:00:16.079 I'm Tracy Alloway and I'm Joe Wisenthal. Joe, do you 0:00:16.079 --> 0:00:20.119 remember Libor? I think I remember that, Yes I do. 0:00:20.360 --> 0:00:25.720 That's totally a loaded question. Libor the London Interbank offered rate, 0:00:26.200 --> 0:00:29.920 basically the rate at which banks lend money to each other. 0:00:30.400 --> 0:00:33.959 It was a big librar scandal, right, yeah, I mean 0:00:34.000 --> 0:00:36.320 there there's so much you could say about libor. So 0:00:36.720 --> 0:00:39.680 it became a big deal during the Financial crisis because 0:00:39.720 --> 0:00:43.680 the rate blew out because basically all these banks didn't 0:00:43.680 --> 0:00:45.519 want to lend money to each other, so they had 0:00:45.560 --> 0:00:48.159 to offer a higher rate in order to do it. 0:00:48.240 --> 0:00:51.839 And then after the financial crisis we found out that 0:00:52.000 --> 0:00:56.680 libor had been rigged in various ways. And that's because 0:00:56.720 --> 0:01:00.320 the way libor actually works is it was done by hervey. 0:01:00.480 --> 0:01:03.080 So someone would actually go to the banks and collect 0:01:03.480 --> 0:01:06.560 there are estimates of libor each day, and then they 0:01:06.600 --> 0:01:08.520 would come up with a sort of aggregate. So it 0:01:08.560 --> 0:01:12.560 was a self reported rate that ended up being manipulated 0:01:12.640 --> 0:01:15.000 by some of the people that were reporting it. I 0:01:15.040 --> 0:01:18.760 was so shocked when it turned out that it was manipulated. 0:01:19.319 --> 0:01:22.360 Isn't the thing where they do the price literally called 0:01:22.360 --> 0:01:26.480 a fix. Yeah, that's right, in retrose. I can't believe that. 0:01:27.080 --> 0:01:30.399 I can't believe that in retrospect something called the fix 0:01:30.440 --> 0:01:33.080 turned out to be manipulated. I was. I was totally 0:01:33.120 --> 0:01:35.560 stunned by that. All right, we are all shocked, But 0:01:35.640 --> 0:01:38.840 I will tell you something that is actually shocking now. 0:01:38.880 --> 0:01:42.280 Sort of. We are all expecting Libor to be phased 0:01:42.319 --> 0:01:45.959 out at one point or another, um relatively soon actually, 0:01:46.640 --> 0:01:50.240 given what happened with the self reporting scheme, it's supposed 0:01:50.240 --> 0:01:53.320 to be replaced by something that hopefully won't be as 0:01:53.360 --> 0:01:58.120 subject to manipulation. But just as Libor was about to 0:01:58.200 --> 0:02:04.280 be consigned to financial market history, it was about to die, right, 0:02:04.480 --> 0:02:08.639 it has come back from the dead effectively to haunt 0:02:08.720 --> 0:02:18.360 financial markets. Oh I'm I'm intrigued. Yes, So we are 0:02:18.360 --> 0:02:21.880 going to call this episode Revenge of the Libor, And 0:02:21.919 --> 0:02:25.080 we have the perfect person to talk about all this, 0:02:25.200 --> 0:02:27.320 not just what happened in two thousand eight and then 0:02:27.400 --> 0:02:31.560 during the Libor manipulation scandal, but also to discuss what's 0:02:31.600 --> 0:02:35.760 happening now and why people are once again discussing Libor. 0:02:36.200 --> 0:02:43.480 Let's do it so, our guest for this episode is 0:02:43.560 --> 0:02:47.720 Scott Pyng. He is the CEO of Advocate Capital Management, 0:02:47.840 --> 0:02:50.440 and he also used to be head of US interest 0:02:50.520 --> 0:02:55.480 rate strategy at City Group of Fact. That will be 0:02:55.639 --> 0:02:58.639 relevant in just a few minutes. Scott, thanks so much 0:02:58.639 --> 0:03:01.440 for coming on. Thanks for having me guys. So I'm 0:03:01.440 --> 0:03:03.360 so glad we could have you do this because you 0:03:03.400 --> 0:03:06.880 truly are the perfect person to talk about libor, because 0:03:06.919 --> 0:03:09.839 you were one of the first people, if not the 0:03:09.880 --> 0:03:13.560 first person, to actually point out that it looked like 0:03:13.840 --> 0:03:19.280 libor potentially was being manipulated in some ways. That right, Yeah, 0:03:19.320 --> 0:03:22.639 And it's been a long and strange journey since that point. 0:03:22.680 --> 0:03:26.079 And I would sort of contend with the statement that 0:03:26.200 --> 0:03:29.600 libor is dead because rumors of its death as well 0:03:29.720 --> 0:03:33.840 discuss are somewhat greatly exaggerated. So, just to back up 0:03:33.880 --> 0:03:37.880 Tracy mentioned in the intro, libor being the rate that 0:03:38.120 --> 0:03:42.480 banks used to price short term lending to one another. 0:03:42.880 --> 0:03:45.440 Just give us the sort of quick history of how 0:03:45.480 --> 0:03:49.320 this rate became a thing. Sure, before I started the 0:03:49.360 --> 0:03:52.800 business in the eighties, the key short term rate was 0:03:52.840 --> 0:03:56.560 actually not liebor, was actually three month treasury bills. Libel 0:03:56.640 --> 0:03:58.840 came along the mid eighties as a way to for 0:03:58.960 --> 0:04:02.640 a non US tom ossalled banks to obtain financing in 0:04:02.760 --> 0:04:07.080 the your dollar market UM and over time, with increased 0:04:07.160 --> 0:04:12.400 usage within with its center status in the middle of 0:04:12.440 --> 0:04:17.000 interest rate swaps, it took over UM the benchmark status 0:04:17.040 --> 0:04:20.480 from three month T bills and it's been the benchmark 0:04:20.680 --> 0:04:24.240 UM since the late eighties early nineties. So that was 0:04:24.279 --> 0:04:27.560 really the genesis of LIBL And at some point maybe 0:04:27.600 --> 0:04:29.440 we'll have some time to touch back on that because 0:04:29.480 --> 0:04:31.880 I think going back to three months T bills may 0:04:31.960 --> 0:04:34.719 actually be a very useful thing in terms of considering 0:04:34.839 --> 0:04:38.279 librar replacements. Yeah, we're definitely going to talk about library 0:04:38.320 --> 0:04:41.800 replacements UM, but before we do, just to set the scene, 0:04:41.880 --> 0:04:45.520 remind us what library looked like, you know, in two 0:04:45.520 --> 0:04:48.000 thousand and eight in the depths of the financial crisis, 0:04:48.080 --> 0:04:51.640 because we not only saw a librar blowout, we also 0:04:51.720 --> 0:04:56.640 measured library against o I s UM overnight index swaps 0:04:56.680 --> 0:05:01.279 basically a risk free rate of lending PEG to typically 0:05:01.400 --> 0:05:04.839 fed funds futures. Walk us through the dynamics there. Why 0:05:04.880 --> 0:05:08.800 did we see that spread blowout? Well, the basic mechanics 0:05:08.920 --> 0:05:12.920 of libor back then was there were sixteen submission banks 0:05:13.040 --> 0:05:17.640 and the library setters, which is the British Banks Association, 0:05:17.760 --> 0:05:20.480 would take the four highest, four lowest, throw them out 0:05:20.520 --> 0:05:23.679 and average the rest, and that process was supposed to 0:05:23.720 --> 0:05:29.080 eliminate any attempt at collusion. During the global financial crisis, 0:05:29.080 --> 0:05:32.880 bank funding costs started to rise and library did begin 0:05:32.960 --> 0:05:37.640 to rise. However, because at that point libor rates um 0:05:37.800 --> 0:05:41.800 submitted by each bank was published on sources like Bloomberg, 0:05:42.040 --> 0:05:45.080 people could see when the bank was vulnerable because they 0:05:45.080 --> 0:05:47.919 could see its library submission start to rise. And people 0:05:47.960 --> 0:05:51.680 began looking very carefully at these library submissions, and that 0:05:51.720 --> 0:05:54.839 creates an incentive on the part of many banks to 0:05:55.200 --> 0:05:59.400 begin to under count the actual financing rate. And that 0:05:59.480 --> 0:06:02.680 really was, you know, the issue that we pointed out 0:06:02.720 --> 0:06:05.640 when we did our analysis on libor in April of 0:06:05.680 --> 0:06:09.200 two tho eight. Can you explain a little bit that 0:06:09.279 --> 0:06:13.320 mechanism The banks submit numbers based on what and then 0:06:13.360 --> 0:06:15.200 they throw some out. It sounds kind of like an 0:06:15.200 --> 0:06:19.200 Olympic scoring system of lopping off the edges. But just 0:06:19.279 --> 0:06:21.800 walk us through that process a little bit more sure. 0:06:21.880 --> 0:06:25.000 Banks are supposed to submit libor based on where they 0:06:25.440 --> 0:06:30.800 are financed, and typically the submission entity is supposed to 0:06:30.839 --> 0:06:34.040 be squared away in the middle of a bank's funding area. 0:06:34.720 --> 0:06:39.080 Over time, some of those supposedly walled off people and 0:06:39.120 --> 0:06:42.960 ward off entities began to be influenced by other parts 0:06:43.160 --> 0:06:46.680 of the trading desk. Very frequently, these submission entities and 0:06:46.720 --> 0:06:49.960 people sat on the same trading floor as traders who 0:06:49.960 --> 0:06:53.200 are taking positions on where library or interest rate swaps are. 0:06:53.360 --> 0:06:57.240 So over time you started getting some influence from the 0:06:57.279 --> 0:07:00.920 traders we were market making and taking market positions, influencing 0:07:01.000 --> 0:07:03.839 the people who are actually setting the rates. So there 0:07:03.839 --> 0:07:06.800 were two reasons to manipulate library, right, Like, on the 0:07:06.839 --> 0:07:12.040 one hand, you could potentially help your portfolio, your colleagues 0:07:12.080 --> 0:07:14.640 at the bank, you know, help the positions depending on 0:07:14.680 --> 0:07:18.080 where you shifted library. But on the other hand, during 0:07:18.080 --> 0:07:22.760 the financial crisis, people were much more concerned about reputational risks, 0:07:22.800 --> 0:07:26.200 so typically they started under reporting the library rate because 0:07:26.240 --> 0:07:27.760 they didn't want to make it look like there was 0:07:27.800 --> 0:07:31.920 a huge interbank lending crunch and that they were getting 0:07:31.920 --> 0:07:34.880 the worst of it. Is that right, right? And you know, 0:07:34.960 --> 0:07:37.760 the more noble goal, if you will, is to make 0:07:37.800 --> 0:07:39.920 a bank appear stronger than it would be, And the 0:07:40.000 --> 0:07:42.640 more mundane goal would be for the traders to trying 0:07:42.680 --> 0:07:46.600 to profit on ongoing basis from these rate sets. Now, 0:07:46.680 --> 0:07:50.240 when I published my article, um, we're not able to 0:07:50.280 --> 0:07:53.200 get access to sort of the day to day manipulations 0:07:53.240 --> 0:07:55.440 that men have been going on. But what we could 0:07:55.440 --> 0:07:58.680 see is using publicly available data, we can start to 0:07:58.680 --> 0:08:01.840 see the discrepancy between where people are staying libboard verses 0:08:01.840 --> 0:08:05.520 where banks are actually funding. So that really was the 0:08:05.600 --> 0:08:09.840 genesis of my analysis that you can uh find um, 0:08:09.880 --> 0:08:13.360 this discrepancy from publicly available market data. So you said, 0:08:13.520 --> 0:08:18.720 there's theoretically two different sort of strains of library manipulation. 0:08:18.880 --> 0:08:23.000 One would be designed to conceal the degree of vulnerability 0:08:23.000 --> 0:08:27.560 in the system overall, which because of self fulfilling prophecies, 0:08:27.600 --> 0:08:30.960 may in theoretically have been beneficial in some way. And 0:08:30.960 --> 0:08:35.440 then the other is the more cynical manipulating the number 0:08:35.840 --> 0:08:39.080 so as to profit off of trades that are tied 0:08:39.160 --> 0:08:43.840 to the number. How big was or is the market 0:08:44.120 --> 0:08:47.760 for instruments that are in some way connected to library 0:08:48.120 --> 0:08:51.760 I mean, libralar is tied into pretty much everything around us. 0:08:51.920 --> 0:08:55.000 We're talking about hundreds of trillions of notionals of interest 0:08:55.120 --> 0:08:59.280 rate swaps that directly refer to libor. On top of that, 0:08:59.360 --> 0:09:03.679 you have ank loans, student loans, mortgages that are all 0:09:03.800 --> 0:09:07.599 indexed to a great variety of lieborars. So library is 0:09:07.679 --> 0:09:11.560 really an intricate part of our everyday lives. So, Scott In, 0:09:11.880 --> 0:09:14.240 I think it was April two thou eight, you publish 0:09:14.320 --> 0:09:19.160 your report is Libor Broken? What happened after that? Did 0:09:19.160 --> 0:09:21.800 you get a lot of backlash? I can't imagine. UM 0:09:21.840 --> 0:09:26.600 your colleagues, even at City Bank potentially were were that 0:09:27.000 --> 0:09:30.040 enthused about it? Yeah? I mean we wrote on analysis, 0:09:30.200 --> 0:09:32.920 UM got sent out to clients and there was kind 0:09:32.920 --> 0:09:36.160 of radial silence for about a five day period, and 0:09:36.200 --> 0:09:38.680 then the Wellster Journal picked it up and was on 0:09:38.720 --> 0:09:40.560 the front page, and then all of a sudden, all 0:09:40.559 --> 0:09:43.120 hell broke loose. So let's just say that I got 0:09:43.120 --> 0:09:45.679 called into quite a few meetings that day as a 0:09:45.720 --> 0:09:48.240 result of that. Who was the most upset about it? 0:09:48.240 --> 0:09:51.000 When you say all hell broke loose? Where were you 0:09:51.080 --> 0:09:54.719 hearing that the most? Um? We heard that bb A 0:09:54.880 --> 0:09:57.959 wasn't happy with us. We heard that UM management was 0:09:58.000 --> 0:10:00.880 not happy with us. UM the good was I signed 0:10:00.880 --> 0:10:04.240 off on the article with my boss, Michael Schumacher of 0:10:04.280 --> 0:10:07.439 the same name as a race car driver prior to publications, 0:10:07.480 --> 0:10:10.120 so I knew he had my back, but there was 0:10:10.160 --> 0:10:13.120 a lot of political blowback from that because if you 0:10:13.120 --> 0:10:16.240 think about it, you know, again library is so central 0:10:16.320 --> 0:10:18.760 to everything, and not just finance but in the whole 0:10:18.760 --> 0:10:21.640 world that you know, calling the question was really a 0:10:21.679 --> 0:10:25.240 big deal. So I want to move on to what 0:10:25.320 --> 0:10:27.839 librar is actually doing now and why we're all talking 0:10:27.880 --> 0:10:30.360 about it, But before we do, maybe just to sum up, 0:10:30.400 --> 0:10:35.360 after the financial crisis, we have an actual investigation into 0:10:35.480 --> 0:10:38.880 libor and how it was said. What was the outcome 0:10:39.000 --> 0:10:41.720 of that investigation. I think the outcome was that a 0:10:41.760 --> 0:10:44.960 great many of the banks who involved in liborar sets 0:10:45.120 --> 0:10:49.160 were were tainted in this submission um, whether it's on 0:10:49.200 --> 0:10:52.920 an ongoing basis or whether it's um infrequently, because of 0:10:53.000 --> 0:10:57.640 the influence of market makers and risk takers on the 0:10:57.679 --> 0:11:01.160 library submission side. So I think the key results is 0:11:01.240 --> 0:11:03.720 that now we have a new administrator for libralar, we 0:11:03.800 --> 0:11:07.360 have banks who who have much clear policies in terms 0:11:07.360 --> 0:11:11.240 of the wall around the library centers, and hopefully when 0:11:11.280 --> 0:11:13.480 a bit of a better place. I have one more 0:11:13.520 --> 0:11:17.440 question about library history before we move on. You touched 0:11:17.440 --> 0:11:19.360 on the important point, and one of the reasons the 0:11:19.360 --> 0:11:22.200 story resonated so much is because it touches all of 0:11:22.200 --> 0:11:24.800 our lives, and so many of us have financial instruments 0:11:24.840 --> 0:11:28.160 that are in some way tied to library costs. But 0:11:28.760 --> 0:11:31.040 why did that happen? I mean, you mentioned there was 0:11:31.080 --> 0:11:33.880 an earlier benchmark, the three month treasury. When you think 0:11:33.880 --> 0:11:36.560 about things like student loans or credit cards, it's not 0:11:36.600 --> 0:11:40.640 intuitive why the industry would start to price those off 0:11:40.679 --> 0:11:43.480 of bank lending rates as opposed to something a little 0:11:43.480 --> 0:11:47.079 more industry neutral. I think if you look at bank 0:11:47.200 --> 0:11:51.640 assets and liabilities, the coevolution of that through time is 0:11:51.760 --> 0:11:55.320 part of what drove liborar's popularity. Again, some of the 0:11:55.360 --> 0:11:57.920 old floating rate indu cries that banks used to use 0:11:58.000 --> 0:12:01.920 where things like prime or our CD rates. But as 0:12:01.960 --> 0:12:05.000 libel kind of gained primacy in the drumatist market in 0:12:05.040 --> 0:12:09.240 the futures market, more banks decided to adopt libel as 0:12:09.240 --> 0:12:12.880 both as assets and liability indices. And when you do that, 0:12:13.840 --> 0:12:17.040 you basically set policies to say, have a fixed floating 0:12:17.120 --> 0:12:19.760 funding mix, and the floating part of it is going 0:12:19.800 --> 0:12:23.200 to be directed towards the standard benchmark, which is libor 0:12:23.800 --> 0:12:26.600 likewise on the assets side. Then as libel kind of 0:12:26.600 --> 0:12:29.360 becomes stand on liability side, the asset side is going 0:12:29.400 --> 0:12:32.359 to take live or as well as its mentionmark. So again, increasingly, 0:12:32.360 --> 0:12:34.640 over time you had more and more bank products beginning 0:12:34.640 --> 0:12:39.080 to index the fillion rates off of libor. Alright, so 0:12:39.200 --> 0:12:43.160 let's fast forward to today. We went through the financial crisis, 0:12:43.200 --> 0:12:46.000 We went through this big libraar scandal. At the end 0:12:46.040 --> 0:12:48.880 of the scandal, most people agreed that we were going 0:12:48.920 --> 0:12:52.400 to try to find a replacement for this rate uh 0:12:52.559 --> 0:12:55.440 something else that we could peg trillions of dollars worth 0:12:55.440 --> 0:12:58.520 of financial assets too. We're going to talk about that 0:12:58.600 --> 0:13:02.480 effort in a second, but before we do, let's talk 0:13:02.559 --> 0:13:06.360 about the recent rise in library because of course, the 0:13:06.440 --> 0:13:08.960 thing has not been doing much for years and years 0:13:08.960 --> 0:13:10.800 and years, and we all kind of forgot about it, 0:13:10.880 --> 0:13:15.520 and then suddenly it's in the headlines once again. Scott 0:13:15.600 --> 0:13:19.160 walk us through what's happening with the rise in library 0:13:19.480 --> 0:13:22.520 short Tracy. Since the end of two thousand seventeen, we 0:13:22.640 --> 0:13:25.560 have seen libar, especially three month libel, which is the 0:13:25.600 --> 0:13:29.120 benchmark in library space, rise more than half a percent. 0:13:29.600 --> 0:13:33.199 And this is in the absence of any Federal Reserve 0:13:33.360 --> 0:13:37.120 rate hike over that period, So that has obviously been 0:13:37.160 --> 0:13:40.480 of major concern to the market because of because everything 0:13:40.559 --> 0:13:44.280 is basically index off of libor. So to me, I 0:13:44.440 --> 0:13:46.800 what I wanted to do was to us to look 0:13:46.840 --> 0:13:50.640 through UM strategistal analyst research to say, okay, what has 0:13:50.679 --> 0:13:52.960 been a driver of this? And I was really not 0:13:53.040 --> 0:13:55.360 able to find it, So I basically had to do 0:13:55.440 --> 0:13:59.520 my own UM analysis and that really drove UM. You 0:13:59.559 --> 0:14:01.920 know what we found out, which is that if you 0:14:01.960 --> 0:14:05.319 look at how much Libel has risen and you really 0:14:05.320 --> 0:14:07.920 try to attribute it into different sources, what we find 0:14:08.000 --> 0:14:10.720 is that about half of the rise came from the 0:14:10.760 --> 0:14:14.920 market pricing in UH future FED hikes only half, So 0:14:15.000 --> 0:14:16.840 that means the other half has to come from some 0:14:16.920 --> 0:14:21.040 other sources. UM about two thirds of that is coming 0:14:21.120 --> 0:14:25.200 in analysis from increases in short term treasury will supply 0:14:25.800 --> 0:14:28.920 as the government UM is in the process of funding 0:14:28.960 --> 0:14:31.720 the tax reform. But there is a there is a 0:14:31.760 --> 0:14:35.960 small but recognizable component of the Libel rise that is 0:14:36.040 --> 0:14:38.840 due to UH shifts in the credit market, which we 0:14:38.920 --> 0:14:42.600 identified as well. Breakdown that that second half. So it's 0:14:42.640 --> 0:14:45.280 easy enough to understand how you could figure out how 0:14:45.360 --> 0:14:48.680 much is attributable to expectations for an increase in Fed 0:14:48.720 --> 0:14:52.520 funds that um the other parts where you said part 0:14:52.560 --> 0:14:56.120 of it is short term treasury supply I guess, competing 0:14:56.720 --> 0:15:01.240 with inter bank lending, and also the slight change in 0:15:01.400 --> 0:15:05.239 credit perceptions of borrowers. How did you sort of disambiguate 0:15:05.360 --> 0:15:07.360 those two aspects right? You can. You can think of 0:15:07.480 --> 0:15:11.280 library as a bunch of stacked lego bricks. So at 0:15:11.280 --> 0:15:14.320 the bottom of that stack is the ristless rate. How 0:15:14.400 --> 0:15:17.800 much the market is expecting uh FED funds rate to move, 0:15:17.960 --> 0:15:20.800 And we can find that out by looking at market 0:15:20.800 --> 0:15:24.760 predictions of three months oh i s overnight index swap, 0:15:24.800 --> 0:15:28.280 which is where markets pricing average three month FED funds. 0:15:28.320 --> 0:15:30.800 That's the bottom stack, and we find that that's really 0:15:30.800 --> 0:15:34.680 about fifty eight percent of the Libel rise. The next 0:15:34.720 --> 0:15:39.760 set of lego bricks is really actual securities, and the 0:15:40.040 --> 0:15:42.920 least risky securities in the three months sector is three 0:15:42.920 --> 0:15:45.600 month treasury bills. So we looked at how much three 0:15:45.600 --> 0:15:47.800 months treasury blow yields have changed since the end of 0:15:47.800 --> 0:15:52.360 the year. We found that it rose thirty seven basis points. 0:15:52.880 --> 0:15:56.160 From that thirty seven basis points, you subtract the twenty 0:15:56.200 --> 0:15:59.360 four basis points the bottom stack of lego bricks that's 0:15:59.440 --> 0:16:02.280 from the three month oh I s and the residual 0:16:02.360 --> 0:16:05.920 the thirteen basis points we attribute to increased strategy bill supply. 0:16:06.440 --> 0:16:08.200 And then the final piece of the puzzle is a 0:16:08.200 --> 0:16:12.080 difference between three month treasury yield and the most comparable 0:16:12.160 --> 0:16:14.640 instrument to three month libr in a market, which is 0:16:14.720 --> 0:16:18.880 ninety day commercial financial commercial paper rate, and that that 0:16:18.960 --> 0:16:22.240 difference contributed to the final eight basis points of the puzzle. 0:16:22.680 --> 0:16:25.040 So this is actually the only analysis that I've seen 0:16:25.080 --> 0:16:28.520 attempt to quantify each of those aspects and their impact 0:16:28.600 --> 0:16:31.400 on library UM. It's really good, But talk to us 0:16:31.440 --> 0:16:35.280 about the tax component of it, because I think for 0:16:35.360 --> 0:16:38.240 most listeners when they think about tax reform, they're not 0:16:38.280 --> 0:16:41.160 necessarily going to start thinking about what the impact is 0:16:41.200 --> 0:16:45.200 going to be on money markets. Sure, and the impact 0:16:45.320 --> 0:16:48.760 of tax reform visa VI. What we're talking about today 0:16:49.000 --> 0:16:53.200 is that as tax reform was enacted, obviously the companies 0:16:53.240 --> 0:16:57.600 that had a significant chunk of their overseas earnings UM 0:16:57.760 --> 0:17:02.520 left in overseas markets had a rake in terms of repatriation. Now, 0:17:02.560 --> 0:17:05.840 a lot of these were already invested in dollar assets 0:17:05.840 --> 0:17:08.239 dollar short term masses such as a CP market, so 0:17:08.520 --> 0:17:13.560 there was no significant asset allocations shift from that repatriation. However, 0:17:13.760 --> 0:17:16.879 what has been noted by industry sources such as Credit 0:17:16.880 --> 0:17:21.240 Swiss is that since the passage of tax reform, the 0:17:21.280 --> 0:17:25.600 CP market has seen significant shortening of the maturity stack. 0:17:25.720 --> 0:17:28.840 So what we've seen is that the percentage of the 0:17:28.880 --> 0:17:32.640 CP market that is six weeks or shorter in credits 0:17:33.040 --> 0:17:37.600 research has risen from low fifties to mid s over 0:17:37.640 --> 0:17:40.480 that same period. Now that may not seem very much, 0:17:40.480 --> 0:17:43.320 but it's a pretty substantial shift in terms of the sponsorship. 0:17:43.840 --> 0:17:46.960 And my interpretation of what that means is that the 0:17:47.040 --> 0:17:50.560 cash rich companies such as a snail Apple, who have 0:17:50.880 --> 0:17:53.880 had that cash overseas, when they bring it back, they 0:17:54.040 --> 0:17:56.480 tend to want to keep it in shorter maturity paper 0:17:56.600 --> 0:17:59.560 because they're not necessarily sure what they're gonna do with it. 0:17:59.600 --> 0:18:03.000 Perhaps they're going to be announcing some um some bonuses 0:18:03.040 --> 0:18:06.760 for workers, perhaps they're gonna start building another another headquarters, 0:18:07.119 --> 0:18:10.199 whatever that may be. There is some policy uncertainty on 0:18:10.200 --> 0:18:12.720 the part of the company, and as a result, that's 0:18:12.720 --> 0:18:15.280 reflected in the stance of the tragedy department who are 0:18:15.280 --> 0:18:18.400 managing this cash flow. Their stands would be, let's keep 0:18:18.400 --> 0:18:20.399 it shorter until we figure out what to do with it. 0:18:21.000 --> 0:18:22.800 But spending it great, we don't have to do very 0:18:22.880 --> 0:18:26.840 much with it. So they shortening in the maturity profile 0:18:26.920 --> 0:18:30.720 in the CP market um has has really been the 0:18:30.760 --> 0:18:34.399 big driver of this increased credit component of LIEB or 0:18:35.240 --> 0:18:38.800 So is this worrisome? The numbers don't seem very big, 0:18:38.920 --> 0:18:41.600 and we're certainly not talking about anywhere near the scale 0:18:41.680 --> 0:18:44.919 we saw during the crisis or anything like that. But 0:18:45.200 --> 0:18:49.479 how much anxiety should the increase, particularly in the credit 0:18:49.520 --> 0:18:53.320 component cause people. But now it is not worrisome if 0:18:53.359 --> 0:18:56.400 you again, if you sum up the tragic bill component 0:18:56.440 --> 0:18:59.119 and the credit component, that adds up to roughly about 0:18:59.640 --> 0:19:04.040 bases points or roughly one FED hike. So it's not 0:19:04.119 --> 0:19:07.399 that worrisome right now, maybe to the majority of the world, 0:19:07.440 --> 0:19:10.200 but to the FED that is an issue that they 0:19:10.240 --> 0:19:13.560 need to keep an eye on because if that component 0:19:13.640 --> 0:19:17.480 of libor continues to rise, then it has the impact 0:19:17.680 --> 0:19:23.200 of additional and intended FED hikes that will reduce liquidity 0:19:23.200 --> 0:19:27.119 in the marketplace over and beyond what the FED is doing. Well, 0:19:27.160 --> 0:19:29.840 I was going to ask the consensus is that we 0:19:29.880 --> 0:19:33.200 shouldn't all freak out just yet. But what does this 0:19:33.320 --> 0:19:38.720 say about the feds exit from monetary policy? At the 0:19:38.880 --> 0:19:41.560 very least, it seems like it's a good example of 0:19:41.600 --> 0:19:45.960 how tricky it might be to actually tighten monetary policy 0:19:46.000 --> 0:19:48.760 and the number of things that the Central Bank is 0:19:48.800 --> 0:19:50.760 going to have to take into account, you know, like 0:19:51.280 --> 0:19:55.000 fiscal stuff such as tax reform. It seems like you're 0:19:55.000 --> 0:19:57.920 asking a lot of them. Yes, right, dude, that's absolutely right. 0:19:58.080 --> 0:20:00.879 And what we are seeing with what is going on 0:20:00.920 --> 0:20:04.640 at CP market is that as the Fed is withdrawing 0:20:04.840 --> 0:20:10.720 its unprecedented liquidity, any additional shifts in liquidity provision is 0:20:11.000 --> 0:20:14.800 probably going to have an amplified effect in this environment. 0:20:15.320 --> 0:20:18.640 So it's revenge of the Library. But we shouldn't all, 0:20:19.240 --> 0:20:23.840 you know, panic just yet. Scott, you mentioned earlier about 0:20:23.880 --> 0:20:27.400 attempts to find a replacement for Library and maybe sort 0:20:27.440 --> 0:20:29.800 of going back to the future and looking at what 0:20:29.840 --> 0:20:34.560 we used to use. What is up for discussion and 0:20:34.600 --> 0:20:37.719 what do you think the best reference rate would actually be. 0:20:38.160 --> 0:20:41.840 Sure Currently, the government has put forth an overnight rate 0:20:41.920 --> 0:20:46.359 called s o f R SOFA, which represents basically an 0:20:46.480 --> 0:20:51.080 arrogant where securitized borrowing takes place. So typically, if you 0:20:51.119 --> 0:20:53.520 hold treasury bonds, you can pledge those bonds and borrow 0:20:53.600 --> 0:20:58.399 cash against that. That's basically what this rate will reflect. Now, 0:20:58.560 --> 0:21:02.000 this is a very front rate and its nature from 0:21:02.119 --> 0:21:05.200 libra or. Libra or is supposed to represent UM a 0:21:05.240 --> 0:21:08.440 couple of things. One is unsecuritized landing and second thing 0:21:08.520 --> 0:21:12.800 is obviously for longer than overnight rates. So this proposal 0:21:13.080 --> 0:21:17.159 is really a very very different animal than LIBOR. It 0:21:17.320 --> 0:21:21.040 is not meant to replace library. Cannot replace librar because 0:21:21.160 --> 0:21:24.200 to attempt to do so would invite many, many different 0:21:24.280 --> 0:21:26.720 lawsuits on the part of at least half the market 0:21:27.040 --> 0:21:31.119 who would be disadvantaged by this. Now, the issues I 0:21:31.240 --> 0:21:35.320 have with using rates like sofar are multipold. One is 0:21:35.480 --> 0:21:38.800 again you're you're using a securitized rate to replace a 0:21:38.840 --> 0:21:42.560 quote unquote replace and unsecuritized rate. The second is that 0:21:42.600 --> 0:21:45.800 the reason they've only proposed this overnight rate is because 0:21:45.800 --> 0:21:49.960 of lack of volume in longer term rates UM. If 0:21:50.000 --> 0:21:54.240 you look at sort of overnight repose, hundreds of billions trade, 0:21:54.680 --> 0:21:57.399 but once you push term repo to one month or 0:21:57.440 --> 0:22:01.720 three months, the percentage of the entire report transaction that 0:22:01.720 --> 0:22:04.040 occurs in the one month three month point relative to 0:22:04.119 --> 0:22:08.600 the overnight point drops to well lesson tempatent, so you 0:22:08.680 --> 0:22:11.240 can't This is why the government can't tell the market 0:22:11.280 --> 0:22:13.520 hey when we use a one month securitized rate, because 0:22:13.800 --> 0:22:17.320 the volumes they're just are not They're just like um, 0:22:17.440 --> 0:22:20.400 you know, their arguments for pushing out LIBORAD. There's their 0:22:20.480 --> 0:22:24.520 arguments for not using lib words that there's insufficient volume there. Well, 0:22:24.720 --> 0:22:28.640 there's insufficient volume in terms strong securitized financing as well. 0:22:29.240 --> 0:22:32.840 So the current best pick by the government is this 0:22:33.359 --> 0:22:38.240 overnight securitized rate, which I disagree with. I'm much more 0:22:38.280 --> 0:22:41.080 in favor of using a rate such as three month 0:22:41.160 --> 0:22:43.679 fee bill because one it's been out there for a 0:22:43.720 --> 0:22:46.719 long time, people know what it is to its weekly 0:22:46.760 --> 0:22:50.040 auction treasury bills. So the rate determination is based on 0:22:50.080 --> 0:22:54.159 the very transparent auction process. And if we need daily sets, 0:22:54.160 --> 0:22:57.120 we can certainly increase the frequency of these auctions and 0:22:57.240 --> 0:23:00.920 still get significant volume. For example, the previous weekly three 0:23:00.960 --> 0:23:05.600 months or thirteen week treasury bill produced well over three 0:23:05.640 --> 0:23:08.719 times the fifty billion of treasury bills that was sold, 0:23:09.080 --> 0:23:11.320 So there's plenty of liquidity in the tragedy bill market, 0:23:11.680 --> 0:23:13.760 and I think the government in putting all of its 0:23:13.800 --> 0:23:17.520 weight behind SOFUR is really doing the wrong thing and 0:23:17.560 --> 0:23:19.240 doing wrong. By doing the wrong thing, I mean that 0:23:19.800 --> 0:23:22.439 we didn't come up with libor as the benchmark rate 0:23:22.480 --> 0:23:25.560 by FIAT. The market kind of gravitated towards that there 0:23:25.600 --> 0:23:28.359 was more and more usage. It started off with tragedy bills, 0:23:28.640 --> 0:23:32.400 market usage kind of gravitated around librard as a benchmark, 0:23:32.840 --> 0:23:36.280 and so I think creating a benchmark by FIAT is 0:23:36.320 --> 0:23:39.480 something that is going to have difficulty working. I think 0:23:39.480 --> 0:23:43.720 what the government and others should do is to promote 0:23:43.760 --> 0:23:47.560 a variety of different types of floating rate indicries and 0:23:47.640 --> 0:23:49.680