Speaker 1: Welcome to Turians. I'm Joel Webber and I'm Eric Bell. Students, Eric,
Speaker 1: do you happen to remember what happened about ten years ago?
Speaker 1: Right now? Vaguely? Uh? You know, I was thinking, it's
Speaker 1: the ten year anniversary of two thou great financial Crisis,
Speaker 1: and when we were preparing for this, I actually didn't
Speaker 1: have many vivid memories, less than I thought. Neither did I.
Speaker 1: I actually, for me that it was I can bring
Speaker 1: this back to a podcast because Planet Money did this
Speaker 1: amazing episode about the financial crisis, and that I was
Speaker 1: not in financial journalism yet, and that was the thing
Speaker 1: that actually helped me understand what what was happening around us.
Speaker 1: I was in financial journalism at the beginning of my
Speaker 1: career in the late nineties, so I very much remember
Speaker 1: the Clinton years. But then I went to data. You know,
Speaker 1: I was working in funds, but we just had to
Speaker 1: get the n A V up, the shares out the holdings.
Speaker 1: Our job was much more mechanical than tied to the markets,
Speaker 1: whether markets up or down, you still have to get
Speaker 1: that data in there, and that was my main focus.
Speaker 1: That's why most of my memories are from my own
Speaker 1: account and remembering the political aspect to that crisis more
Speaker 1: than you know the financial aspect. But going back surprised
Speaker 1: me actually, And there's many different ways you could call
Speaker 1: call it a tenure anniversary, right, but I think the
Speaker 1: one that that everyone's gonna hang their hat on is
Speaker 1: gonna be the Lehman Brothers bankruptcy, which pappens September. And
Speaker 1: I also think that over time two thous eight becomes
Speaker 1: this boogeyman that is so big you just assume the
Speaker 1: whole year was this giant black hole. It cast this
Speaker 1: long shadow. It still gets brought up, but when you
Speaker 1: go back, there were definitely some some rough points, but
Speaker 1: it was much more diverse than just this general general
Speaker 1: black hole of of market. And then let's bring it
Speaker 1: back to et S because that's what we're going to
Speaker 1: spend the episode, talking about both what happened that year
Speaker 1: and what's happened since. And you found what five or
Speaker 1: so data points that we're gonna walk through. Yeah, So
Speaker 1: in preparing for this, I went through I just found
Speaker 1: I thought five stats that I found interesting, surprising, and
Speaker 1: pointed to deeper issues within how ETFs handled and behaved
Speaker 1: in two thousand eight. And because neither of us were
Speaker 1: really on the front lines. Were joined by a wonderful guest,
Speaker 1: Christine Harper, who is the editor of Bloomberg Markets magazine,
Speaker 1: and in two thousand eight she was actually covering banking
Speaker 1: for Bloomberg News, so she was literally at the front lines.
Speaker 1: That's basically the world started to crumble. So she'll be
Speaker 1: joining us and kind of helping us bring a different
Speaker 1: perspective of what it was actually like to be watching
Speaker 1: this thing in slow motion this week on Trilliance, Remembering
Speaker 1: two thousand eight and what it all means. Now, Okay,
Speaker 1: so Eric, you've got a stat that you want to
Speaker 1: start with. Christine Harper is joining us. She's the editor
Speaker 1: of Bloomberg Markets Magazine. She's also the author of a
Speaker 1: book forthcoming book about Paul Volker, which we're all really
Speaker 1: excited about. Eric, what's the first step. The first step
Speaker 1: is e t f s took in a hundred and
Speaker 1: seventy five billion dollars in flows in two thousand and eight.
Speaker 1: That is a bit right. So first of all, the
Speaker 1: context is I find this data shocking because the word
Speaker 1: on the street, especially from active funds, is hey, all
Speaker 1: you people going to passive that they're all weekends are
Speaker 1: going to flip out as soon as the market gets tough,
Speaker 1: and it's gonna the market will blow up even more
Speaker 1: because of all these e t f s. But if
Speaker 1: you look back in two thousand eight, e t F
Speaker 1: took in a hundred and seventy four billion, index mutual
Speaker 1: funds took in another looks like ninety billion, and active
Speaker 1: mutual funds lost two hundred and fifty nine billions. So
Speaker 1: if anything, it was the active mutual fund investors who
Speaker 1: got um you know, scared or panicked and left, whereas
Speaker 1: the e t F investors. Again, this is a net
Speaker 1: number over the year. Within months, there was definitely some
Speaker 1: volatility in and out of some products, but that is
Speaker 1: quite a shocking number in my opinion, given that you
Speaker 1: would think that e t fs are used more by
Speaker 1: retail and advisors, less sophisticated investors. They trade intra day
Speaker 1: and so they would be sold off in mass and
Speaker 1: people running for the hills. Christine, I want to I
Speaker 1: want to rewind the clock too. You were on the
Speaker 1: finance team covering Goldman Morgan Stanley. How familiar were you
Speaker 1: with ETFs at that point in time? So at that
Speaker 1: point in time, we I knew they existed, but what
Speaker 1: I'd like to say is that at that point you
Speaker 1: can almost think of the run up to the financial
Speaker 1: crisis as a run up in investment in a liquid products.
Speaker 1: I mean, Goldman Sachs disclosed in early two thousand seven
Speaker 1: that they had a hundred and eleven billion dollars of
Speaker 1: assets that they defined I gotta read this phrase as
Speaker 1: more difficult to fund on a secure basis during times
Speaker 1: of market stress that was up, that was more than
Speaker 1: double two years earlier, everybody was, you know, plunging into
Speaker 1: mortgage backed securities that were put into c d O
Speaker 1: s and then into c d O squares, things that
Speaker 1: were almost inherently illiquid, with the assumption that they would
Speaker 1: always go up in value or they could always find liquidity.
Speaker 1: And they always had these you know, great acronyms of
Speaker 1: nbs and c d O s. But the point was
Speaker 1: they were all traded through banks that none of them
Speaker 1: were on exchanges. They were very difficult to get out
Speaker 1: of when people wanted to get out of. So my
Speaker 1: theory is that E t F s, almost by dint
Speaker 1: of the fact that they were exchanged traded funds, became
Speaker 1: the one of the go to assets just purely for
Speaker 1: I mean, t bills were trading trading negatively at that period.
Speaker 1: People just wanted liquidity, no matter what the cost. So
Speaker 1: it makes a lot of sense to me that all
Speaker 1: this money that was desperately getting out of a liquid
Speaker 1: credit was going into exchange traded funds. Because also another
Speaker 1: thing that was happening at that point for the banks,
Speaker 1: there became this vogue for reporting what did you ever
Speaker 1: hear this term level three assets? Probably it rings all
Speaker 1: that became very, very very important to investors during the
Speaker 1: financial crisis because what it is is it's the most
Speaker 1: hard to value assets on banks balance sheets, and those
Speaker 1: were the ones nobody wanted, right, So exchanged anything exchange
Speaker 1: traded as a level one asset, that's great. Then level
Speaker 1: two are things where there's some inputs that are a
Speaker 1: little bit less clear. Level three are the ones where
Speaker 1: they're basically it's their own model that tells them how
Speaker 1: much it's worth. And so literally investors were demanding, we
Speaker 1: were sending headlines on the amount of level three assets
Speaker 1: that banks had and that banks were trading on how
Speaker 1: liquid they were. I'm sure those stories were getting highly
Speaker 1: highly read, yes, and so any amount of any any
Speaker 1: It makes sense to me that people are going into
Speaker 1: exchange traded funds purely for liquidity. And the other thing
Speaker 1: which we've talked about a lot, the you know c
Speaker 1: d O s and if he has were part of
Speaker 1: the problem was that you didn't know what you exact
Speaker 1: There was no transparency, and so almost the perfect antidote
Speaker 1: to that was an exchange trade exactly where you could
Speaker 1: see what you're you were getting. When when Um in
Speaker 1: the book I wrote nameless plug, one of the advantages
Speaker 1: that I don't want to hear it again. You don't
Speaker 1: even know what it is, and that's not the name
Speaker 1: the institutional e t F two. Okay, all right, we're
Speaker 1: friends again. Okay, all right. Um. One of the advantages
Speaker 1: that I will riff off this, which was when I
Speaker 1: was going through and interviewing people by advantages, is fiduciary vehicle.
Speaker 1: And I think that speaks to the level one asset,
Speaker 1: the fact that there's a prospectus tied to it, the
Speaker 1: fact that it's a forty act fund. I do think
Speaker 1: that probably give people a lot of comfort in a
Speaker 1: time of derivatives, and the fact that you know it
Speaker 1: trades like futures, but it is backed. Those stocks that
Speaker 1: are in the e t F are with a custodian
Speaker 1: physically backed probably did help that year in terms of
Speaker 1: being a contrast to these other products. And there's real
Speaker 1: time pricing, right, that's very transparent. Okay, Point number two,
Speaker 1: this one riffs great off of the first conversation, which
Speaker 1: is that each f S traded just about trillion dollars
Speaker 1: worth of shares. Now that's significant for a couple of reasons.
Speaker 1: First of all, it's more than the US GDP. That's
Speaker 1: a lot of money exchanging hands. Second, that is by
Speaker 1: and far the most et f s ever traded in
Speaker 1: a year ever to this day, and they only had
Speaker 1: a sixth of the assets back then. Why. Here's why,
Speaker 1: and it just speaks what when the going gets tough,
Speaker 1: E t f s tend to be traded more and more.
Speaker 1: They sort of thrive in volatility. They are trading vehicles,
Speaker 1: so when people are uncertain, that's when they tend to
Speaker 1: go up. And they tend to be about of the
Speaker 1: equity trading every day, but in highly volatile times they
Speaker 1: can be and this has been indicated since then. Um.
Speaker 1: In fact, I've frequently charted sp wise dollar volume with
Speaker 1: the VIX. I mean it perfectly overlays. In other words,
Speaker 1: it's almost like E t F volume is a fear gauge.
Speaker 1: And part of the reason is people can use et
Speaker 1: F to short there's options on them. There's all kinds
Speaker 1: of ways you can use them to protect yourself, go along, speculate,
Speaker 1: and ultimately their liquids so on the portfolio. If you
Speaker 1: don't want to disturb your individual holdings, the E t
Speaker 1: F might be the first thing you move around to
Speaker 1: deal with what's happening out there. I like the idea
Speaker 1: of E t F s a the fear gauge, right,
Speaker 1: And we talked about that actually a little earlier in
Speaker 1: the year with what happened back in February when we
Speaker 1: also saw some volatility. When you look back and can
Speaker 1: kind of compare the volatility at those two moments and
Speaker 1: the volumes that were happening, what do you what do
Speaker 1: you notice between what we saw earlier this year? How
Speaker 1: do they compare? Just size? Uh, you know, early February
Speaker 1: was pretty intense. Uh. The spy traded about ninety billion
Speaker 1: on a couple of days. That's almost its record was
Speaker 1: a hundred billion just about back in two thousand eight,
Speaker 1: So it had a day or two in February where
Speaker 1: almost trade as much. But you have to remember SPY
Speaker 1: is much bigger than it was back then, so if
Speaker 1: you adjust for the asset size two eight, you could
Speaker 1: argue was two or three times more than anything that's happened,
Speaker 1: since that's how mega that year was in certain days,
Speaker 1: and there was even a month where SPY traded over
Speaker 1: a trillion dollars into this day, that's the most it
Speaker 1: ever traded in a month, which which month was that October?
Speaker 1: That was the roughest month of the of the year.
Speaker 1: So what what how much bigger is the et F
Speaker 1: market now than it was ten years ago? Six times?
Speaker 1: So now it's got three point six trillion and it
Speaker 1: had about six billion back then. So that is why
Speaker 1: that number, that dollar volume number, because when you make
Speaker 1: a dollar volume, you adjust for the assets. So that's
Speaker 1: that is an I mean, if you take six billion
Speaker 1: and put into trillion, what is that that's the amount
Speaker 1: of turnover that year in e t F. It's a
Speaker 1: large number, way larger than normal. And Christine, can you
Speaker 1: now that we know October was that that that month
Speaker 1: with that volume, can you put us back in what
Speaker 1: it was like then, Well, October, you're right, I mean
Speaker 1: that was the most dire month. That was a month
Speaker 1: where you know, so it was September every but you know,
Speaker 1: Lehman got went bankrupt. Meryl was acquired by Bank of America.
Speaker 1: A week later, Goldman and Morgan Stanley converted to bank
Speaker 1: holding companies supervised by the FED. They also both got
Speaker 1: equity injections. In Goldman's case it was from Warren Buffett
Speaker 1: and uh Morgan Stanley's case it was from this Japanese bank. Um.
Speaker 1: But it wasn't until October that Paulson then sent Secretary
Speaker 1: of the Treasury Hank Paulson brought all the CEOs of
Speaker 1: the nine biggest financial institutions at the time to Washington
Speaker 1: and basically told them they were going to all get equity.
Speaker 1: This was the tart the first round of the tarp,
Speaker 1: and that was the point at which people started to
Speaker 1: feel like, okay, there's a bottom to this. But right
Speaker 1: up to that point, and that was Columbus Day. I remember,
Speaker 1: it was a it was a national it was federal holiday.
Speaker 1: Um so one of those convenient federal holidays where everybody
Speaker 1: actually works, but yeah, exactly. The markets were open, I
Speaker 1: think yeah, so um, but it was it was really unclear.
Speaker 1: And there was also that vote in Congress I think
Speaker 1: in early October before that when they voted down the
Speaker 1: TARP originally, and that was I think you'll remember that
Speaker 1: was when the market really went. That was one of
Speaker 1: the worst days in the equities market we saw, and
Speaker 1: then they reversed the vote. But I wouldn't be surprised
Speaker 1: if that day when the vote on TARP, the first
Speaker 1: vote on TARP happened, whether that wasn't the day when
Speaker 1: you saw the biggest trading. And one thing to add
Speaker 1: here is even though E t F s I think
Speaker 1: got a good grade in two thousand eight were trading
Speaker 1: and I think they did well. I just saw the
Speaker 1: Turkey et F traded fine through all the drama. Briggs
Speaker 1: that they did well, but they've had a couple problems.
Speaker 1: August fifteen, that was that was some crazy days in
Speaker 1: the market. That day, in particular, what happened was E
Speaker 1: t F started trading at discounts. And it wasn't just
Speaker 1: some exotic ones like X I V. There's been some
Speaker 1: sort of exotic blow ups here and there, but this
Speaker 1: was like Vanguard Dividend e t F, and I think
Speaker 1: what what really is important remember here is as long
Speaker 1: as the exchange is having pricing for the stocks and
Speaker 1: the bond market is it available to investors, and there's
Speaker 1: futures pricing. As long as these inputs are available to
Speaker 1: market makers, ets will trade fine. I called that the
Speaker 1: plumbing when the some hiccups start to emerge on August,
Speaker 1: they had made rules from the flash crash that had limits.
Speaker 1: So if an e t F started to trade, um,
Speaker 1: I think it was belower above ten percent, they just
Speaker 1: halted it. So what happens is stocks were halted, but
Speaker 1: the e t F wasn't, and so market makers did
Speaker 1: not know how to price what the e t F
Speaker 1: was worth. That's the worst they've cleaned that up since then.
Speaker 1: That's why Bragg's it did fine. But that's so I
Speaker 1: just want to point out that e t f s
Speaker 1: are they have a good record, but there have been
Speaker 1: some cases. Usually it's involved if there's lack of pricing
Speaker 1: in the underlying holdings of e t f s. That's
Speaker 1: when you can have a problem with the e t
Speaker 1: F trading. That's interesting because I think it was an
Speaker 1: October two thousand night also when they halted sword sales
Speaker 1: because the bank started complaining that their stocks were falling
Speaker 1: to and uh and so it's interesting that e t
Speaker 1: F survived that without any hiccups because that caused a
Speaker 1: lot of issues. If that happens, the e t F
Speaker 1: will trade, but it will move away from its fair value,
Speaker 1: and sometimes that fair value is actually stale. It hasn't
Speaker 1: taken into account like other data. Um, So the takeaway
Speaker 1: here is that, uh, you know, they're not they are
Speaker 1: vulnerable if in fact there's a problem with the anything
Speaker 1: that they hold. Okay, Number three, we're gonna talk about active, right, Yeah,
Speaker 1: because two thirds of active mutual funds underperformed the S
Speaker 1: and P five. This was big for a couple of reasons. One,
Speaker 1: the market was down, so you had to be really
Speaker 1: bad to underperform it. That to me, I think left
Speaker 1: the bad taste and a lot of investors mouths because
Speaker 1: I think they thought, hey, look, I'm paying you this money.
Speaker 1: Couldn't you have sidestep this at all? And you're seeing
Speaker 1: some high profile people actually pull off, like, you know,
Speaker 1: the biggest win of all time basically with some of
Speaker 1: their bets. Yeah, and normally two thirds of active equity
Speaker 1: funds will underperform the benchmark. But a lot of the
Speaker 1: active managers will say, well, that's just because of quantitative
Speaker 1: easing in this bull market, it's made it harder to outperform.
Speaker 1: But this data shows that it's kind of doesn't matter
Speaker 1: the market and the two thirds number, to me, is
Speaker 1: really the cost issue. If you took away all their fees,
Speaker 1: you'd have two thirds of them outperforming. So cost is
Speaker 1: a big issue why they underperformed. But the other issue
Speaker 1: is that active managers. I have empathy for them. If
Speaker 1: you're an active equity fund, a lot of times you
Speaker 1: you can't not hold these big stocks in the sp
Speaker 1: because if you don't hold them when the market's going up,
Speaker 1: you'll lag and get fired. So that's what's developed what's
Speaker 1: called closet indexing. And I don't quite blame them because
Speaker 1: advisors like something that mirrors the index, and so a
Speaker 1: lot of them were just holding the same stock, so
Speaker 1: there's no way they could have possibly sidestepped it when
Speaker 1: they're holding the same thing perform and that's the conundrum
Speaker 1: they're currently in. I mean, I'd talk of fund managers
Speaker 1: all that year, and there was a sort of desire
Speaker 1: on the part of a lot of them to believe
Speaker 1: the worst was over. So you had the Barristern's collapse
Speaker 1: in March, and then we interviewed financial stock investors who
Speaker 1: were convinced, Okay, that's it, you know, let's get in,
Speaker 1: and of course they got slaughtered. In the second half
Speaker 1: of the year, the same thing. People were getting into
Speaker 1: Fannie and Freddie convinced that there was no way it
Speaker 1: would I mean, there were just nobody had ever seen
Speaker 1: anything like this, so they kept jumping in trying to
Speaker 1: catch this falling knife and getting burned by it. And
Speaker 1: then and also I mean, I think, I think, I
Speaker 1: think hedge funds didn't didn't prove themselves to be such
Speaker 1: great hedges. And with a few very notable examples, and
Speaker 1: here's one example. The worst of the big active funds
Speaker 1: was Fidelity Magellan. It was down that year. That must
Speaker 1: have been one of the falling knife catchers. Okay, number four.
Speaker 1: Number four Gold showed the meaning of zero correlation. And
Speaker 1: what I mean by that is gold is perceived as
Speaker 1: a safe haven. Gold was up three percent that year,
Speaker 1: so while it didn't go down, it didn't exactly offset
Speaker 1: the losses in the SP correlated with anything correct, It's
Speaker 1: got zero correlation, which interesting the next year when the
Speaker 1: market rebounded, gold rebound rate with it. Well, I think
Speaker 1: what it is correlated with is inflation fears, and so
Speaker 1: as the central banks went in and started pumping in
Speaker 1: liquidity late in two thousand eight early two thousand nine,
Speaker 1: that's when you saw a lot of big investors say, oh,
Speaker 1: this is a time to start hoarding gold and buying
Speaker 1: real estate and preparing for you know, hyperinflation, which of
Speaker 1: course by two thousand twelve they realized wasn't coming. And
Speaker 1: I think that's true. Gold has a lot of currents
Speaker 1: coming at it um. You know, there's there's emerging markets,
Speaker 1: buyers that come in and weird you know. You I
Speaker 1: learned to appreciate the zero correlation because it doesn't do
Speaker 1: what anybody thinks it should do. And that's why I
Speaker 1: think it's a decent diversifier, because it's that's special. Almost
Speaker 1: everything is negative or positive correlation, but it's not. It's
Speaker 1: a shaky hedge, and I think that's where it gets
Speaker 1: miss characterized a lot. But what was a good hedge,
Speaker 1: what really worked was long dated treasuries T l T
Speaker 1: which is the twenty plus your treasury e t F
Speaker 1: was up the exact same amount of the market was down,
Speaker 1: So if you had long dated treasurys, you completely offset
Speaker 1: your losses in the market. And the best performing e
Speaker 1: t F that year was e d V, which is
Speaker 1: an extended duration TRIST Treasury strips the duration on that's
Speaker 1: like twenty seven years, so it has the highest interest
Speaker 1: rate sensitivity possible. That was up fifty that year. And
Speaker 1: as long as we're talking about performance, you pulled a
Speaker 1: couple of other numbers that are sort of noteworthy to
Speaker 1: write the VIX right. So the VIX was up and um,
Speaker 1: their vix et p s are controversial because they always
Speaker 1: they have role costs that can be a year. So
Speaker 1: VXX is down since launching. However, in a crisis, that
Speaker 1: role cost can turn into roll yield. So the VIX
Speaker 1: Futures Index, which VXX tracks, because VXX wasn't around two,
Speaker 1: it was up a hundred and twenty. In other words,
Speaker 1: if you help vicks futures, enrolled them because the demand
Speaker 1: for short term VIXED futures was so high, you actually
Speaker 1: were buying low and selling high constantly, and you actually
Speaker 1: made a one guy in his garage did that, Well,
Speaker 1: that's like the black swan, right. Well, that to me,
Speaker 1: I call that the jackpot potential. And that's why the
Speaker 1: vix products are media proof. They've never gotten a good review.
Speaker 1: They're like an Adam Sandler movie, like they've literally never
Speaker 1: They always get trashed, but they see a lot of
Speaker 1: volume because when they work, there's nothing like it um
Speaker 1: where I like, I like when people UM give possible
Speaker 1: black swans, I'm like, if you know it, it's not
Speaker 1: the black swan, right, because you're being trading it, right, Yeah,
Speaker 1: it's some unknown thing that we don't know. Okay. Number five,
Speaker 1: the junk bond etf saw inflows of one point five billion.
Speaker 1: I found this astonishing because h y G is the
Speaker 1: big junk bond I don't know. In fact, what's interesting
Speaker 1: is if you look at the h y G s
Speaker 1: performance that year, it was okay until about October, and
Speaker 1: then it went down thirty percent in ten weeks. I mean,
Speaker 1: this was a blood bath. It was the It was
Speaker 1: the reason people worry about junk bonds. This was the
Speaker 1: kind of sell off that has people shorting junk bond
Speaker 1: ETFs every now and then. In mass and it went
Speaker 1: down that much, and there was a couple of days
Speaker 1: of outflows, but mostly it saw inflows. There were buyers
Speaker 1: apparently for the e t F at that time. I
Speaker 1: don't remember. Again, I wasn't studying as it closely, but um,
Speaker 1: that's when it saw its most inflows and then when
Speaker 1: it hit that bottom boy, where the flow is really
Speaker 1: coming in. So clearly there are these vulture type buyers
Speaker 1: out there, which should give some comfort because h y
Speaker 1: G to me is the canary in the coal mine
Speaker 1: in terms of people worrying about the et F structure
Speaker 1: because they're like, well, yeah, sure to can do equities,
Speaker 1: but junk bond you can't really wrap that up. I
Speaker 1: mean Carl Icon and Howard Marks had both come out
Speaker 1: and said you cannot have a liquid instrument tracking something
Speaker 1: in liquid. And it was a rough year. There was
Speaker 1: premium discounts of eight percent, but it it survived, It
Speaker 1: saw inflows, and then after that it's obviously built its
Speaker 1: fan base. Was it relatively small at that stage? Yes,
Speaker 1: I will say the small is a double edged sword,
Speaker 1: because yes it was. And that's a great point you
Speaker 1: bring up, because I will say that prims and discounts
Speaker 1: and h YG have shrunk so much over the past
Speaker 1: ten years because more and more market makers make a
Speaker 1: market in it. However, h y G has vampired away
Speaker 1: some of the liquidity from the high yield market. And
Speaker 1: this is my big worry about et f s is
Speaker 1: not the asset growing, it's the vampire of liquidity. Because
Speaker 1: if more and more people just get lazy and say
Speaker 1: I'm just going to trade h y G instead of
Speaker 1: trading high yield debt myself because it's easier, that does
Speaker 1: steal some of the liquidity. So we have a stat
Speaker 1: that says h y G is still only two percent
Speaker 1: ownership of all the junk bonds, but it accounts for
Speaker 1: of all high yield debt trading today and it was
Speaker 1: nowhere near those numbers back then. So on one hand,
Speaker 1: there's more market makers watching it, which you could argue
Speaker 1: is good, but another hand, it's way bigger part of
Speaker 1: the market, which means there's probably arguably less liquidity in
Speaker 1: the junk bonds. And this gets back to something I
Speaker 1: think Christine can talk about, which is complacency that now,
Speaker 1: I mean, you know, when everything's going up, as we've
Speaker 1: just described, all of these products and everything going up
Speaker 1: for the longest period. So everything was terrific in two
Speaker 1: thousand and seven when all of the subprime c dos
Speaker 1: seem to be performing and people weren't so worried, So
Speaker 1: that's why people were loading up on them. But as
Speaker 1: soon as it turns around, people were completely shocked at
Speaker 1: how a liquid and how you know, little they understood
Speaker 1: these products. And the fear I think is that E
Speaker 1: t F have become such a part of the furniture
Speaker 1: now people just assume they're always going to work. There's
Speaker 1: no example of them failing in a big way, and
Speaker 1: so people get complacent about that. And and yet the
Speaker 1: market is morphing in really important ways, as you've been describing,
Speaker 1: and so that could mean the whole landscape is extremely
Speaker 1: different if and when as a classes fall, especially if
Speaker 1: they've fallen some kind of correlated way. Yeah, and I
Speaker 1: think E t F s right now, Um, they own
Speaker 1: about eight percent of stocks, but the account for about
Speaker 1: like I said, twenty five, the trading in a crisis,
Speaker 1: as long as the stocks are trading, somebody can rbin.
Speaker 1: The E t F investor will have a market. But
Speaker 1: if there are no buyers for junk bonds for that time,
Speaker 1: there's probably going to be a huge discount that uh
Speaker 1: happens in H Y G or whatever E t F
Speaker 1: it is. So I always tell people, ask yourself this question.
Speaker 1: You have three choices. You can use the E t F,
Speaker 1: you can use the active mutual fund, but that manager
Speaker 1: will have to try to sell those securities the end
Speaker 1: of the day anyway if you redeem. And the third
Speaker 1: thing is do it yourself. So on a really hurricane
Speaker 1: type day when the big one hits, which would you
Speaker 1: rather try to sell? Because none of them are going
Speaker 1: to be great, and so you sort of have to
Speaker 1: just decide from there. And if you pick the E
Speaker 1: t F knowing like all of that, it's good. But
Speaker 1: if you go into the E t F thinking it
Speaker 1: is utopia because it has traded so perfectly, I do
Speaker 1: think you'll be disappointment disappointments because you went in there
Speaker 1: thinking it's like this perfect magical vehicle, but in effect
Speaker 1: it's not. So I also want to talk about a
Speaker 1: few people who who doubled down in the midst of
Speaker 1: all of this. Can we talk about that? Sure? Because
Speaker 1: Vanguard in particular, what what happened when you looked at
Speaker 1: those investors. This is this is unbelievable numbers. I was shocked.
Speaker 1: Um Again, I looked this up because on Twitter, a
Speaker 1: lot of people will say, oh, wait, till the big
Speaker 1: one hits these passive investors, they're going to lose their marbles.
Speaker 1: So I go back to Vanguard. Vanguard took in money
Speaker 1: every month, including October. They took in ninety billion dollars
Speaker 1: that year. The rest of the industry combine lost I
Speaker 1: think about a hundred billion. It's in these times of
Speaker 1: crisis that Vanguard UM sees their absolute flows go down
Speaker 1: a little bit, but they increased their market share. That's
Speaker 1: when they gobble up a little market share against the
Speaker 1: other competitors. But I was stunned. This is navy seals
Speaker 1: like disciplined if you're actually putting in money. In two
Speaker 1: thousand eight October, Vanguard at acts really like hardcore discipline
Speaker 1: bogel head type investors. Now, some people say since then
Speaker 1: they've attracted more common folk who aren't like bogel heads,
Speaker 1: and we'll we'll see if that plays out. But I
Speaker 1: have seen these mini crisis Vanguard does seem to be
Speaker 1: stickier than most. There's one other uh two eight anecdote
Speaker 1: that I think, because we're talking about two th eight,
Speaker 1: we have to bring up which was smart Bata was
Speaker 1: around then, and there's a product called called PRF. And
Speaker 1: we talked about this briefly before, but smart Beata basically
Speaker 1: starts its process every quarter and then rebalances, and PRF
Speaker 1: sauce up thing and took advantage of it. Do you
Speaker 1: want to describe what happened? Yes, So in the industry
Speaker 1: we call this the immaculate rebalance. That's just the best
Speaker 1: name this is because if they don't have that on
Speaker 1: their shirts and hand get credit to Ben Johnson at morning.
Speaker 1: Sorry he came up with it, but it's it's actually
Speaker 1: really fascinating. In two thousand eight, let's face it, it
Speaker 1: was it was a tough to buy bank stocks. If
Speaker 1: you're an active manager, you probably fired on the spot
Speaker 1: if you went in and bought City Group, right. Well,
Speaker 1: smart data products are just active but put into a
Speaker 1: rules based index, so they're like robots. They have to
Speaker 1: just screen the stocks every quarter, and if they're cheap
Speaker 1: and they passed the screens, they have to buy them. Well,
Speaker 1: PRF is a smart data product and it it bought
Speaker 1: up all these bank stocks in late two thousand eight
Speaker 1: to the point where it had fifty financials in two
Speaker 1: As we've said before, it's like walking into the burning building. Yeah,
Speaker 1: oh yeah, yeah, and we trace PRF in the next
Speaker 1: I think it was like six to seven years that
Speaker 1: one trade, that one rebalance accounted for just tons of
Speaker 1: alpha that kept giving for years and years and years
Speaker 1: after that. And what's interesting is the guy who runs
Speaker 1: that index, which power Shares license had institutions using that
Speaker 1: index in separate accounts. They called him up and said,
Speaker 1: do not do the rebounds. We're not buying City Group,
Speaker 1: and so he didn't, and of course the et F
Speaker 1: outperformed the s m A and that I think it's
Speaker 1: value to the robotic nature of smart beta. But my
Speaker 1: colleague Ben will bring up that a lot of investors
Speaker 1: were unable to hang in there in PRF, So the
Speaker 1: this brings up behavior and the importance of hanging in there.
Speaker 1: If you pick a strategy and you like it, you
Speaker 1: gotta stick with it. I mean, what what was it?
Speaker 1: Was there any robout buying Lehman Brothers but in sort
Speaker 1: of July or August, I'd have to see if it checked.
Speaker 1: That's a good question. That's a good research note. I
Speaker 1: don't know if Lehman would have checked off momentum, but
Speaker 1: Lehman fell right so fast that it didn't even it
Speaker 1: would have been a quarter because these things usually look
Speaker 1: over quarters or semi annually. It wouldn't have become a
Speaker 1: value stock for long, right, Like it didn't. We didn't
Speaker 1: hang it like a low p for a long time,
Speaker 1: depending on when the robot resets, right, But it's possible.
Speaker 1: But I just did recall seeing some of the bigger
Speaker 1: banks in there that have gone yeah, yeah, yeah, I
Speaker 1: remember distinctly going for drinks with somebody who was a
Speaker 1: consultant and he was he was bragging to me about
Speaker 1: how he just loaded up in Fannie and Freddie because
Speaker 1: it was so low. I couldn't go any lower, you know,
Speaker 1: very very badly. You know, this idea of buying stuff cheap,
Speaker 1: it's it is really tempting. We see this all the
Speaker 1: time with with stocks. And my wife actually like she
Speaker 1: wants to buy J. C. Penny and she's just she's
Speaker 1: like a natural value investor and I understand that, but
Speaker 1: you know, it can go lower the floor there's a
Speaker 1: trap door, but I mean there were yeah, I mean there,
Speaker 1: I think one of the you know, several of the
Speaker 1: hedge fund managers sort of made their names also for
Speaker 1: recognizing that some of these banks, for instance, we're not
Speaker 1: going to be allowed to fail, right, and so City
Speaker 1: Group was a good investment because there was no way
Speaker 1: the government was going to let it fail. Christine, can
Speaker 1: we bring it back and you can help us maybe
Speaker 1: put a bow on all of this. You were on
Speaker 1: the front lines. You've seen how everything's evolved for ten years.
Speaker 1: You've seen Eric stats. Now can you help us make
Speaker 1: sense of this? What what's the takeaway that you get
Speaker 1: from this conversation that we thought? Well, for me one
Speaker 1: of the biggest lessons of the financial crisis. Having been
Speaker 1: a reporter covering financial companies at that point for maybe
Speaker 1: five six years, I was pretty convinced that these people
Speaker 1: all knew what they were doing. They're they're very smart,
Speaker 1: they're highly sophisticated, very numerous, very data driven, and I
Speaker 1: was shocked the number of them who were completely taken
Speaker 1: by surprise and didn't see it coming at all and
Speaker 1: actually didn't really understand how things worked. So it gave
Speaker 1: me a sort of much more skeptical view of the
Speaker 1: experts in the financial industry. I mean, you know, people
Speaker 1: who were running these firms really didn't know what was happening.
Speaker 1: So I get I just kind of always keep that
Speaker 1: in the back of my mind, no matter how good
Speaker 1: something sounds, and no matter how well it's worked. I
Speaker 1: I think it's always a good idea to remain somewhat
Speaker 1: skeptical and do your own homework. And the people who
Speaker 1: came out looking smart of the people who ask the
Speaker 1: most questions and to that point, you know, uh. In
Speaker 1: going back to the very podcast, when he talked about
Speaker 1: why he thought Passive got so big, he did bring
Speaker 1: up these large sell offs where it did the experts
Speaker 1: did look a little bit like the Emperor wearing no clothes,
Speaker 1: and that over and over, I think is where you
Speaker 1: have a lot of investors going, you know what, screw it.
Speaker 1: I'm just gonna put it in this like dirt cheap
Speaker 1: SMP thing and then that that's all I'm doing. But
Speaker 1: there is some concern if everybody feels like that and
Speaker 1: there's a crowd into this one, you know, dirt cheap
Speaker 1: SMP trade, that's I think where I have to think
Speaker 1: there's some credence the SMP in particular, that index is
Speaker 1: so all powerful because it's it's big and passive, but
Speaker 1: also active managers are orbiting around it too, and I
Speaker 1: think that is where there's some legitimacy to it. But
Speaker 1: I agree with you. I think if you just judge
Speaker 1: this stuff not versus not versus reality, and you think
Speaker 1: of the other options available to you to get exposure
Speaker 1: when you make a choice that way, I think it's
Speaker 1: much better our approach than just buying it because you
Speaker 1: saw commercial or you know, you heard somebody talk about it.
Speaker 1: Everybody else is doing it, right, Christine. One final thing,
Speaker 1: can we talk about your book for a second. What's
Speaker 1: it called? It's First of all, I will say it's
Speaker 1: not My book helped Paul right the right his memoir
Speaker 1: um so he has written the story of his life.
Speaker 1: He's almost ninety one years old. And for those who
Speaker 1: are not familiar with Paul Volker, so, Paul Vulgar was
Speaker 1: the chairman of the Federal Reserve. He killed in the
Speaker 1: hyper and we're not quite hyper inflation, but serious inflation
Speaker 1: problem we had in the United States in the late
Speaker 1: seventies early eighties. And he's a very important rule named
Speaker 1: after him. He has the Vulcar rule named after him
Speaker 1: because he was really he was shocked and horrified during
Speaker 1: the financial crisis and how everything suddenly got treated as
Speaker 1: it was a bank. Right, banks are supposed to be
Speaker 1: special entities, right that you have special rules, I have
Speaker 1: special protections. Suddenly of Goldman, SAX and mor eanxamily were
Speaker 1: treated like banks. Suddenly all mutual fund money market mutual
Speaker 1: funds were treated like banks. Everything was getting bailed out
Speaker 1: as was a bank. And he thought this was a problem,
Speaker 1: which I think a lot of people do, and uh,
Speaker 1: and wanted to make a distinction. You know, if you're
Speaker 1: a bank, there should be certain things protections you get
Speaker 1: because you're important, you're kind of utility for our society.
Speaker 1: But you shouldn't put yourself at undue risk. And that's
Speaker 1: a vocal rule. But anyway, so but he covers everything,
Speaker 1: you know, the end of Bretton Woods, you're fighting inflation,
Speaker 1: financial rulemaking, his personal life story, lots of things he
Speaker 1: did after he left the FED, and so it's a
Speaker 1: it's a good book. And he does it all in
Speaker 1: about three pages, so it's not along yet and the
Speaker 1: books called keeping at It and it comes out. It
Speaker 1: comes out in November seven, can wit good Christmas gift.
Speaker 1: Thanks for listening Trillions until next time. You can find
Speaker 1: us on the Bloomberg Terminal, Bloomberg dot com, Apple Podcast,
Speaker 1: and where else you would like to listen. We'd love
Speaker 1: to hear from you. We're on Twitter, I'm at Joel
Speaker 1: Weber Show, He's at Eric Baltunas, and you can find
Speaker 1: Christina Harper at the cr Underscore. Harper Trillions is produced
Speaker 1: by Magnus Hendrickson. Francesca Levy is the head of Bloomberg
Speaker 1: podcast by